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THE BUSINESS ENVIRONMENT
QCF Level 5 Unit
Contents
Chapter Title Page

Introduction to the Study Manual iii
Unit Specification (Syllabus) v
Coverage of the Syllabus by the Manual ix

1 The Nature of Business 1
Introduction 2
The Nature and Purpose of Business 2
The Business as a Legal Entity 8
The Economic View of the Firm 16

2 Introduction to the Business Environment 27
Introduction 28
The Internal Environment 28
Change and The Business Environment 42
Managing the Change Process 45

3 Strategic Choices 57
Introduction 58
The Life Cycle Concept 58
The Nature of Strategic Management 59
Analysis of the Business Environment 64
Organisational Growth 80

4 Market Structure and Business 91
Introduction 92
Perfect Competition 92
Monopoly 94
Monopolistic Competition 97
Oligopoly 98

5 A Macro-economic Perspective on Business Economic Systems 107
Introduction 108
Macro-economic Systems 108
The Government and Economic Activity 115
Regulating the Market 127
Government Interventions to Achieve Economic Objectives 131

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Chapter Title Page

6 Governments and Business 139
Introduction 141
Pressure Groups 141
Reasons for Government Intervention in Business 143
Forms of Government Intervention 146
Equality and Diversity 151
Fair Treatment of Employees 154

7 Business in the Global Context 163
Introduction 164
The Characteristics of Global Business 164
Free Trade and Globalisation 168
Technology as a Driver of Globalisation 175
Theories of Globalisation 179

8 Going Global 189
Introduction 190
Growth Options in a Global Perspective 190
The Global Financial Environment 193
Globalisation and Culture 198
Limitations to Globalisation 205

9 Introduction to the Socio-cultural Business Environment 213
Introduction 214
Demographic Trends and Business 214
Business Ethics 225
Corporate Social Responsibility 237
Whistle-blowing and Corporate Responsibility 245

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Introduction to the Study Manual
Welcome to this study manual for The Business Environment.
The manual has been specially written to assist you in your studies for this QCF Level 5 Unit
and is designed to meet the learning outcomes listed in the unit specification. As such, it
provides thorough coverage of each subject area and guides you through the various topics
which you will need to understand. However, it is not intended to "stand alone" as the only
source of information in studying the unit, and we set out below some guidance on additional
resources which you should use to help in preparing for the examination.
The syllabus from the unit specification is set out on the following pages. This has been
approved at level 4 within the UK's Qualifications and Credit Framework. You should read
this syllabus carefully so that you are aware of the key elements of the unit the learning
outcomes and the assessment criteria. The indicative content provides more detail to define
the scope of the unit.
Following the unit specification is a breakdown of how the manual covers each of the
learning outcomes and assessment criteria.
The main study material then follows in the form of a number of chapters as shown in the
contents. Each of these chapters is concerned with one topic area and takes you through all
the key elements of that area, step by step. You should work carefully through each chapter
in turn, tackling any questions or activities as they occur, and ensuring that you fully
understand everything that has been covered before moving on to the next chapter. You will
also find it very helpful to use the additional resources (see below) to develop your
understanding of each topic area when you have completed the chapter.
Additional resources
ABE website www.abeuk.com. You should ensure that you refer to the Members
Area of the website from time to time for advice and guidance on studying and on
preparing for the examination. We shall be publishing articles which provide general
guidance to all students and, where appropriate, also give specific information about
particular units, including recommended reading and updates to the chapters
themselves.
Additional reading It is important you do not rely solely on this manual to gain the
information needed for the examination in this unit. You should, therefore, study some
other books to help develop your understanding of the topics under consideration. The
main books recommended to support this manual are listed on the ABE website and
details of other additional reading may also be published there from time to time.
Newspapers You should get into the habit of reading the business section of a good
quality newspaper on a regular basis to ensure that you keep up to date with any
developments which may be relevant to the subjects in this unit.
Your college tutor If you are studying through a college, you should use your tutors to
help with any areas of the syllabus with which you are having difficulty. That is what
they are there for! Do not be afraid to approach your tutor for this unit to seek
clarification on any issue as they will want you to succeed!
Your own personal experience The ABE examinations are not just about learning lots
of facts, concepts and ideas from the study manual and other books. They are also
about how these are applied in the real world and you should always think how the
topics under consideration relate to your own work and to the situation at your own
workplace and others with which you are familiar. Using your own experience in this
way should help to develop your understanding by appreciating the practical
application and significance of what you read, and make your studies relevant to your
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personal development at work. It should also provide you with examples which can be
used in your examination answers.
And finally
We hope you enjoy your studies and find them useful not just for preparing for the
examination, but also in understanding the modern world of business and in developing in
your own job. We wish you every success in your studies and in the examination for this
unit.

Published by:
The Association of Business Executives
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All our rights reserved. No part of this publication may be reproduced, stored in a retrieval
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recording or otherwise without the prior permission of the Association of Business Executives
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The Association of Business Executives (ABE) 2011

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Unit Specification (Syllabus)
The following syllabus learning objectives, assessment criteria and indicative content for
this Level 5 unit has been approved by the Qualifications and Credit Framework.
Unit Title: The Business Environment
Guided Learning Hours: 160
Level: Level 5
Number of Credits: 18
Learning Outcome 1

The learner will: Understand the significance of the environment on business activity.
Assessment Criteria
The learner can:
Indicative Content

1.1 Explain the features of
business activity.

1.1.1 Explain the business organisation as a transformation
process.

1.1.2 Describe the different ways in which a business may
structure its activities.

1.2 Discuss the complex
interactions that operate
between a business and
its environment.

1.2.1 Discuss the complexity, volatility and uniqueness of an
organisation's environment.

1.2.2 Outline the nature of the external environment (PEST).

1.3 Explain the need for
change and its
management within an
individual business.

1.3.1 Discuss the need to monitor changes in the external
environment.

1.3.2 Discuss the implications of environmental change for a
business, its stakeholders and society.

1.3.3 Explain reasons for resistance to change by firms,
managers and employees.

1.3.4 Describe ways in which resistance to change may be
overcome.

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Learning Outcome 2
The learner will: Understand the structure and organisation of business.

Assessment Criteria
The learner can:
Indicative Content

2.1 Discuss the impact of
industrial and legal
structure and size on
organisational behaviour.

2.1.1 Classify businesses by sector primary, secondary and
tertiary and discuss reasons for changes in industrial
structure, including concentration.

2.1.2 Discuss the advantages and disadvantages of different
legal forms of organisation.

2.1.3 Discuss the use of franchises, licensing and joint ventures
as means of doing business in both national and international
spheres.

2.1.4 Distinguish between public sector and private sector
organisations and their objectives.

2.1.5 Explain the advantages and disadvantages of large and
small firms.

Learning Outcome 3
The learner will: Understand the competitive and political environment facing businesses.

Assessment Criteria
The learner can:

Indicative Content

3.1 Discuss differing ways
of analysing the
environment of a business.

3.1.1 Discuss the need to monitor the competitive environment
of businesses.

3.1.2 Analyse a business organisation, using SWOT analysis.

3.1.3 Apply Porters Five Forces analysis of the competitive
environment to a business organisation.

3.2 Explain the impact of
market structure on the
behaviour of firms.

3.2.1 Describe the characteristics of perfect competition,
monopolistic competition, oligopoly and monopoly.

3.2.2 Describe forms of anti-competitive behaviour and their
impact upon other organisations and consumers.

3.3 Describe the complex
interactions between

3.3.1 Describe the different ways that a government may
affect business.
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business and government.

3.3.2 Assess the role of pressure groups and lobbyists on
business and government.

3.4 Discuss the need for
government intervention
and the forms it might
take.

3.4.1 Describe the need for government intervention to control
the competitive activities of business organisations.

Learning Outcome 4
The learner will: Understand the impact of the macro-economic environment on business.

Assessment Criteria
The learner can:
Indicative Content

4.1 Compare and contrast
alternative economic
systems.

4.1.1 Assess the advantages and disadvantages of centrally
planned and market economies.

4.1.2 Discuss the need for the provision of public goods and
merit goods in a mixed economy.

4.2 Analyse the role of
government in controlling
the level and pattern of
economic activity.

4.2.1 Describe the four main macro-economic objectives of
government: low inflation, economic growth, low unemployment
and balance of payments stability.

4.2.2 Explain the nature and characteristics of the business
cycle.

4.2.3 Discuss the impact of the stages of the business cycle on
business and the economy.

4.2.4 Discuss the role of fiscal policy in the control of the
economy.

4.2.5 Discuss the role of monetary policy in the control of the
economy.

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Learning Outcome 5
The learner will: Understand the influence of the global economy on business.

Assessment Criteria
The learner can:
Indicative Content

5.1 Discuss the
importance of international
free trade and its
operation.

5.1.1 Explain the reasons for international trade and barriers to
free trade.

5.1.2 Describe the importance of regional trading blocs such as
ASEAN, NAFTA, SADC, CARICOM and the EU.

5.1.3 Explain the impact of exchange rate fluctuations on
international business.

5.2 Assess the main
causes and implications of
globalisation.

5.2.1 Describe the main causes of globalisation.

5.2.2 Describe the advantages and disadvantages of
globalisation.

5.2.3 Describe the advantages and disadvantages of multi-
national corporations, franchises and joint international
ventures.

Learning Outcome 6
The learner will: Understand the impact of socio-cultural influences and technology on
business decisions.

Assessment Criteria
The learner can:
Indicative Content

6.1 Describe key
demographic and social
trends that affect business.

6.1.1 Describe the implications of demographic changes for
business activity (e.g. the age profile of the countrys
population).

6.1.2 Describe the impact of social and cultural changes on the
conduct of business and business activity.

6.1.3 Explain the impact of national culture on the conduct of
business and business activity.

6.2 Discuss Corporate
Social Responsibility
(CSR) and its implications
for business.

6.2.1 Define the meaning of CSR and explain the different
views on it.

6.2.2 Discuss the role of business in promoting ethical
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practices.

6.2.3 Discuss the costs and benefits to businesses of
implementing environmentally friendly (green) policies.

6.3 Discuss the impact of
technology on business
and business systems.

6.3.1 Identify and describe the different forms of technological
change, including the introduction of e-commerce and different
applications of technology.

6.3.2 Assess the advantages and disadvantages for business
activity of technological change.

Coverage of the Syllabus by the Manual
Learning Outcomes Assessment Criteria Manual
The learner will: The learner can: Chapter
1. Understand the
significance of the
environment on business
activity.
1.1 Explain the features of business activity Chaps 1 & 2
1.2 Discuss the complex interactions that
operate between a business and its
environment
Chaps 2 & 3
1.3 Explain the need for change and its
management within an individual
business
Chap 2
2. Understand the structure
and organisation of
business.
2.1 Discuss the impact of industrial and
legal structure and size on
organisational behaviour
Chaps 1 3
3. Understand the
competitive and political
environment facing
businesses.
3.1 Discuss differing ways of analysing the
environment of a business
Chap 3
3.2 Explain the impact of market structure
on the behaviour of firms
Chap 4
3.3 Describe the complex interactions
between business and government
Chaps 5 & 6
3.4 Discuss the need for government
intervention and the forms it might take
Chaps 5 & 6
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4. Understand the impact of
the macro-economic
environment on business.
4.1 Compare and contrast alternative
economic systems
Chap 5
4.2 Analyse the role of government in
controlling the level and pattern of
economic activity
Chap 5
5. Understand the influence
of the global economy on
business.
5.1 Discuss the importance of international
free trade and its operation
Chaps 7 & 8
5.2 Assess the main causes and
implications of globalisation
Chaps 7 & 8
6. Understand the impact of
socio-cultural influences
and technology on
business decisions.
6.1 Describe key demographic and social
trends that affect business
Chap 9
6.2 Discuss Corporate Social Responsibility
(CSR) and its implications for business
Chap 9
6.3 Discuss the impact of technology on
business and business systems
Chaps 7 & 9

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Chapter 1
The Nature of Business

Contents Page
Introduction 2
A. The Nature and Purpose of Business 2
Two Basic Categories of Business 2
For Profit Business 3
Not-For-Profit Business 7
B. The Business as a Legal Entity 8
Non-corporate Organisations 8
Corporate Organisations Limited Companies 11
Charitable Status 12
Overview of Accounting Rules for Each Legal Business Entity 13
C. The Economic View of the Firm 16
Factors of Production 16
Business Organisation as a Transformation Process 18
Classifying Production 18
Classifying Firms into Industry Sectors 20
Summary 22
Answers to Activities 23

2 The Nature of Business
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INTRODUCTION
This chapter is intended to provide you with the basic framework of business: the reasons for
starting a business, the categories, ownership and legal status, basis of accounting rules and
a discussion of the business as a transformation process.
As you work through the chapter, you will find some activities to help you to reflect on each
part in order to develop your understanding of the issues involved.
A. THE NATURE AND PURPOSE OF BUSINESS
What a business does depends on the purpose for which it was established and we shall
start our examination of this by considering a fundamental difference in the types of
businesses which exist.
Two Basic Categories of Business
There are a number of ways of categorising businesses, but we shall start with a very basic
distinction in the types of purpose for which they may be established those that operate for
profit and those which don't.
For Profit Businesses
The fundamental characteristic of most businesses is to make profit. Whatever the
size of the company, the primary objective of the owners or shareholders is to make as
much profit as possible.
Examples of "for profit" businesses range from multinational companies such as Coca
Cola, BP and Xerox to small, local firms such as your local restaurant, hairdresser or
dentist.
This is not to say that profit is the only objective many businesses have other
important purposes, as we consider below. However, profit making is generally the
main goal of Anglo-American business enterprises. By contrast, many Asian
businesses provide an example of those for which making profit may be a secondary
purpose.
Not for Profit Business
Usually businesses that are set up as "not for profit" are charities or organisations
seeking to provide a service to the community or to improve circumstances for the
"social good".
The goal of the business is to spend all of the proceeds on its selected mission and
therefore, not to make a profit. These organisations may generate a profit, but in the
UK, a not-for-profit organisation does not distribute profits to the owners or
shareholders but passes them on to selected recipients or members of the
organisation.
Examples of not-for-profit organisations are clubs, societies and charities. These may
have widely differing objectives and undertake many different activities, as the following
examples show.
Trade associations These exist to provide services to their member firms,
such as undertaking public relations and advertising for the trade as a whole,
publishing trade magazines, providing information services and arranging
exhibitions. They may also offer other services themselves or through a third
party for example, an arbitration service or employment services could be run
as a direct service, whereas the trade association might negotiate special terms
The Nature of Business 3
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with a third party for members to buy insurance products, holidays or publications
at a discounted rate.
Professional bodies which provide qualifications and education, information
services, employment advice, meetings and conferences for their members with
the aim of developing and maintaining their knowledge and skills in a particular
area of employment.
Learned societies which exist to further understanding, studies and education
in their specialist field. An example is the Royal Horticultural Society.
Clubs which provide a variety of activities catering for the specific interests of
their members, such as sports facilities (for example, rugby, football or tennis),
dinner clubs for members to meet new people, young farmers clubs for those
working in agriculture, etc.
Charities which can be formed for many reasons, but always for the benefit of
a defined group of people. For example, the National Trust owns and preserves
properties and open spaces for the general benefit of UK citizens, the friends of a
local hospital provide resources to help care for the very ill, and various
children's' charities exist to assist disabled or disadvantaged children.
Think point
What is the key purpose of the businesses in your country and of the organisations that you
have worked for?
Make a list of five "for profit" and five "not-for-profit" businesses that you have regular
dealings with.

Each of these categories has a distinct set of characteristics which define their nature and
purpose.
For Profit Business
We noted above that the primary purpose of these types of business is to make profit. That
may be a bit of an oversimplification, but it is generally true. However, an organisation's
objectives can vary a great deal and often change with time as the internal and/or external
environment alters. For example, many J apanese car companies originally focused on
gaining a share of the car market and often made minimal or no profit on each item sold. As
time progressed and they became recognised for quality and value, then maximising profit
became more important.
In general, a business will not normally pursue one objective to the exclusion of all others.
However, if there are too many goals there is often no clear focus and owners or other
stakeholders can be easily distracted by following several aims, so that the business may not
prosper.
The major objectives of business usually include one of the following:
Survival
This is the prime objective of a business since, unless a business can generate sufficient
sales to cover its running costs, its start up capital will soon be exhausted and it will fail.
Once a firm has reached this stage, which often takes a year or longer, it may then change
its prime objective to one of the other common business objectives.
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Profit Maximisation
Making profit is normally essential for a business to survive in the long term. There are
unusual exceptions, such as where the owners have sufficient funds to ignore profit levels
and run the business as if it is a hobby, but these are rare. In most cases, the level of profit
is crucial to most stakeholders who depend on the organisation for an income. At the most
basic level, the profit generated must be sufficient to make it worthwhile to continue to
operate of business.
However, profit goals can vary in the way they are set, measured and applied to different
types of business for example, as time progresses, larger companies, in particular, seek to
achieve some accounting measure such as a specified level of return on capital employed
(ROCE) or income per share.
Economic theory states that businesses should have the over-riding goal of profit
maximisation. In economic terms, profit is defined in two ways:
Normal profit which is the minimum return that owners must make on the capital
sum they invest to prevent them from closing that business and moving their capital to
an alternative source, which returns more income from that same capital sum. This
could be another business or an interest bearing investment.
This approach is a practical application of the economic term "opportunity cost". This
concept describes the situation in which as an individual investor uses his/her money to
support a particular firm, s/he loses the opportunity of investing it another way where a
better return might be received.
Acti vi ty 1
What is the opportunity cost of you studying for this qualification?

See the suggested answer at the end of this chapter.

Using opportunity cost, normal profit can be seen as the return available on a risk free
investment, plus an additional return for the risk involved in different type of investment:
Normal profit =rate of riskless interest +risk premium
The risk premium will depend on the amount of business risk of a particular enterprise.
A retail business would usually have fairly low value of risk premium compared to new
high technology or mineral exploration business.
In summary, the normal profit is the level of profit that will just satisfy the owner and
encourage him/her to remain in business.
Supernormal profit This is the excess of profit above normal profit. If firms earn
supernormal profit they will definitely prefer to stay in business.
This type of profit potential will attract new firms into the industry sector and create
competition for the existing businesses. In the short term, this may be unlikely as there
will not be time for new firms to identify this characteristic of the business sector, but in
the longer term, their entry is likely to reduce the level of supernormal profit and
possibly force some firms to close their businesses.
An example is firms selling computer equipment. When few people wanted to buy
computers, prices and profit levels were high, but as demand increased, more firms
entered the market and prices dropped. Now that most businesses have computers,
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higher profit levels are to be found in associated areas, such as information security
where intellectual capital must be protected for the firms to retain their competitive
edge.
Market Share
Gaining a share of the market for a particular product is essential for a business to survive. If
it is not possible to achieve a viable level of sales, the firm will fail.
In the short term, most new entrants to a market aim to gain market share through market
penetration. However, market share is often linked to competitive advantage, particularly
in the longer-term, whereby a firm attempts to achieve and maintain its position in the market
by offering a better "deal" to its customers than that offered by its competitors in the same
market. This can be in terms of price, quality, service, etc.
The importance of this can be seen in a firm such as Coca Cola, which has the biggest share
of the non-alcoholic drinks market but is always seeking to improve this, partly in order to
reduce the possibility of its closest rivals such as Pepsico gaining further share.
Growth Increasing Market Share
Often firms are forced to grow to survive in their market sector. If they fail to grow, their
competitors may take a more aggressive approach and force them out of business.
Expansion can be accomplished by internal and/or external growth that results in a growth in
their share of the market in that industrial sector:
Internal expansion can be achieved by increasing manufacturing capacity, expanding
the premises, purchasing more equipment or adding a new building, for example.
External expansion is achieved when the business joins with another firm through a
joint venture (strategic alliance), merger (mutual agreement) or acquisition (takeover).
Sales Revenue Maximisation
According to Baumol (1959), sales levels alone are not an adequate business goal rather,
sales maximisation is the ultimate objective of the firm. Hence, business management
should direct its energies to promoting and maximising its sales revenue instead of profit.
This approach does not ignore the cost of production and the need for a margin of profit.
Baumol encourages the adoption of a price that will cover costs and also yield a minimum
rate of profits. Thus, while the firm is maximising its revenue from sales, it should generate
enough profit to keep its owners/ shareholders satisfied.
The objective is usually linked to the desire to retain competitive advantage. It is also closely
linked with measuring management success, especially for sales managers whose
performance is linked to increases in sales and, thus, revenue. The magnitude of sales is a
major indicator of a firm's achievement and a manager's reputation, level of power, speed of
career progression and salary may all depend on the level of sales generated.
If the sales department is perceived as having a major role in the organisation's success,
then sales revenue maximisation is more likely to be the primary objective. Sometimes this
results in managers pursuing their own objectives to the detriment of the shareholders, but
this is tolerated so long as there is enough profit to keep shareholders content.
Satisficing
Large organisations are often complex, consisting of many different divisions and or
subsidiaries each with different objectives which sometimes may conflict with each other.
Hence, it is impossible for the firm to have a single primary objective. In such cases a
minimum level of achievement will be set for the organisation as a whole, and the firm is said
to "satisfice" instead of maximise.
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Simon (1957) proposed that decisions were taken in conditions of uncertainty and ignorance.
He believed that decision-makers could rarely obtain and evaluate all the information which
might be relevant to the making of the best decision. Instead, they work with limited and
simplified knowledge in order to reach acceptable choices (satisficing), rather than pursue
the best choice where one particular objective is fully achieved.
The reason for this could be
Time pressure
The influence of powerful stakeholders
Lack of knowledge about future external or internal factors.
The adoption of satisficing models of behaviour, instead of maximising, has been found
useful in the theory of the firm and corporate behaviour.
Cyert and March (1963) perceived the firm as a coalition between shareholders, managers
and customers. In their publication "A Behavioural Theory of the Firm" (1963), they reasoned
that organisational goals and the outcomes of decision making were a compromise between
those of these various stakeholder groups. They also recognised that the compromise
reached would depend on the relative power of the different stakeholder groups.
A satisficing strategy minimises conflict between different parts of the organisation. In
practice, this usually results in setting targets for production, sales, profit, research and
development, stock levels and so on. Each period's targets is usually set with reference to
the target or the outcomes from the previous period, the logic being that there is certainty
about the previous year's achievements. Using past performance to predict the outcomes of
an uncertain, unknowable year ahead is seen as better than a 'wild' guess (reflecting Simon's
approach to decision making).
The targets set are also likely to take supply and demand into account, be influenced by
competition in the market and the economy in general. If there is conflict between parts of
the organisation about the level of targets, this may be resolved by bargaining on the agreed
target outcomes with the result depending on the departments or managers that wield most
power in that firm. (This aligns with Cyert and March's approach.)
If the targets are not achieved there will be an investigation as to why this situation has
occurred and how to rectify it. If it is not possible to meet the targets, they may be reduced
or, if they appear too easy to achieve, increased.
Coalition governments are a practical example of satisficing. The UK's Coalition Government
elected in 2010 was formed by an agreement between the Conservative and Liberal
Democrat political parties. The Conservatives pledged to abolish rises in National Insurance
for employers and employees planned by the former Labour government, while the Liberal
Democrats promised to give "substantial increase" in personal tax allowances to benefit low
and middle-income workers from April 2011. The compromise was to keep part of the
planned National Insurance rise, the employee element, and to increase capital gains tax on
non-business assets to pay for a rise in personal tax allowances, but one which was lower
than the Liberal Democrats had planned.
Technical Excellence
This is a frequent objective of research organisations and engineering firms. Innovation and
technological advances may be considered as more important than sales or profit
maximisation.
The pursuit of excellence may bring the kind of reputation which builds sales and profit in the
longer term. For example, Rolls Royce is renowned for its excellence in engine technology.

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Corporate Social Responsibility
Although in many cases it will not be the primary objective, corporate social responsibility is
growing in importance. CSR covers a wide range of goals relating to the environment and
support for social communities associated with the business for example, demonstrating
careful use of scarce resources, avoiding use of child labour and funding projects to help
disadvantaged members of the local community.
Often, a reason for setting such goals is to attract consumers to buy products based on the
perception of the firm as acting for the social good, rather than for the social good in itself.
For many firms, there may be a tension between these goals and business goals for
example, Coca Cola's 'Rain' project to assist African people to obtain drinkable water and its
confrontation with Indian farmers over its use of water in beverage production when there is
too little for locals to grow crops.
Think point
Which companies do you recognise as having a good reputation for corporate social
responsibility?
Do you see any of these as having conflicting social and business goals?
Do you have doubts about the authenticity of any companys stated commitment to the good
of society as a whole?

Not-For-Profit Business
The primary purpose of not-for-profit businesses will be to fulfil a social need of some kind.
Thus, the objective of a healthcare organisation might be to meet the healthcare needs of its
community whereas a community play group's might be to make basic social and learning
skills accessible to all pre-school children.
However, revenue maximisation remains a key objective of these types of business in order
that they have the resources to achieve that purpose. They will aim to generate a high level
of income while keeping costs to a minimum in order to maximise the use of that income for
the primary purpose.
Associated with this, many not-for-profit businesses have high level of service as an
objective aiming to provide the highest possible level of service or the best service
achievable for a given cost. The UK National Health Service aims to do this.
Not-for-profit businesses may also seek to generate the maximum income in order to extend
the services and benefits they provide. There are many organisations which are supported
by government bodies to run certain services such as education, travel and so on. This
support, often in the form of a subsidy, may cover the cost of providing the service for a
certain level of users, but any additional revenue can be used to provide all sorts of special
offers to get more people to travel or attend basic skills courses and so on. It can also be
applied to other objectives including staff development, management excellence or
outstanding customer service.
Note, though, that whatever objectives they try to achieve, singly or together, the ultimate aim
of not-for-profit businesses is, as with profit-making organisations, to survive.
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Acti vi ty 2
Choose two for-profit and two not-for-profit companies in your country.
(a) Find out the purpose of their businesses what their main objectives are.
(b) Examine those business objectives and compare the rationale behind any differences
(c) Try to find out how their main business objectives have changed over times and for
what reasons.

B. THE BUSINESS AS A LEGAL ENTITY
The basic legal distinction between types of business enterprise is their status as corporate
or non-corporate organisations:
Non-corporate organisations are those which do not have a separate legal identity
from their owners. The main forms of non-corporate organisations are sole traders and
partnerships.
Corporate organisations are those where the legal status of the organisation is
separate from that of the owner. The main categories of corporate organisations are
private limited companies and public limited companies (plc).
Very often an individual will start a business working on his/her own as a sole trader.
Alternatively two or more individuals may work together in a partnership. In both cases, sole
trader and partnership, the business may grow larger and the owners will decide (or not) to
change the type of legal business status to a private limited company or a public limited
company. (There are some types of organisation in the UK, such as solicitors, that are not
allowed by law to form either type of limited company.)
Before we go on to examine particular aspects of the legal status of these different types of
organisation, there is a further important distinction to consider that between limited and
unlimited liability.
Unlimited liability means that the individual owner or owners of an organisation have
unlimited liability for all debts or actions taken by the business. If, say, the organisation
fails, the owner(s) would be liable for the full extent of any debts of the organisation and
would have to use all their personal resources to meet those debts.
Limited liability means that the responsibility of the owners of a business for its debts
or actions is limited in some way. In practical terms, this means that the shareholders
who are its legal owners are not liable for any debts of the organisation beyond the
amount they have paid or agreed to pay for their shares. They may lose all the money
they have invested in the company, but cannot be called upon to pay any more. (Thus,
the term "limited" in public or private limited companies means that the organisations
or more properly, the owners/shareholders enjoy limited liability.)
Non-corporate Organisations
As noted above, the main forms of non-corporate organisations are sole traders and
partnerships.
Sole Trader
This type of business is owned and managed by one person who provides the financial
resources and makes all the business decisions. Since the owner makes all the business
decisions, s/he is responsible for the success or failure of the business.
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The sole trader is the most common form of business ownership in many countries. Typical
examples of sole traders are small shops, builders, window cleaners, electricians, caterers
and plumbers. In the UK, approximately 20 percent of sole traders operate in the
construction industry, 20 percent in retailing and 10 percent in catering.
In most cases in the UK, there are no restrictions on the ability of a person to set up and run
a business as a sole trader. S/he can start up a business at any time and does not need
complete any specific documentation s/he merely advises the Her Majesty's Revenue and
Customs (HMRC) of the date the business commenced. (There are a few exceptions where
special licences need to be granted, for example, opening a retail wine and spirits shop or
starting a taxi firm.) In other countries the rules can be very different especially those
countries where trade is highly regulated a good example being Italy where all businesses
must be approved by the local council and are very restricted in their operation.
The key legal principle of sole trader status is that the proprietor of the business is liable for
all the debts of the business that is, has unlimited personal liability. An important
consequence of this is that if s/he takes out a loan to support the business or its growth, s/he
will normally have to provide some form of personal security such as his/her house
against any failure of the business to repay it. If the business is unable to make the
repayments, the bank will seize the property that was taken as security for the loan. This can
make investment capital difficult to obtain, and lack of investment capital often severely
restricts growth of the sole trader firm.
Partnerships
The legal definition of a partnership was put forward in the Partnership Act 1890 as:
"The relation which subsists between persons carrying on a business in common with a view
of profit".
Partnerships offer a business the opportunity to share skills and workload, and importantly, to
raise more capital than would be available to a sole trader. Common examples of
partnerships include the practices of doctors, solicitors, accountants, estate agents,
architects and auctioneers.
There are two main types of partnership ordinary and limited partnerships.
Ordinary partnerships
There are two types of such partnerships
(a) Partnership without a legal contract
This is the simplest type of partnership where the partners informally set up a
business with no legal contract. It is often applies to married couples or members
of a family who open a business together.
The partners are jointly and severally liable for all the debts of the business. This
means that each of them have unlimited liability in the same way as sole traders.
Each partner can be sued for the whole debt and could lose all of his/her assets
or be forced into bankruptcy. If one partner leaves the business, the other(s) is
responsible for settling all of the debts.
(b) Partnership with legal contract
This is where there is a formal partnership agreement or deed of partnership
between the owners.
The existence of a formal deed avoids disputes on how work and profits are to be
divided. The agreement will also record the date the partnership commenced
and, if it is to exist for a fixed period, the date on which it is to end. If it is not for a
fixed period, there should be agreement on what will happen on the retirement or
death of a partner.
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If there are no procedures for operating and dissolving the partnership, the
individual members can suddenly be faced by all the financial difficulties caused
by unlimited liability for all the debts of the partnership.
Limited partnerships
The Partnership Act 1907 states that a limited partnership shall consist of no more than
twenty limited partners and include one or more persons who are termed general
partners. General partners have unlimited liability whereas limited partners have
limited liability. From 20 December 2002, the restriction on the number of partners was
lifted.
Limited partnerships must be registered with Companies House which will issue a
newly registered limited partnership with a certificate. This will be conclusive evidence
of the partnership's formation. In addition, such partnerships are required to register in
that part of the United Kingdom where their principal place of business is situated or is
proposed to be situated.
As noted above, one or more persons in a limited partnership are general partners who
are liable for all debts and obligations of the partnership i.e. they have unlimited
liability.
In addition, there will be one or more persons called limited partners, who contribute a
sum of money as capital, or property valued at a stated amount, to the partnership.
Limited partners are not liable for the debts and obligations of the firm beyond the
amount contributed, but are unable to receive back any part of their contribution to the
partnership during its lifetime. They also cannot take part in the management of the
business and do not have power to oblige the firm to any action; if they do, they
become liable for all the debts and obligations of the firm up to the amount drawn out,
received back or incurred while taking part in the management of the company.
The same person cannot be both a general and a limited partner at the same time.
An individual or a legal body such as a company may be a partner in a limited
partnership, either as a general or as a limited partner.
The limited liability of limited partnerships means that they are able to raise any capital
needed more easily, and more finance can be raised in this kind of business
organisation than by a sole trader.
Partnerships are usually set up by writing out a deed of partnership which is witnessed
by a solicitor and sets out the important details such as how the profits and losses will
be shared. In a limited partnership arrangement, income can be distributed to partners
in a way that minimises the tax liability. This means the partners can pay the taxes on
their individual shares of the profits, rather than pay taxes on the partnership itself.
Limited partnerships are much less common as it is easier to form a limited company to
achieve the same purpose
Acti vi ty 3
Take a walk around your local area and see what proportion of businesses are sole traders
or partnerships, and in what business specialisations.
Find out how easy is it to become a sole trader or to establish a partnership in your country.
Are there any restrictions on setting up such a business?

ABE
Corporate Organisations Limited Companies
In legal terms, a limited company is an organisation that has a separate legal status from
those who own it. This means that all assets belong to the organisation and not to the
owners. The owners have limited liability.
The owners of a limited company are the shareholders those who have invested their
money in the firm by buying (ordinary) shares in the company. The proportion of the
company that they own is known as the equity and, hence, ordinary shares are often called
equities.
If the company fails, the owners are generally not responsible for settling its debts. The
shareholders' liability is limited to the amount of equity they own and would lose only the
amount they originally paid for their shares. The exception is where owners have secured
loans from financial institutions using their own property; this would be seized by the financial
institution if the business failed.
Shareholders often take no part in managing the firm.
Forming a Limited Company
Companies normally have two or more individuals wishing to start a business together. They
are required to file a number of documents to establish the company, including:
Articles of Association this is the document which sets out the rules by which
shareholders and the company will be administered, for example voting rights, powers
of directors.
Memorandum of Association this document sets out the company name, status,
address of the registered office, objectives of the company, statement of limited liability
and amount of guarantee.
Statement of Capital this gives details of the types of share (ordinary, preference,
etc.), the amount paid up and unpaid on each share, the number of shares issued, the
nominal value of shares issued, voters rights and the shareholder's details.
Public limited companies must also issue a prospectus which describes the history of
the firm, its future prospects and the terms on which it offers its shares.
If the Registrar of Companies approves the application, a Certificate of Incorporation is
issued.
Directors
Directors in limited companies are chosen by the owners to manage the affairs of the
company.
The powers of directors are written down in the company's Articles of Association which
serve as the internal rules of the company. They are also governed by statute, including the
Companies Act 2006 which added duties in such areas as:
A duty to promote the success of the company
To take reasonable care, skill and diligence and to give consideration to matters that go
beyond the Balance Sheet and impact of the business operation on the environment
and community.
The Companies Act (2006) also introduced some significant changes to the way companies
were registered and included a reduction in the time allowed to file the company accounts as
well as making it mandatory to submit the Statement of Capital when applying for
incorporation. They now must also complete a Statement of Capital when filing annual tax
returns and notify Companies House if the amount of capital changes.

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Types of Limited Company
There are three main types of limited company private, public and limited by guarantee.
A private limited company is one in which the owners hold a percentage share of the
value of the company. Often this is dictated by the amount of the capital sum or the
value of the property that each person contributed to the company.
There must be at least two directors
Owners of private limited companies have limited liability for the debts of the company
up to the amount they originally invested.
Private companies do not trade their shares to the public, but can offer shares to
business contacts. This constraint often restricts raising capital for growth so that most
private limited companies remain relatively small.
A public limited company (plc) is a company that trades shares nationally and or
internationally. It can sell shares directly to the public or through an investing
institution.
A plc is owned by the shareholders who have bought an interest in the company. Their
liability is limited to the value of their original purchase of shares.
In the UK, a public limited company must satisfy the following conditions:
A minimum of paid up share capital of 50,000
There must be at least two shareholders
There must be at least two directors
The right to offer its shares (and debentures) to the general public
A certificate from the Registrar of Companies that states these requirements have
been met
A memorandum that states it is a public limited company
A Company Limited by Guarantee is an alternative type of company usually used
primarily for non-profit organisations that require corporate status. It does not have
share capital and has members who are guarantors instead of shareholders.
Guarantee companies include clubs, membership organisations, sports associations
and some charities.
The guarantors give an undertaking to contribute a nominal amount towards the
winding up of the company in the event of a shortfall of funds upon cessation of
business.
A guarantee company cannot distribute its profits to its members, and is therefore
eligible to apply for charitable status if necessary.
Charitable Status
In the UK, applications for charitable status are usually made to the Charity Commission. An
organisation may apply for charitable status if its aims are exclusively for the "public benefit".
There are currently four categories under which an organisation may qualify:
Educational advancement
Poverty relief
The advancement of religion
Purposes beneficial to the community
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Charities with an annual income of less than 1,000 do not need to register. (There is also a
category of "exempt charities" in England and Wales who do not need to register, including
Industrial and Provident Societies whose objectives are exclusively charitable. However they
must still register with the HMRC.)
Charities do not have owners in the same sense as non-charitable organisations. Rather,
they have "trustees" who have responsibility for the running of the charity and for its property,
finances and the employment of any staff or volunteers.
There are significant advantages for organisations dedicated to the public benefit to be
registered as charities, including:
Charities do not normally have to pay income tax or corporation tax and most other
taxes
Charities are perceived and regarded in a way that can make it slightly easier to raise
funds than it would be as a non-charitable body.
Some funding is only available to charities.
Donors can receive tax relief on their donation.
On the other hand, the disadvantages of charitable status include:
Obtaining charitable status can take a long time and the organisation is subject to
considerable controls, as the Charity Commission imposes complex trading and
financial rules to ensure that all money raised, and any surpluses, can only be
distributed in accordance with the charitable objectives of the organisation.
The trustees can be paid only reasonable expenses, which could restrict the type and
complexity of professional assistance from those in senior positions that the
organisation can call on.
Charity law also restricts what charitable organisations can do and how they are run,
including that trustees avoid any situation where charitable and personal interests
might conflict, that employees of a charity cannot usually serve on its governing body,
and that charities are not allowed to undertake political campaigning.
Being a charity restricts the type of trading activities allowed.
Overview of Accounting Rules for Each Legal Business Entity
The basic accounting rules vary according to the legal status of the organisation. The rules
are very simple for small businesses such as sole traders, but become increasingly complex
as size and legal status changes. Here, we are only concerned with a brief overview of what
can be a highly complex area of study you should, though, be aware of most of these rules
from your studies of other, specialist units in your course.
Sole Trader
Sole traders are required to submit their accounts to the HMRC annually. They can choose
not to prepare formal accounts if their turnover is below a fixed threshold which is dictated by
HMRC, but they still need to keep records of income and expenditure over a set accounting
period.
The sole trader is taxed as an individual and is liable to pay tax on any profit.
Partnership
If the partnership receives income only from its sales and taxed interest on its bank or
building society investments, the accounts the partnership must submit to the tax authorities
is very simple. However, if the business income is more complex, a more detailed return will
be required.
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Partners may be an individual or a company and different rules apply in relation to their
position. In simple terms, these are as follows:
Where the partner is an individual, he/she will be self employed for tax purposes and
must pay income tax on his/her share of the partnership profits. S/he must complete
documents relating to the partnership as well as his/her own self employed tax return.
Where the partner is a company, its partnership profits must be included in the
accounts of the company itself and, as such, will be liable to corporation tax.
Private Limited Companies and Public Limited Companies
These companies must draw up Annual Accounts which report its performance and activities
during the year. The accounts must include the following main specific financial statements:
Balance Sheet (now known as the Statement of Financial Position)
Profit and Loss Account (now known as the Statement of Comprehensive Income)
Certain other information depending on the type of limited company.
The period reported on in the accounts is called the "Accounting Period" or "Financial Year".
Among other uses, the accounts are used by HMRC to work out tax due.
Acti vi ty 4
Complete the following table on the advantages and disadvantages for businesses of the
different legal entities.
Type of
Organisation
Advantages Disadvantages
Sole Trader

Partnership

Limited
Partnership

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Type of
Organisation
Private Limited
Company

Public Limited
Company

Company Limited
by Guarantee

Charitable Status


ABE
C. THE ECONOMIC VIEW OF THE FIRM
This concerns how a firm operates and acts as a transformation process.
A firm needs to have certain factors of production in order to transform starting materials
(inputs) into products and services (outputs). Since so many combinations of factors of
production are possible, firms are classified into particular sectors and then further divided
according to actual activities. This form of classification allows us to quickly find information
and details about the types of firm and production activities within an economy, and to make
comparisons between economies.
Factors of Production
Traditionally, there are three accepted factors of production land, labour and capital. More
recently, it has been proposed that a fourth should be added entrepreneurship. This is
considered a vital addition in a business world that is becoming increasingly competitive.
Land
Land as a factor of production can be interpreted in two ways:
The space occupied to carry out any production process, such as the land
needed for a factory or office, or to grow crops
The basic resources within the land, sea or air which can be extracted for
productive use, such as metal ores, coal and oil.
Labour
Labour refers to any mental or physical effort used in a production process. Some
economists see labour as the ultimate production factor since nothing happens without
the intervention of labour. Even the most advanced computer can only provide outputs
as a result of some human involvement.
Capital
This term is also used in several senses. There are two main categories:
Real capital consists of the tools, equipment and the human skills employed in
production, which can be either:
physical capital, such as factory buildings, machines or equipment, or
human capital the accumulated skill, knowledge and experience which
allows the physical capital to achieve its full productive potential.
Financial capital, which is the fund of money which is usually needed to acquire
and develop real capital, physical or human.
All of the production factors are closely related with most production requiring some
combination of all the factors. Only labour can function purely on its own, if the need for
space is ignored for example, an unaccompanied singer or singers. However, the addition
of a musical instrument and some training usually provides a better product, and resources
and labour are needed to make the instrument and financial capital to make it.
The majority of economic history evolves from people's success in increasing the quantity
and quality of production through the accumulation of human capital and the development of
technically advanced physical capital.
Modern firms depend for their survival and success on both their physical and their human
resources. Human resources are scarce and talent is at least of equal value to the
successful firm as the physical resources it needs to manufacture its products, even when it
has adequate capital available.
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Scarcity of Resources
At any period of time, there will only be a limited quantity of the production factors available
to businesses. For example:
The workforce will have a certain skill set
There will be limited amount of capital assets available
Land may be restricted in the location
Hence, an economy would only be able to produce a limited output with all resources it has
available. In order to progress, it must find ways to increase its resources.
Increasing the supply of labour
The supply of labour can be increased in three main ways:
By the population of the country increasing, through either an increase in the birth
rate, which is a normal trend in some countries, but in others, such as UK, the
birth rate has been falling over a number of decades, or by the immigration of
people of working age from other countries.
By decreasing the numbers of people currently not working, through such
measures as lowering the threshold at which young people can begin working,
extending the retirement age, or persuading retired workers or others such as
mothers and fathers who stay at home to care for the children to return to the
workforce
By developing the skills available in the workforce to improve performance
Increasing the supply of land/resources
There is a finite quantity of land and resources such as minerals, water or wood, so this
is effectively impossible. However, advances in technology can make previously
unusable land and unreachable resources available for productive purposes. More
efficient use of resources also makes greater output possible, and recycling and other
conservation methods mean that productive resources can be extended.
Increasing the availability of capital
Plant and machinery used in the production of goods and services wears out with time
as well as becoming less effective as technological progress is made. Therefore it
must be replaced by newer items. This requires financial capital investment (spending
on capital assets).
Enterprise as a Production Factor
Enterprise is often quoted as the fourth production factor, but there is considerable
disagreement about what this term means.
The concept of enterprise was developed by economists who wished to explain the creation
and allocation of profit which these economists viewed as the reward earned by the initiator
and organiser of the economic activity. This individual possessed the special factor of
"enterprise" and was able to identify an unsatisfied economic want and to successfully
combine the other production factors in order to supply the product that satisfies that want.
Larry Page and Sergey Brin, the founders of Google, are an example. They began by
exploring how to retrieve relevant data from the large sea of data floating on the internet and
within a short period the public were using their website to quickly retrieve facts to satisfy
their personal knowledge needs. Enterprise was the factor that started them along the route
to Google's global success. The idea came first, then the labour, resources and capital.
Many other modern firms have been formed in the recent past by initiators, innovators and
risk takers of the kind that certainly fit the accepted definition of the business entrepreneur. It
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is often the case that innovating is easier for a smaller firm where there is less structure in
the way operations are carried out and where it takes less time to influence others to invest
in an idea and an oft-cited example to support this is that some of the most important
inventions have been declined by large companies (for example, Xerox declined the personal
computer).
Nevertheless, this identification of enterprise in terms of individual risk-taking raises a great
many problems when we attempt to apply it in a general way to the modern business
environment. Much contemporary business activity is controlled by very large international
and multinational companies such as Microsoft, Toyota, Sony, Philips and Unilever who are
constantly challenged to continue to recruit and foster enterprise. This can be seen
effectively as developing the skill levels of the existing labour supply and, indeed, most
universities now run MBA courses and modules in entrepreneurship in an effort to supply
"ideas" people to existing organisations. The notion that large companies do not innovate is
also contradicted by the fact that the personal computer was taken up and developed by
IBM.
Business Organisation as a Transformation Process
All businesses undertake the conversion of an input into an output; in other words a
transformation process. The inputs are the factors of production land, labour, capital and
entrepreneurial skills. The outputs produced can be tangible such as shoes, clothes,
skateboards or magazines, etc. or intangible such as insurance, service in a shop.
INPUTS

OUTPUTS
Land
Labour
Capital
Entrepreneurship
Tangibles products
Intangibles services

The output could be a combination of all four inputs above. For example, a fashion designer
producing a new dress or suit, will need resources such as material, labour (to cut, sew,
check and pack), real capital in the form of machinery (to sew and pack the item) plus
financial capital (money) to buy the physical and human resources. The combination of the
risk the designer takes in terms of innovating, using sales skills and being intuitive as to what
will appeal to a potential customer are all a part of entrepreneurship.
The outputs are the tangible dress or suit and the intangibles are aspects such as the quality
of the product and the status or confidence the customer receives from the dress or suit.
The nature of the transformation process will differ from one business to another and firms
are constantly competing to add value to retain competitive advantage, improve profit level
and/or combine the inputs in a way that will reduce costs. Cost reductions are achieved by
producing more with the same level of scarce resources, or by producing the same amount
(or more) with lower levels of inputs. This can involve changes in the way in which the
factors of production are applied for example, through new working practices, investing in
new technology, motivating staff or modifying the way goods and services are produced.
Classifying Production
Production is usually classified into three types:
Primary the extraction of natural raw materials from land, sea or air, including
agriculture and fishing
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Secondary the conversion of primary materials into more useful physical forms
through construction and manufacturing, for example, taking copper extracted from the
earth and making copper tubing, or refining oil into various useful liquids such
petroleum and diesel. It also includes the production of further products from the
outputs of other secondary production, such as the manufacture of cars from steel,
plastics and rubber.
Tertiary the production of services in a wide range of categories such as finance,
retail, transport, leisure and education. Services are often the last stage of the process
of delivering products to the consumer for example, iron ore is extracted from rock,
converted into steel and then manufactured to produce steel tube, which is then
transported by rail services to a customer. They can, though, be a product in their own
right, such as insurance policies or education.
Note that an individual business may span all the different sectors. For example, a farmer
could grow fruit, manufacture jam and then sell it in his/her farm shop and so be involved in
primary, secondary and tertiary production.
The proportion of employment in each of these sectors is often an indication of the stage of a
country's development and/or available resources. Generally, advances in development are
associated with a move from, firstly, predominantly primary production to secondary
manufacturing, and then into tertiary service-based economies. For example, compare the
following proportions for the UK and Ghana.
Figure 1.1: Employment by Sector (UK and Ghana)
UK Ghana

Acti vi ty 5
Find out the proportion of total employment in each of these sectors in your country.

Primary
Tertiary
Secondary
ABE
Classifying Firms into Industry Sectors
Industries, firms that produce similar goods or services, can be grouped together in
categories such as engineering. A broad group of similar industries makes up an industry
sector. Key industry sectors include manufacturing, finance, chemicals, engineering, leisure
and recreation.
The Standard Industry Classification
The Standard Industry Classification (SIC) is a formal system used in the UK to classify
business establishments and other productive units by the type of economic activity in which
they are engaged. This provides a standard framework for the collection, tabulation,
presentation and analysis of data which can then be used for comparing industrial
production, employment, etc. both over time within particular categories and between
different categories.
The Standards Industrial Classification (2007) has 21 sections and 88 subdivisions. These
main sections are then further divided. For example, Classification Section C is
Manufacturing, which contains Divisions 10 23. Each of these divisions contains groups,
which are broken down into classes and subclasses. So:
Within Section C, Manufacturing:
Division 10 is the Manufacture of Food Products
Group 10.5 is the Manufacture of dairy products
The classes and subclasses within Group 10.5 include
10.51 Operation of dairies and cheese making
10.51/1 Liquid milk and cream production
10.51/2 Butter and cheese production
10.51/9 Manufacture of other milk products (other than liquid
milk and cream, butter, cheese, etc.)
10.52 Manufacture of ice cream
(Source: UK National Statistics Office)
In this way, the SIC system covers every industrial activity within the 21 sections.
Trends and Reasons for Changes in Industry Sectors
The SIC structure changes over time to reflect new products and the emergence of new
industries that produce these products. The UK Office for National Statistics states that the
classification has been revised six times since 1948.
There are also changes in the relative importance of existing industries. In the UK, for
example, manufacturing has declined while services have increased very substantially, and
this will be reflected in the changes since 1948.
Rural development is a key factor in changes in the SIC. With economic growth, workers in
the country (mostly in the primary sector) tend to move into the manufacturing (secondary)
and service (tertiary) sectors. This involves movement of labour from rural to urban areas.
The migration of labour to the secondary and tertiary sectors forces agricultural production to
become more efficient and intensive in its use of physical and human capital, of knowledge
and technology, in order to maintain and develop production levels with decreasing
resources.

ABE
Acti vi ty 6
You are thinking about setting up a business to provide web design, hosting and search
engine optimisation. You have approached a number of friends who are interested in joining
you in the business. As a group of five people, you have 20,000 that you could invest to
start the business.
(a) What types of legal business status should you consider and why?
(b) What factors should you consider when deciding on the main purposes of the business
and why?
(c) How will the different factors of production impinge on your success?


ABE
SUMMARY
Businesses are set up for two main purposes to make profit for their owners, or "not-for-
profit" which aim instead to provide services for the benefit of (particular parts of) society.
For-profit businesses can have a variety of key objectives such as sales maximisation or
growth in market share, rather than being solely about profit maximisation.
The legal status of the business defines particular operational rules applying to the business
organisation, including those about the way in which it presents its accounts. There is a
basic distinction between corporate and non-corporate forms of organisation, the former
including private limited companies and public limited companies (plc), and the latter
covering sole traders and partnerships.
A further distinction between business organisations is that of the liability of the owners for
the debts and commitments of the organisation. In limited liability businesses (which
includes all corporate businesses and certain types of partnerships), the owners are
considered to be separate entities from the business itself and are only usually only
responsible for debts and commitments to the extent of the property they originally invested.
Unlimited liability means that the owner does not have a separate legal status from the
business and is responsible for all debts and commitments made.
Businesses may be considered as transformation processes that convert resources into
products and services. The resources required for this process are termed factors of
production and there are generally considered to be three such factors land, labour and
capital. A fourth and more recent addition to factors of production is entrepreneurship; an
ability to visualise the unconscious future need of a customer and to innovate a product or a
modification to a product to satisfy that need and to find ways to sell it successfully.
Production, and businesses, are divided into three economic categories primary (extraction
of natural resources and agriculture), secondary (manufacturing) and tertiary (services).
Production, and businesses, may also be further classified into industry types or sectors
under the standard industry classification (SIC). Such classification enables the
development of comparative data to show trends in production and employment within and
between different types of industry.
ABE
ANSWERS TO ACTIVITIES
Activity 1
The opportunity cost of you studying for this qualification is any other activity you could be
carrying out instead during the same time period such as earning money on a part-time job,
enjoying leisure activities with your friends and helping your family with some of the domestic
tasks. You could also include the financial cost of your studies, in which case the opportunity
cost would be what you may otherwise have spent the money on (or, perhaps the return
possible from investing the same sum).

Activity 4
For this task, you should have been able to think of several aspects not mentioned in the
text. The following is a fairly complete list and many will be covered in later chapters. If you
have identified any additional points, well done.
Type of
Organisation
Sole Trader Simpler tax
Free to make own decisions
No difficult legal contracts to
start the business
All profits are the owner's
Legal status is same as
business therefore, unlimited
liability
Limited resources
Growth difficult
Long working hours
Partnership Simple tax returns
Profits shared between partners
Easier to make decisions
Can be a legal arrangement
Legal status is unlimited liability
liable for all debts, jointly and
solely
If a partner leaves, the other(s)
must pay all outstanding
commitments
Limited resources
Growth difficult
Limited
Partnership
Limited partners have limited
liability for debt up to the value
of property originally invested
Legal agreement
Tax advantages
Able to share skills and
responsibilities
Able raise capital relatively
easily
Limited partners have no
decision making power
Ordinary partner is liable for all
debts and liabilities
More complex tax matters
Must register with Companies
House
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Private Limited
Company
Shareholders have limited
liability
Owner and company are
separate entities
Company owns the assets
Profits are distributed between
shareholders
Usually the shareholders
manage the business
Taxation is much more
complicated
Legal documents provide the
working practices and other
rules which must be adhered to
Tax documentation must be
lodged annually with
Companies House
Shares are not available for sale
publicly, so raising funds for
expansion can be limited
Public Limited
Company
Shareholders have limited
liability
Owner and company are
separate entities
Company owns the assets
Profits are distributed between
shareholders as dividends
Shares can be sold to the public
and substantial capital can be
raised
Owners do not generally get
involved in managing the
business, so actions taken in
running the business may not
be in the interests of the owners
The amount of profits distributed
as dividends is at the discretion
of the Board, but may also be
partly retained in the business
for growth
Dividends not guaranteed
Taxation can be very
complicated
Legal documents provide the
working practices and other
rules which must be adhered to
Tax documentation must be
lodged annually with
Companies House
Company Limited
by Guarantee
Can be for non-profit
organisations that require
corporate status without the
applying for charitable status
It cannot distribute its profits to
its members, and is therefore
eligible to apply for charitable
status if necessary
Guarantee companies can be
very varied giving considerable
decision making flexibility
Its owners are guarantors not
shareholders
The guarantors give an
undertaking to contribute a
nominal amount towards the
winding up of the company in
the event of a shortfall of funds
upon cessation of business
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Charitable Status Do not normally have to pay
most standard taxes
Regarded by public in a way
that can make it easier to raise
funds than non-charitable
bodies
Donors can receive tax relief on
their donation
Obtaining charitable status can
take a long time and the
organisation is subject to
considerable controls
Trustees can be paid only
reasonable expenses which
restricts the professional
assistance available
Charity law demands that
trustees avoid any situation
where charitable and personal
interests might conflict
Restricts the type of trading
activities allowed

Activity 5
(a) It is likely that you would be a "for-profit" type business unless the group is intending to
offer a "not-for-profit" service to some sector of the community.
The options for legal status would be to form a partnership or a private limited
company.
A legally binding limited partnership agreement would be sensible as one of the original
team might leave the organisation and the others will be left to pay all the commitments
if the business should fail. In that case, though, one person would have to be a general
partner and assume unlimited liability.
You could also consider setting up a private limited company and allotting shares
according to the capital you have invested. The documentation and legal formation can
be relatively straightforward, and as the owners you will all have limited liability.
However, there will more restrictions on the way you operate and a more complex tax
regime to comply with.
In summary there are advantages and disadvantages to each option. As a group you
have to make the choice between being the owners of a company with more freedom
but unlimited liability, or the more complicated operation (with less freedom to act) and
more complicated tax affairs which comes with limited liability.
(b) The business objective will probably be survival in the first instance, but you would also
want to set some positive goals which will enable you move forward after establishing
the viability of the business in the market. This may be to gain a particular market
share and to maximise sales to start with. Profit maximisation is likely to be an
objective when the business is on a sound footing.
Having one or two main purposes allows you to set your goals or targets accordingly
and work towards them. However, remember not to have too many objectives or you
may lose focus and fail!
(c) The possible ways that the factors of production may impinge on your business
include:
Labour You and your colleagues may not be sufficient, on your own, to make
the business a success and you would, then, have to employ additional staff.
More importantly, you and your colleagues may not have all the skills required to
make the business a success. If the missing skills are scarce, then, if you can
find individuals with them, you may have to pay more to acquire their services.
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Alternatively, you could develop those skills by training one the founders or taking
on an untrained person and developing that person. If the skill is crucial to the
initial success of the business, then it could be a big cost. However, this has to
be balanced against failure without that skill.
Land This should not be an issue as, usually, IT based firms require only small
premises and you could even start operations out of your home or garage!
Capital This is, with labour, is often the most scarce resource. 20,000 may not
go very far in covering start-up costs, so decisions will have to be made about
how the capital you have is spent, keeping some for day-to-day running costs
and unforeseen emergencies. You will have to create forecasts for spending and
income and monitor these carefully so that you do not incur cashflow problems in
the early stages. Technology also changes quickly and it may be that having the
most up-to-date equipment is important and, then, you may need to budget for
changing some of it regularly.
Enterprise Are you entrepreneurs? Who are the ideas people? As a small
organisation, you should be able to make fast decisions and thus get your service
to market quickly. However, you need to consider what will make potential
customers perceive your service as superior to that of your many competitors in
this area.

27
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Chapter 2
Introduction to the Business Environment

Contents Page
Introduction 28
A. The Internal Environment 28
Forms of Organisation 29
Formal and Informal Structures 30
Line Organisation 31
Span of Control 34
Functional Organisation 34
Staff Relationships 37
Matrix Structures 38
Mintzberg's Model 40
The Virtual Organisation 41
B. Change and The Business Environment 42
The External Environment PEST Analysis 42
How can the Firm Influence its Environment? 43
The Internal Environment Responsiveness to Change 43
C. Managing the Change Process 45
Planning and Communication 46
Change Models 47
The Role of Change Agents 50
Stakeholders and Change 51
Summary 54

28 Introduction to the Business Environment
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INTRODUCTION
This chapter provides an overview of the manner in which organisations structure
themselves so that they are able carry out their business effectively. We start by looking at
ways the internal environment can be organised. While there are a number of classical ways
of attempting this, we also reflect on less conventional structures that firms have adopted in
an attempt to cope more adequately with the needs of modern business and/or globalisation.
The external environment of the company can have an affect on the way in which the internal
organisation is structured, but its most important influence is on business planning.
Organisations need to continuously monitor and review the external environment for change,
and assess how such change may impact on both the content and implementation of their
business plans. Managing and responding appropriately to changes in the external
environment is a crucial process for survival and prosperity, especially in the fast moving
world of business today, and it is this which we examine in the second half of the chapter.
Change is no longer a step process which must be handled on a periodic basis it is a
continuous process that impacts greatly on success, failure and mediocrity.
A. THE INTERNAL ENVIRONMENT
The internal environment is concerned with the way in which people interact with each other
for the purpose of accomplishing the organisational goals.
Most large businesses started either as one individual carrying out every function of the
business or a group of entrepreneurs who got together to take a business idea or philosophy
forward. These small firms will then have subsequently grown into much larger organisations
and, in the process, will have had to consider how they can best be organised to use their
skills and competences to grow the business successfully.
For example, in 1824 J ohn Cadbury opened a grocers shop in Birmingham, selling cocoa
and drinking chocolate that he prepared himself using a mortar and pestle. In 1831 he
started to manufacture on a commercial basis. Many years later, the business was
enormous and employed many thousands of people - and in 2010 Cadbury's was acquired
by Kraft Foods Inc for $19.5 billion. A further example of this scale of expansion is Lenovo,
the Chinese PC manufacturer that started business in 1984 with 11 people working in
bungalow. By 2010, Lenovo had become the third

largest PC manufacturer in the world.
Think Point
What issues do you imagine Mr Liu, the founder of Lenovo, encountered when organising his
team to start the business?

Introduction to the Business Environment 29
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Mr Liu would have had several issues, but perhaps the key ones were:
What role each person would play in the new organisation to maximise their strengths
How the business should be organised internally to ensure communication between
them
What skills did they not have and how would they acquire them.
Underlying this, and the first step in creating an organised structure, even in the initial
expansion from one to two people, is the division of work. The first task, therefore, should be
to list the tasks to be performed and decide who has the best skills and experience to
complete each task. The next step is to decide how each person is going to relate to the
others in carrying out their tasks particularly in terms of decision-making and management
authority.
Thus, we can say that all organisations require a system for:
Planning and decision making
Implementing decisions through a structure of authority and delegation
Organising work into functions so that people can specialise and decisions are carried
out efficiently.
Different structures provide these systems and are used to ensure that plans and decisions
are made on the basis of informed knowledge and that decisions are understood and carried
out effectively by all. In every case, good communication is essential.
Forms of Organisation
Many forms of business organisation exist, providing alternative structures for different
purposes. In all cases, whatever the type or size of the organisation, general organisational,
management and leadership will be the same; it is the way in which these principles are
applied that varies. The kinds of questions that will be asked include:
Should the company organise according to its products or services?
Would structuring the organisation according to the markets it serves be more
appropriate?
Should the firms management be centralised or decentralised?
Should all the business functions come under one line of control or should each be
separate?
In time, the solutions to these questions will alter and it will be external factors as well as
internal preferences that will influence the move to new formats. For example, in 2010 Kraft
Foods, one of the largest firms in their sector, was organised into three geographical units:
Kraft Foods North America
Kraft Foods Europe
Kraft Foods Developing Markets.
However, the North American and European operations were then organised by product
category, but the Developing Markets by location.
Structures must allow for change and development, to enable the organisation to respond to
technical innovations, social and environmental developments and, above all, competition.
Thus, Kraft changed its organisational structure for Europe in 2009 to provide centralised
category management:
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"In line with a revision in strategy, the European operations were reorganised to be
based upon a pan-European centralised category management and value chain
model. The European Biscuit, Chocolate, Coffee and Cheese categories were
changed to become fully integrated business units, further strengthening the focus
on these core categories and to ensure that decisions are made faster and closer to
the customers and consumers. Each category is fully accountable for its own financial
operations, including marketing, manufacturing and R & D. Category leadership based
in Zurich, Switzerland, reports to the Kraft Foods Europe President. These business
units now make up the Kraft Foods Europe segment." (Authors emphases)
In small organisations, there is not so much specialisation. In a partnership of three or four
people, for example, one person may be responsible for all the accounts, purchasing and
marketing. The accountant in a small to medium sized business will need to be credit
manager, cost clerk, wages clerk and purchasing controller as well.
Large businesses, though, need a high degree of specialisation to manage all the work.
Communication between specialists then becomes a key issue and is the fundamental
challenge when deciding on the organisational form. There can easily be a loss of co-
operation and control in large organisations with highly structured specialist departments,
which can adopt their own business plans and operational priorities. Any structure must
reflect the priorities of the business and be capable of adapting to changes in the
organisation's environment and objectives. We shall return to this later.
Formal and Informal Structures
All organisations have formal structures. However, it is important to realise that all
organisations also have informal structures existing alongside them at the same time. These
informal structures, if powerful, can have considerable influence on decision making and
operations.
In large companies the two structures are usually quite distinct and in some companies any
tendency for overlap of the two is discouraged. In small, especially small family-controlled
organisations, the two are very likely to be intertwined.
Whilst the formal organisation structure of roles and relationships is determined by
management and can be represented by an organisation chart, the informal organisation
varies in structure and composition. It is based on relationships between groups and
individuals and the power and influence that these have outside of the formal structures for
example, groups of friends, a particular group within a department or even a whole
department within the organisation. Any of these may have their own particular agenda, such
as a commitment to corporate responsibility or a commitment/inertia to any change in their
job roles.
The informal organisation has its advantages but also its dangers. For example:
(a) Information can often flow freely without time-consuming and frustrating formal
communication networks, but personalities can damage business effectiveness and
personal arguments or divisions can literally ruin a business.
(b) A strong and effective informal structure can make it extremely difficult for a successful,
family-managed or individual-entrepreneur-dominated company to transform itself into
the kind of professionally managed corporate organisation that the financial institutions
and operating capital markets expect in a large public company.
(c) When professional managers are brought into an organisation, they can quickly find
themselves in conflict with the informal structure.
The formal organisational structure is made up of two basic parts:
The infrastructure, which is the way in which authority is allocated in an organisation.
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The superstructure, which is how employees are grouped into various departments or
sections.
Line and function are the names given to the two different types of authority that exist in
organisations.
Line Organisation
Traditionally, line relationships have been the most important in shaping the structure of the
organisation. The key elements are:
(a) There are direct lines of authority, linking superior and lower ranking employee/
subordinate directly.
(b) There is a chain of command, which means that each subordinate knows from whom
he/she is to take orders.
(c) At its simplest, line organisation is a direct flow from the top to the bottom of the
organisation.
The form of organisation is hierarchical as shown in Figure 2.1.
Figure 2.1: The Hierarchical Line Organisation

Communication flows up and down. Information about plans and decisions is communicated
downwards through the levels of the hierarchy, while information required so that senior
levels of management know how well targets are being met by those at a lower rank, flows
upwards. This upward communication flow will include information on sales, output, stocks,
orders and finance.
Henri Fayol identified the features of the hierarchical line organisation in the early 20th
century. According to Fayol, the two key "principles" of management are:
Unity of effort everyone in the organisation should be working towards achieving the
goals of the organisation.
Unity of command each member of the organisation should have one clear superior
to whom he/she is responsible. The span of control should not be too wide; ideally no
Board
of
Directors
Senior
Management
Middle
Management
J unior
Management
Supervisors
Operatives
Vision of future development
Strategic decisions
Administrative decisions
Operating decisions
Carry out decisions
Set objectives
Long term planning
Short term planning
Operational planning
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person should supervise more than five or six subordinates. (We shall consider this in
more detail in the next section.)
Line organisations fall into two categories which reflect key aspects of their structure:
(a) The number of levels in the hierarchy which then defines its height as either a tall or a
flat structure
(b) The number of lower ranking employees that each manager or supervisor manages,
making the structure either wide or narrow. This is also known as the span of control.
Tall Structures
Tall structures have many levels, as demonstrated by Figure 2.2.
Figure 2.2: Tall Organisational Structure

There are advantages and disadvantages to such a tall structure:
Clear line of authority
Clear division of work between the various
levels
Possible confusion of objectives between
the numerous levels
Possible communication problems both
ways, top to bottom and vice versa
Slow decision making and implementation
Tendency to be bureaucratic, generating an
increasing number of levels
Career progression and promotion can
seem very slow, and those at the bottom
may be discouraged
Director
Divisional managers
Supervisors/foremen
Section heads
J unior staff/operatives
Team leaders
Assistant directors
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Flat Structures
A flat structure has relatively few organisational levels, as shown in Figure 2.3.
Figure 2.3: Flat Organisational Structure

The advantages and disadvantages of flat structures are essentially opposite to those of tall
structures:
Good communication
Smaller risk of divergence between the
objectives of one level and another
More flexible and less bureaucratic
Short ladder of promotion
Some lack of clarity in authority and division of
work
Requires greater flexibility at all levels with
people being prepared to undertake a wider
range of activities. This calls for dedicated and
well-trained employees.

In recent years, there has been a reaction against the hierarchical type of organisation
shown in Figure 2.1. Instead of the "tall" structure shown there, with several layers of
management and supervision, firms have been changing to "flat" organisation structures.
In the 1990s, in many organisations, layers of middle management were cut as responsibility
for decisions and functions was pushed down to the lowest practical level in the business.
The main reasons for this included:
A better educated and trained workforce meant that employees could be given
the opportunity to manage their own work
New technology made it possible for shop floor workers to schedule, control and
maintain their machinery and organise their workload
Employee empowerment was considered to be the best route to better motivated
staff as people took more responsibility for their own jobs.
Director
Departmental managers
Team leaders
Operatives
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Acti vi ty 1
In what types of industry might you find either a tall structure or a wide structure? Make a
note of your answer below:
(a) tall structure:

(b) wide structure

Can you think of two examples of organisations with each type of structure?

Span of Control
The span of a manager's or supervisor's control refers to the number of subordinates which
he/she controls. When an organisation decides the span of control for each manager it will
consider the following points:
(a) A narrow span for situations is appropriate where much support is required:
Complex work
New members of staff
Recently promoted employees.
(b) A wider span of control is considered appropriate when
Staff carry out relatively simple tasks
Employees are very experienced and do not require much supervision.
Naturally the experience and quality of the manager or supervisor must also be taken into
account the more able the manager, the wider the span of control s/he can operate.
Therefore, the key variables in deciding on the width of the span of control are the nature of
the work, the quality of the subordinates and the quality of the manager or supervisor.
There is often a relationship between the height of the structure and the span of control.
Narrow spans of control are most often associated with tall structures, while wide spans of
control may be associated with flat structures with fewer levels each manager has more
people to control.
Functional Organisation
This is an organisational structure arranged into specialist groups or departments. Most
organisations have at least a degree of functional organisation since it provides for the
grouping of specialist work within one area.
All organisations have similar specialised business functions but the importance of each of
them varies, according to the size and objectives of the firm. Functions include sales and
marketing, finance/accounting, human resource management or personnel, security and
production. A sole trader will have to manage and complete all functions alone. In smaller
firms some of the functions will be merged to form one role.
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The Main Functional Departments of a Business
The main functional areas of business can be classified as follows:
(a) Human Resource Management (or Personnel)
This function covers all aspects of managing people:
Strategic human resource planning numbers and types of employees required
for future activities, and integration of staff that become part of the firm after an
acquisition
J ob design
Recruitment, retention and talent management
Training and development
Performance and reward management
Redundancy systems, procedures and decisions
Industrial and employee relations
Health and Safety
All legal aspects of complying with current employment law
Record keeping.
(b) Security
Security is essential to safeguard people, premises and materials. Knowledge
management and personal data now forms an essential part of this function although
the IT department is more likely to manage these aspects of security.
(c) Marketing
Marketing is concerned with ensuring that the products and or services of the business
are purchased by consumers. It is involved in the whole process from research into
new products through to sales. Responsibilities may include:
Producing a strategic marketing plan that aligns with the organisations strategic
plan
Market research
Product management
Sales promotion, traditional and web based
Public relations
Selling and distribution
Servicing and payment.
A large company will have a Marketing Director with managers for specified functions.
(d) Production
The objective of the production department is to provide an agreed quantity of products
in line with the marketing plan. Products have to be of appropriate quality and made at
the right cost.
Quality control is an essential part of production. It is responsible for:
setting standards
checking
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materials and components
monitoring production
following up sales.
Internationally recognised quality standards such as IS0 9001 series are adopted by
many firms. Quality control is equally vital in service industries. Many retail stores,
banks, hotels and transport firms employ specialist agencies that send out mystery
shopper or inspectors posing as customers to check on the way customers are
actually treated.
(e) Purchasing
Purchasing is the specification and sourcing of materials and components required for
all the firm's operations. It may form part of the production department or may stand
alone, with separate department sourcing the requirements of all the other
departments.
Purchasing can be a key element within a company, particularly in respect of costs and
the supply of components as they are needed. As a result, many organisations have
strict purchasing systems. For example, in American Express a 50 strong Global Real
Estate & Procurement Services EMEA team is responsible for acquisition of all goods
and services across the organisation and forms an integral part of the business
structure.
Just-In-Time manufacturing is a relatively recent development, involving component
parts being delivered to the factory only as they are required in the production process
and reducing (sometimes to zero) the holding of stock. This reinforces the importance
of purchasing and stock control. Holding too much stock is costly for the organisation
as more effective use of the investment capital could be made in other parts of the
business. If stock control is not well managed, production may be held up resulting in
lost employee hours.
The use of IT based purchasing and inventory as well as the ability to source materials
globally has given purchasing a much more responsible role in assisting companies to
manage costs, remain competitive and therefore improve shareholder return.
The internet has allowed both suppliers and purchasers to gain very detailed
information on the quality and price of goods from different competing firms. This has
made the role of purchasing easier in many ways.
(f) Financial and Management Accounting
The Finance Director has responsibility for all the finance and accounting functions.
These include:
Obtaining the funds required to run the business. This can be long term capital
raised through share issues, long term borrowing possible by issuing debentures
or short term working capital.
Managing these funds. In large organisations this is the job of the Treasury
Department that will also manage foreign exchange dealings. BP, for example,
has its own foreign exchange dealing room to do business with the banks.
Provision of information to the Board, shareholders and tax authorities. All the
financial accounts required by law and the information for investors and analysts
are its responsibility.
Pay and pensions matters. These are often outsourced to specialised
organisations.
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Internal budgets and financial information must be produced for every department
and section. This may be carried out by Management Accountants who do these
for each department. They will also provide budget control information, usually
on a monthly basis.
In manufacturing companies, the role of management accountant is particularly
important for managing costs and pricing products appropriately.
Credit management and control are important functions. There may be a large
department in firms that work with huge numbers of customers on a credit basis.
Ensuring that payment is made on time is essential for managing the cash flow
and for maximising interest on income. This function is sometimes outsourced
debtors are handled by factoring companies, who pay the organisation a
guaranteed percentage of the invoice, while deducting an agreed percentage of
the invoice as their fee for collecting the debt.
(g) Research and Development
This department carries out research into new products and into ways of improving
existing ones.
Development is the process of planning, making prototypes, setting up feasible
manufacturing processes and generally bringing ideas to production and sale. If a firm
is to grow and/or survive, it is vital that it has a constant flow of new or updated
products to replace those which have reached the end of their commercial life. R&D
will liase closely with marketing, production and purchasing, so that product
development will be appropriate to consumer needs and the organisations resources.
(h) Information Technology
Personal computers (PCs) are an essential tool in all modern organisations and can be
either physically or wirelessly networked into systems, linking everyone in an
organisation. In large and small organisations, on all continents, electronic
communication has transformed working practices.
Although some countries still do not have extensive access to computers or the
internet, this situation is rapidly changing as emerging economies that use IT
extensively in business, become committed to introducing the computer to school age
children. For example, in 2008, the Uruguay Government launched a campaign to
provide a laptop for each primary school child.
Many organisations in developed countries possess computers with more processing
power per employee than they need. This has happened as prices have fallen and
firms have purchased the newest models. This has meant that emphasis in some IT
departments has shifted from provision of new machines to securing the data that is
stored on them. This is the challenge that IT departments increasingly face as keeping
confidential data is essential to retaining competitive advantage.
Outsourcing Functions
In the last decade or more, many whole specialist functions or parts of the traditional
functions have been outsourced. The work has been contracted out to other firms who either
have greater expertise in that area and/or can complete the work at lower cost.
The larger the organisation the more interdependent are its parts and the greater the
problems of communication, coordination and control. Outsourcing is perceived as one way
to overcome some of the problems.
Staff Relationships
Line management describes the direct relationship between a manager and his/her
subordinates. "Staff" relationships describes the indirect relationships between different
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functional departments where some interact in an advisory capacity with managers in other
departments. For example:
A personnel assistant who has no direct line management authority may advise or even
require a line manager to take particular actions in respect of some aspect of human
resource management such as performance appraisal or job description for new
recruits.
Similarly, a Finance Controller may offer advice (on request or as one of their
responsibilities) to managers elsewhere, so that she/he can forecast budgets, raise
limits of authority on budgetary expenditure and so on.
Many medium to large companies have an IT department that provides a help desk for
computer issues and manages all aspects of electronic communication and security
within the firm.
Functional authority gives the staff manager the clear right to instruct line managers in other
departments on certain specified activities or procedures, wherever these are being
undertaken in the organisation. For example, the Human Resources Manager may be given
functional authority over redundancies in all departments of the organisation or the
Accounting/Finance Manager may be given authority over budgetary planning and control of
other departments. Within these specified areas the staff expert's authority takes
precedence over that of the line manager, but in all other areas the line manager's authority
is unquestioned.
This type of arrangement explains the dual role of many managers as a line manager within
their own department and a staff manager with specified functional authority in other
departments of the organisation.
Issues with Staff Relationships
Problems may arise when staff department experts try to control the conduct of line
managers in other departments.
Line managers may reject the guidance being offered to them, because they feel that it
is they who will carry the ultimate responsibility for their department's performance.
Many line managers resent the interference of staff experts whom they consider to be
too "theoretical".
Some experts argue that having both line and staff managers, complicates the
structure of authority because it infringes the principle of "unity of command".
The situation is further complicated by the fact that staff managers are also line
managers in their own departments. For example, the manager of an accounting
department exercises line authority over his/her own subordinates and may resent the
intrusion of "advice" from a staff manager from, perhaps, the personnel department
about people management matters.
Functional authority can work well at the higher levels, but problems may arise when lower
ranking employees, such accounts or personnel administrators are sent in to work in other
departments. These assistants may be called upon to report both to their staff managers and
to the line manager of the department in which they are located. This can be very frustrating
and demotivating as often they will receive conflicting instructions and/or guidelines.
Matrix Structures
The matrix structure combines two structural dimensions simultaneously for example,
functional and product divisions, or geographical and divisional. BP used this type of
structure extensively in the 1990s.
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A common form of such organisation is for regional managers and centralised functional
divisions to have a formalised relationship as shown in Figure 2.4.
Figure 2.4: A Matrix Structure
Managing Director

Matrix
heads

Director
Marketing

Director
Finance

Director
R&D

Director
Production

Director
Personnel

Manager
Region A

Manager
Region B

Manager
Region C

The advantages and disadvantages of matrix organisation are as follows.
The organisation is seen as a network of
tasks that are best undertaken by teams or
taskforces which are set up to achieve
specific objectives.
They are effective at knowledge
management teams are made up of
individuals with specialist skills and
information such as different cultural or
market knowledge.
They are particularly useful to global
organisations since they will allow the mix
of global and local knowledge.
Professional and operational staff are
drawn together into a co-ordinated group
with shared goals.
Individuals are responsible to two
managers so that there is a strong potential
for confusion and conflict over authority
and responsibility among both staff and
managers.
There may be power struggles for control.
Decision making may take longer because
of negotiations between managers on
different aspects of the task.
Dual management has a higher
administrative cost.
Such structures are harder to control.

Similar types of structure are often employed for organisations working in a project-based
manner, when the emphasis is on multi-disciplinary teams involved in complex projects.
Project teams or taskforces are important building blocks in many organisations. They may
have relatively few members, drawn from higher or lower levels of specialist departments
depending on the nature and importance of the task being tackled and they are also flexible,
coming into being to tackle a given task and disbanding when the task is finished. This type
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of structure can help build team spirit which lives on, ready for new taskforces to be formed
as needed.
The most common types of such groups are temporary project groups, set up to investigate
and recommend new working strategies or to introduce a new product or service.
(a) Strengths of a project structure are:
its strong focus on the objectives of the project
co-ordination of work to achieve those objectives
designation of a project manager
the employment of specialist skills and support services as necessary
centralisation of decision making on the project
consequent faster and more flexible response to changing needs.
(b) Weakness in this structure include:
lack of strategic control
lack of co-ordination
constant breaking up and reforming of project teams can hinder the accumulation
of knowledge over time.
Mintzberg's Model
The structure of an organisation, then, is the formal pattern or framework of interactions and
co-ordination designed by management to link the tasks of individuals and groups in the
achievement of organisational goals. Mintzberg's work in the area of organisational structure
is useful as it also considers management. Mintzberg, identifies five key elements to an
organisation's structure.
Figure 2.5: Mintzberg's Model of Organisational Structure

(1)
STRATEGIC APEX
(Senior Management)

(4)
TECHNOSTRUCTURE
Quality Control
Maintenance
Work Study
Human Resource
Management
(5)
SUPPORT STAFF
Finance Functions
Legal Functions
Administration
Press and Public
Relations
(2)
MIDDLE LINE
(Middle Managers)

(3)
OPERATING CORE

Sales Marketing

CUSTOMERS/CLIENTS
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The elements are as follows:
Strategic Apex Senior management takes the ultimate decisions for the
organisation. It establishes the core values which are revealed in the organisations
mission statement.
Middle Line This reflects the authority structure (infrastructure) linking senior
managers to middle managers/supervisors and then to the workers in the operating
core. Information flows both ways along this line.
Operating Core This consists of the people who make the goods and/or perform the
services. In small organisations, this may be most of the organisation.
Technostructure The function of this element is the co-ordination of the work of the
organisation. A key technique for this is Total Quality Management (TQM) where
standardised high quality production is the objective.
Support Staff The function of this element is to provide the indirect services required
by the organisation; the legal, financial, press and publications experts and
professionals.
Flexible organisations can adapt by allowing certain sections to expand, whilst increasing
productivity can bring lower numbers of workers to the operating core. This model
demonstrates the importance of senior, middle and supervisory management.
The Virtual Organisation
Extensive adoption of the internet has created two additional aspects to organisational
structure.
The possibility of international or global business for relatively small organisations
Less need for office bound staff.
Firms can do business using only their website as a means of communication with both the
customer and supplier. Financial transactions take place electronically and the website can
contain the database with the information concerning customers and suppliers. Web
analytics provide the data the organisation needs to measure return of marketing investment
and so on.
Similarly, a firm using electronic business methods can operate globally from a small office
and have employees, consultants or freelance associates working anywhere in the world
from their own home base.
There are advantages and disadvantages of the virtual organisation:
Lower administration costs.
Fewer and potentially lower employee
costs.
Bringing in specialists as necessary from
anywhere globally.
Instant communication.
Part time and flexible working for
individuals with other responsibilities such
as bringing up young children.
Control of employees working hours and
quality of service.
Electronic communication can be subject to
connection issues.
Some parts of the world will be relatively
inaccessible as they have not yet adopted
the technology
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B. CHANGE AND THE BUSINESS ENVIRONMENT
The term "change" refers to any situation where conditions differ from one time to another.
Development is planned change that is implemented so that objectives can be accomplished.
Change can be the result of many factors, not least of which is the modification in consumer
attitudes and value systems. The rate of change has never been greater than now and, in
particular, the business environment both internal and external is accepted as being
subject to constant change. Many organisations find this difficult to cope with as it can have
a significant effect on all aspects of their business operations. To survive and prosper, every
organisation must identify the changes that affect it and adjust its operations to maximise or
minimise these effects as best it can.
So that we can examine the reasons why organisations need to change to survive, we will
examine the impact here that the business environment can have on organisations. (We
cover the external environment in outline here as a means of identifying the need for change,
and shall return to it in more detail in the next chapter.)
The External Environment PEST Analysis
There are five major questions which managers must consider when assessing changes in
the external environment:
(i) What are the threats and opportunities from the external environment in the short and
longer term?
(ii) How can we minimise these threats?
(iii) How can we take maximum advantage of the opportunities which may exist?
(iv) What advantages do we have over our competitors and how do these changes help
us?
(v) What are our limitations?
We need to understand the functioning of an organisation as it interacts with its environment.
Four key elements have been identified which, taken together, make up the total environment
these are the political, economic, social, and technological sphere. (There have been
extensions to the basic PEST model which we will examine in Chapter 3.) Some of the key
issues in these four areas are as follows.
(a) Political
Organisations are influenced by government policies such as those concerning
taxation, political orientations, legislative structures, trade union power and so on.
Firms also attempt to influence government thinking in these and other relevant areas
to their own advantage by lobbying, providing party funds and through their trade or
professional associations, etc.
(b) Economic
Firms operate in conditions of economic booms and lows (recession). Interest rates
change, tax rates change, the money supply can alter and investment levels go up and
down, as people try to guess likely future market movements, etc.
In the global economy, exchange rates can have an important effect on business
performance and since stock markets throughout the world are linked to one another
electronically, change can happen and be communicated extremely quickly, resulting in
an instantaneous impact on firms.
Energy costs play an increasingly significant part in business activity. The world is
dependent on a few nations for its oil and gas.
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Pricing and pay policies of large organisations can affect the wider economy
particularly as companies compete to recruit and retain scarce talent as well as
maintaining profit levels.
(c) Social
The culture of an organisation is affected by the culture of the society in which it
operates. Changes in lifestyles affect the market and thus the running of an
organisation, not only employee practices, but the nature of products and services
demanded. Social mobility, demography, family size, etc. can all contribute and have
an effect on the human resources inputs and the market(s) in which an organisation
operates.
(d) Technological
The level and focus of government and industrial research and development
expenditure has an effect on technological changes in the environment. The nature of
such changes and the speed of technology transfer will have an influence on an
organisation's own technological preferences. Product life cycles appear to get shorter
and shorter, particularly in the electronics industry, and shape change.
In reality these elements may overlap.
How Can the Firm Influence its Environment?
Sometimes, the potential changes in the environment can be foreseen a long time in
advance. In such cases, it is possible for the firm to plan action to counteract their effect, if
they are likely to pose a threat, or to take full advantage of them if they are likely to offer an
opportunity.
If changes in the environment happen suddenly, then it is the organisations which can best
handle change that are more likely to survive. If firm Xs competitors adapt to change faster,
their actions will impact even more severely on the prospects of firm Xs survival.
Interaction with the external environment is not, though, a one-way process of being
influenced by outside factors over which it has no control. It is, rather, a two-way process
with the organisation able to make an impression on its environment, through activities such
as marketing, use of technology and corporate responsibility initiatives. An organisation can
exert influence over its customers, both existing and potential, by making a product or
service available or demonstrating a social conscience in its development and so
establishing a demand for it which did not exist previously.
The Internal Environment Responsiveness to Change
Acquisitions are an example of an organisation taking action to influence its external
environment, but that in itself may generate change in the internal environment which can be
extremely difficult to handle. In most cases, the purpose of acquisitions and mergers is to
reduce costs and increase competency levels and ultimately to increase competitiveness and
company performance. Yet, if the acquired business is not integrated properly into the
companys portfolio, the acquisition may result in poorer performance through the inability of
both the acquired and the acquiring organisation to change and not deliver the enhanced
performance anticipated.
There are a number of areas which an organisation needs to consider in respect of its
internal environment to ensure that it is prepared for change.
(a) Identifying change
An organisation must constantly monitor progress in achieving its objectives and
identify changes in the internal and external environments that may be impacting
positively or negatively on meeting those objectives. It is then in able to adapt in ways
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that will maximise performance. By integrating scheduled monitoring of objectives,
identifying change will be more likely and the firm will be more prepared to take
remedial action and to stay competitive as a consequence.
This may mean changing the organisational structure, working procedures and
systems, and management methods.
(b) Change areas
The organisation needs to be aware of the areas in which change is most likely for
example:
Staffing levels and, particularly, skills profiles
Location of employment
Working practices
Technology and globalisation are two key external influences which have enormous
impact on these areas, often beyond what could have been imagined.
Customer power to demand the products and services they require and the companies
they will buy from has also had a great influence. Social networking sites and online
purchasing have given consumers the ability to research the best products and to
quickly advise large numbers of people of the shortcomings of products. These two
factors alone have transformed the nature of competition and impact strongly on
working practices.
(c) Responses to change
Some organisations are very responsive to change and have the culture and structure
needed to support it. Some are proactive when it comes to change they plan for
change, making contingency arrangements to buffer any changes that may affect them.
Other firms, mechanistic organisations, react to it in a crisis situation, when it is too late
change is not usually related to their corporate strategy.
(d) Organisational processes involved in change
In general, change is best implemented incrementally that is, in small steps over a
period of time since this allows the firm to use the skills and values of members of the
organisation, allowing a smooth transition from one situation to another.
A small entrepreneurial company is able to implement change virtually instantaneously
as few individuals are involved in decision making. However, in large organisations
such as multinational corporations or some public sector bodies, this is very much
more difficult. These large organisations will have set structures and routines, and are
likely to be far more bureaucratic, slower and more resistant to change.
Transformational change occurs when huge strategic movements are required. This is
most often the case with bureaucratic organisations, such as the armed forces, local
councils and government departments, which have not gradually adapted to
modifications in the environment. Over time there has been strategic drift, the
organisation has not made strong, radical decisions to deal adequately with all of the
changes in its business.
(e) Change and context
The process of change can be complex and the less change the organisation is used
to, the more extensive and painful the change process is likely to be.
Change must be approached according the context of the organisation. J ohnson and
Scholes provide contextual features that need to be considered, these are considered
in the following diagram.
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Figure 2.6: Change and Context

(Adapted from Johnson and Scholes)
C. MANAGING THE CHANGE PROCESS
The number of aspects to be considered and then implemented in a change situation means
that it is often met with resistance from several perspectives such as:
Middle managers who fear that changes in structure such as moving to a flat or matrix
one will adversely affect them through a reduction in their authority and power.
Employees who fear that change will affect the status quo, separate them from friends
and colleagues with whom they currently work or end in redundancy.
Uncertainty about what the changes involve results in substantial resistance to change
by individuals in an organisation, which can result in, at best, indifference to new
strategies and at worst hostility and defiance.
Power and
Influence
Does the leader
have sufficient
power and influence
to implement the
change
management?

Time
How quickly?

Attitude
How well will the
staff adapt to
change?
Capacity for
Change
What resources do
we have for the
change?
Money? Time?

Capability
How capable are
managers of
implementing
change?

Breadth of
Experience
Is there enough
breadth of
experience, views
and opinions to
assist the change
process?

Scope
How much change?

Resources
Which resources
should be retained?

STRATEGIC
CHANGE
PROGRAMMES
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Resistance to change is a perfectly normal and understandable facet of human behaviour,
but if strong enough, it can detract, in a major way, from the effectiveness of proposed new
corporate strategies and plans.
The manager responsible for the implementation of corporate plans must be skilled in the
management of change and in particular must seek to try to minimise or, better still, plan to
avoid resistance to change.
Planning and Communication
There are a number of factors which the manager can consider in planning to minimise
resistance to change.
(a) The involvement of the HR Manager in planning how to approach change and then to
implement the agreed plan is a crucial factor in a successful outcome. This is
particularly important during a merger or acquisition when two organisations are
combining to form one bigger entity.
(b) A vital aspect to successfully managing change is effective communication.
The reasons for change must be communicated effectively by focusing on the
main points
Communicate points in a manner that indicates their significance and
acknowledges the challenges for all involved in the organisation
Make communication two-way by involving all employees in planning the change
itself.
(c) If the organisation recognises a union or unions, the union representative needs to be
involved at the earliest possible stage.
Communication is the key not everyone can be involved in the change to the same extent,
but everyone does have something to add.
Change should be communicated through as many channels as possible so that everyone
will have the opportunity to understand that change needs to happen. Channels include:
Group meetings
One-to-one sessions
Online questionnaires
Telephone and video conferencing
Traditional written mechanisms such as memos, circulars and using notice boards.
Warning! Where proposed changes are significant and particularly when they involve
complex issues, the use of memos and notices should be minimised. They are
impersonal and make the employee feel isolated from the change, can cause low
esteem and alienation if their opinions and feelings seem not relevant.
Where significant change is required and employee involvement is crucial to success, as
many personal face-to-face channels as possible should be used..
Regular meetings and workshops can be particularly effective, especially if organised for
groups of employees from different levels and disciplines to discuss issues, give their
opinions and feedback. Cross functional and multi-level groups aid understanding of the
issues faced by other departments or organisational levels, and this may help in breaking
down resistance to changes that are not understood.
Anonymous questionnaires, which allow some capacity to write free text, provide a method of
gaining feedback that individuals may not feel comfortable to give in the group situation.
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Feedback should be treated and be seen to be treated, as valuable and important, while the
use of more than one technique is likely to provide a more appropriate set of solutions.
Effective communication is thus crucial to the issue of managing strategic change in
organisations and in particular in trying to minimise or avoid resistance to any such change.
Change Models
Theoretical models can assist organisations in planning change.
(a) Schein's " unfreeze-change-refreeze" model
Schein recognised the problems that organisations face when planning and
implementing change and developed a model to use to pre-empt any potential
resistance. This model is known as the unfreeze-change-refreeze model and has three
steps:
Step 1: Unfreeze
This involves the organisation "unfreezing" existing attitudes and behaviour.
Individuals go through a process of "unlearning" old habits, old perceptions and
old ideas about how change will affect them.
Step 2: Change
This involves a "change" in behaviour. Individuals modify their old ways and
adopt new ways of thinking about change how it should be implemented and
how it can be positive rather than negative.
Step 3: Refreeze
The final stage involves "refreezing" the newly-adopted behaviours and attitudes.
The organisation may need to offer positive reinforcements, such as incentives,
to encourage individuals to accept the changes.
In this three-step model of change, the process as a whole is achieved through:
leadership
communication
education and training.
Effective training can be used to create a major change in the attitude of employees,
which must then be made permanent by creating the necessary structures, procedures
and incentives to support the new culture.
A major task for management is to produce the initiatives necessary to achieve the
unfreezing step. Good communication is the basis for this:
Setting up employee suggestion schemes
Giving staff a greater input into the decision making process
Implementing schemes which reward good effort, such as "employee of the
month"
Creating good team spirit through company identification schemes, such as logos
advertising, badges, etc.
Producing company newsletters
Making managers more visible, for example by "open door" policies.
This model can be used when individuals are opposing change, or when management
wants to gain acceptance for a change that directly affects employees, such as a
change in working conditions.
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(b) Lewins " force field analysis" model
This is another model for assisting with the implementation of change. Lewin identified
"driving forces" for change and "restraining forces" against change. Lewin believed
that driving forces try to push change through, whilst restraining forces try to resist
change and maintain the status quo. The model uses the concept of apparent
immobility in a social situation representing a state of "dynamic tension" between the
needs, drives, aspirations, fears and other feelings of the people involved.
Figure 2.7: Force Field Analysis
Forces for Change Forces Against Change

Plan
change
systems
to
become
fully
IT-based

Time saving

Record

Skills

Quality

Redundancy
Production

Communication

Cost

Global reach

Force field analysis concentrates attention on the identification of the driving forces and
the restraining forces, their strengths and how they can be modified. Lewin suggested
two ways of dealing with change through this form of analysis:
(i) Strengthen the driving forces by encouraging those associated with the change
and driving it, to educate and convince those who oppose it that it is for the
organisational good.
(ii) Weaken the opposing forces by:
persuading someone to act as a change agent in order to win over
opponents
offering concessions to opponents in order to buy them off
involving individuals by means of employee participation principles such as
quality circles, joint consultative committees, etc.
using a manager, with positional and personal power, to coerce opponents
into accepting change.
Movement in the desired direction can most readily be achieved by firstly reducing or
removing restraining forces. Increasing driving forces before reducing restraining
forces often increases the restraining forces in reaction. Merely trying to force change
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through may cause its own problems people can be uncooperative if change is forced
on them.
Once restraining forces have been reduced, attention can be given to the driving forces
and to gaining further employee commitment through such actions as:
Training staff although initial cost is increased, fear of technology may be
reduced and implementation could take place more quickly, leading to a better
revenue stream earlier than forecast.
Showing staff that the new systems would introduce variety and interest to their
jobs and give them skills which make them more valuable to the business and to
employers generally.
Raising salaries to reflect new productivity.
The force field model can be used effectively with employees in workshops as
part of the process of aiding understanding of the nature of change. It is
appropriate to all levels of staff and easy to administer.
Each individual or group can be asked to produce two lists the forces for and against
change and to evaluate why the change is needed. Once the analysis has been
carried out, the group can asses whether the project is viable and then examine how to
address the two opposite forces identified. Involvement of employees in this way can
often generate new ideas that enhance the initial plan.
This type of workshop activity should help to break down resistance to change
and is particularly useful in getting staff to understand for themselves that change
is necessary for business survival.
Acti vi ty 2
Your company is thinking of sending production to a cheaper country. They will retain all the
other business operations in your location.
(a) Write a list of all the factors for the change and another list of factors against the
change?
(b) Decide whether the company should go forward with the change
(c) How could you increase the number of forces for change and reduce those against
change?


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The Role of Change Agents
Organisations can speed up and facilitate the process of change by using a change agent in
a similar way to the way in which a catalyst is used in a chemical reaction. This is a good
analogy in that it identifies two important aspects of using change agents:
Only a very specific chemical catalyst will change the rate of a standard chemical
reaction and the catalyst used in one reaction will not work in another. Thus:
Initial substance Catalyst (change agent) Final substance
A X B (desired outcome)
But
A Y A (no change)
Or
A Z C (unwanted outcome)
You need to ensure that you use the right change agent to achieve the desired
outcome.
Similarly you can alter the rate of a reaction by an increase or decrease in pressure or
temperature i.e. changing the environmental conditions can have an effect as well.
You need, therefore, to ensure that the conditions are right for the change agent to
have the desired effect.
Very often a new CEO and/or senior managers are recruited to effect change, to act as a
catalyst and change the working environment. Companies also seek assistance from outside
agents or consultants who have not absorbed its current culture or values and can offer
alternatives routes for accomplishing the same change.
However, it is not always necessary to recruit new management it may be that an existing
enlightened manager who is able to look beyond traditional approaches can have the same
effect.
Schein describes the role of change agent as follows:
".to help the organisation to solve its own problems by making it aware of organisational
processes, of the consequences of these processes, and of the mechanisms by which they
may be changed. The ultimate concern is for the organisation's capacity to do for itself what
he/she has done for it."
The role of the change agent, then, is not to solve problems, but to be a facilitator, helping
the organisation to discover how to solve them itself. The change agent is there to set in
motion the collection of information and the building of models for the organisation, prior to
indicating where intervention may be of use. The agent is also there to decide which
techniques are the right ones to use in a particular situation and to guide their use.
The change agent is also a powerful intervention tool, acting as a trigger for action. Much of
their influence springs from the way they relate to the organisation. Therefore, they must live
the values they are trying to implant.
Change Agent Programmes
Some companies develop change agent programmes where they bring together a group of
people who are given specific training and tasks to assist the organisation in making the
planned change.
Change agents are leaders who work across the organisation and its business units and are
not limited by the traditional organisational structure. These employees are freed from day-
to-day tasks in order to focus solely on leading and driving change. They implement new
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processes, directly or indirectly, train employees on new procedures and act as role models
to demonstrate new and better ways to work.
Change agents might spend most of their time visiting areas undergoing change, auditing
progress, or advising managers on how to improve performance. A change agent
programme requires:
careful recruitment and development of personnel
close integration between the change agent team and the organisational areas
targeted for transformation
highly detailed programme design.
Stakeholders and Change
Stakeholders also have a role to play in change, including:
shareholders
managers
employees
customers
the wider community whose lives are affected by the organisation.
The role of managers, employees and customers was considered earlier. It is not so widely
recognised that shareholders and the community can impose a lot of pressure on an
organisation to change working practices.
(a) Shareholders
Shareholders have control of strategic resources and can remove or increase the
supply of money to the organisation. They can bring pressure to bear through:
their voting power at Annual General Meetings, both with resolutions supporting
(or otherwise) change and the appointment of directors who will ensure that their
will is put into effect
their financial power by disposing of their shareholdings and precipitating
reductions in share prices.
In these ways they act as a controlling influence on what the business is able to do.
(b) Community
The members of the wider community have a political role to play. This is clear where
governmental organisations are involved and they can vote for or against particular
policies and proposals on spending, etc. Public pressure can also be a strong factor,
preventing or pushing for change in policies and plans. This can be effective on private
companies as well, particularly where communities feel their environment is
threatened.
Think Point
You should now reflect on the issue of change in the organisation in which you work, or one
in which you have worked recently. Think through the following questions so that you have
some of your own examples of change and the way in which organisations handle it.
(a) What changes have you witnessed in your organisation in the past two years?
(b) What were the main aspects of the change?
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(c) How many of these changes do you feel were a result of what was happening outside
the organisation?
(d) How has the organisation handled the change?
There are obviously no right or wrong answers to this as it will depend on your particular
circumstances. However, think carefully about where the pressure for change came from.
Where it came from external factors, consider how PEST analysis can help to classify it for
eaxmple, economic factors such as the credit crunch or social factors such as the growing
importance of corporate social responsibility. What changes were proposed in terms of the
internal organisation and what issues arose because of this (for example, the threat of
people losing their jobs), or was the response to the pressure to change made in respect of,
say, adapting existing products to meet new customer needs or by raising prices.
How well the organisation handled the change will again depend on your own perception, but
do you yhink it was successful or not, and why? How was the change was managed
compared to the methods mentioned here, and would some of these have supported a
smooother transition?

Acti vi ty 3
Finally in this chapter, we present a short case study of the development of Lenovo, the
Chinese computer company we introduced earlier. Consider the following summary of its
development and then answer the questions that follow.
In 1984, 11 entrepreneurs had a vision to bring the advantages of information
technology to the Chinese people. With approximately US$25,000 to invest and
the determination to turn their research into successful products, this team
opened their business in a rented bungalow. Today it is one of the largest
technology firms in the world.
Its founder, Liu Chuanzhi, was determined and politically shrewd. Mr. Liu and his
colleagues had no experience of running a private company, no idea about
modern computers and a formal education that had been cut short by the Cultural
Revolution. As they built Lenovo, they had to teach not just themselves, but a
generation of Chinese bureaucrats how to run and regulate a private corporation.
Much of the credit for Lenovo's success is given to Mr. Liu, who pushed
boundaries while staying just the right side of the ideological line. The solutions
found to the various problems of the company's development changed the way
China does business.
Mr. Liu launched incentive schemes and share options to motivate Lenovo's staff,
handing out suitcases of cash (and risking imprisonment to avoid the
government's 300% tax on bonus payments). He applied pressure for employees
to own their own homes, a revolutionary initiative in 1992. Lenovo was the first
Chinese company to create advertisements that did more than just name a
product and its price, so introducing brand building to China. Though urged to
develop a Chinese chip and fight Western competitors on quality, Mr. Liu
resisted. Seeing that Chinese science lagged behind, he focused instead on
cutting prices and copying Western technology and sales methods.
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Questions
(a) List Lenovos internal strengths and weaknesses when it started its business in 1984?
(b) How did the external environment impact on the decisions the company had to make
about the way it ran and expanded the business?
(c) What were the biggest challenges for Mr Wu in changing the Chinese business model?
(d) What lessons about managing change can be drawn from this case study?


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SUMMARY
In order to survive and prosper, organisations must be aware of the need to effectively
organise their internal resources to maximise performance.
The internal structure chosen will depend on the organisation's purpose, size and owner
preferences. All organisations will develop structures based to some degree on functional
specialisation, but alternative groupings are possible based on geographical location or
types of production or service. Matrix and project structures both involve different levels of
employees from diverse functional groups coming together for a specific purpose.
Structures may be tall or flat. A tall structure has many hierarchical levels and is found most
often in large scale organisations, including many in the public sector. Communication is
likely to be poor and decision making is slow. A flat structure has fewer layers so
communication will be better and decision making faster. However a manager will have
more subordinates to manage that is, a wider span of control.
There is a basic distinction between line and staff relationships.
The line relationship is one of a hierarchy of management where subordinates report
directly to higher ranking managers and there is a clear line of management
responsibility. Information flows both ways through this line, from top to bottom of the
organisation.
Staff relationships refer to the exercise of management authority or advice from outside
of the line management. This is usually where authority stems from specialist
professional knowledge or skills.
The external environment also influences the way in which the business is run, but is harder
to control as it comprises forces that the organisation can only usually minimise by adopting
appropriate practices. These forces are political, economic, social and technological. They
will vary at different time periods and their nature will often depend on location. The impact
of these forces requires organisations to change if they wish to have continued success.
Change is a continuous process for business today. However, there is often significant
resistance to change for reasons such as:
Uncertainly
Poor communication
Perceived loss of power or authority
Lack of understanding of the need for change
Social working implications.
To be successful change needs to be managed carefully.
Devise a change plan
Involve Human Resources and the unions in devising the plan
Communicate the need for change to employees
Actively involve employees in planning the change by instigating activities that will help
them to:
(i) Accept the need
(ii) Provide ideas for making the change
(iii) Gain their commitment
Employ a change agent to assist with the implementation.
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Activity 1
(a) Tall structures are traditionally found in large organisations, particularly those where
there are strong bureaucracies such as government establishments and possibly
former government firms that have been privatised, for instance telephone and rail
companies. However, this is becoming less common now.
(b) Flat structures are most often associated with small companies, particularly those in the
creative industries such as advertising and design, and with IT companies.

Activity 2
(a) Examples of the factors for and against the change might include the following:
For: Against:
Lower cost of labour
Lower cost of resources
Better distribution centre for
global sales
Better skills in the production
process
Quality
Lack of management control
from the centre
Loss of jobs in home country
Communication
Potential political risk
Financial risk

The answer will depend on the list you generate. In the above list, there are more
negatives that positives and some negatives seem particularly important such as risk
and quality. However, it may be that high quality is not so important and the country is
fairly low risk.
(c) The company could instigate a joint venture or licensing agreement with a company in
the cheaper country, which would reduce both sets of risk and possibly communication
and control problems. The company could also put in a quality control system that
could monitor the quality of products from the home country. Either of these initiatives
would reduce the negatives.

Activity 3
(a) The strengths included:
Entrepreneurship and innovation
Vision of the future opportunities
Flexible working and excellent communication
Current knowledge of the technology
Working capital without borrowing.
The weaknesses included poor knowledge of business techniques in terms of how to
turn their research and knowledge base into a successful commercial product for
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example, marketing, allocation of financial resources, management structures and
organisation.
(b) We can see from the case study that three of the four PEST factors were in evidence:
The political environment, with a high level of State control, was not supportive of
such a development. This meant that political risk was high.
Economic factors linked with this, limiting the way in which employees could be
rewarded through bonuses.
Technology in China was limited and advances were not appreciated by the
State.
(c) Mr Liu had to find ways around the problems involving introducing capitalist schemes
such as share incentives and cash bonuses which were, at the time, illegal.
(d) We can see the practical application of both Lewins Force Field or Scheins models in
the way in which Mr Liu addressed the problems. He had to unfreeze the existing ways
of operating and did this by finding methods which reduced the negative forces holding
back the development of his company and promoted the greater commitment and
flexibility needed to fuel change.
We can also see how a change agent, in this case a single person, can be effective in
even the most difficult environmental situation.

57
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Chapter 3
Strategic Choices

Contents Page
Introduction 58
A. The Life Cycle Concept 58
B. The Nature of Strategic Management 59
The Strategic Planning Format 60
C. Anal ysis of the Business Environment 64
SWOT Analysis Strengths and Weaknesses 66
GAP Analysis 68
Value Chain Analysis 69
SWOT Analysis Opportunities and Threats 70
PEST, PESTLE or STEEPLE Analysis 71
Competitor and Market Analysis 75
Benchmarking 78
D. Organisational Growth 80
Advantages and Disadvantages of Small and Large Businesses 80
Growing the Business 83
Financing Growth 84
Summary 88

58 Strategic Choices
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INTRODUCTION
This chapter is concerned with the decisions organisations make and how these change
during the firms life cycle.
When an organisation starts in business it will usually have values that it wishes to operate
by and these will very much influence its strategic choices. The values will not be the same
for every organisation and neither will its goals. We examine profit and not-for-profit
organisations to establish what the difference in their values and hence their strategic
choices may be.
We look at the influence of internal factors the strengths, weaknesses, competences and
capabilities and how these affect what an organisation does and how it operates. The
external environment will also affect the firms choices and in many ways, these will be out of
its control. We examine the opportunities provided by the external environment as well as
the threats to its continued survival.
Not many companies will be able to ignore competitors and what they are doing. Examining
the competition, to assess how to reach organisational goals, is a vital step to take in the
strategic plan and helps to enhance business performance. Michael Porter is the leading
guru in this area, but we also look at the merits of benchmarking as a strategy.
As small firms become more successful they make the choice of whether to grow bigger or
remain as a small business. There are pros and cons to both alternatives and if growth is the
chosen route, the firm needs to determine how best to structure and finance it. At the end of
the chapter, we evaluate growth options and the financing methods which underpin them.
A. THE LIFE CYCLE CONCEPT
The concept of a product life cycle used in marketing is familiar to many students and
practitioners. There are commonly four phases used to describe the way in which a product
is developed and sold within a market launch, growth, maturity and decline.
Organisations also have a similar life cycle, but with five phases:
Figure 3.1: The Business Life Cycle

Market
size
Time
Maturity
Decline
Growth
Slow growth
Development
Strategic Choices 59
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This life cycle represents the progress of the company slow development with low market
share, followed by rapid growth, then growth slows as the organisation matures and
eventually declines.
We can illustrate this process by considering the case of Xerox.
Xeroxs history from 1947 - 1980 demonstrates the phases of the industry life cycle well. It
was originally formed in 1908 and produced photographic paper, but it was not until it
became the market leader in plain paper copying in 1960s that is growth became
outstanding. It reached the mature state probably in early 1970s. In 1977 its patents ran out
and competition became fierce so that by the 1980s its market share had declined
significantly.
However, some large companies which have moved into decline, have managed to regain
their industry position, at least in part, after some years. This was the case with Xerox which
revived its fortunes by becoming The Document Company in the 1990s and later adapted its
model to become an outsourcing business. In early 2000, the company went into
administration in the US and was in danger of bankruptcy. Once again it managed to
reinvent itself into what is again a thriving company.
At each stage in its life cycle, a company will make different choices about how it drives its
business forward, as we can again illustrate with Xerox:
In the early development stage, a new company will be innovative and seek to
differentiate itself from the competition in its market sector. In this stage, Xerox
developed its patents which gave it a competitive advantage and allowed it to start its
growth.
During its growth it was able to demand its own price as competitors were unable
compete owing to patent protection (high barrier to entry) and customers were forced to
pay the high price demanded. It thus underwent massive growth in the 1960s and
early 1970s, and by the late 1970s it was in the mature stage.
However, with its patents running out, competition entered the market. Barriers to entry
fell significantly, prices reduced and competitors were now able to produce plain paper
copiers with superior features. Xerox did not foresee this change in the environment in
time and it passed its decline stage without realising it was happening.
A new set of strategic choices was required, as its purpose turned to finding a way to
survive in a different market environment.
B. THE NATURE OF STRATEGIC MANAGEMENT
The Xerox example demonstrates the constant need to monitor the external environment and
make changes to its strategic direction to survive. It also reinforces the need to make
different choices about how to manage business success over the life of the business,
involving different types of decisions at different periods.
As you will have already noticed, every organisations decisions are influenced by a number
of factors:
Its purpose
The external environment
The internal environment
The stage in its life cycle.
Strategic management is concerned with deciding on the organisations long term goal and
making choices about how to achieve that goal within the parameters in which it is working
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that is, deciding what strategy to pursue. Each firm will have a different set of parameters as
the factors listed above will all vary considerably in every case. So, for example, as we
discussed in Chapter 1, the business aims could be maximising:
profit
market share
revenue share
product development
growth
social, environmental or ethical outcomes.
The Strategic Planning Format
This involves a number of steps:
Mission Statement

Vision Statement

Values

Objectives

Implementation

Monitoring/Control/Review
(a) Mission, Vision and Values
We shall consider the first three steps together as they are closely interrelated.
The mission statement expresses the organisations overall business purpose.
This is the starting point in the planning process.
The vision statement sets down what the organisation's aspirations are in other
words, what it wants to achieve in the foreseeable future.
The values are the principles the company and its employees must work within,
as it attempts to achieve its vision.
These tend to be fixed for a number of years before the organisation may want to
reconsider them in the light of the parameters within which it is now operating.
Most organisations will spend some time formalising their mission, vision and values
and will often write them out as documented statements for all their stakeholders to
see. However, some organisations find these difficult to express and it is only by their
actions that we can try to establish the purpose, aims and values.
We can illustrate these key elements in the strategic planning process by considering
three examples:
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Xerox
Mission and vision statement:
"Through the world's leading technology and services in business process and
document management, we're at the heart of enterprises small to large, giving our
clients the freedom to focus on what matters most: their real business."
Core values:
"One thing that never changes is our core values:
We succeed through satisfied customers
We deliver quality and excellence in all we do
We require premium return on assets
We use technology to develop market leadership
We value our employees
We behave responsibly as a corporate citizen."
Lambeth National Health Service (London)
Mission and vision:
"Our mission is to improve health throughout the diverse communities we serve
and ensure access to consistently safe and effective services which provide an
excellent experience for users."
"Our vision reflects our commitments to improve health and well-being and to
reduce health inequalities."
"Lambeth NHS, as a non-profit organisation, is focused on doing good in the
community."
Google
Mission:
"To organise the worlds information and make it universally accessible and
useful."
Think Point
What differences do you notice in the mission, vision and values of these three
organisations?

Xerox has a "for profit" type of mission and vision, focused on revenue generation and
business to business activity. It publishes these statements given on its website and,
from these, you could relatively easily evaluate Xeroxs business actions and determine
whether it meets its own written standards.
Lambeth NHS does not state what its core values are in its strategy document, but
relies on a generalised "doing good" approach. Do you notice the differences in
emphasis of this public sector organisation compared with a large private sector
corporation? It is often more difficult for not-for-profit to make precise statements since
they serve a variety of stakeholders.
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Google gives little information except that it appears to have a more philanthropic
mission than the standard for profit firm. Its mission is published on the investor area
of its website, but there is no vision statement or list of values. It states values
occasionally in other text (where one of these is "teamwork"), but does not make a
conventional statement.
For profit organisations' missions and visions are likely to be based on shareholder
value or revenue generation, although some commercial companies in Asia Pacific, for
example, have purposes which are nearer to that of not-for-profit organisations in the
West such as the NHS.
Acti vi ty 1
Find out what the mission, vision and core values of your own organisation are (or those of
an organisation you have worked for or studied with)? Are they stated explicitly in documents
and, if so, how widely available are they? Are the organisation's stakeholders aware of
them?
What are the main differences between the mission, vision and core values of your
organisation and those of Xerox and of Lambeth NHS? Can you explain why they should be
different?

(b) Setting Objectives
Following on from the establishment of the mission, vision and values for the
organisation, the next stage is to set objectives. These are very specific statements of
what the organisation wants to achieve in a stated period of time, in order to realise its
mission and in accordance with its vision and values.
Objectives mean very little if they are not SMART objectives:
Specific stating exactly what is to be accomplished
Measurable how progress will be quantified
Achievable realistic, it is possible to achieve the goal
Results orientated it is focused toward getting the result stated
Time bound within what time scale.
Acti vi ty 2
A company might state that it wishes to improve sales of product X by 10% by the end of the
quarter.
Is this a SMART objective?

When a company is planning its objectives it cannot do this in isolation. It must take
into account a number of factors such as:
its resources and competences
its weaknesses
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the external environment
competitors.
We will examine these factors in more detail in the next section of this chapter.
In setting objectives, there are two important aspects to consider:
(i) Ensuring that the whole organisation understands and is geared towards
achievement of the objectives.
One problem can be that employees at lower levels of the firms hierarchy may
not understand the contribution they can make to the accomplishing the firms
objectives, and not be fully committed to them. This may be overcome by
involving employees in the planning process seeking their contribution in
actually structuring the strategic plan. This approach bottom-up planning as
opposed to top-down (imposed from above) often results in generating new and
more practicable solutions.
(ii) Building in flexibility objectives should be flexible enough to be modified.
To allow innovation to occur. If the objectives and/or their implementation
are too rigid there will be no opportunity to take advantage of innovative
ideas that might occur, owing to changes in the internal or external
environment. For example, a new manager is recruited and has some
useful new ideas or an existing member of staff contributes an idea to save
resources.
To respond to the business environment. Organisations operate in a very
turbulent environment and changes in interest rates, regulations,
government policy, etc. can impact on the original objectives in a positive or
negative way. The organisation needs to be able to adapt its objectives to
minimise the potential damage of negative changes in the environment or
to maximise opportunities.
(c) Implementing the Strategy
Once the objectives have been agreed, resources will need to be allocated to achieve
them. Thus, financial objectives will be set and resource levels agreed.
All employees will need to be briefed on what the organisations objectives are and
what their part will be in accomplishing the stated outcomes. In some organisations,
there is an Annual Conference where employees are able to share the strategic goals
for the year, discuss in groups how they will be achieved and celebrate success of the
previous years plan. This type of approach helps in communicating and implementing
the firms targets.
Ensuring appropriate resource levels for the of the objectives may also involve some
training and development of staff, in order to ensure there is the necessary skills and
knowledge profile required to enable specified goals to be met.
(d) Monitoring and Control
Progress towards achievement of objectives needs to be constantly monitored, with the
extent of progress, against set goals, measured at regular intervals.
The firm should have a monitoring mechanism with specified measurement tools and
time periods. There are many different types of monitoring mechanisms that can be
used, separately or together. Examples include:

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Budgets
Quality control
Balanced scorecard
Customer feedback
Change in market share
Employee feedback.
Monitoring systems are vital to the achievement of goals. The organisation needs to
measure progress and either address problems in implementation which are preventing
the achievement, or amend the objectives themselves if the set goals do not appear to
be feasible and/or to take advantages of new opportunities to exceed the stated
outcomes.
However, before the firm can get to this stage, it needs to carry out an analysis of its
environment to enable it to set appropriate, SMART objectives.
C. ANALYSIS OF THE BUSINESS ENVIRONMENT
For all organisations, setting objectives is a significant task. They provide a framework for
achieving goals within the core values they commit to, whether these are expressed or
intuitive.
Large companies and public sector bodies very often use an annual planning cycle, which
begins with trying to make sense of the multitude of factors that could positively and
negatively affect their potential to be successful.
There are a variety of standard techniques for carrying out the process.
SWOT Analysis
PEST/PESTEL or STEEPLE Analysis
Competitor Analysis
Benchmarking.
Note that many organisations, particularly smaller ones, do not always do these consciously
or in a formal manner, but carry out certain parts of the process in an informal way.
In this section we will look at each of these techniques in turn. One or more of these usually
forms the basis of the choices made by organisations.
We shall start by visualising the organisation as being at the centre of a layered structure
such as an onion, as shown in Figure 3.2.
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Figure 3.2: The Business Environment

The individual firm is a very small part of a much larger sphere of influence which impacts on
the way it manages its internal resources and reacts to changes that occur in that external
environment. In many cases the organisation has little control over its environment but must
adapt and make choices about how to adapt so that it can survive and prosper, as discussed
in Chapter 2.
The environment may be divided into the internal and external environments, and different
types of types are appropriate to each. Here we shall examine the following:
The Internal Environment:
SWOT analysis
Gap analysis
Value chain analysis
Macro-environment:
broad environmental factors
Industry or sector influences
Competitor
competences and activities
The
Organisation
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The External Environment:
SWOT analysis (again! we shall consider the differences between internal and
external SWOT below)
PEST, PESTLE or STEEPLE analysis
Competitor and market analysis
Benchmarking
SWOT Analysis Strengths and Weaknesses
SWOT stands for Strengths, Weaknesses, Opportunities and Threats.
Strengths and Weakness refer to the internal environment whereas Opportunities and
Threats focus on the external environment. This difference in focus is often forgotten and
this is one reason why, in this chapter, we will separate the analysis into the two
environments to which the factors relate.
If we think of our own situation for a moment, we can acknowledge our own internal
strengths and weaknesses which impact on our lives, but we need to set these in the context
of the external environment events and situations outside of ourselves before we can see
opportunities for improving our well-being or threats which are present. The same is true of
any organisation.
When we reflect on our own strengths and weaknesses, it is usual to be able to think of lots
of strengths and few weaknesses! We also have to think really hard to find a list of
weaknesses that is as long as the strengths. For example:
Strength Weakness
Hard working Find it difficult to relax
Generous Impatient
Analytical Suspicious
Innovative
Good communicator
Ambitious
Sometimes our strengths can also be weaknesses and vice versa. A person who is
ambitious may not be patient with those who are happy with their life or job and so find it
difficult to build relationships with colleagues at work who do not share their attitude to life. A
suspicious person also may find it difficult to trust others but in some circumstances, this can
be a strength, such as when negotiating for a new apartment with someone you do not know.
A similar situation arises in companies. Imagine a company ABC with a list of strengths and
weaknesses compiled by its managers:
Strength Weakness
Cash rich Technology poor
Innovative Credit control
Sales skills Union strength
Loyal employees Cautious in expansion
Customer service Knowledge management
Market leader in product X
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While this company values "cash rich" as a strength, if the company was a plc this would be
seen as a weakness by financial experts since the cash could be working to improve the
companys performance. Poor credit control may also link with being cash rich and
demonstrates poor use of financial resources.
However, in times of economic downturn, having cash reserves can be vital to the survival of
the company. A cash rich company can be independent and its managers can innovate
without having to answer to shareholders or financial institutions. The Armani business, for
example, is cash rich and run without external loans, allowing Giorgio Armani to make the
business decisions he chooses without pressure from outside. Many Asia Pacific companies
are family run and independent of banks or other lending institutions and operate with a
similar philosophy.
Loyal employees can be a great strength, but they may also be unwilling to change and this
might account for technology being poor. So, is the company innovative or just thinks it is?
Will it lose its market leadership through the weaknesses?
The power and influence of trade unions varies from one organisation to another and from
one country to another. In the UK the role of unions has changed considerably in the past 30
years. Legislation has weakened their power to negotiate national wage rates and to strike.
However, many unions have become involved in assisting with employee development and
working with companies more closely, on health and safety issues for example. Unions also
offer their members access to legal services for issues inside and outside the workplace,
such as personal injuries like deafness from machine noise and road accidents. Hence trade
union presence may add a strength to the organisation rather than be perceived as a
weakness. On the other hand, in some countries, unions are more powerful, particularly
where employee working conditions are poor, and their power can be perceived as being a
weakness in terms of potential threat to the organisations business performance.
The level of technological competence and capability is an increasingly necessary strength
within the majority of organisations. It is not only important in production, but in sales and
marketing, value chain and general communication. The internal technological competence
that is a strength today can quickly transform into a weakness.
Thus, in carrying out the internal analysis, the group responsible for doing so must look at the
list they produce objectively some weaknesses can also be strengths and vice versa.
If the organisation is to produce an analysis of its internal environment that will help it to
plan for the future, being objective is crucial.
Organisations must seek to build on their strengths and reduce weaknesses to improve
future performance.
Competences and Capabilities
In the table of strengths and weaknesses, a few skills have been mentioned. These would
be termed as competences or capabilities which assist the organisation to be competitive.
When analysing organisations using case studies, we need to identify the capabilities so that
we can assess the potential for competitive advantage. Examples of organisational
competences/capabilities are:
Marketing
Customer service
Strength of value chain
Financial capability
Talent management
Innovation.
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In the Italian fashion industry, for example, design and marketing are two of its core
competences.
The sustainability of these competences must be monitored if the company is to continue to
thrive they may need to be updated. For example:
Companies that have talent management competence will be constantly appraising
employee development issues, to ensure that training and development initiatives
provide the staff with skills to make a difference to performance. Loss of key
employees may well cause a decline in a core competence such as technical expertise.
Organisations are constantly seeking to improve the value chain by cutting costs,
reducing the time between manufacture and delivery to the customer and so on.
Organisations that have patented products or services will have capability to
differentiate themselves from their competitors. On expiry of these patents, the
organisation can be vulnerable to the external competition, as was Xerox in 1977.
Capability through patents rights may not be sustainable and ultimately become a
weakness.
GAP Analysis
At its simplest, this planning activity is a case of establishing where the organisation is now
and where it would like to be in the future and examining how to close the gap. For example,
if an organisation manufactures 5,000 units and makes a profit of 50,000, what must it do to
manufacture the same number of units and make a profit of 55,000.
The gap is 5000 profit. How could the present operation be changed to meet this goal and
what is realistic? There are many alternatives to examine to close the gap for example:
Cut costs
Increase prices
Improve manufacturing techniques
Reduce waste
Reduce cost of materials by negotiating with suppliers
Reduce marketing/administrations costs.
The technique can be used in any area of the business to improve on the present situation.
It just needs the identification of the key gaps which are holding back the achievement of
objectives. Examples are:
In marketing increasing market share
In HR assessing employee skills now and those that will be needed in the future.
Acti vi ty 3
Imagine you want to start a business now offering web design to small companies and make
a profit of 6,000 by the end of your first year.
Make a list of what skills and physical resources you are likely to require.
What might be your strengths and weaknesses in terms of reaching this goal?
What activities and resources will you need to employ to allow you to reach your goal?

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Value Chain Analysis
The value chain is a term used to describe the way in which an organisation links together all
the activities that form part of producing a product or service and delivering it to the
customer. It is a capability (or a competitive strength) if the organisation can do this as
effectively as possible so that its product of service is of the highest quality, delivered in the
shortest and most effective manner. Therefore, organisations examine every aspect in their
process to try to find cost or efficiency savings or enhancements to improve the linkages.
Michael Porter developed this concept in regard to manufacturing systems. He used the
term 'value activities' to describe the different identifiable activities of which any business is a
collection, such as procurement, marketing, production, etc., and suggested that, by
examining effectiveness at each individual level, rather than at whole company level,
competitive advantage is achieved.
Porter classified these activities as either primary or secondary (support). These are shown
in the diagram below:
Figure 3.3: Michael Porter's Value Chain

(a) Primary Activities
These are:
Inbound logistics receiving, storing and distributing inputs
Operators which turn these inputs into the final product or service
Outbound logistics storage and distribution to consumers
Marketing and sales which make consumers aware of the products or services
available
Service installation and after-sales servicing.
Company infrastructure
Human resource management
Technology development
Procurement
Inbound
logistics
Operations Service
Outbound
logistics
Marketing
& Sales
Margin
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(b) Secondary Activities
These provide the infrastructure that enables the primary activities to take place and
are:
Infrastructure systems vital to the organisation's strategic capability, which
usually support the whole chain, such as planning, finance, quality management
Human resource management recruitment, training, development, etc.
Resource and technology product or process development, etc.
Procurement acquisition of the necessary resource inputs to the primary
activities.
Few organisations will be able to complete all the value chain functions in house and
may be part of a larger value network.
In deciding how this will work most effectively, the firm must assess in which parts of
the value chain it has most expertise and then find other organisations to work with it to
set up an efficient and effective network.
Firms may outsource certain activities because it is cheaper to do so or the external
organisation has greater expertise.
Organisations often ultimately acquire companies that are originally part of their value
network in an attempt to improve the value chain. For example, Coca Cola acquired
bottling operations in North America in 2010, in an attempt to maintain its leadership
position in response to Pepsicos acquisition of its bottlers earlier. The value chain is
now considered one of the most important sources of competitive advantage.
SWOT Analysis Opportunities and Threats
We now turn our attention to the forms of analyses appropriate to the external environment
that are considered in strategic planning, starting with the second part of the SWOT analysis
opportunities and threats.
Our imaginary company, ABC, might evaluate its external environment as having
opportunities and threats such as those set out in the following table.
Opportunities Threats
New markets for product X owing
to closure of major competitor
Decrease in rate of value added
tax, more sales
Initiate e-marketing to improve
sales levels and margins
Acquire local supplier of
components
New packaging methodology to
reduce costs and improve image
New skills owing to acquisition.
Changes in employment law
increasing costs
Employees joining competitors
Lack of skills in workforce
Integration issues.
Again some opportunities also pose threats. Acquiring a supplier may well increase the
efficiency in the value chain and reduce costs, but not if the newly acquired firms employees
cannot adapt to the organisations working practices and/or culture.
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PEST, PESTLE or STEEPLE Analysis
The forces in the external environment which are imposed on a organisation will greatly
affect the way it operates and the choices it makes to improve its business performance.
One way of assessing these is to examine them according to different headings. Initially, this
was known as PEST analysis, looking at the following types of factors:
Political
Economic
Socio-cultural
Technological.
PEST analysis has since evolved to several longer acronyms owing to changes in the nature
of the environmental factors that impact on organisations. It became PESTLE with the
addition of legal and environmental factors and then STEEPLE when ethical factors were
added ethics now have a major impact on strategic choices as organisations seek to adapt
to changing societal and consumer pressure.
Legal
Environmental
Ethical.
(a) Political Factors
This refers to the role of governments and affects all organisations to a certain extent.
Some governments work with a free market policy in which private companies can
thrive while others are under state control. The latter are called planned or command
economies which are state owned and controlled. There are now far fewer global
command economies than in the past, and even China has evolved from being purely
state owned towards a proportion of free market economy in the past two decades.
Since the early 1980s the UK has privatised many former state owned industries such
as electricity, gas, water and railways. However, while this has created more
competition in these fields, there has also been an increase in regulation.
Central and local government that are state owned and are large employers. Any
changes in their policies can have a significant effect on private business. Since the
Government is also a customer of the private firm, shrinking that sector has an impact
on the level of private business operation.
On a national basis, pressure groups exist to influence government and politicians;
their activities can also have a major impact on industries and individual firms.
Government departments frequently consult pressure groups about new regulations
and legislation.
Government policy also has substantial implications for companies wishing to globalise
their operations. Some will insist on very specific conditions for an overseas firm to
operate in their country.
Very often the organisation is faced with increased costs, to comply with new
regulations. For example, in recent years the UK, as a member of the European
Union, has been forced to apply EU Law to working hours and other employment terms
and conditions.
(b) Economic Factors
Economic factors include exchange rates, economic cycles and different growth rates
around the world. Organisations have to be prepared for the risk of exchange rate
changes which, if their currency weakens, makes importing supplies very expensive
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but makes exporting the goods or services offered more attractive to the countries
affected.
(c) Socio-cultural Factors
These influences concern different cultural and demographic factors.
Is the population ageing and how does this impact on the sales of the firms
product or service in that country?
Older age groups generally have the most disposable income. How can the firm
adjust its product or service to maximise revenue from this sector?
How will the demographic change affect employee recruitment? More women
have entered the workforce than in the past and demand for part time jobs has
risen. This has also meant less time being spent on domestic tasks such as
cooking and opened up opportunities for companies to provide larger ranges of
ready-made meals.
Is a change in taste/ingredients necessary in a foodstuff to make it attractive to
people of another culture?
If an organisation is planning to operate part of its business in a new country what
cultural aspects does it need to take into account?
(d) Technology Factors
This is a rapidly changing factor that influences the organisation in a number of ways:
Communication is faster
Operational costs can be reduced as fewer employees are required
New materials developed
Monitor and control of quality of all aspects of the business can be more effective
Technical skills may be needed in the workforce which are not currently available
Growth in e-commerce allows organisations to sell globally without having to set
up operations in all the countries that buy their products. The whole transaction
can be completed online
Virtual working is now normal practice for large numbers of employees and
entrepreneurs.
(e) Legal Factors
This refers to regulation which can be national or regional. An example is recent
Corporate Governance Regulations which governments have applied to organisations
wishing to float shares on the stock exchange.
Health and safety legislation and employment law have been developed in all EU
countries in the last 50 years, and are being continuously extended by the Parliament
in Belgium, resulting in sometimes quite drastic changes in operational costs.
Restrictions on mergers and acquisitions, to prevent the growth of monopolies, and
hence the national and international power of individual large firms, operate in many
developed countries, including the UK and USA.
Governments are increasingly collaborating to produce legislation to reduce global
emissions and regulate financial transactions and reporting.
(f) Environmental Factors
The earth has finite resources which are rapidly diminishing. Organisations are under
a lot of pressure from consumers and governments to conserve resources such as
ABE
water, energy and raw materials. In addition, the manufacturing process can cause the
emission of harmful substances into the air, rivers and rubbish dumps.
Many large and small organisations have green corporate policies which state their
specific commitment to effective use of resources and responsibility in their interaction
with the environment. Such policies can have the effect of making their products more
attractive to some consumers, acting effectively as a strategic marketing tactic. In
many cases, these policies also allow the organisation to reduce costs, for example, by
recycling waste or pursuing research to reduce the proportion of raw materials required
to produce a product.
(g) Ethical Factors
These concerns have always been present internally and externally for example:
How does a company treat its employees?
Does the company deal with corrupt governments?
Is it considered ethical to use child labour?
Nations and regions of the world have different ethical principles, some of which are
based on their cultures.
Organisations planning their business strategy may have to take into account cultural
ethical differences, but may also have a policy which states what they stand for and so,
ethically, the types of business practice they will not engage in.
Large multinationals such as Coca Cola have published Corporate Governance and
Ethics Policies that their employees and suppliers must adhere to.
We now present an outline STEEPLE analysis for you to consider the range of factors
covered.
ABE
Example - STEEPLE for Beverage Industry
Political
Does the government own a share in a national beverage organisation
Is the government a stable one?
Government support for overseas investment
Economic
Disposable income available
Economies of scale possible
National growth rate
Favourable interest or exchange rate
Social
What kind of products will appeal to the various age groups
Environmental
Use of water in process
Ingredients are a health hazard
Raw material wastage including packaging
Technological
Collecting data from drinks machines to measure popularity
Lean manufacturing to reduce costs
Quality monitoring and control
R&D advances for packaging, new drinks
Ethical
High sugar and calorie drinks offered to poor countries
Consumption of water that is needed for growing food
Using cheap labour in emerging countries
Legal
Level of undesirable contents in drinks
Quality controls standards
Restrictions on mergers/acquisitions
Acti vi ty 4
Think about the car industry and make a list of the STEEPLE factors that might affect the
strategic choices of a car manufacturer. What changes might you see in that list in 10 years
time?

ABE
Competitor and Market Analysis
The macro environment affects every organisation to differing degrees and they have little
control over many aspects of it. The factor of competition in their industry sector, and more
particularly their category within the industry sector, is perhaps the most influential on their
strategic plan.
Most for-profit organisations have a purpose which involves being more effective than the
competition in some way, whether that purpose is maximising shareholder value, sales
revenue, market share or having a technologically superior product. In addition, public sector
bodies are increasingly being tasked by their governments to adopt for-profit techniques and
are sometimes in competition with private firms for contracts. Thus, local colleges compete
for training business with private training companies, or hiring premises for conferences and
business meetings in competition with hotels or conference centres.
When planning, strategy managers will analyse what the competitors are doing and try to
make those choices which will give them the best chance of succeeding, despite the
activities of competitors.
A number of techniques, or tools, have been developed for this purpose and we shall look at
two here, developed by Porter, before moving on to examine the similar technique of
benchmarking.
Porters Five Forces
According to Porter, firms must decide the section of the market they wish to exploit. Initially
Porter built the model to assess profit potential within an industry but the model has
developed into a tool for examining the forces of competition in a specific industry. Doing this
enables managers to identify a firms opportunities and protect it against threats.
The five forces are:
(i) The power of buyers
(ii) The power of suppliers
(iii) Threat of substitutes
(iv) Threat of new entrants
(v) Extent of competitive rivalry.
Figure 3.4: Porter's Five Forces Model

Bargaining power of suppliers Threat from new entrants
Potential Entrants Suppliers
Industry
Competitors

Rivalry between
existing firms
Bargaining power of buyers Threat of substitutes
Substitutes Buyers
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(a) The Power of Buyers
The power of buyers will be high when:
A few organisations, able to buy in large quantities, will be able to negotiate
heavily on price by promise of a secure contract, squeezing the firms profit
margin and demanding high quality
The cost of switching to another company is low i.e. it does not cost the buyer
to change its process or machinery
The buyer could produce the product or service themselves and result in closure
of the supplier
There are many other suppliers in the same business so finding alternative
suppliers is easy. If the purchase has specific qualities, then the buyer will be
less powerful.
Large organisations who buy products, services or components from a firm also have
the buying power to force down the price they pay, reducing the supplier organisations
profits.
(b) The Power of Suppliers
If your organisation is buying components or services from a supplier, supplier power
will be high and affect the cost structure of the organisation dramatically in the following
cases:
There are few suppliers in the market in which case, you will be forced to pay a
higher price than if there was a wide choice of suppliers for a component or
service since there is little ability to switch suppliers
Switching costs may be high
There are no alternative suppliers
Supplies are a large part of the firms product or service cost.
Looking back at our Xerox example earlier, prior to 1977 the company had immense
power as a supplier there were no other suppliers of plain paper copiers in the
market, alternatives (coated paper copiers) were both expensive and copies were of
low quality. Once the patent ran out, Xeroxs power as a supplier dwindled as there
were a lot of suppliers available. The power of buyers became stronger.
(c) Threat of Substitutes
If the firm produces a product or service that is unique and/or makes large profits, there
will be a huge threat from new entrants, attracted by profit margins, offering substitute
products.
The business needs to be aware of:
The ease and extent of cost for a customer to switch to a substitute product
The threat from competitors bringing out a more advanced or technically superior
product
The impact of substitutes on the price they can charge.
Xeroxs business came under immense threat from substitutes in 1977 because:
Most of its machines were rented, so the cost of switching was low
The majority of substitutes were technically superior
The pricing was cheaper so that the new suppliers could gain quick entry to the
plain paper copier market.
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(d) Threat of New Entrants
This threat will be greatest to the existing firm if barriers to entry are low, such as:
Lack of patents required
Low set up costs
Product is not unique or technically sophisticated
Low brand identity.
Any one company trying to set up a plain paper copier company prior to 1977 would
have experienced impossible barriers to entry. Apart from having the patent, the brand
identity is so immense that Xeroxing is still the term used by many when discussing
taking a photocopy.
(e) Extent of Competitive Rivalry
The threat of a large number of competitors in a firms market will depend of the extent
of the factors listed above. If there is a low barrier to entry, this will encourage new
entrants to attempt to compete in the market with a substitute product. The result will
be more suppliers, so the power of buyers will be increased.
Competitive rivals have similar products and services and the same groups of
customers.
As well as the four factors listed above, rivalry will also be enhanced if:
There are many competitors of similar size operating in the same market
Products or services are similar then buyers can easily and cheaply switch
suppliers for example, supermarket rivals
There is low growth in a market and price competition is strong, this results in low
profits and companies leaving the market
The business has high fixed costs it will need to keep volumes high to make a
reasonable amount of profit and may therefore cut prices to make volume sales
Barriers to exit are high, companies will try to survive in a downturn by cutting
costs owing to excess capacity in the market.
This type of analysis should allow an organisation to assess:
(a) The type of industry it should target or leave when making its strategic choices.
The industries where the five forces tend to work for them.
(b) How the organisation can raise barriers to entry to prevent others gaining their market
share through:
Brand awareness and loyalty
Reducing the power of suppliers to reduce costs
Increasing R & D to improve products
Exceptional after sales service
Exceptional ethics and corporate responsibility to build customer loyalty.
(c) How badly its competitors are affected by the changes in the industry structure.
In economic downturn, some larger organisations could be hit badly because of
large fixed costs whereas a small one can be more flexible
Large organisations may be able to withstand increased buyer power compared
with smaller firms.
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Porters Generic Strategies
When companies enter a market or reassess their competitive strategy, according to Porter
they have three choices.
This model claims that there are only three main strategies a business can follow:
Cost leadership
Differentiation
Niche/Focus.
A business which followed none of these strategies would become "stuck in the middle".
Figure 3.5: Porter's Generic Strategy Model

(a) Strategy 1: Cost Leadership
The company aims to produce in large quantities, at the lowest cost possible and sell at
lower prices than the competition. By doing this it can capitalise on economies of scale
and defeat any competitor who has not got equal production capacity, or who can keep
prices to a minimum. This strategy will also attract price-sensitive buyers away from
the competition.
(b) Strategy 2: Differentiation
This strategy involves offering some unique selling (or service) proposition (USP) that
the competition do not have. Prices may not be too important to buyers of products
sold under this strategy and it often follows that customers become brand or product
loyal.
(c) Strategy 3: Focus/Niche
The company aims at very select market sectors and will be charging higher prices or
offer special USPs. The company can concentrate on its key products for specific
targets, acquire a reputation for being "specialist", or can simply attack sectors of the
market which are being ignored by the competition.
Porter's strategy model allows a company to decide which overall "type" of marketing they
want to adopt. If the firm is powerful and rich in resources they may well choose to follow a
Cost Leadership or Differentiated strategy. Smaller firms may be forced to adopt a Niche
strategy because their product offering has a very specific market.
Benchmarking
There are several approaches to benchmarking that allow strategic planners to make choices
about their future actions.
Cost Leadership Focus
Stuck
With No
Clear
Strategy
Differentiation
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Historical benchmarking
This is reflecting on performance in previous years to identify any changes that need
making. The issue with this technique is that it is subjective and may leave an
organisation feeling complacent. It is not actively looking externally to judge what
changes competitors may be taking or how the external environment could impact on
the organisation in the future.
Comparing with others in the same industry or sector
This is also limited in so far as, if the whole industry is not performing well, then
complacency could set in. Other firms which are not currently active in that industry
sector may enter as they can meet customer needs more satisfactorily.
Benchmarking against best in class
This can be done irrespective of the industry. Xerox actually revived this kind of
benchmarking in the 1980s when its quality had declined. It chose best organisation in
class and went out to observe how they operated, as shown by the following example.
Case Study 1: Benchmarking at Xerox
The 'Leadership through Quality' programme introduced by the new CEO revitalised
the company. The programme encouraged Xerox to find ways to reduce their
manufacturing costs. Benchmarking against J apanese competitors, Xerox found out
that it took twice as long as its J apanese competitors to bring a product to market, five
times the number of engineers, four times the number of design changes, and three
times the design costs.
The company also found that the J apanese could produce, ship and sell units for about
the same amount that it cost Xerox just to manufacture them. In addition, Xerox's
products had over 30,000 defective parts per million about 30 times more than its
competitors. Benchmarking also revealed that Xerox would need an 18% annual
productivity growth rate for five consecutive years to catch up with the J apanese. After
an initial period of denial, Xerox managers accepted the reality.
Following this, Xerox defined benchmarking as 'the process of measuring its products,
services, and practices against its toughest competitors, identifying the gaps and
establishing goals. Our goal is always to achieve superiority in quality, product
reliability and cost.' Gradually, Xerox developed its own benchmarking model. This
model involved tens steps, categorised under five stages planning, analysis,
integration, action and maturity. Xerox collected data on key processes of best
practice companies. These critical processes were then analysed to identify and
define improvement opportunities. As a result of its benchmarking in J apan, Xerox
eventually developed a completely new copying process by creatively improving on the
concepts it had learned from its chief competitors. Xerox went on to become the only
company worldwide to win all the three prestigious quality awards: the Deming Award
(J apan) in 1980, the Malcolm Baldridge National Quality Award in 1989 and the
European Quality Award in 1992.
The success of benchmarking at Xerox motivated many companies to adopt
benchmarking. By the mid 1990s, hundreds of companies implemented benchmarking
practices at their divisions across the world. These included leading companies like
Ford, AT&T, IBM, GE, Motorola and Citicorp
Adapted from www.improvementandinnovation.com

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Xeroxs benchmarking model is now taught in business schools and regularly used by
companies when making strategic choices.
The impact of benchmarking, as it was with Xerox, is often to change behaviours.
However, there are some potential negatives such as:
It may not be used to ascertain why the process benchmarked works so well if it does
not compare competences between organisations. For what reason is distribution
better in company X than company Y? What are the underlying competences of
employees in both firms?
It may change focus in an unintended manner. School league tables in UK were meant
to provide benchmarking comparisons between teaching quality, but have led to a
narrow focus on the questions that will be asked rather than improving thinking skills
and application of knowledge.
D. ORGANISATIONAL GROWTH
Most firms begin as small organisations and if successful, can grow into multinationals.
Hotel Chocolat began with two people making mints and has grown into a multimillion
business.
Case Study 2: Hotel Chocolat
Hotel Chocolat was founded by Angus Thirlwell and Peter Harris in 1993. Angus had
speciality food retailing in his genes. He had spent his childhood in the Caribbean
where he developed a love for cocoa and the region. A further influence on his taste
for real food was the two years spent living and working in France. In 1987 his first big
idea was the production of corporate mints.
He and Peter Harris each contributed 5,000 and started the Mint Marketing Company
from home. Most of their time was spent in Cambridge library with scissors and glue,
using the library's colour photocopier to print logos off companies' literature, which
were then shrunk and wrapped around packs of mints. A company in Holland was
employed to make the mints.
By 1990, the Mint Marketing Company had hit 1m in annual sales and had landed
contracts with British Airways and various hotels.

In this section we examine the advantages and disadvantages of large and small businesses,
and look at the methods by which businesses grow.
Advantages and Disadvantages of Small and Large Businesses
Statistics show that the number of small business far outweighs those that grow into
multinational companies. The figures below indicate the importance of small businesses to
the UK economy and their contribution to continuing innovation.
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UK Small Business Sector
There are 4.8 million small businesses in the UK (up from 4 million in 2003) of
which 3.6 million businesses are sole proprietors and 444,000 are partnerships
(Small businesses are defined as those with 10-50 employees)
97 per cent of firms employ less than 20 people
95 per cent of firms employ less than 5 people
(Micro businesses are defined as those with 0-9 employees)
Over 500,000 people start up their own business every year
Small and medium-sized firms employ more than 59.8 per cent of the private
sector workforce
Small firms contribute more than 49 per cent of the UK turnover
64 per cent of commercial innovations come from small firms.

(a) Staying Small
Advantages of small companies
More control by owners
Flexible to changing conditions
Closer relationship with customers a more personal relationship is possible and
perceived quality of service is higher
Lower overhead costs potential to avoid diseconomies of scale experienced by
larger companies
Lower financial risk
Innovation and entrepreneurship are very strong many operate in niche
markets making substitutes less of a threat
Less bureaucracy.
Disadvantages of small companies
Limited scope for making profit
Lack of expertise in some areas such as management and Research and
Development
Competition may be too strong for example, production costs are likely to be
higher than in a larger business where economies of scale can result is offering
similar lower priced goods
Statistically small businesses have a substantially higher failure rate a
significant proportion of companies are in business for less than three years and
many fail before this point owing to cash flow problems (cash runs out or clients
do not pay promptly)
Customers may have less trust in a small business especially if it is selling goods
or services overseas
The ability to attract finance to improve areas of the business such as product
development is often limited.

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Personality and entrepreneurial character
Small businesses are very much a reflection of the owners. They are often run by
entrepreneurs who generate new ideas or find gaps in the market, sometimes by
accident. Their contribution to innovation and invention is very important to the
economy of a country.
Entrepreneurship has become a global movement universities offer MBAs in
entrepreneurship whilst large companies try to re-create the environment within their
own larger corporate structures.
The Global Entrepreneurship Monitor (GEM) is a not-for-profit academic research
consortium that has as its goal, making high quality information on global
entrepreneurial activity readily available to as wide an audience as possible. GEM is
the largest single study of entrepreneurial activity in the world. It was initiated in 1999
with just 10 countries taking part.
(b) Grow Large
Organisations may be forced to grow to meet customer demand or may make a
conscious decision to expand the business. While there are many well known
multinationals such as Pepsico, Walmart, Kraft Foods and BP, there are numerous
large companies that are much smaller. Growth may start by exporting to some
overseas markets and eventually expanding into a global company which has become
considerably easier since the removal of trade barriers by many countries.
Conscious decisions to grow can be a result of spotting opportunities. For example,
many multinationals are exploiting opportunities in emerging markets where the
disposable income of consumers is forecast to show significant growth in the medium
term, and where resources, including cheaper labour, are available. Opportunities too
arise where governments support external companies in order to grow their economies
and increase business expertise, including the skills of their people.
Advantages of large companies
Exploit more opportunities for trade and new customers
Lower risk, as not all business is concentrated in one location and subject to
market conditions in that location; reduces reliance on home market
Potential economies of scale which reduces overall cost
Access to less expensive resources which impacts on prices and profit levels
Higher levels of expertise, as there are more employees with different
skills/knowledge
Potential for new ideas
Easier to gain financial support.
Disadvantages of large companies
Innovation and entrepreneurship are difficult to maintain
Loss of control by the owners
Risk can be high, particularly in emerging economies where there can be
political, cultural and financial risk
Environmental and ethical issues increase such as pollution, use of countrys
resources in production processes, corruption
Tendency to bureaucracy, meaning that decision making and change can be slow
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Communication between employees can be more difficult as size increases,
particularly where employees work in different locations
Marketing may not be appropriate in new locations (if company becomes global).
Growing the Business
Businesses growth occurs in two ways
(a) Internal or Organic Growth
The company expands using its own resources by increasing its manufacturing or
office space, taking on new staff etc.
Internal growth can take place in three ways:
Horizontal expansion
The company continues to make the same product or provide the same service,
but increases sales (market share). It may produce additional versions of the
same product or service. For example, a chocolate manufacturer may move into
organic chocolate production.
Vertical integration
This is when the company extends its part in the whole production process for
example, the chocolate manufacturer decides to open a shop at the factory to sell
the chocolate (forward integration) and/or grows the cocoa to make the chocolate
(backward integration).
Hotel Chocolat now grows cocoa in St Lucia, produces the chocolates and has
many shops selling the chocolate all over the world.
Diversification
This is the third method of external expansion. A firm decides to offer a product
or service that is different from its core business. Hotel Chocolats Boutique
Chocolate Hotel opened in December 2010 offering guests luxury
accommodation on the cocoa plantation in St Lucia.
The disadvantage of this method of growth is that internal resources can become
stretched as the firm grows.
(b) External Growth
Here, the company accomplishes growth either by joining with another company
(strategic alliance) or acquires a company (merger or acquisition). The options are:
Joint venture
This usually occurs when organisations work together on a specific project, the
original organisations remain independent. This spreads the financial risk
between them and provides each with access to a wider variety of skills and
resources. The difficulty here may be in identifying a suitable partner and
agreeing terms.
Merger or acquisition
A merger takes place when two companies of approximately equal size form a
new company by joint agreement.
Acquisition is where a larger organisation buys a smaller one which becomes
integrated into the larger firm
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In either a merger or acquisition, it is anticipated that competences and
capabilities are increased, but there is potential for cultural clash making
integration difficult and failure is high.
Franchising
Franchising occurs when the company (the franchiser) permits the franchisee to
carry out specific activities such as manufacturing, sales or distributions. The
franchiser remains responsible for marketing activities and protecting the brand.
Many of Coca Colas bottlers operate under franchise agreements.
Licensing
In this situation another organisation pays a fee to use the intellectual property
rights, such a trademarks, patents, or technology, under defined conditions. For
example when you buy a Microsoft Product such as the Student Version of Office,
you are the sole person licensed to use it and pay a special fee as a student.
If you are not a student or you allow others to make copies, then you are not
keeping to the terms of the licence.
The subject of growth will be discussed in some detail in a global context in a later chapter.
Financing Growth
There are a number of methods of financing growth, some of which are applicable to different
stages in the organisational life cycle.
Initial capital investment is required to begin a small firm. This is usually in the form of loan
from a bank or by using personal savings.
Working capital is then required for the day-to-day running of the business paying wages,
paying creditors, purchasing small items such as stationery, advertisements and so on. This
will either come from sales made and/or the support of a bank overdraft facility.
In the early stages of the business it is quite common for firms to have cash flow problems
where the amount of revenue earned is insufficient or not paid quickly enough by debtors,
and the business cannot pay its day-to-day bills. The owners will often rely on a bank
overdraft to relieve the problem. However, if this does not solve the issue in the short term,
the firm will probably close.
When larger amounts are required for purchasing large items or expansion of premises,
funding research and development projects and so on, the business will need to consider
longer term financing. There are several options available including bank loans and venture
capital. We consider four such options briefly here.
(a) Overdrafts
Easy to arrange and relatively
cheap
Useful as a method of easing
cash flow strains during peak
periods
Interest charges are only
incurred whilst the facility is
overdrawn and only the exact
amount of funding required is
utilised.
Security may be required
Can be withdrawn by the bank
at any time or may not be
renewed when it is required in
future
Banks may require
management figures at regular
intervals, to monitor progress.
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(b) Long term loans
Can be structured so that
repayments can be met out of
future income deriving from the
expansion
Cannot technically be
withdrawn as long as the
borrower honours all of the
terms of the facility
Repayments can be structured
to meet the needs of the
business.
Security will generally be
required which adds to the
initial costs and puts the
business at a degree of risk
Management figures may be
required at regular intervals
An agreed sum of money is lent
which may be more than is
actually needed for expansion
Can be expensive for a small
company.
(c) Leasing
Assets leased can be on-
balance sheet (a finance lease)
or off-balance sheet (an
operating lease)
The period can match the life of
the expansion assets
There are usually no set-up
costs and repayments can be
structured to suit the cash flow
of the business
In effect, only the required
amount is advanced and there
are no surpluses on which
charges accrue.
In an operating lease, the
benefit of any residual value in
the asset is lost to the lessor
(owner)
Costs may be higher than
those of a bank but this may be
outweighed by the absence of
fees
Capital allowances are lost to
the lessor but the rentals will
usually be tax-deductible
Early settlement of the facility is
usually expensive.
(d) Additional equity capital
Can be a cheaper form of
raising capital and dividends
will only have to be paid when
the enterprise can afford it
Capital is raised in the long-
term
Increasing the equity capital
should increase the ability of
the enterprise to borrow in the
market.
A degree of control over the
enterprise will be lost
Possibility of takeover is
increased when the shares are
widely held.
ABE
Acti vi ty 5
Finally in this chapter, we present a further case study of the development of Xerox.
Consider the following summary of its development and then answer the questions that
follow.
Case Study 3: The Company with Nine Lives
Xerox can trace its roots to 1906, when a photography-paper business named
the Haloid Company was established in Rochester, New York. In 1958 Haloid
changed its name to Haloid Xerox, reflecting its belief that the company's future
lay with xerography, although photography products were still more profitable.
That balance quickly changed with the success of the Xerox 914 copier.
Introduced in 1960, it was the first automatic Xerox copier and the first
marketable plain-paper copier. Demand for the 650- 914 model exceeded
Haloid-Xerox's most optimistic projections and Fortune later called the copier "the
most successful product ever marketed in America". Sales and rental of
xerographic products doubled in 1961 and kept growing.
However, by 1985 Xerox's worldwide plain-paper copier share had dropped to 40
percent, from 85 percent in 1974.
In 1988, Xerox underwent a $275 million restructuring, cutting 2,000 jobs and
creating a new marketing organisation, to get new technologies into the
marketplace more effectively. Xerox's comeback was so impressive that in 1989
its Business Products and Systems Unit won Congress's Malcolm Baldridge
National Quality Award for regaining its lead in copier quality. Xerox had
demonstrated its ability to change.
In 1994, Xerox began calling itself The Document Company to emphasise the
wide range of document processing products it produced.
April 1998, Xerox announced yet another major restructuring, as its shift to the
digital world led it to spend more on overheads than its competitors. The
company eliminated 9,000 jobs over the next two years. The cuts came at a time
when Xerox was enjoying record sales and earnings as well as a surging stock
price, so the company was clearly proactive in maintaining the momentum it had
gained through its impressive 1990s resurgence.
This resurgence, however, came to a crashing halt during the later months of
1999. For both the third and fourth quarters, Xerox was forced to issue warnings
that its profits would be well below the expectations of Wall Street analysts,
sending its stock tumbling.
Sales and profits were hurt by a number of factors, several of which were out of
the company's control, including the strength of the dollar against European
currencies, heightened competition from J apanese rivals, particularly Canon,
which launched new lines of midrange and high-end copiers that ate into Xerox's
market share, a slump in the sales of high-end copiers and printing systems late
in the year because of Y2K fears, and a severe economic downturn in Brazil, a
long-time key market for Xerox that had been responsible for about 10 percent of
sales and an even-larger portion of profits.
In March 2001, Xerox sold half of its stake in Fuji Xerox to Fuji Photo Film for
more than $1.3 billion in cash, reducing its interest in the joint venture to 25%. In
another key move, Xerox outsourced about half of its worldwide manufacturing
operations to Flextronics International Ltd., at the same time selling to Flextronics
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plants in Canada, Mexico, Malaysia, the Netherlands and Brazil. Several other
non core operations were also sold off as part of this overhaul, which in total
culled 11,200 positions from the payroll. During 2001, a separate restructuring,
which aimed to sharpen the company's focus, saw Xerox eliminate product lines
aimed at the small office/home office business segment. Approximately 1,200
more employees were laid off. Xerox eliminated its stock dividend that year to
conserve cash and in August, Mulcahy was named CEO. She replaced Allaire as
chairman in early 2002.
Late in 2000, the Securities and Exchange Commission (SEC) launched an
investigation into Xerox's accounting practices for the period from 1997 to 2000.
The SEC eventually found that the company had been improperly accounting for
revenues associated with office equipment it leased to customers, booking more
of the lease revenue up front than was proper and thereby artificially, if
temporarily, inflating revenue and according the SEC, misleading investors. In
April 2002, Xerox agreed to pay a record $10 million civil penalty to settle the
charges.
In addition to shedding unprofitable businesses and lines of business, and
eliminating tens of thousands of workers from the workforce (which was reduced
by one-third from the beginning of 2001 to the end of 2003, from 92,500 to
61,100), Xerox vastly improved its balance sheet. Total debt was reduced from
$18.64 billion in 2000 to $11.17 billion in 2003. Perhaps most importantly, Xerox
moved aggressively to regain lost market share by introducing 38 new products
during 2002 and 2003 as well as a wide range of new document-related services.
Through the CEOs able leadership and dogged pursuit of a turnaround, Xerox
was able to post strong results for 2003. Net income of $360 million was the
firm's highest profit level since 1999. Debt was reduced further during 2004 to
less than $10 billion and the now cash rich company was poised to begin
pursuing acquisitions again. From the real possibility of bankruptcy when she
took over, CEO Mulcahy had engineered at least the beginnings of a remarkable
comeback, though the competitive environment showed no sign of becoming less
brutal.

Questions
(a) Identify three separate and different examples that show Xerox changed its strategic
choices over the years.
(b) Describe how the external environment has impacted negatively on Xerox in a way that
was beyond its control.
(c) What actions did Xerox take as a result of the impact of the external environmental?
(d) What effect did these actions have on the business?
(e) From the limited information in the case study, describe the strategies Xerox used to
grow the business.
(f) Which of Michael Porters generic strategies has Xerox focused on? Provide
supporting evidence for your answer.


ABE
SUMMARY
Organisations exhibit life cycles in a similar way to that of products, with different
characteristics at each stage.
The strategic choices they will make will depend to some extent on the stage they have
reached in the business life cycle.
All organisations whatever their size have to make strategic choices about how the firm can
survive and prosper in the future.
The stage in the life cycle can be very important. An organisation in the development stage
may have few or no competitors. An example of this was the early days of online recruitment
when there was little competition.
A company in decline will have to examine every aspect of its business and decide what it
can do to either adapt its operation or change its products or services to regain momentum.
In either case, when making strategic choices, firms need to carry out a structured
examination of their internal and external environment so that they can make informed
choices:
Internal strengths and weaknesses identifying the competences and capabilities that
can be built on and the weak areas that need to be improved, and listing the actions
required to make improvements. Similar results could be obtained from a SWOT or
Gap Analysis.
The external environment conducting a STEEPLE analysis to identify factors that
provide opportunities and challenges, and analysing the competitive environment of the
business. The aim will, again, be to identify what competences and capabilities the
organisation has to maximise the opportunities and minimise the challenges that affect
it. Porters Five Forces and Benchmarking can be used to identify the forces that
provide its best advantage against rivals and consideration given to how could these be
enhanced. One of the strategies here could be to benchmark its business activities
against the best in class.
A company may choose to grow larger or not. This may be a personal preference of the
owner, but the situation may be forced owing to customer demand.
If the organisation chooses to grow it will either grow through use of its own resources or by
alliance with or acquisition of another company. Again the choice made will depend on the
stage in its life cycle and the STEEPLE factors surrounding the other organisation.
Growth will require financing whether this is short term working capital or a long term
financing vehicle. This is yet another choice for the firm to make.
Making the right strategic choices is vital for organisations of any size. A systematic
approach is more likely to result in appropriate decisions for an individual firm.
ABE
Activity 2
In terms of SMART, we can say that:
S This objective is specifically about sales of product X.
M 10% is measurable
A we cannot state whether this is achievable without further information
R it is focused on results
T the time period is clearly stated as 3 months.
The objective does appear to fit the criteria as in a real situation we would be able to look at
past sales and the business environment to determine its achievability.
It is, therefore, not quite a SMART objective.

Activity 3
The skills and competences are likely to include innovation, entrepreneurship, marketing and
good communication. The physical resources should include hardware and software of
various types, working capital, work space and a business plan.
Strengths and weaknesses will depend on the circumstances. Appropriate strengths may be
knowledge of small business operations, experience in successful web design for small firms
and technical ability, while weaknesses could be lack of knowledge of running a business,
poor financial skills and so on.
The activities and resources that you will need to employ again depend on the
circumstances, but you may need financial backing to meet the forecast cash flow, a
colleague with business and/or financial skills, and a database of growing and successful
small companies.

Activity 4
The STEEPLE analysis for the car industry might be along the following lines
Political
Does the Government own a share in car manufacturers
Is the Government a stable one?
Government support for overseas investment.
Economic
Disposable income available
Economies of scale possible
National growth rate
Favourable interest or exchange rate.
Socio-cultural
What kind of products will appeal to the various age groups.
ABE
Environmental
Use of resources in the production process
Emissions are a health hazard
Raw material wastage
Alternative fuels available to appeal to conservationists.
Technological
Lean manufacturing to reduce costs
Quality monitoring and control
R&D advances for new fuels or engine improvement.
Ethical
Level of corruption in industry and location
Consumption of resources needed to provide essential energy requirements.
Legal
Emission level regulation
Other regulation relating to the industry specifically
Quality control standards
Restrictions on mergers/acquisitions.

Activity 5
(a) You could have identified any of the following:
Xerox changed the type of business it wished to be in when it switched emphasis
from producing photographic paper to photocopiers.
When it lost its patents Xerox could no longer ignore the competition and had to
create a new marketing organisation to get new technologies into the market
place quicker. (1988)
In March 2001 instead of growing in size it divested companies in order to go
back to core business.
It decided in 2001 to move out of the small office/home business market.
(b) In 1999 the negative impact included the strength of European currencies against the
dollar, a slump in sales of high end copiers, Year 2K fears and a severe economic
downturn in Brazil, one of Xeroxs key markets.
(c) It sold businesses, outsourced manufacturing, sold non-core operations and downsized
in number of employees. It also paid no dividend that year.
(d) This allowed it to recover its financial strength by 2003 and to recover market share by
introducing 38 new products in 2002-3.
(e) It used a joint venture with Fuji (which it subsequently sold). In 2004 "it was poised to
begin pursuing acquisitions again". It acquired many non-core businesses in 2001, so
had been involved in conglomerate operations previously.
(f) Initially Xerox could be said to have a differentiation strategy it offered a unique
selling (service) proposition (USP) that the competition did not have. Prices were not
important to buyers of the products and they became so brand loyal that Xeroxing is
still a word used globally for photocopying.
91
ABE
Chapter 4
Market Structure and Business

Contents Page
Introduction 92
A. Perfect Competition 92
Conditions for Perfect Competition 92
Contestable Markets Error! Bookmark not defined.
Views on Perfect Competition 933
Disadvantages of Perfect Competition 94
B. Monopoly 94
Sources of Monopoly 944
The Case For and Against Monopolies 955
C. Monopolistic Competition 97
D. Oligopoly 988
Oligopoly and Anti-competitive Behaviour 98
Non Collusive Oligopoly 100
Game Theory 1011
Summary 1044

92 Market Structure and Business
ABE
INTRODUCTION
The focus of this chapter is on how the degree of competition within a market affects prices,
resource use, profit levels and efficiency.
There are four different market structures and it is the difference in the number, type and size
of the firms in the market, as well as the nature of the product itself, that affects the type of
competition and extent to which companies can control price.
We also examine the ways in which firms attempt to keep their prices high, legally and
illegally, and the tactics they use in competing for market share.
Competition
The concept of competition is fundamental to understanding the different market conditions
considered in this section. As consumers, when we think of competition, it suggests a choice
which is a desirable state of affairs. Thus, if you wish to buy a new netbook computer,
there will be a choice of makes, colours and technical features. In some cases, you can
negotiate on prices with the supplier knowing that some suppliers charge less than others.
Owing to our ability as the buyer, to choose and apply pressure on prices, we expect
competition to oblige producers and distributors to use their resources efficiently and keep
production and distribution costs low. Competition is also, therefore, usually thought to be a
very powerful force to ensure production efficiency.
Competition is consequently regarded as a desirable feature of markets. Most of the major
modern market economies have legislation and institutions concerned with preserving or
increasing competition. How firms plan to effectively compete against each other will be
covered in Chapter 5.
However, there are variations in the degree of competition in different types of market, and
this can have a significant impact on issues such as price, costs and market share:
Figure 4.1: Degrees of Competition
Great competition No competition

Perfect
competition
Monopolistic
competition
Oligopoly Monopoly

A. PERFECT COMPETITION
A perfectly competitive market is one where suppliers and consumers essentially have no
control over prices. This occurs because there are so many suppliers and consumers and,
as a consequence, the market is very competitive and the market itself determines price.
In such a market, buyers and sellers are said to be "price-takers" that is, suppliers wish to
sell all that they can produce at the market price, and buyers are indifferent as to which
seller's product they buy at that price. The price is determined by the level of demand (from
buyers) and supply, which will fall into balance. Surpluses and shortages will guide the price
and on each occasion the market will settle at the equilibrium price where demand is equal to
supply.
Conditions for Perfect Competition
These can be summarised as follows:
Market Structure and Business 93
ABE
(a) All goods are identical and therefore equally acceptable to the buyer
The buyer is indifferent to which supplier s/he buys the goods from as long as they
conform to any description adopted by and understood in the market.
(b) Perfect information and communication
All consumers in the market must have the same information about products and
prices. Suppliers must have access to the same information about production factors
and the technical conditions of production. No producer is in a more favoured situation
than any other.
(c) Price established only by market forces
No producer or buyer is able to influence the price by his or her own actions, or by
actions agreed with other producers or buyers.
(d) Economic motives only
Firms can earn only normal profits, i.e. just sufficient for them to remain in business.
The actions of suppliers and buyers are influenced only by economic motives. If
buyers or sellers are influenced by a desire to support, say, a charity or a political party,
the market will not be purely economic, however worthy the social motives.
(e) No barriers limiting market entry and exit
Suppliers and buyers must be free to enter and leave the perfectly competitive market
as they choose and as they are guided by considerations of profit and utility (the ability
of a good or service to satisfy one or more needs or wants of a consumer).
If any firms are making abnormal profits, this acts as an incentive for new firms to
enter the market. Supply then increases and the market price will fall, reducing profits
to normal profits.
Similarly if some firms are making losses, they will leave the market. Supply will fall and
prices will rise, returning profits to normal profits.
Contestable Markets
The lower the barriers, both natural and artificial, the more contestable the market.
Contestability is a powerful force in determining the behaviour of suppliers in a market. If
producers know that they can easily be challenged by new competitors, they will behave as if
they were subject to competition because they will not wish to provide incentives for new
firms to come into the market.
Incentives for new contenders to enter the market would include the potential to earn
supernormal profit or the existence of buyers who were dissatisfied with existing goods,
standards of service or prices.
The market is being regulated in this case by potential competition and existing firms will act
to ensure this does not occur.
Views on Perfect Competition
Economists often favour perfect competition for the following reasons:
It ensures the elimination of abnormal profit
It promotes the efficient use of resources
There is a tendency to encourage producers to reduce average costs as much as
possible. This is equivalent to making the most efficient use of resources.
ABE
Disadvantages of Perfect Competition
(a) It prevents producers from making the profit necessary to provide funds for investment
and research, to find better ways of producing goods.
(b) Competition can be wasteful, as the resources of each of the competitors are doing the
same things. If there were fewer competing firms, total costs could be reduced and
some resources freed to produce something else.
(c) Firms dislike perfect competition because there is no price stability since prices follow
changes in demand and supply.
If communications are good, then supply can adapt very quickly to price changes
caused by changes in demand. The result is that prices are constantly adapting to new
equilibrium positions. (This is demonstrated well by the Stock Exchange it is one of
the best examples of a market that is close to perfect competition, since prices change
in real time owing to the use of electronic communication methods.)
(d) For manufacturers, swiftly moving prices are untenable. They can survive in such a
market only if they could keep changing the prices paid for production factors, including
the wages paid to workers. Producers want stable or, preferably, rising prices.
(e) From a social standpoint, perfect competition is far from ideal. Perfect competition,
which economists perceive to be in the consumer interest, cannot exist together with
stable wages and secure employment conditions.
B. MONOPOLY
Monopoly is the opposite extreme to perfect competition. It exists when there is only one
supplier for a particular product and there are no close substitutes for that product. The firm
has complete control over prices.
Many state owned organisations are monopolies. The amount of power a monopoly has
depends on the barriers to entry to the market.
Historically, almost all monopolies are subject to destruction by the continuous improvement
in technology. For example, the Post Office used to have a monopoly in the delivery of low-
price letter mail in Britain, but did not have a monopoly in personal and business
communication. Traditional mail has declined in the face of competition from mobile devices,
email, online purchasing, telephone and private firms of leaflet distributors. In addition, it has
failed to implement electronic sorting methods sufficiently quickly to retain its monopoly.
In the UK, telephone, water, gas, electricity and railways are a few examples of state
monopolies that have disappeared as result of government privatisation policies.
Sources of Monopoly
Monopoly can arise in three ways.
Law
Possession of a unique feature
Controlling the market.
(a) Law
Some countries may grant a company the right to be sole supplier of a product or
service (e.g. telephones) in return for some measure of state inspection and control
over profits and prices.
ABE
In Britain, before 1979, it was usual for such monopolies to be public corporations
under public ownership and control. Privatisation changed this and resulted in a policy
which separated regulation from operation. British Telecom (BT), for instance, is a
private sector company with shareholders. In the case of BT, there still remains a
virtual monopoly, as other firms found the barrier to entry too high. However, the
extensive use of mobile phones has reduced its monopolistic status significantly.
Because many of the privatised monopolies were utility companies, providing essential
services to the public, a system of watchdog regulatory bodies was established to
control prices to consumers and to adjudicate if there were complaints. Examples are
Ofgem for gas and electricity companies and Ofwat for water companies.
Patents and copyright law provide for a more limited type of monopoly. These
concepts are similar in most countries. The essence of both a patent and copyrighting
is that the inventor of a new product or idea is granted exclusive rights (usually by the
State) to benefit from the product or idea for a limited number of years in effect,
monopoly control over its use. If rival suppliers are unable to develop a competing
product without breaking the patent, this form of monopoly can be very valuable, such
as the monopoly enjoyed for some years by Xerox as mentioned in Chapter 3
(b) Possession of a unique feature
Individuals have monopoly control over the supply of their own skills and this may be a
source of considerable profit. Footballers, tennis players and entertainers are all
monopolists.
When the skill lies in producing something written or recorded, then the monopoly
position is protected by copyright laws. This protection has become more difficult to
enforce as the internet has grown and downloads of copyrighted music and films have
become common.
(c) Market control
A monopolist's output is the total market supply and the demand for its product is the
total market demand.
This can only be sustained, without the protection of the law, by exercising some form
of control over the market which prevents competition from arising. There is evidence
that Microsoft did this in the past through aggressive pricing, buying up rival companies
and/or their technologies, and bundling different technologies together.
The Case For and Against Monopolies
There is a view that monopoly is always against the public interest because it restricts output
and raises price. However, there is much evidence that large firms with considerable market
power may not maximise profits, but may pursue quite different objectives, such as growth or
sales revenue maximisation.
Is Monopoly Good?
Most arguments in defence of monopoly are based on the economies of scale in production
that very large firms may experience and the capacity of these firms to innovate, resulting
from their superior ability to fund and undertake research and development.
The monopolist's size and ability to produce for the whole market enables it to achieve
economies of scale, so that costs and, therefore, prices are actually lower than they
would be under perfect competition.
The monopolist employs professional managers who make more efficient use of
available resources than small owner/managers, who often lack managerial skill.
ABE
Monopolies can grow a market which did not exist previously a good example being
the success of Microsoft in standardising the PC market which allowed for its
phenomenal growth from the 1980s.
The monopolist does not always maximise profits, but is content with just a satisfactory
level of profit.
Some element of abnormal or monopoly profit is desirable, so that the firm can:
(i) spend money on research and gather funds for further capital investment;
(ii) have the incentive to take risks and innovate and sometimes suffer losses that
would cripple smaller firms.
Supernormal Profit
In perfect competition, firms are restricted in the amount of profit that they can make because
they have no control over profits and there is very aggressive competition. In a monopoly
there is no competition, allowing the monopoly to set the price and make substantial profits.
It may then use those profits for R & D and investment, as mentioned in the last point above,
or it may simply take the profits for the benefit of the owners.
A monopoly may not have the incentive to be super efficient as is the case with firms in
perfect competition who must survive. The monopoly has no competition in the market
place, but it can still make substantial profit without operating at high efficiency.
The Case Against Monopolies
We can summarise the disadvantages of monopoly as follows:
higher prices than in competitive markets due to persistence of excess profit
wasteful expenditure on R & D and low productivity of R & D expenditure
no incentive to innovate because of high monopoly profit and absence of competition
from other firms
no incentive to invest in new production process and products because of existing high
monopoly profit and absence of competition from other firms
lack of customer focus limited choice and poor product quality due to lack of
competition.
So, Can Other Firms Enter a Monopoly Market?
Since monopolies can make supernormal profits, the market that they operate in is attractive
for new firms to try to enter. This may be easier in the provision of services than for goods.
It is difficult to maintain a total monopoly over supply without the protection of the law, and a
monopoly without that protection does not usually last very long. When a large rival decides
to challenge the monopolist, there is little that can be done to prevent this.
A badly run monopoly would also be an attractive target for a takeover bid.
Acti vi ty 1
What monopolies do you know of in your country?
As a consumer, what are the main advantages and disadvantages of these organisations for
you?

ABE
C. MONOPOLISTIC COMPETITION
Monopolistic competition has many of the same characteristics as perfect competition:
there are many firms with unrestricted entry to and exit from the market
good (but not perfect) communication and transport conditions
motivation by economic considerations only
perception by buyers that the products of the various firms are good substitutes for
each other.
It is in this last point that monopolistic competition differs from perfect competition. Although
the products are considered to be good substitutes, they are not the same (i.e.
homogeneous). Buyers do express preference for one seller's product as opposed to
another's.
It is, therefore, the buyers perception of the substitutes that differentiates monopolistic
competition from perfect competition. Although the product may be effectively the same, it is
the branding which alters the buyers perception of the substitute as being equivalent.
Sellers use marketing to increase this preference and grow brand loyalty. This enables them
to increase the price.
However, the individual firm will be prevented from raising the price too significantly and
taking supernormal profits, as can a monopoly, since the substitutes do not have that
substantial a difference. Its price will still be closely influenced by the market price for the
class of product.
The negative perception of monopolistic competition is that it is not really in the best interests
of either consumers or business firms:
Price is higher and output lower than would be the case with perfect competition
The firm is not making the best use of its resources
Profits are confined to the normal minimum required to keep firms in the market
Firms cannot achieve the profits needed for investment and research or the high output
levels necessary for economies of scale.
In support of monopolistic competition, it is said that consumers are prepared to accept
additional prices and costs in return for the benefits they receive through greater choice of
product and the ability to choose between competing brands and competing suppliers. This
competition may also lead to improvements in product quality and design as well as services
to the consumer.
We can expect firms operating in such market conditions to seek to increase their monopoly
power. They will do this by:
Brand advertising
Securing favourable treatment from distribution organisations
Technical improvements in their products
Possibly also by patent protection or keeping processes secret from their competitors.
The best examples of monopolistic competition come from retail trade, including restaurants,
clothing stores and convenience stores, and in certain technology markets, such as
smartphones.
ABE
D. OLIGOPOLY
Oligopoly is the market structure where supply is controlled by a few firms that are large in
relation to the market size, although there may also be a number of smaller firms in the
market.
As a result of there being so few dominant firms they will observe the actions taken by each
other very closely and react accordingly to protect their market share. Oligopolistic firms are
therefore interdependent.
Very often the firms are also large, by any standards, and are likely to be oligopolists in
several markets.
Oligopoly is common in the advanced industrial countries but there is no single model which
can be held to apply under all circumstances.
Examples of oligopolies in the UK
Groceries Tesco, Sainsbury and Morrisons
Chemicals/oils Key players are Shell, Exxon, GlaxoSmith Klein,
ICI, Kodak, Astra-Zeneca, BP, DuPont, BASF and Bayer
Fast food restaurants McDonalds, Burger King, KFC
Bookshops Amazon, Borders, Blackwells, Waterstones
Music retailing HMV, Virgin, Tower, Amazon, MVC
Banks NatWest, Barclays, HSBC, Lloyds TSB
Electrical retailing Dixons, Currys, Comet
Mobile phone networks O2, Vodafone, Orange, T-Mobile
Home DIY B&Q, Homebase.

Oligopoly and Anti-competitive Behaviour
Oligopolistic firms compete with each other for the same customers in trying to increase their
market share through marketing or product development, after sales service and so on.
However, at the same time, they will try to keep the price high and/or hinder entry to their
market by new firms. One means of doing this is by colluding with each other in effect
acting as if they are (together) a monopoly. This type of action is most commonly called price
fixing and is illegal in many countries.
We know that competition reduces prices and profits, which is why it is beneficial for
consumers and the success of economies. In perfect competition, the very large number of
firms in the market makes it difficult for firms to get together and fix the market in their own
interest.
Oligopolists are likely to use more of their supernormal profits to develop better products or
services. If they can demonstrate a superior product or service they will increase their
market share. Product differentiation by oligopolists competing with each other thus provides
more choice in the market and it can be said that the customer will benefit from the
enhancements.
However, under oligopoly, the small number of firms involved know all the other firms they
are competing against. Each knows that if it changes its price or any of the non-price
features of its marketing, it will have an effect on the other firms' market share and they will
ABE
take action to restore their position. Thus, they will incur higher marketing costs and have
lower economies of scale, and it is likely to make prices higher.

Case Study
In 2007, British Airways was fined 270 million by the Office of Fair Trading
for price fixing after it admitted collusion in fixing the price of fuel
surcharges (which were added at a time of huge, unexpected increases in
oil prices) to customers booking its flights. The US Department of J ustice
fined it an additional $300 million for the same reason. It was stated that
BA had colluded with Virgin Atlantic on at least six occasions between
August 2004 and J anuary 2006 and that during that time, surcharges rose
from 5 to 60 per ticket. Virgin Airlines reported the collusion to the OFT
and became, therefore, immune from legal action. Consumers who were
affected by this illegal action were entitled to apply for refunds.

Collusion and Cartels
Oligopolistic firms that collude in formal price fixing arrangements are said to be part of a
cartel. The oil industry is a very good example of this where OPEC the Organisation of
Petroleum Exporting Countries is the most powerful cartel in modern history. Prior to its
formation over 50 years ago, each oil producer set their prices independently.
Members of a cartel meet at regular intervals to decide on the price that they will sell their
product in the particular market. This can be done to regulate supply for the purposes of
ironing out fluctuations in price caused by changes in demand and supply under normal
competitive conditions, particularly where it is not possible, or at least very difficult and
perhaps extremely costly, to vary supply to meet changing demand. (The fuel surcharge
mentioned above resulted from the action of OPEC in 2007 to raise oil prices.) It may also
be seen as a mechanism to conserve the supply of a scarce product. However, given this
position, a cartel can also operate to charge higher prices than would be possible under
competitive conditions.
Cartels can, under certain circumstances, be perfectly legal. However, there are other forms
of collusion known as tacit collusion which operate where price fixing is illegal, but
oligopolistic firms find a way around the law.
They can ignore the law, as we read in the BA case study, or they can watch each others
prices and keep theirs similar. This type of action is called price leadership.
Price leadership is the tendency observed in some oligopolistic market situations where the
few firms in the market follow the price movements of one firm, the price leader. Such
leaders can be:
The least-cost firm, which can force competitors with higher costs to follow its prices,
even though they cannot maximise their own profits at the levels it sets.
A firm which is typical of others in the market and which becomes a barometer of
market conditions. If this firm feels that a price change is necessary, then it is likely
that others will feel the same.
The largest and the dominant firm in the market. The most common model of this
situation assumes that this firm, because of its size and the economies of scale it can
achieve, is able to achieve lower costs than the others. The lower its costs compared
with the other firms' costs, the greater will be its market share and consequently, its
dominance in the market.
ABE
Collusion between firms in a cartel is more likely when:
There are only a few firms who know each other well
Firms are willing to share reliable information on general and production costs
They produce similar products using closely related processes
There is a dominant firm in the market
Barriers to entry are high
The market is stable with no huge fluctuations in demand or production costs
No government measures exist to prevent collusion.
Collusion is unstable as demonstrated by Virgins whistle blowing action against BA and it is
this instability that is a fundamental reason why collusion agreements break down. Other
reasons include:
The incentive for each member of a cartel to cheat on the other members
The incentive for a member to sell more than its quota as agreed in the cartel
Reluctance of firms to share full information about their true costs, prices, sales and
profits can lead to disagreements and lack of confidence that others will stick to the
rules.
Collusive behaviour is more common than is generally recognised and with globalisation,
many markets such as air cargo, steel, oil and cement are oligopolistic. Governments
competition authorities try to prevent or break up collusive agreements between firms, to
protect consumer interests against the monopoly exploitation such collusion is intended to
achieve. Their effectiveness is, though, dependent on the power of the cartel.
Non Collusive Oligopoly
Where there are few common factors favouring collusion, firms will compete on price. Even
so, the price tends to stay fairly stable. This is referred to as price stickiness.
There have been attempts to produce oligopolistic models based on traditional assumptions
of profit maximisation. One such model seeks to explain the observed tendency that the
prices of some goods in oligopolistic markets remain steady in spite of fluctuations in the
prices of basic commodities. This "stickiness" is apparent in more normal, less inflationary
periods. For example, the price of bars of chocolate in some markets remains constant in
spite of frequent movements in the prices of the basic materials required for chocolate
manufacture.
If there is little price competition and if consumers are not thought to choose brands on the
basis of comparative price, then each oligopolist has a high degree of monopoly control over
the demand for its own product and will price accordingly.
Whether this is possible will depend on whether the consumer sees any difference between
this suppliers product and possible substitutes. For example, it may seem unlikely that
consumers will find much to choose between various brands of plain, salted crisps. If there
are price differences, customers are likely to choose according to price. In these
circumstances, suppliers may seek to operate in different sections of the market, such as
different supermarket chains or in hotels and pubs rather than retailers. They may also seek
to differentiate their products through such devices as flavour or by developing novelty
shapes or other related products and using famous celebrities for advertising.
If one firm reduces it price, its competitors are likely to cut theirs so as not to lose market
share. However, if a firm increases its price, others many not follow as there is the potential
to increase market share.
ABE
Acti vi ty 2
Describe the type of competition which exists in the airline industry.
If two large airlines merge, what do you think will be the affect on the consumer?
Why is there unlikely to be a price war between competing low cost airlines?

Game Theory
Firms in an oligopolistic market situation recognise that their price and output decisions are
interdependent. The significant implication of this is that the normal relationships between
price changes and the consequent changes in sales and sales revenue depend on how other
firms respond to a firm in the market changing its price.
This interdependence creates uncertainty for firms as they determine their production and
pricing decisions. One method of assessing the implications of any such decisions is to use
game theory.
For example, when making a decision on whether to increase the price or not, the firm will
need to consider such questions as:
"If I increase my price 20 per cent, can I manage it without losing market share?
How will the other firms in the industry retaliate?
What if my main competitor responds by reducing rather than matching my price
increase?"
Game theory is about strategy and deciding on the particular strategy which the player thinks
will be the winner. J ust like placing a bet, the firm will assess the chances involved of the
reaction one action has on another, and success in the game will depend both on how the
firm thinks its rivals will react and how willing it is to take the chance. In some circumstances
the firms price strategy will win the game and it will achieve its goal of greater profits or price
leadership. However, there is no certainty and the firm could be the loser.
There are various types of game.
(a) Single Move Games
Here, companies are in a position of having just one opportunity to win in a
competition. The simplest example is in bidding for a contract. The competitors have
to guess what the other firms will include in their bid and prepare theirs to compete.
However, the game is essentially the same when considering the implications of price
rise on the competition for market share.
Sometimes the outcomes of such games are predictable, especially where there is one
criterion which will determine who wins. These are called dominant strategy games.
The best such example is where contracts are awarded to the lowest price and the
competing firms know that the lowest bid will win the contract.
More complex games will not have a dominant strategy and will include more
competing firms. In such cases the game will be much harder to win with firms having
to investigate many aspects of their rivals position for example, costs, potential effect
on demand and supply, likely reactions in the market, the effects on its own profits, etc.
The game could involve not only a rise in price, but aspects such as differentiated
product development.

ABE
(b) Multiple Move Games
These involve, as the term suggests, a series of moves backwards and forwards one
firm differentiates its product, others do the same; next it reduces price to gain market
share, the others follow. For example, firm 1 knows that firm 2 will only cut its price if
firm 1 takes the lead. If firm 1 then cuts its price, firm 2 will follow and they will both be
making lower profits. However, firm 1 will know that firm 2 will only cut its price in these
circumstances so firm 1 has an incentive not to cut its price, but it can threaten firm 2
with a price cut.
In game theory, threats can be implied or open and, if the rival believes that there is a
real threat, it will influence the rivals behaviour.
Supermarkets play these kinds of games. The local versions of big supermarkets
often charge higher prices or have fewer special offers available to consumers because
they are the only one in a small town or railway station.
However, when there are a number of rival stores within easy access, price movements
will be carefully examined and very often followed. In the 2008 recession, for example,
several supermarkets produced lower priced versions of vegetables, fruit, salads and
so on. Waitrose, which was considered a superior organisation, started to lose
customers because consumers were being more careful about spending and after
some time it was forced to produce a similar range. Waitrose did not initially react to
the threat of lower priced goods as being credible.
(c) Price Promises
These are another example of the application of game theory. PC World, a large IT
retailer in the UK, has promised to beat the price of any other competitor and not only
to match it but beat it by 10% of the difference. Since PC World is very large it is likely
that this promise will be seen as credible by other retailers and so their prices are likely
to match. PC World will not want to lower its profits and gambles on the fact that no
other store will want to either.
However, such promises usually have some conditions. Can PC World beat every
other store in the UK on price? It will not take such a big risk, so it hedges its bet by
attaching conditions on the unit purchased requiring any rival store to be within 30
miles and have stock ready for delivery.
In this situation the market is unstable. A price war is a likely consequence, even when
firms have a collusive agreement, if at least one firm to the agreement thinks that it can
come out the winner in such a situation.
(d) The Prisoners Dilemma
This is a classic of game theory which demonstrates why two firms may not cooperate
even if it is in the best interests of both to do so. Albert W. Tucker formalised the game
with prison sentence payoffs and gave it the "prisoner's dilemma" name (Poundstone,
1992).
The basic set up is as follows:
Two suspects are arrested by the police. The police, having separated the prisoners,
visit each of them to offer the same deal.
(i) If both say nothing there is sufficient evidence to sentence them for one year
(ii) If one confesses he will get six months in prison and the other will get 10 years
(iii) If both confess to the crime they will each get 5 years in prison.
ABE
Each prisoner must choose to betray the other or to remain silent. Each one is assured
that the other would not know about the betrayal before the end of the investigation.
How should the prisoners act?
If prisoner 1 coperates he will get only six months and prisoner 2 will get a long
sentence. However, prisoner 1 does not know how prisoner 2 will react to the same
question if he also cooperates they will both get 5 years. For prisoner 1 this is better
than getting 10 years if he says nothing and prisoner 2 cooperates.
They will only both end up better off if they collude and say nothing. However, the
police will prevent this action. They will also try to persuade each prisoner that the
other is bound to confess. Option 3 then is the safest strategy.
The actual position taken by the prisoners will depend on:
- Their attitudes to risk.
- One prisoner assessing how likely the other prisoner is to cooperate.
In this game, as in most game theory, the only concern of each individual player
(prisoner) is maximising the outcome for him/herself (minimising his or her own
sentence) without any concern for the other person's outcome.
ABE
SUMMARY
There are four possible market conditions:
Perfect competition comprising many suppliers of homogenous products where price
is fixed by supply and demand in the market. Firms have no influence over price and,
since the market is competitive, profits are low. There are low barriers to entry and
exit.
Monopoly where there is only one firm in the market and there is no competition.
Monopoly firms are like to be large and very bureaucratic. They are able to charge
high prices and earn supernormal profits which can be invested in R&D (innovation).
Governments will sometimes intervene so that two companies cannot merge to form
one larger monopoly and thus reduce competition.
Monopolisitic competition this has many of the features of perfect competition, but the
buyer perceives a difference in substitutes owing to branding. The seller increases
advertising to increase brand loyalty and can ultimately increase price, but only within
what the market will allow it cannot earn supernormal profits as a monopoly can.
Oligopoly where a market has only a few very large firms. The firms are often
diversified into several markets. There is no model for this type of firm. Oligopolies try
to keep prices high by collusion or price fixing which is illegal in some countries.
Supernormal profits are usually only possible for monopolies and in certain cases,
oligopolists.
Game theory can be used by firms in an attempt to determine the outcomes of competition.
Oligopolies may use it to assess whether and by how much they can raise their prices and
hence profits.
ABE
Activity 1
Your answer will probably include all state owned companies or powerful large companies
with existing patents.
The advantages of monopolies can be that:
The product (goods or services) they provide is standardised and you know what to
expect
Where it involves an important utility or similar key product, it may be argued that the
supply of that product is safer under state control
Disadvantages can be:
High prices
Poor customer service
Mediocre quality of service/good

Activity 2
The airline industry is predominantly an oligopoly, dominated by a few firms who form
alliances to keep the price high. Low cost airlines are a threat to this, although in the early
days of low cost, the large airlines had the power to force the lower cost airline out of
business. (Laker Airways was the forerunner of Ryanair, Easyjet and other small European
airlines.) It could be argued that there, in fact, two separate oligopoly markets in operation
one comprising the main carriers and another being the low cost ones.
If two large airlines were to merge this would reduce competition, which could result in higher
prices and lower services.
Since low cost airlines operate on low profit margins, a price war might mean that they would
both end up making insufficient profit to continue in business. Competition is more likely on
branding and on the cost of "add-ons".
ABE

107
ABE
Chapter 5
A Macro-economic Perspecti ve on Business Economic
Systems

Contents Page
Introduction 108
A. Macro-economic Systems 108
Planned Economy 109
Market Economy 111
Mixed Economy 112
B. The Government and Economic Activity 115
Gross National Product 115
Gross Domestic Product 117
Understanding and Interpreting National Accounting Data 123
The Business Cycle 124
Aggregate Demand 126
C. Regulating the Market 127
Inflation 127
Unemployment 128
Balance of Payments 130
Managing Economic Growth 131
D. Government Interventions to Achieve Economic Objectives 131
Fiscal Policies 131
Monetary Policies 134
Supply Side Policies 135
Summary 136

108 A Macro-economic Perspective on Business Economic Systems
ABE
INTRODUCTION
An economic system can be defined as the organised way in which a nation allocates its
resources and apportions its goods and services.
In this chapter we will examine the three most common economic systems:
(a) Planned (or command) economy where the State makes all the decisions concerning
production of goods and services
(b) Market economy where the owners of private businesses make the decisions which
will vary according to supply and demand
(c) Mixed economy where production decisions are a combination of those made by the
State and private business.
National economies are dependent on the flows of production and money. We will look at
how the national income is measured and the information this gives us about the efficiency of
work and living standards in different countries.
The level of economic activity varies over a period of time in a cyclic manner. Its peaks are
the boom periods and the troughs are known as recessions. We investigate the reasons for
this periodic behaviour and what governments can do to smooth the extremes of boom and
recession.
A. MACRO-ECONOMIC SYSTEMS
The study of economics focuses on unlimited wants and limited resources. As a result, in any
economic system three questions arise:
(a) What goods and services should be produced?
(b) How should these goods and services be produced?
(c) How will the goods and services be distributed amongst the population?
As noted above, there are three possible answers to these decisions:
the Government decides the answers to the questions given above giving rise to the
economic model of a planned (or command) economy
buyers and sellers make all the decisions and the Government plays no part giving
rise to the economic model of a free market economy
a combination of both the Government and buyers and sellers make the decisions
giving rise to the economic model of a mixed economy, which has elements of the
market and planned economies.
Think Point
Which type of economic model has been adopted by your country?
Can you identify any examples of either a pure planned economy or a pure free market
economy?

The vast majority of economies around the world today are mixed economies. It is difficult to
have a pure free market economy as there are certain aspects that any Government will wish
to control for the good of all its citizens (and we will return to this in more detail in later
A Macro-economic Perspective on Business Economic Systems 109
ABE
chapters). Planned economies were a feature of Communist states and have become less
popular following the break-up of the Soviet Union. Possibly the only example of a fully
planned economy now is in North Korea. Cuba is also sometimes cited as an example,
although it could be argued that there are also elements of a market economy present there.
Planned Economy
Central economic planning, known as a planned or command economy, is best known as the
model that was adopted by the Soviet Union following the Bolshevik Revolution of 1917.
The total direction and development of the nations economy was planned and administered
by the Government from that point. This type of economy has since become associated with
other communist or socialist countries.
The Soviet Government operated its economy on the basis of a five year plan, which
attempted to arrange a balance between demand and output. The primary purpose of
central planning in the Soviet Union was the attainment of the five year goals that state
authorities formulated.
The key features of the model are that it:
Has strong political overtones
Works on a set planning cycle
The Government decides what should be produced and in what quantity as a result of
its forecast of demand
The Government sets prices
The Government decides how the output is distributed.
In the Soviet Union everyone involved in the process answered to the State, obeyed all its
directives and practised self discipline for the benefit of the State. This is common practice in
planned economies.
(a) Advantages of a Planned Economy
Whilst it might seem difficult to imagine for those of us brought up in modern mixed
economies with a substantial element of the free market present, there are a number of
great advantages to planned economies.
All resources are focused on meeting a social or economic goal.
Long term projects can be planned without fear of a downturn in the economy,
which can result in projects being left unfinished.
Resources can be allocated by the Government to any cause that it considered
most beneficial. For example, in World War II, the Soviet Govenrment needed to
make parachutes. These were made from nylon and as a result, all the nylon
needed was deployed for this purpose and other uses, such as manufacture of
ladies hosiery, were ignored.
A stable, safe environment is provided for investors as production is under state
control.
There is a guaranteeed standard of living for all, including:
Free education
Free healthcare
Disablity allowances
Retirement benefits/pension guaranteed.
ABE
(b) Disadvantages of a Planned Economy
On the other hand, there are a considerable number of down sides.
Choice is limited to the existing supply of goods and services.
Planners do not take account of customer preferences, shortages or surpluses,
resulting in the waste of resources that could have been employed in producing
more appropriate goods.
Often the forecasts are wrong and products are just left to rot for example, in
the 1960s and 1970s the Soviet govenrment quota on tractors was too high and
unused ones were left to rust as they could not be sold.
The price mechanism set by the State does not always benefit the State for
example, the relative income from different uses of the same materials is ignored,
as in the case of nylon given above. Massive amounts of state income that
would have resulted from the manufacture and sale of hosiery was missed
because parachutes, which sold for a low price, were seen by the goverment as
the priority.
There may be issues of poor quality, probably through the lack of incentives other
than to reach numeric goals.
Many planners and administrative support workers are involved in each step,
leading to slow decision making, lack of innovation and corruption.
There is no competition to the state produced goods, resulting in lack of
innovation and quality.
Private decision making in regard to choice of employment, occupation and
selection of workplace is severely restricted.
Where unions exist, as happened in Poland, their primary role was to ensure that
the production goals of the state planning commissions were met.
Wages are set by the governemnt with no union input.
The standard of living does not grow as quickly as in a market economy.
Central planning failed for a number of reasons including:
Inefficient allocation of resources and labour
Upward communication of distorted and self-serving information from agencies low on
the hierarchical ladder
Prices were set without any relation to cost, supply and demand
Inefficient execution and administration of the various economic plans.
Within command economies, secondary economies often spring up. Because of the lack of
choice and poor quality of goods, consumers often resort to the black market to obtain
superior goods, with corruption and moonlighting being involved in obtaining such goods.
Resources meant to meet central planning needs may also be diverted to satisfy consumer
demand, shifting scarce resources away from the Governments priorities. All these types of
behaviour conflict with the philosophy of central planning.
Some of the communist governments that continue to exist are moving away from a totally
centrally planned economy. China is a good example, where its government has adopted
some market economy techniques, although strong State control is still in place. Its universal
healthcare system, which was based on central planning, has largely been dismantled and
replaced with various health insurance schemes, mostly funded by member contributions.
As a result, many private sector employees and the self-employed are often without any
cover and must bear the entire cost of health care themselves.
ABE
Market Economy
A market, in economic terms, is defined as an area within which forces of demand and
supply for a particular economic good can communicate and interact so that the good can
be transferred from seller to buyer. An economic good is said to afford utility (usefulness) to
people.
Therefore, a market economy is characterised by:
private rather than public sector control of production, distribution and consumption
being regarded as an economic rather than a political system, responsive to
marketplace demands.
Market economies work on the assumption that market forces, such as supply and demand,
are the correct system for the allocation of resources. That way producers know how much to
produce, based on the demand for their products at every price. Therefore, private
businesses make the decisions rather than the State.
(a) Advantages of a Market Economy
The advantages stem from the freedom of action within the market.
Minimum goverment intervention
Any individual or firm has the right to act on his/her/its own account to satisfy the
needs of others
Competition between different firms leads to increased efficiency
Most people work harder, as the rewards act as an incentive
There is more innovation as firms look for new products to sell and cheaper ways
to produce goods and services
Foreign investment is attracted as new opportunities emerge
The size, power and cost of the state bureaucracy is reduced, as various
activities that are usually associated with the public sector are taken over by
private enterprise
Increase in skill levels and technological advancement
Lack of price fixing
Free trade no limits on franchises and licences, and a lack of export/import
quotas
Choice no compulsion for any individual to buy a product
Provides information about the preferences and beliefs of consumers.
(b) Disadvantages of a Market Economy
The disadvantages stem from the lack of regulation and the way in which this exposes
individuals and forms to the fluctuations in market conditions.
No industry subsidies
No control on goods produced
Economic cycles affect employment and income levels
Exploitation of employees can occur
Gap between rich and poor often results
Reduced social benefits
ABE
Environmental issues result, such as apporpriate use of resources and waste
disposal.
The market economy is the most popular system in the current global market place.
However, no economy can claim to be a purely free market economy, as some intervention
from government always occurs.
Mixed Economy
Those in favour of the free market believe that central planning wastes resources, and that a
free market ensures that consumers receive the goods they prefer, at an economic price,
produced efficiently by competitive firms hoping to make a profit.
In reality, most societies operate some form of mixed economy partly planned and partly
free market. These economies are still generally referred to as market economies as the
amount of State intervention is limited.
In the UK there is a mixed economy. Most decisions are made by the market i.e. by
consumer supply and demand. So, what the consumer chooses to buy creates demand, and
this demand is crucial in a firms decision-making process about what to produce, how to
produce it, as well as how to distribute and price the goods.
The efficiency of the free market in the UK is very high, so the market makes most of the
economic decisions. However, it is generally accepted that there a range of decisions about
production and the supply of services which have a wider impact on society and must be
taken by the Government of that society. These decisions include those relating to
infrastructure such as road building; school and hospital construction, and to public services
such as military spending and the supply of medicines in hospitals. These activities are
usually carried out by government employees and progress controlled centrally. (Later in this
chapter we will look at how some government funded projects may be completed by market
based means rather than using public sector employees).
This mix in the economy is also be very political, with decisions about which parts of the
infrastructure and what public services should be centrally planned varying depending upon
prevailing central government policy.
(a) Advantages of a Mixed Economy
These are a mix of those for both free market and planned economies. In particular,
the free market advantages are seen as being augmented with the addition of controls
on issues such as:
Employee health and safety
Employee rights
Environmental protection
Growth of monopolies, which can be disadvantageous to consumers
Collusion between oligopolies.
(b) Disadvantages of a Mixed Economy
Government intervention in certain areas will be classed as a disadvantage to a firm,
but this will sometimes be a distinct advantage to society. The intervention may add to
the firms costs.
The global trend is towards the free market economy, with most countries now adopting
a mixed economy that is predominantly free market with a degree of state intervention.
Some planned economies do exist, but these are getting fewer and large economies
such as China are increasingly adopting free market techniques.
ABE
Acti vi ty 1
The following case study considers the development of a mixed economy in China. Read
through it carefully and then answer the questions which follow, using just the information in
the case study.
Case Study: Chinas Hybrid Economy
China is no longer a planned economy but it is not yet a fully capitalist
economy. The State still wields power through the allocation of massive
state resources and effective control of large-scale SOEs (state owned
enterprises), which continue to dominate key sectors of the economy.
Despite formally being transformed into joint-stock companies (selling
shares to private investors), the major banks are still effectively controlled
by the State. Currently, state owned and state holding enterprises account
for roughly half of all (non-property) urban investment in fixed assets.
At the same time, the party-state, a powerful apparatus with massive
financial resources, continues to exercise general political direction over
the economy. Sweeping measures taken by the regime to facilitate the
recent Olympic Games demonstrated the power of the State to mobilise
resources and sweep away obstacles to its policy objectives. There was
phenomenal public expenditure on the Games, the Government ruthlessly
cleared residents from large areas of Beijing and heavy industries were
shut down in a desperate attempt to reduce air pollution for the duration of
the Games.
How much of the economy remains under the direct control of the State?
While the class character of the State is not determined mechanically by
the percentage of state ownership, the changing balance of ownership is
an important indicator of the direction of change. But it is not easy to
determine the state/private balance of ownership. Different studies give
different figures. Will Hutton wrote in his book, Writing On the Wall:
"Chinas approach to private ownership means that attempting to assess
how much of China is public and how much private is a fools errand
because it cannot capture how the Party is trying to develop Leninist (in
reality, ruling party) corporatism." Like many other commentators, Hutton
shows how, in practice, the State has effectively retained control of former
SOEs that have become joint-stock companies. With many apparently
privatised companies, "the shareholder and accounting structure is such
that at any time the Party can regain control if it is necessary".
SOEs and corporations controlled by the State (including joint-stock
companies) accounted for 49.6% of industrial output in 1998. In 2004, this
had declined to 38%. Central government (as opposed to provincial and
local government) accounted for 23.7% of the workforce of all State-
controlled firms but 48% of their assets.
" the decline in the state share of output has been much more gradual
than the decline in state employment. As state ownership has become
increasingly concentrated in large, capital-intensive firms and as demand
for energy and raw materials has pushed prices up for those firms state-
controlled companies have sustained only a small decline in their share of
total output.
ABE
Agencies of State Control
IN 2003, the Government established the SASAC (State-owned Assets
Supervision and Administration Commission) to exercise ownership rights
of State SOEs. Subsequently, local SASACs were set up to exercise
ownership of State firms in every province. There are undoubtedly many
tensions between the SASACs and the bosses of the powerful SOE
corporations under their oversight. Nevertheless, the SASACs are
powerful agencies of State control.
The central government SASAC has authority over 196 key firms:
"Many of the 196 enterprises governed by central SASAC are in fact large
holding corporations that evolved from the former government ministries.
These corporations have hundreds of subordinate firms, control large sums
of money and exercise strategic control over decision making. Moreover,
these corporations typically retain their own revenues and remit only taxes
(not profits) to the Government. For example, SASAC exercises nominal
ownership rights over the five large electricity conglomerates that produce
virtually all of Chinas electricity, as well as the two primary electricity grid
operators. These conglomerates, in turn, control hundreds of firms,
including at least ten listed corporations. These conglomerates are highly
opaque and in practice, officials with political ties and little accountability
exercise government ownership rights within the organisation.
There are numerous similar cases in the sprawling industrial empire
overseen by SASAC. Thus SASAC has a long way to go before it can
serve as a government holding company, exercising ownership rights in an
unambiguous fashion, governed by law".
In theory, the SASAC should be operating at an arms-length distance from
the party-state, overseeing state-run firms on the basis of a clear legal and
regulatory framework.
However, "the demarcation of SASACs authority is plagued with a number
of difficulties. By far the most important is the inherent conflict with the
Communist Party over appointment power. Arguably the most fundamental
characteristic of the Chinese political system is that the Communist Party
retains its traditional nomenklatura role, in which party committees make all
the key personnel appointments in the state sector".
(Source: Socialist Worker)

Questions
(a) Describe the aspects of Chinas economy that suggest it is a centrally planned
economy, as suggested by quotations from this article.
(b) To what extent do you believe it is moving to a market economy? Again, use quotes
from the article to support your argument.


ABE
B. THE GOVERNMENT AND ECONOMIC ACTIVITY
The best measure of a national economy and its level of economic activity is its Gross
National Product (GNP). This is defined as the value of all the goods and services produced
in an economy, plus the value of the goods and services imported, less the goods and
services exported.
GNP = goods and services produced in the economy + imports - exports
Gross National Product
We start examining how GNP is made up by considering two fundamental concepts the
flows of production and consumption, and the opposite flows of money within the economy.
In examining these flows, we make a number of assumptions:
That production and consumption are separate.
That production is all organised by business firms in the private sector and government
organisations in the public sector (government sector).
That consumption is decided by individuals, families and households note that
households are seen as purely a consumption and social unit, and have no role in
production.
That all goods and services produced are exchanged through a market based system,
with households paying money to buy products and firms paying money to households
for the use of production factors (land, labour and capital).
A proportion of production is organised by the State and its agencies (and paid for by
revenue raised in the form of taxation by the State from households).
Figure 5.1 shows the circular flow of production and consumption the goods and services
produced by firms/government and consumed by households that in turn provide factors of
production such as labour and capital. These are known as real flows.
Figure 5.1: Flow of Production and Consumption

Firms

Households
Factors of production
(land, labour, capital)
Goods and services
Employ

Produce
Bought through
product markets
Sold through
factor markets

ABE
Figure 5.2 shows the counter-flow of money, which represent the flow of payments made in
respect of the flow of production and consumption.
Figure 5.2: The Counter Flow of Money

In these diagrams, households represent all individuals and families, and firms represent all
the various types of organisation (including government).
These basic diagrams assume that the total volume of production is immediately and totally
consumed, i.e. nothing can intervene to enlarge or diminish this continuous circular flow. The
models also assume that there is no foreign trade, no taxation and no government spending,
and that total income is all spent on consumption.
However, the real world is not quite like this, so we need to take account of a number of
additional factors:
1. Leakages from the circular flow
Not all the income received by households is immediately spent on goods and
services; some income is saved. We can develop an important equation from this:
Income (Y) is either spent on consumption (C) or saved (S). Therefore:
Y =C +S
Therefore, any increase in income will be divided in some way by consuming more and
saving more. The amount of any increase in income which is consumed is often
referred to as the marginal propensity to consume. The greater the propensity to
consume, the higher will be the proportion of total income that is consumed at any
given income level.
Another part of the total income of households is not actually spent on goods and
services, or saved, but handed over to government authorities as taxation, either taken
directly from income or indirectly through taxation included in the purchase price of
certain goods and services.
Yet another part of the total income is spent on goods and services produced by other
national economies; imports from other countries.
Firms

Households
Factors rewards
Revenue from the sale of
goods and services
Pay

Receive
Expenditure Income
ABE
2. Injections into the circular flow
Firms enter the circular flow as buyers of goods and services, such as factories,
machines and research, so that they are able to increase their capacity to produce.
This is called investment or capital accumulation.
The Government must also be seen as a separate element within the circular flow,
producing goods and services on behalf of the community as a whole. (These include
building roads, schools and hospitals, maintaining law and order and a defence against
external aggression.) All of these are combined under government expenditure.
Firms supply other countries with exports of their products. Trade is a two-way
process.
When these adjustments are taken into account, an amended flow diagram is produced.
The first three items can be regarded as leakages from the circular flow of economic activity,
because they reduce the purchasing power of total incomes. The second three can be
regarded as injections into the circular flow, because they increase total purchasing power
and demand.
Figure 5.3: Leakages from and Injections into the Circular Flow
Injections of expenditure
Firms
Leakages from
income
Business investment

Savings
Government expenditure

Taxation
Exports

Imports

Households
National Product, Income and Expenditure
We can now see that this circular flow of economic activity, modified by injections and
leakages, is that encompassed by the term Gross National Product.
The term emphasises that it is the total production of goods and services that is the really
important matter (as per Figure 5.1).
The counter flow of money in the second diagram (Figure 5.2) can be seen as both the total
income of households and as the total expenditure of households.
These three aspects, total product, total income and total expenditure, are all really
describing the same essential flow. They can be regarded as equal provided that
Total value of leakages =Total value of expenditure
So we can say that, if P denotes total product, Y denotes total income and E denotes total
expenditure, then:
Total Product =Total Income =Total Expenditure
or P =Y =E
Gross Domestic Product
One of the key sets of data in the accounts for GNP is that for Gross Domestic Product
(GDP).
In general GDP is the economic activity taking place within a countrys borders. So, the UK
GDP is defined as "the sum of all economic activity taking place in UK territory".
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Data on aggregate economic activity in the UK is published each year in the United Kingdom
National Accounts (the publication which is also called the Blue Book). It defines economic
activity as follows:
"In its widest sense it could cover all activities resulting in the production of
goods and services and so include some activities which are very difficult to
measure.
Economic activity or production generates output that is carried out by
organisations using inputs of labour or capital and good and services to produce
outputs of other goods and services.
These activities range from agriculture and manufacturing to service producing
activities to the provision of health, education, public administration and
defence: they are all activities where an output is owned and produced by an
organisation, for which payment or other compensation has to be made to
enable a change of ownership to take place."
The annual value of the Gross National Product (GNP) is an estimate of the total money
value of all the final goods and services produced in a given one-year period by the factors of
production owned by a particular country's residents. (This includes economic activity
outside the countrys borders).
To avoid double counting "final" goods and services means goods and services sold or
otherwise provided to their final consumers. An example of this is that the value of steel sold
to a car manufacturer to make a car will not added separately into the GNP or GDP totals
because its value is already included when we add in the final sales price of the car to the
customer.
GNP and GDP are very closely related concepts in theory and in actual practice the numbers
tend to be very close to each other for most large industrialised countries.
The differences between the two measures arise from the fact that there may be foreign-
owned companies engaged in production within the country's borders and there may be
companies owned by the country's residents that are engaged in production in some other
country, but provide income to residents.
For example:
Country X receives 10 billion in income from its overseas investments in country Y in
a given year.
In the same period, country Y receives 3 billion from its investments in country X.
The GNP of country X will be larger than GDP in that year.
Calculating GDP
Gross Domestic Product represents the gross value added by the whole of the communitys
economic activity; it does not include indirect taxes and government subsidies.
The Blue Book actually show two versions of GDP based on expenditure.
(a) At market prices, which takes no account of expenditure taxes or subsidies paid to
producers. This measure shows the totals of spending at the prices actually paid "in
the market".
(b) The second measure of GDP is calculated by deducting the total value of expenditure
taxes and other indirect taxes and adding back the total of subsidies paid to producers.
This measure shows the "true" cost of production of output, since indirect taxes are not
a true cost of production despite the fact that they appear as part of the cost when the
goods and services are purchased. Similarly subsidies reduce the prices paid for
goods and services below their true cost of production.
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The figure for GDP based on basic prices is the one normally used. It is considered to be the
fairer reflection of true expenditure on goods and services total expenditure includes
government spending on final consumption and much of this is paid for from expenditure
taxes. If we value GDP at market prices, then we are, in effect, including expenditure taxes
twice; once when they are paid by the consumer and again when they are used to pay for
goods and services by the various government bodies.
Similar adjustments need to be made to take account of subsidies. These are payments
made by government to producers and have the effect of reducing market prices. To obtain
the true cost of goods and services any subsidies need to be added back.
Given that, though, there are a number of issues which mean that some economic activities
remain outside of the scope of the official figures for example:
The desire to evade taxes the extent of the hidden (or black) economy in some
countries is estimated as being as high as 2050 per cent of the official economy.
The contribution made to economic and social welfare by unpaid parents and others
who perform services within the family.
The official figures also ignore unpaid voluntary activities within local communities and
amateur sporting activities.
The way in which production, especially service production, is valued may cause further
problems.
Where goods and services are distributed through unregulated markets in a market or
mixed economy, we accept that market price is a fair method of arriving at their value.
However, in a planned economy, where the State is the sole provider of a service and
the sole employer of the factors used to produce that service, we cannot be sure that
the recorded value bears any relation to the value to the community or to their value
in another country where similar services are distributed.
Any comparison or calculation is likely to rely on money as a measuring device.
However, money value is not a constant its value is eroded over time by price
inflation. The rate at which prices increase (or sometimes decrease) differs greatly
over time and from country to country. The rate of change in prices in a country can be
measured using price indices and in many countries various price indices are compiled
for this purpose. These cannot be entirely accurate and the longer the period over
which comparisons are made, the less reliable the figures become. (In the UK National
Accounts, allowance for changes in the value of money is incorporated into the
figures.)
There is also the problem of comparing accounts when these are prepared in different
national currencies.
Note, too, that equivalent estimates of GDP (or GNP) produced in a given year may
theoretically be arrived at through at least three different accounting approaches, depending
upon how the transactions that determine the prices of final goods and services are
calculated:
by focusing on the buying
by focusing on the proceeds from selling
by focusing on the nature of the products themselves.
Therefore comparison between countries will require knowledge of the basis of the
calculation.
Trends and Comparisons in GDP
In 2008 the UK GDP by industrial sector was broken down as follows:
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Services Sector 76.2% of UK GDP
Industry & Manufacturing 22.8% of UK GDP
Agriculture 0.9% of UK GDP.
The share of GDP accredited to manufacturing has been declining for many years and is a
common trend in the older industrialised countries in North America and Western Europe. In
recent years, manufacturing has moved increasingly to Far Eastern countries, particulary
China.
The move away from manufacturing to services reflects both rising living standards in these
countries, where people spend an increasing proportion of incomes on services instead of
goods and changes in the pattern of world production. Financial services, for example,
accounted for 8.3% of UK GDP in 2007 having risen steadily from 5.3% in 2001. The
proportion of GDP accounted for by education, health and social work has also increased in
recent years for a number of reasons:
changes in technology affecting the work performed and equipment used by these
services
the age structure of the population, as the rising numbers of older people put more
pressure on the health services
changes in economic and social conditions, with the expansion of education, to cope
with the demands of a technology based society and social work, to cope with the
casualties of that society.
Manufacturing still provides a very large part of the wealth of the community, but it has
changed from the labour intensive manual process of the past into a complex, computer
based process, with ever more focus on lean manufacturing to reduce costs and to enhance
quality.
Figure 5.4: Trends in UK Domestic Product Real GDP Quarterly Growth

Source: www.statistics.gov.uk
4
2
0
-2
-4
-6
-8
Quarterly percentage change
Cumulative annual percentage change
2005
Q3
2006
Q1
2006
Q3
2007
Q1
2007
Q3
2008
Q1
2008
Q3
2009
Q1
2009
Q3
2010
Q1
2010
Q3
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The borderline between the new manufacturing processes and services is blurred for
example, assembling a computer is clearly a manufacturing process but designing the
software and systems that control the computer and all the other equipment in the factory,
depend on the services. Fewer people are currently employed in manufacturing than in the
past owing to the increasing use of technology and the outsourcing of services such as
design, catering and distribution.
The UK Office for National Statistics produces a number of economic indicators relating to
the UK economy. At the end of 2010, the five year trend in GDP growth is demonstrated in
Figure 5.4.
As the bar chart demonstrates, the Gross Domestic Product (GDP) increased 0.8 per cent in
the third quarter of 2010, compared with an increase of 1.2 per cent in the previous quarter.
The ONS (Office for National Statistics) explained these trends as follows:
Total services output rose 0.6 per cent in the third quarter, compared with a rise of 0.9 per
cent in the previous quarter. The largest contribution to the growth in this quarter was from
business services and finance and government and other services.
The trend in the UKs GDP as measured per head of population is shown in Figure 5.5.

Figure 5.5: Trend in UK GDP and GDP per Head 1990 - 2008

Source: Office for National Statistics

The UK Department for Envrionment, Food and Rural Affairs (DEFRA) placed these trends in
context:
Between 1990 and 2009, GDP grew in real terms by 47 per cent. However, following a
steady increase between 1992 and 2008, GDP decreased by 4.9 per cent between
2008 and 2009.
GDP per head followed a similar trend. Whilst there was an overall increase of 36 per
cent between 1990 and 2009, GDP per head decreased by 5.5 per cent between 2008
and 2009.
The growth in GDP as compared with that of other nations gives a measure of the relative
strength of the UK economy. The graphs below (Figures 5.6 and 5.7) indicate that the UK
GDP per head was growing faster than that of other nations (shown in the graph) up until
2006.
160
150
140
130
120
110
100
90
80
70
I
n
d
e
x

(
1
9
9
0

=

1
0
0
)
*

GDP
GDP per head
1990 baseline
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008
* Chained volume measures re-referenced to 1990 = 100
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Figure 5.6: GDP per Head for Several Industrialised Nations, 1990-2006

Source: United Nations Statistics Division
GDP per capita is an indicator of a country's economic strength, and has been linked by
economists with the standard of living in the country (although note the comments on this
below).
Output per worker (or efficiency) for UK, can be compared with other countries using
government GDP statistics.
Figure 5.7: Ouput per Worker for UK and Selected Countries, 2008

DEFRA noted that, between 1991 and 2008, the UK experienced faster productivity growth
(as measured by GDP per worker) than all other G7 countries. During the period, output per
worker increased by 39% compared with the G7 average (excluding the UK) of 29%.
However DEFRA also emphasises that "a degree of caution should be taken when
comparing the productivity estimates of individual countries. Differences should be only seen
as significant when they reach a threshold of five percentage points".
UK
Australia
US
J apan
Germany
Sweden
250
1990 1992 1994 1996 1998 2000 2002 2004 2006
220
190
160
130
100
70
G
D
P

p
e
r

c
a
p
i
t
a

(
$
U
S
)

(
1
9
9
0

=

1
0
0
)

J apan
Germany UK France G7
(Excluding
UK)
US
150
100
50
0
I
n
d
e
x

(
U
K

=

1
0
0
)

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In 2008, GDP per worker was higher in the US and France than in the UK (by 33% and 9%
respectively). Germany had a similar output to the UK in 2008, whilst J apans GDP per
worker was 8% lower than the UKs.
A countrys growth may look very different when output per head is examined; a nation may
have high growth but still be inefficient in terms of per capita output.
Acti vi ty 2
(a) What is the difference between a countrys GDP and its GNP?
(b) In interpreting Figure 5.5:
(i) Why do you think there was a decrease in UK GDP and GDP per head
in 2008-9?
(ii) Can you give reasons why the GDP line is higher than the GDP per head line?
(c) How useful are calculations of GNP and GDP?

Understanding and Interpreting National Accounting Data
The detailed calculation and publication of annual national product figures is a practice with
only a relatively short history. United Kingdom figures have been compiled regularly only
since the early 1950s.
After the Great Depression of the 1930s, the economic role of the Government changed and
there was a widespread belief that the Government should become involved in some degree
of economic planning. The realisation that the periodic economic problems arising out of
industrial activity could not be measured and properly understood unless accurate figures
were available, eventually led to acceptance by the Government of its duty to prepare these
figures.
If a government is to try to manage the national economy, it needs national accounts in the
same way as business managers need business accounts for the firms they are seeking to
control.
The existence of national accounting figures also helps us to understand how an economy
actually works. Without precise figures, issues such as the influence of interest rates on
savings or of income levels on consumption, cannot be measured. When we have
continuous records of interest rates, savings, incomes and consumption over a reasonable
number of years, then we can produce evidence of cause and effect.
The more we know about the workings of a modern economy, the more hope there is that
action can be taken to produce results that are beneficial to the community and that solutions
can be found for the great problems which beset industrial societies, such as mass
unemployment and price inflation.
Accounting records make comparisons possible. We can find out whether the economy is
operating more or less effectively than in the past, or more or less efficiently than the
economies of other countries. As mentioned earlier, caution is required when making
comparisons but, without national accounting figures, no comparison is possible.
One very practical use for national accounting figures is as the basis for a number of United
Nations calculations. Member contributions to some UN institutions depend on their national
product. National Income and Product figures are the starting point for many UN
investigations, designed to improve the economic and social performance of poorer nations.
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Note, though, that some countries may have an interest in ensuring that figures are not too
accurate. A country hoping to obtain maximum help from and make the smallest possible
contribution to United Nations institutions will wish to keep its national income figures as low
as possible.
National Product and Comparative Living Standards
Owing to all the points outlined above, careful use should be made of national product or
national product per capita or per head figures for the purposes of comparing living
standards. This becomes particularly important when we make the comparisons between
countries with different economic and social systems, or attempt to measure changes over
long periods of time.
When we talk about the standard of living, there are important aspects that cannot be
measured in terms of economic activity. A person may have a higher real income if
employed in 2010 than his/her mother had in 1990, but if they are unemployed and have little
prospect of employment, is their standard of living any higher?
Elements in the standard of living that are not included in any Gross National Product
calculations include opportunities for travel, for changing employment, freedom of speech
and religion, freedom to walk the streets without fear of violent crime, arbitrary arrest or
political coercion. Working hours and leisure time are also ignored as is the value of the
environment.
Some countries attach great importance to protecting their environment and preventing
pollution and other actions that degrade the physical environment, whereas in other countries
the environment may be ignored in both private and government decisions. The physical
environment may be so damaged and polluted that it damages people's health and reduces
living standards. Some countries, such as China and India, are currently achieving very high
rates of real economic growth using conventional measures of national income but at the
expense of large scale damage to their physical environments (including their supplies of
water).
Material living standards measured by real GDP per capita can increase at the same time as
the quality of life deteriorates and the former is the cause of the latter.
The Business Cycle
As we have seen in the graphs showing trends in GDP, there are fluctuations in economic
activity which affect the quantity of goods and service produced. When there is an
exceptional output of products and services this is called an economic boom and the
opposite situation is termed recession.
In the global economy the interdependence of nations means that a recession in one area of
the world is likely to affect many other distant countries too, as was the situation in the
2008-10 recession.
This cycle of booms and recessions is called the business or trade cycle.
Periods of recession occur when demand is far below the maximum potential output of the
nation. There is little or slow growth and perhaps even a decline. Businesses tend not to
invest.
In the boom period, there is rapid growth, business confidence and investment.
Each nation will only have limited resources (labour, land and capital) and so there is a
maximum possible output. Sometimes in a boom this maximum output will be reached as
shown in the first boom on the diagram.
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Figure 5.8: The Business Cycle

Maximum possible output can grow over a period of time due to:
Changes in demographics more labour becomes available, owing to changes in the
population size or more people of working age being available
Increases in productivity/use resources new technology means more efficient
resource use or more efficient working practices being employed.
J ust as there is a maximum output level there is also a minimum amount of products and
services that a nation needs to consume a minimum consumption. In a recession there
has to be a bottoming out after which there is an increase in demand again.

Date
Duration
(Months)
Date
Duration
(Months)
Sept. 1902-Aug. 1904 23 Feb. 1945-Oct. 1945 8
May 1907-J une 1908 13 Nov. 1948-Oct. 1949 11
J an. 1910-J an. 1912 24 J uly 1953-May 1954 10
J an. 1913-Dec. 1914 23 Aug. 1957-April 1958 8
Aug. 1918-March 1919 7 April 1960-Feb. 1961 10
J an. 1920-J uly 1921 18 Dec. 1969-Nov. 1970 11
May 1923-J uly 1924 14 Nov. 1973-March 1975 16
Oct. 1926-Nov. 1927 13 J an. 1980-J uly 1980 6
Aug. 1929-March 1933 43 J uly 1981-Nov. 1982 16
May 1937-J une 1938 13 J uly 1990-March 1991 8
March 2001-Nov. 2001 8
Source: National Bureau of Economic Research
Boom
Maximum
output
Trend
Recession
upturn
downturn
GDP
Time
Recession
Boom
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Between recession and boom the stage is called an upturn in the economy, demand
increases, growth in GDP occurs and businesses gain confidence. They begin to invest in
the business again.
After a boom there is a downturn in the economy, growth slows, demand falls and business
confidence dwindles.
The periods between boom and recession are not predictable. Some booms can be for
several years followed by a short recession. In 2008-9 the recession was deep and some
countries took two years or more before the upturn was detected.
However, as shown by the trend line on the graph over a long period, booms and recessions
even out to generally give a general rise in GDP.
The above table shows the pattern of recessions in the UK during the 20th century. It is
interesting to note that economics has not been able to predict booms and recessions in
many cases and could therefore be said to be an imprecise science based on these results!
Aggregate Demand
This is the sum of all demand in an economy:
Aggregate demand = Total expenditure on consumer goods & services (C)
+government spending (G)
+investment (I)
+net exports (X M)
Net exports =Total exports (X) Total imports (M)
The equation is conventionally written as: AD = C + I + G + (X M)
The trade cycle is affected by aggregate demand and this can change if any of the four
components that are used to calculate it alter:
Total expenditure will depend on consumer income and confidence if wages rise or
taxes are cut this will boost consumer confidence and they will buy more goods.
Amount of Investment depends on business confidence and interest rates low
interest rates encourage investment
Government spending is decided autonomously by the Government according to its
political and economic priorities
Exports will decrease if the countrys currency is strong as goods will be too expensive
for other nations to buy and
Imports will increase if the goods imported are perceived as inexpensive.
How Does Aggregate Demand Start to Rise Again?
Even in a recession, equipment will wear out and businesses will have to replace it.
Similarly, consumers will have to replace products such as washing machines, televisions
and kitchens that wear out. Both of these natural occurences will increase aggregate
demand.
As demand starts to rise after a recession it starts to accelerate at a rate faster than the
producer can supply, resulting in the need for increasing investment. The Government can
influence aggregate demand by altering taxes and influencing interest rates.
Goverments often do intervene to get the economy moving by instigating a demand policy,
but it takes time for businesses to gain the confidence to invest again and the consumer to
spend more of their disposable income on goods and services. We will look at this in more
detail later in this chapter.
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A change in goverment can also affect the aggregate demand for example, if an incoming
government was to seek to stimulate demand by lowering taxes and interest rates or to
increase government spending.
Random events can also affect aggregate demand. These can be national or international,
and may be political for example, September 11 and the 7/7 bombings in Central London
affected consumer confidence.
In a long boom period, continued fast growth can influence price rises and create inflation.
Recession means lower demand, resulting in rising unemployment, lack of growth and
investment.
Governments will adopt policies in an attempt to reduce inflation in a boom and stimulate
growth employment and investment during a recession to increase demand.
C. REGULATING THE MARKET
We saw that government will try to influence aggregate demand with the objectives of:
Managing inflation
Reducing unemployment
Controlling the Balance of Payments
Managing economic growth.
They usually adopt one of two methods of to achieve this:
Stimulating or reducing demand by use of "Fiscal Policy"
Controlling the money supply and demand, known as "Monetary Policy".
We shall look at each of these interventions in detail in the next section, after revisiting the
terms inflation, unemployment and balance of payments.
Inflation
Inflation is the term used to describe a condition of constantly rising prices. There are
several causes of inflation:
(a) Continuous rises in aggregate demand termed demand-pull inflation and associated
with a booming economy.
(b) Continuous rises in costs termed cost-push inflation. Firms attempt to respond
partly by raising prices to pass the costs on to consumers.
Inflation is a problem because it results in production and distribution systems becoming less
efficient since:
it creates uncertainly about prices
makes planning more difficult
long term agreements are hard to make
inflation creates a situation where consumer and business confidence reduces as there
is no constancy in the purchasing power of money.
In inflationary periods, savings lose their value and people who have saved for future needs
feel a sense of injustice.
If inflation is not checked, it increases in intensity until prices rise daily and all confidence in
money is lost.
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This condition of hyperinflation is usually associated with extreme political and social unrest
and uncertainty for the future. The best relatively recent example of hyperinflation was in
Germany in the 1920s, which caused social and political unrest providing the opportunity for
Hitlers rise to power. Germany recorded an astronomical inflation rate of 3.25 million percent
in a single month in 1923. Since the 1950s, hyperinflation has been confined to developing
and transition economies examples include Argentina (1989-90), Ukraine (1991-94) and
Zimbabwe more recently.
Trade difficulties are closely associated with inflation, which increases the prices of exports
and reduces the relative price of imports in world markets. Countries that have the most
severe rates of inflation find that their exports become more expensive and are difficult to sell
in world markets, while imports become cheaper and grow in volume.
Trade difficulties are detected in the structure of a country's balance of payments accounts
and are usually associated with deficits on the current account of the balance of payments
(see below).
Unemployment
Unemployment is an economic and a social problem.
Economic because production that could have been achieved is lost, since not all available
resources are employed in the production process. It is also social because generally work
is an important element towards a persons self esteem and standing in the community.
Someone who feels that they ought to be working, but who cannot find work can feel rejected
by society and sometimes resort to antisocial behaviour as a result.
Disequilibrium and Equilibrium Unemployment
Disequilibrium unemployment occurs when:
(i) the aggregate (total) supply of labour exceeds the aggregate (total) demand; and
(ii) there is a stickiness in wage rates such that those rates remain above the equilibrium
point where the supply of labour equals the demand.
As a result, there can be seen to be two main causes of disequilibrium unemployment:
Demand-deficient unemployment which is associated with recessions. As consumer
demand falls, firms will eventually cut back on the number of employees, so aggregrate
demand for labour becomes less than the supply. As the economy recovers, the
demand deficient unemployment will start to fall.
Real wage unemployment where wages in a particular sector of the economy are set
above the equilibrium wage level due to legislation or by negotiated agreement
(perhaps by unions). This results in a reduced demand for labour as profits fall.
Equilibrium unemployment occurs where there are excess job vacancies in some parts of the
economy, but a lack of vacancies in others. There are a number of reasons for this:
Structural unemployment which occurs when the structure of the economy
changes. When traditional industries decline, such as coal mining, steel making and
manufacturing in the UK, workers will lose their jobs. Also large scale redundancies
may occur when there are huge changes in technology and fewer people are required
to produce the same production output. This type of unemployment may also result
from major shifts in economic activity at both the regional and world levels. If, as in this
case, there are lots of redundancies in the north-east of the country these individuals
cannot suddenly move to other parts of the country to find work. An example of this is
when a big employer closes a site in a particular location. This results in:
Regional unemployment which is concentrated in a specific region of the country.
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Seasonal unemployment which occurs when work is associated with events that
occur at particular times of the year. For example, people working in the tourist
industry in the UK are likely to be unemployed for most of the winter months, and
agricultural workers experience fluctuations in employment associated with the timings
of crop harvests.
Frictional unemployment which is the term used where someone leaves or is
sacked from their job and looks for a new job, but does not necessarily take the first
one offered.
Cyclical unemployment which occurs when demand in the economy is low and
there is a downturn in the business cycle, with workers laid off. Cyclical unemployment
particularly affects workers in the building industry, who will be re-employed in an
upturn in the economy.
Measuring Unemployment
Unemployment is usually quoted as a number of people or as a percentage of the working
population (or labour force).
Labour Force = employed people + unemployed people
In the UK, the unemployment figures are based on the number of individuals claiming
unemployment benefit. The method of measurement changes from time to time.
The International Labout Organisation (ILO) defines unemployed people as people of
working age without work who are available to take up a job offer within two weeks and who
are actively seeking work or waiting to take up an a work position they have been offered.
Countries have different ways of calculating their unemployment rate so it is difficult to
compare figures.
Regional Problems
In the United Kingdom and in other countries,the problems associated with inflation and
unemployment do not affect all areas of the country equally.
In the UK there is north-south divide. The south of England is much richer than the north.
The City of London as a prime global financial services centre has a marked effect on this
divide. In the southern areas of the UK, inflationary pressures seem to be greater, whereas
unemployment is generally more severe in the northern areas. In the less industrialised
regions or areas with a less developed service sector, the unemployment rate is likely to be
higher. A lot of manufacturing industry was based in the north of England in the early 20th
century but as this declined, services did not fill the void.
In Italy the divide is the other way around, a rich industrial economy in the north and a poor,
mainly agricultural economy in the south.
Think Point
Is there a regional divide in unemployment in your country?
Unemployment can be seen as both an economic and a social problem. What are the
implications of a regional divide in terms of both economic activity and social issues?

Regional differences in unemployment mean that certain areas have failed to develop as
successfully as others. Production is being lost to other parts of the country and this can be
self-perpetuating, with a lack of investment and the underuse or inefficient use of available
scarce resources.
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It also causes social problems and political discontent since individuals and groups tend to
think that they are well off or badly off, according to the comparisons they are able to make
with other people. Standards of living, based purely on disposable income, are generally
much lower in the north of England, although the pace of life tends to be slower and the
community is more intact.
Where there are such problems this can invoke large scale movement of people from one
region to another to find employment and this is a further possible cause of social unrest.
Families are divided and pressures build up on housing and other services in the more
prosperous areas. In the UK, migration to the south has been significant, although many
workers will commute south on a weekly basis rather than move away from their families and
communities. Of course another factor is the very high cost of property and of living in the
south compared with that in the north of the country.
Balance of Payments
A countrys balance of payments is a record of all the money flows from transactions
between that country and the rest of the world.
Money received from abroad is recorded as inflows
Money sent to other countries is recorded as outflows.

The Balance of Payments Account comprises:
(a) Current Account
This account records
(i) exports (+) and imports () of goods and services
(ii) incomes flowing in and out of the country wages, dividends on shares, profits
(iii) net transfers of money, such as money sent abroad from migrant workers or
support for, say, students in the UK received from abroad.
(b) Capital Account
This records flows of money into (+) and out of () the country that are associated with:
(i) acquisition or disposal of fixed assets such as land
(ii) transfer of funds by migrants
(iii) payment by the govenment for overseas projects
(iv) receipt of payments from other bodies for capital projects in the the country (such
as money received for capital projects in the UK that were funded by the EU.
(c) Financial Account
The financial account records cross border changes such as:
(i) shares
(ii) property
(iii) bank deposits and loans
(iv) government securities.
These are funds for the sale and purchase of fixed assets
For a balance of payments to actually be in balance, credits must equal debits.
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When the inflows of funds on the current account are less than the outflows, there is a
balance of payments deficit. Similarly if the inflows of funds are greater than the outflows,
there is a balance of payments surplus.
When the balance of payments is in deficit this may affect the exchange rate of the currency.
For example if there were a current account deficit in the UK, the demand for foreign
currency to pay for imports will be greater than the demand for sterling by customers
overseas to pay for exports. As a result the exchange rate of sterling will fall. This means that
imports to the UK will become more expensive and exports will be cheaper for overseas
customers.
When the balance of payments is in surplus the opposite situation will arise and the value of
the currency will rise. Then imports will become cheaper and exports more expensive.
Managing Economic Growth
Nations all perceive adequate growth in different ways. If the UK growth of GDP was 1% a
year, this would be seen as inadequate if that of other developed nations was much higher.
When a countrys economy is growing at a fast rate and living standards are rising, its
government is likely to be in a relatively secure position as it has the resources to carry out
popular measures. Low growth means an inability to carry out popular measures and this
will make it difficult for governments to stay in power in countries where there is a
democratically elected government. People's aspirations may be raised by what they see
being achieved in more successful economies and there is dissatisfaction and unrest at the
failure to make similar progress at home.
Hence the economic growth prospects are one of the areas that governments will wish to
regulate.
D. GOVERNMENT INTERVENTIONS TO ACHIEVE
ECONOMIC OBJECTIVES
In this section we are going to examine the three strategies that governments use in an effort
to achieve their economic objectives.
Fiscal Policies
Fiscal policies relate to the use of government spending and taxation as instruments to
influence the economy.
The origin of this type of strategy is the work of J ohn Maynard Keynes, a UK economist who,
in 1936 at the height of the great depression, published a book entitled General Theory of
Employment, Interest, and Money. The main theme of the book was that the aggregate
demand created by households, businesses and the Government was the most important
driving force in an economy, not the dynamics of free markets. His theory also states that
free markets have no self-balancing mechanisms that lead to full employment.
Keynesian economists urge and justify a government's intervention in the economy through
public policies that aim to achieve full employment and price stability.
These ideas have greatly influenced governments across the world into accepting a
responsibility to provide full or near full employment through measures that stimulate
aggregate demand. Keynesian economics established the following principles.
During times of economic hardship, governments should work to set up employment
programmes for the people
Governments should increase government spending to stimulate the economy
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Governments must spend money in order to maintain full employment because
consumer spending is imperative for economic growth.
How Does Fiscal Policy Work?
In simple terms, fiscal policy comprises the adjustment of tax rates and government spending
to influence aggregate demand and therefore economic growth.
In the UK, government spending, at both local government and central government levels,
covers a wide range of goods and services, including health (the National Health Service),
education, defence, social security benefits and state pensions. Government spending may
also be used to subsidise infrastructure projects and support environmental projects.
Direct taxes are levied on both individuals income and organisations profits, such as income
tax and corporation tax respectively.
Indirect taxes are levied on goods and services, such as VAT and excise duties. Additional
excise duties are levied on fuel, alcohol and tobacco to try to deter consumption of these
demerit goods.
The incidence of tax refers to where the tax is paid, so in most cases the incidence of VAT
and excise duties falls on the consumer to pay. An increase in either is likely to reduce
consumer demand for these products or services.
The balance between government spending and taxation has a significant impact on the
economy.
(a) If the economy is in recession, the Government can increase government expenditure
and/or cut taxes. The effect of this is to increase aggregate demand, resulting in a
growth in GDP and reduced unemployment. In practice an increase in government
expenditure to reduce unemployment has often taken the form of government
investment in new projects that create jobs. This is known as expansionary fiscal policy.
(b) If the economy is growing too quickly and there are inflationary pressures with prices
rising rapidly, the Government may reduce government expenditure and increase taxes
to reduce aggregate demand. This is a deflationary fiscal policy (also known as a tight
fiscal policy).
A combination of these policies, known as demand management, is intended to smooth out
the fluctuations in the business cycle.
We can see examples of the operation of expansionary fiscal policies in response to the
2008-2010 recession:
In the USA, President Obama implemented spending programmes such as Dollars for
Dishwashers in the hope of stimulating the economy. The idea was that consumers
would trade in old dishwashers and receive a rebate when they bought a new one,
stimulating production. Obama also attempted to create jobs through the American
Recovery and Reinvestment Act, another government stimulus package intended to
create jobs and promote investment and consumer spending during the recession.
In the UK, the government scrapage scheme for trading in cars 10 years or older, with
a 2,000 rebate given for the traded in vehicle, was a similar attempt to stimulate
growth in the rapidly declining car manufacture sector.
Public Finances Deficit and Surpluses
Since expansionary fiscal policy involves an increase in public expenditure and/or lowering
taxes:
(a) The Government's budget may show a deficit because government spending exceeds
the amount collected in taxes.
(b) The level of national debt will increase.
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Keynes believed that this was a necessary short term measure to stimulate the economy.
He also believed that the amount invested had a multiplier effect on growth for example:
Investing 1 million into the economy (increasing aggregate expenditure by 1m)
produces a higher increase in GDP, say 3m.
The multiplier in this case would be 3.
In recent times most governments have run budget deficits. A budget surplus will occur only
if level of taxation collected is greater than government expenditure.
Limitations of Fiscal Policy
The Government may decide to deliberately alter expenditure or taxation levels, such action
is termed discretionary fiscal policy. Fiscal policy does, to some extent, automatically have
an effect on stabilising the economy through changes in expenditure and taxation. However,
this cannot prevent fluctuations it can only reduce their scale.
Cutting taxes has less effect on GDP growth than raising expenditure since:
Raising expenditure tends to ensure that all the money is spent and GDP rises
significantly, but
Lower tax rates will increase the disposable income of consumers but there is no
guarantee that all of the increase will be used to consume more goods/services.
The effect of fiscal policy on GDP, unemployment and inflation is very difficult to forecast for
the following reasons.
Crowding out
If the Government raises expenditure by xm, this action may lead to injections into the
economy of less than xm. This is because other types of injection into the economy
may decrease at the same time for example business investment. Check this by
looking back at Figure 5.3.
The Government will increase the budget deficit by increasing expenditure, but it will
have to either increase the supply of money to do this, or alternatively it can borrow
money from individuals and firms. When it borrows money it will compete with the
private sector to raise its finance from similar sources, resulting in an increase in
borrowing interest rates and so depressing the amount businesses will wish to borrow
and hence invest into the economy. This action is said to crowd out businesses from
borrowing and individuals from buying products/services on credit. Ultimately the
increase in government expenditure could be negated by the lack of consumption and
the fall in business investment.
Taxes
It is also not easy to predict how a change in taxes will affect savings, If individuals feel
that a cut in taxes is only temporary, or they lack confidence in the future for some
reason, they may not consume all of the additional disposable income.
Unpredictability of the multiplier
Time lag is an additional uncertainty how long will it take businesses to invest and the
consumer to begin spending when the Government increases expenditure or lowers
taxes? In a recession the Government will wish to encourage investment and
consumption, but lack of confidence may prevent this until the economy begins to
recover and moves towards a boom.
Fiscal Rules
The UK, like many other governments is less likely to change fiscal policy automatically each
time the economy is in recession or boom. Instead, it will set a rule for the level of public
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finances, usually annually. Government expenditure and taxation levels are then adjusted to
meet the level of public finances required.
Monetary Policies
Monetary policy is fundamentally concerned with managing the money supply. It involves
government using interest rates and other monetary tools to influence the levels of consumer
spending and Aggregate Demand.
In many countries, the Government sets a target for the rate of inflation and the Central Bank
must adjust interest rates to keep within this target rate. The Government will also other
monitor other macro-economic variables such as growth and unemployment.
In the UK, monetary policy is set by the Bank of Englands Monetary Policy Committee,
which is independent of the Government. If the Committee fails to keep inflation within the
target rate of 2% they must confer with the Chancellor of the Exchequer.
How does Monetary Policy Work?
In the UK, the Bank of England studies inflationary trends in the economy. This involves
looking at a range of economic variables such as:
Unemployment
Consumer confidence
Spare capacity in the economy
Exchange rate index
House prices
Economic growth.
(a) Stimulating growth
The Government or central bank will increase the money supply to stimulate growth in
a recession. Lowering interest rates is aimed at increasing the demand for money
which then flows into the economy, increasing its supply to stimulate investment,
consumption and growth. Quantitative easing, or simply printing more money, is one
method of increasing the amount of money in the economy.
(b) Reducing inflation
Increasing interest rates is intended to have the opposite effect decreasing the
money supply and reducing inflation. The Government can also sell government
securities on the open market, which are bought by investors who take money from
their banks to purchase the securities. This results in the banks having lower reserves
and, therefore, there is less money in circulation.
If interest rates are higher, businesses will find their costs of borrowing rising and they
will be less likely to increase investment, and may lay off staff.
An example of use of Monetary Policy occurred during the 2008 -2010 when both the UK and
the USA introduced quantitative easing as a part of monetary policy in an attempt to ease
the effects of recession. This involved creating money electronically to buy assets (such as
government bonds from banks).
Limitations of Monetary Policy
Interest rate rises may not have the desired effect on decreasing demand for money until
they have risen to a high level. Fluctuations in the demand for money also make managing
aggregate demand through interest rates difficult. Speculation about exchange rates,
interest rates and inflation add to this.
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However, using interest rates as a means of controlling inflation has come to be accepted
globally as an indication that a government is serious about keeping inflation under control.
The EU, for example, also has a target inflation rate which it controls by altering interest
rates.
Supply Side Policies
Keynesian and monetarist ideas that we have focused on in this section have concentrated
on demand and ignored supply. In reality, supply must be also taken into account.
There are a number of strategies for achieving this.
The UK Coalition (Conservative and Liberal Democrat) government in 2010 and the
Margaret Thatchers Conservative government in 1979 reduced the public sector
massively. They perceive the public sector as being inefficient, and look to encourage
growth by stimulating supply in the private sector through better use of resources.
Such governments encourage increases in aggregate supply by rewarding individual
enterprise and initiative. Conservative governments in the UK have also seen this as a
way of reducing public expenditure and reducing the size of the public sector.
Governments often give direct incentives and rewards to businesses, for example:
Monthly allowances to support the owners of start up businesses while the
business grows
Cuts in the taxation of company profits (Corporation Tax) which increases the
after tax profits of the business.
Restricting the power of trade unions to improve pay and conditions can be used as
another means of ensuring that private sector firms profits are sustained or improved.
In the Thatcher era, laws were passed to prevent strikes, picketing and closed shops.
Labour mobility can be improved by offering the unemployed advice, work experience
and training, and by providing better information on job vacancies.
Encouraging competition by, for example:
Privatising nationalised firms such as rail, electricity and other utilities and
telephone
Introducing private sector (or free market) practices into public sector
departments
Promoting free trade initiatives and movement of money across borders
Using private businesses to carry out government projects and then maintaining it
on completion called a Public-Private Partnership.
Increased competition in general also reduces the power of unions, and globalisation
has created increased competition and has impacted significantly on the power of
unions, particularly in developed industrialised countries.
Acti vi ty 3
Summarise the main advantages and disadvantages of Fiscal and Monetary Policies.

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SUMMARY
Countries make decisions about how production will be managed. This will usually be
Planned economy where all decisions of what is produced, methods of production,
distribution and price are the responsibility of the State
Market economy where supply and demand dictates the decisions which are made
by private business owners
A mixed economy which has elements of both systems as the State will wish to
produce goods and services that it considers vital for the community.
Governments measure their economic output using two main categories:
(a) Gross National Product (GNP) which takes into account all products and services
produced and purchased by the countrys citizens wherever the live.
(b) Gross Domestic Product (GDP) which is the market value of all final goods and
services produced and purchased within a country during a given time period. There
are two ways to measure GDP:
Nominal GDP is the value of production at current market prices
Real GDP is the value of production using a given base year prices, here
presented at constant (2005) market prices measured in millions of British
pounds.
GDP per capita is calculated by dividing either nominal or real GDP for a given year by the
population in that year. These numbers can be thought of as the average share of output per
person.
Calculations of GNP and GDP are useful for comparing the economic health of different
countries, but these should be use with caution as they may be calculated in different ways.
Governments intervene in the economy to manage unemployment, inflation, manage growth
and control the balance of payments. The main methods used in an attempt to control these
factors and so reduce the booms and recessions of the business life cycle are fiscal and
monetary policies.
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Activity 1
(a) Aspects typical of a centrally planned economy are shown by the following quotes:
allocation of massive State resources and effective control of large-scale SOEs
state holding enterprises account for roughly half of all (non property) urban
investment in fixed assets
continues to exercise general political direction over the economy
Olympic games demonstrated the power of the state to mobilise resources and
sweep away obstacles to its policy objectives. There was phenomenal public
expenditure on the games, the government ruthlessly cleared residents from
large areas of Beijing and heavy industries were shut down in a desperate
attempt to reduce air pollution for the duration of the games
the state has effectively retained control of former SOEs......that at any time the
Party can regain control if necessary
As State ownership ....increasingly concentrated in large, capital-intensive
firms...
SASAC are powerful agencies of State control...authority over 196 key firms
SASAC exercises nominal ownership rights over five large electricity
conglomerates that produce virtually all of Chinas electricity
inherent conflict with the Communist Party over appointment power....makes all
key appointments in the State Sector
(b) The evidence here suggests there is only a very slow move away from the planned
economy. The signs of market economy described in this article are few:
joint stock companies (selling shares to private investors)
it is not easy to determine the state/private balance of ownership

Activity 2
(a) GDP is the total market value of goods and services produced within the borders of a
country regardless of the nationality of those who produce them.
GNP is the total market value of goods and services produced by the residents of a
country, even if they are living abroad.
(b) (i) There was a recession in 2008-9 so that GDP decreased.
(ii) There are two possible answers to this:
There are different ways of measuring GDP at market prices and true
cost. The GDP per head may be based on different calculation method
The growth in population may have been greater than the growth in GDP.
(c) The estimation of GNP or GDP assists in government economic policy, in planning by
decision-makers in private business, in estimating how efficient workers are compared
with other countries and the potential reasons for this.

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Activity 3
Fiscal Policies
Uses taxation and government spending
to:
Create more jobs/reduce
unemployment in a recession
Create demand for products/services
to stimulate the economy out of
recession
A small injection of capital into the
economy is said to create a much larger
result multiplier effect.
Reduces inflation by decreasing
expenditure or increasing taxes.
Can smooth out the booms and recessions
of the business cycle.
Can send the balance of payments into a
debit situation.
Cutting taxes does not necessarily make
consumers spend the extra income they
may save and demand is not increased.
The extent of the multiplier cannot be
easily forecast.
Government borrowing to increase
spending can reduce private investment
and raise interest rates by crowding out.
There can be a considerable time lag
between injection of capital and economic
growth.
Monetary Policies
Governments manage the economy by
restricting the flow of money, usually using
interest rates as the mechanism
Inflation targets are set and the central
bank must adjust the money flow to keep
inflation within that target.
Increasing the flow of money by lowering
interest rates or printing more money
(quantitative easing) stimulates borrowing
by firms and consumer spending.
Reducing the flow of money by increasing
interest rates reduces borrowing and stems
consumer spending.
Enterprise and innovation are encouraged
with certain monetary based incentives.
Encourages competition.
Raising interest rates does not guarantee a
reduction in spending; sometimes rates
have to become very high before there is
any effect.
Fluctuations in interest rates and
speculation make it difficult for interest rate
policy to be effective.

139
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Chapter 6
Governments and Business

Contents Page
Introduction 141
A. Pressure Groups 141
What is a Pressure Group? 141
Lobbying 142
Pressure Groups and Business 142
The Trade Unions as a Pressure Group 143
B. Reasons for Government Intervention in Business 143
Market Failures 143
Anti-competitive Behaviour 146
C. Forms of Government Intervention 146
Taxation 146
Subsidies 147
Advantages and Disadvantages of Taxes and Subsidies 147
Regulation and Legislation 148
Consumer Protection 149
Employee Protection 150
D. Equality and Diversity 151
Discrimination and Less Advantageous Treatment 151
Equal Pay 152
Disability 153
Managing Equality and Diversity in the Workplace 154
E. Fair Treatment of Employees 154
Dismissal 154
Redundancy 155
Harrassment and Victimisation 156
Health and Safety at Work 156

(Continued over)
140 Governments and Business
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Summary 159

Governments and Business 141
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INTRODUCTION
Chapter 5 concentrated on the use of fiscal monetary policies to manage the economy.
In this chapter the focus is on the reasons national governments intervene in the business
activities of firms at the micro-economic level and the forms that this involvement takes.
The extent to which governments intervene in the economy depends on their political
agenda. This will determine how much and in what ways it becomes involved.
As we discussed in Chapter 5, socialist governments favour a larger role for the State
than a non-socialist one. The State acts as both a regulator and a producer.
In non-socialist governments, there is a smaller State role and firms are encouraged to
improve operations in a free market environment.
A. PRESSURE GROUPS
Firms interact with government in various ways in order to influence policy on matters
relating to the operation of their business for example, on the extent of proposed new
legislation.
Acting on their own, very large organisations are likely to have the greatest influence on
government policies. This may result in being of advantage to business generally. However,
since some multi-national companies have a turnover greater than the GDP of single
countries, many perceive this as business practice being too powerful and potentially
damaging to society as a whole. Also acting on their own, some large organisations are
government suppliers and have direct contact with ministers, and so have a powerful
negotiating position. There is no guarantee that these firms will persuade government to
take certain actions or desist from others, but normally that their view will be considered
along with those of others.
More usually, though, businesses work together to influence the actions of governments, and
the groups which are formed to pursue this come under the general heading of pressure
groups.
What is a Pressure Group?
A pressure group is a group of people who believe in the same cause and who come
together in order to influence some aspect of society to act in accordance with their views on
that cause. The cause may be anything from issues about the local, regional or global
environment, through the defence or promotion of the rights and influence of particular
groups, to specific issues of consumerism. For example, high profile pressure groups
include:
Shelter - aim to help homeless people and promote policies to address their problems
Amnesty international - defends human rights
Greenpeace - campaigns on environmental issues
CBI (Confederation of British Industry) - promotes business interests
TUC (Trade Unions) - promotes workers' interests.
These groups act on Governments to try and influence their policies, but perhaps one of the
most successful pressure groups of recent times was CAMRA the Campaign for Real Ale,
which campaigned against the practices of the large breweries in the 1970s in what they saw
as changing the nature of beer in the UK. Within a few years, its high profile campaigning
had such an influence on consumer behaviour (independent breweries selling "real" beer
flourished and the big breweries started losing trade) that there was a complete about-turn
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among the large breweries, who started producing traditionally brewed beer again
themselves and also selling the produce of independent breweries.
The activities used by pressure groups varies with the nature of the cause and the bodies
they are trying to influence. They can exert direct pressure on these bodies through letters,
petitions, demonstrations and direct actions against particular sites or activities (which,
although usually illegal, can be particularly effective). However, most pressure groups also
aim to build public support for their cause through these activities, as well as various
publicity campaigns, as a means of getting their cause recognised as both valid and widely
supported.
Lobbying
When established pressure groups want to influence the decisions of governmental policy
makers, there is the option of direct approaches to the people involved in the decision
making process.
Lobbying is the practice of individuals and organisations trying to influence the opinions of
MPs and Members of the House of Lords. Methods of lobbying vary and can range from
sending letters, making presentations, providing briefing materials and organising private
meetings.
In the UK, anyone can lobby a Member of Parliament or a Member of the House of Lords,
including:
individual members of the public
groups of constituents
local businesses, usually through Trade Associations and local Chambers of
Commerce
organised pressure groups/campaigners
commercial organisations.
MPs and Lords are the target of many different lobbying interests, attempting to persuade
them to vote a certain way on a specific issue. Whilst, their decision will ultimately be down
to their own judgement and the influence (if any) that existing party policy has on them,
lobbying remains an important method of influencing government policy and decision
making. Indeed, there are firms specialising in lobbying and these are often employed by
large organisations to advance their own interests.
The same processes operate at local level where local councillors may be lobbied on matters
of interest to local constituents and businesses.
Pressure Groups and Business
Pressure groups of varying kinds have always tried to influence firms about issues such as
pollution, using animals for testing and expansion plans in built up areas. Often this is
intertwined with pressure on government to act on the way firms operate. There are now a
whole range of groups, some large and relatively powerful, that pressure government and
business regarding types of ingredients in foodstuffs, obesity, use of resources, climate
change and other concerns.
In recent times, this has extended a great deal further to cover what is now termed corporate
responsibility. Pressure groups and lobbyists, therefore, exert pressure on both groups to
change practices for the social good.
Corporate responsibility is not a well defined term. In this manual it is regarded as covering
the areas of:
Corporate governance
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Social responsilibility with regard to the environment and the well-being of people
affected by a firm's actions
Ethics.
We will be examining these areas in some detail in Chapter 9.
The Trade Unions as a Pressure Group
The Trades Union Congress in the UK has approximately 6 million members, making it
Britains largest pressure group. The TUC comprises 58 affiliated unions representing
working people from all walks of life. It campaigns for a fair deal at work and for social justice
at home and abroad. It negotiates both in Europe and in the UK to build links with political
parties, business, local communities and wider society.
The TUCs stated activities include:
Bringing Britains unions together to draw up common policies
Lobbying the Government to implement policies that will benefit people at work
Campaigning on economic and social issues
Representing working people on public bodies
Representing British workers in international bodies, in the European Union and at the
UN employment body the International Labour Organisation
Carrying out research on employment related issues
Running extensive training and education programme for union representatives.
Union representatives work voluntarily in the workplace to support their colleagues at work.
Members receive assistance, support and representation on a range of issues from achieving
a better work-life balance to improving access to training and skills.
Although their power to influence the employer has been much reduced in the UK, the unions
still have a major role in some organisations and have contributed much to training and
development initiatives in recent years.
B. REASONS FOR GOVERNMENT INTERVENTION IN
BUSINESS
Market Failures
Free markets do not operate is a perfect manner and, without any intervention, the market
economy would not always operate in a socially or economically practicable way. In other
words, free markets are rarely socially efficient.
In economics, the term social efficiency depends on the balance between two terms:
(a) Marginal Social Benefit (MSB) is seen as an extra benefit to society from producing (or
consuming) a good or service'
(b) Marginal Social Cost (MSC) which is the cost to society of producing (or consuming) a
good or service. This cost includes all aspects both financial and non-financial.
Socially efficiency occurs when Marginal Social Cost =Marginal Social Benefit.
A practical example of this concept is to assess the social efficiency of building a high speed
rail link between London and Birmingham, which goes through the countryside. Is the cost to
the environment, of taking away the publics leisure activities in that countryside and
residents' quality of life, plus the financial cost, greater than the benefit of passengers
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journey being one hour shorter than at present? If the marginal social cost is calculated to
be higher this project will be socially inefficient.
All governments intervene in business to ensure that social efficiency results, an outcome
which firms would not pursue if they were able to make their own decisions on this matter.
Imperfect Information
A perfect market is only possible if there is perfect knowledge of all the costs and benefits
that affect the individual. This is one of the basic assumptions about the operation of free
markets. However, it is rarely true.
Often a consumer will purchase a good or service without really understanding its features
until it has been used. The lack of accurate information may be worsened by the way that
firms market their products or services.
In business, firms are usually not well informed about their competitors, market opportunities,
costs and the potential productivity of their employees. Business forecasting is made in
conditions of uncertainty and ignorance about the future.
Type of Market Failure
There are two main types of issues which the market cannot efficiently deal with and require
some form of government intervention.
(a) Externalities
When producers or consumers take actions that affect other people, but not
themselves, these effects are known as externalities. There are good and bad
externalities:
A good production example could be planting new trees which benefit the community in
many ways such as the visual impact, the exchange of carbon dioxide and oxygen in
the air and a haven for wildlife.
For consumption a desirable externality is car sharing when three or four people go to
work together in one car, reducing the traffic congestion as a result and making
travelling easier for others.
The provision of street lighting in an urban area is funded by local government, which in
turn raises revenue from local taxation. The residents of the area in which the lighting
is installed benefit from it through greater physical safety and less risk of road
accidents. However, others will benefit, such as people from other districts and towns
who did not pay for the lighting but nevertheless gain some advantage from it.
Bad examples include firms dumping used tyres in a private parking area, factories
dumping waste into rivers, air pollution from cars and factories and so on. The local
council has to pay to have these types of situations rectified; the cost is incurred by the
community and not by the firm. Individuals also cause externalities; examples of
consumption are dumping, excessive noise in public places, litter etc.
Since nobody owns rivers or the air, no individual or group can be charged for cleaning
them so the cost is borne by society; it is a social cost.
(b) Public Goods
These are goods that are not practical or profitable for any private firm to produce and
can only be provided by the Government or by the Government paying private firms to
produce the goods or service.
(i) Merit Goods
Merit goods and/or services are those of benefit to the public , but which are
likely to be under-produced or provided for by the private sector. Education,
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community centres and libraries are services that the government perceives the
public may consume too little of if decisions on levels of supply were left to the
free market.
The government, acting in the publics interest to ensure they consume sufficient,
can either provide them free or give subsidies.
(ii) Demerit Goods
On the other hand when there are goods that people consume which the
government consider harmful, such as smoking and drinking alcohol, they act in
an attempt to decrease consumption, perhaps through taxation. These are
termed demerit goods.
Acti vi ty 1
(a) Which of the following externalities are positive and which are negative, and why?
(i) Litter
(ii) Man Made Lakes
(iii) Official Rubbish Tips
(iv) Drinking alcohol
(b) Consider the following short case study and then answer these two questions:
(i) What is the externality that the UK government is trying to address using this
policy?
(ii) What are the negative implications of the immigration cap for British and
J apanese firms?
Japanese Firms Lobby British Government
to Rethink Immigration Plans
J apanese firms are threatening to review future investments in Britain if the
Government goes ahead with plans to put an annual cap on immigration
levels.
Company bosses have told ministers that moves to limit the number of skilled
citizens from outside the European Union that can be employed in Britain will
seriously harm their businesses. J apanese firms are particularly concerned
about plans to curb the number of senior staff who can be transferred from
J apan on a short term basis, or intra-corporate transfers (ICTs), as well as
limits on recruiting skilled staff from outside the European Union.
The new centre-right Coalition government has decided to impose a cap on
immigration due to growing concern that non EU citizens are taking jobs that
could be done by skilled British people.
An interim cap was previously only imposed on skilled workers, but ICTs are
currently exempted. A new cap is planned for next year and ministers are
consulting on the size of the cap and which sectors should be covered,
including possibly ICTs.

See the suggested answers at the end of this chapter.

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Anti-competitive Behaviour
We examined anti-competitive behaviour in Chapter 4. This behaviour is typical of some
powerful large suppliers and often results from collusion between them to fix prices. In turn
the consumer is forced to pay the asking price. Some governments do not condone this
activity and instigate legal means to minimise it.
The present UK legislation will be examined later in this chapter.
C. FORMS OF GOVERNMENT INTERVENTION
Governments intervene in business activities to a substantial extent mainly to protect the
interests of consumers, workers and the environment, for example in respect of:
Health and safety in the workplace
Terms and conditions of employment
Firms colluding against the interest of consumers
Use of resources
Environmental damage
Advertising legislation
Product safety.
Governments adopt policies to adapt the market to offset the failures in these areas and
there are three main methods of intervention:
Taxation
Subsidies
Regulation and legislation
Taxation
Apart from its role in raising revenue to fund government expenditure, taxation is also used to
encourage either:
Lower consumption of those goods and services which are deemed harmful.
Thus, tax on cigarettes is used in an attempt to encourage people to stop smoking,
which is both bad for the health of individual consumers, but also has an externality in
passive smoking which results in injury to the health of others and induces extra costs
to the National Health Service.
Lower production of those goods and services which the market produces in excess of
what is required or deemed appropriate.
Thus, green taxes have been introduced by governments in an attempt to reduce
environmentally harmful practices. These have become an increasing concern to
members of the public with issues such as acid rain, air and land pollution and climate
change now under scrutiny.
Globally, green taxes and charges cover many different situations including:
Fuels for example, leaded petrol being taxed more heavily than unleaded
Landfill tax to encourage more recycling and re-use
The range of taxes and charges varies by country.
ABE
To be fully effective the charge or tax should be equivalent to the degree of marginal extra
cost that it causes although this is not usually the form it take (see legislation and regulation
below).
Acti vi ty 2
Find out what green taxes your country imposes.

Subsidies
Subsidies are used to incentivise production of goods and services when the market is likely
to produce too little.
A very good example is the EU system of subsidies for agriculture the Common Agricultural
Policy (CAP). The EU agricultural policy continues to evolve. In the 1950s it focused on
providing enough food for the European population, emerging from over 10 years of war-
induced shortages. It subsidised food production and brought up surplus production. Now
the policy is used more selectively and helps farmers when they are faced with natural
disaster or when their production is halted because of diseases such as foot and mouth.
When subsidies are awarded they are dependent on compliance with broader objectives
such as farm hygiene, food safety, animal health and preservation of traditional rural
landscapes.
Advantages and Disadvantages of Taxes and Subsidies
(a) Advantages
As we noted earlier awarding a subsidy can be linked to improvements in practice
such as in the CAP, where farmers get a subsidy on condition that they comply
with improvements in animal care.
Taxes force firms and individuals to become more aware of the social cost of the
externalities they cause. They also encourage firms to improve practice such as
lowering their pollution levels by changing working methods and/or equipment.
(b) Disadvantages
It is difficult to assess the cost to the public caused by each externality, whether
this is caused by a firm or an individual.
There is no way of measuring the longer term effect of various forms of pollution
so that their cost to society cannot be accurately assessed.
The regulation of non-compliance would be extremely costly if each firm, for
example, was monitored individually.
In the past the European Union has continued to pay subsidies to farmers for
producing foodstuffs such as beef and milk. Stockpiling these foodstuffs kept prices
unnaturally high and there was a great deal of public opposition to the continuance of
this practice.
ABE
Regulation and Legislation
In terms of their application to business enterprise, legislation is used to:
Prevent or regulate the behaviour of firms in their productive operations
Prevent firms from providing misleading information
Prevent firms from producing products which are harmful to individuals and/or society.
We shall examine two such forms of legislation in respect of consumer and employee
protection below.
Regulation is primarily used to regulate the activities of monopolies or oligopolies such that
they do not exploit their position in the market to act against the interests of consumers. This
has generally taken the form of discouraging firms from adopting anti-competitive practices,
particularly in respect of prices. Thus, in the UK, privatised former nationalised industries
such as rail, telephone, gas, water and electricity are now regulated by the Government.
Each has a watchdog regulator to which the consumer can complain if the firms try to raise
prices above inflation for example, Ofgem is the regulatory body for the gas and electricity
industry.
A general regulatory body is the Office of Fair Trading (OFT). The OFT's mission is "to make
markets work well for consumers. Markets work well when businesses are in open, fair and
vigorous competition with each other for the consumer's custom. It offers the public
information and advice on subjects such as product safety, consumer debt agreements and
appraises mergers and acquisitions.
The Competition Commission is the public body in the UK that is responsible for reporting on
cases referred to it by the OFT on anti-competitive agreements or abuse of a dominant
market position.
Control of Environmental Issues
Command and control (CAC) regulation has traditionally been used to control environment-
related issues. Under this, specific guidelines are given by a government on how to comply
with mandatory requirements about, for example, emissions levels. Thus, a maximum limit
on emissions is imposed with firms being subject to inspection and failure to keep within the
specified limits resulting in substantial fines.
The main disadvantages of CAC are that it is a costly method to enforce and it does not
provide any incentive to reduce levels below the maximum permitted.
An alternative is pollution taxes, such as the landfill tax. This is a more effective deterrent in
that the firm gets charged for the amount of pollution it generates the lower the pollution the
lower the tax bill. The other advantage is that it encourages firms to invest in cleaner
technology to reduce emissions.
Another form of regulation which has gained popularity in recent years is the concept of
tradable permits. These work on the basis of a firm paying a fee for the amount of pollution
it produces above the permitted limit. However, if it reduces its level of pollution below the
limit, it receives what is known as a tradable credit. This can then be sold on to another firm
that has exceeded the limit. There are permits for each type of pollution waste disposal,
emissions into the air or water, etc. This practice links well to the CAC method and is
regulated by the market.
Think Point
What disadvantages might there be with tradable permits?

ABE
The main problem is that the overall level of pollution may not change. In addition, pollution
could become concentrated in one geographical area. The practice may reduce the
incentive for dirtier factories to reduce their pollution.
Consumer Protection
There are a number of laws intended to protect the consumer against unfair practices. The
main ones for the UK are summarised below.
(a) Consumer Protection Act 1987
This includes sections related to product liability and consumer safety. It has
undergone several revisions since it was first passed.
Product liability is the term given to laws affecting the rights of indiviudals who are
injured by defective products. Injured individuals may have the right to sue the supplier
for damages whether or not the product was sold to them personally.
In broad terms, the injured person can take action against the producer (usually the
manufacturer) and/or, if appropriate, the importers who brough the product into the EU,
not just into the UK. If the supplier has branded a product with its own name, it can
also be liable as it has given the impression that it is the producer.
Liability under the Act is joint and several, so the injured party may sue both (or all, if
more than two) defendants.
(b) The Consumer Protection from Unfair Trading Regulations 2008
This introduced a general duty not to trade unfairly and seeks to ensure that traders act
honestly and fairly towards their customers. These regulations apply primarily to
business to consumer practices.
(c) Distance Selling Regulations
These have become very important with the increasing role of e-commerce. They
apply to any firm selling goods or services to consumers by:
internet
digital television
mail order, including catalogue shopping
phone
fax.
The regulations provide for:
giving consumers clear information, including details of the goods or services
offered, delivery arrangements and payment, the supplier's details and the
consumer's cancellation rights. This information has to be provided, in writing in
addition to verbally, before they buy (known as prior information)
giving the consumer a right to a "cooling-off" period of seven working days within
which they can cancel the purchase.
(d) The Consumer Credit Act 1974
This requires most businesses that offer goods or services on credit or lend money to
consumers to be licensed by the OFT. Trading without a licence is a criminal offence
and can result in a fine and/or imprisonment.
The Act also requires certain credit and hire agreements to be set out in a particular
way and to contain specific information.
ABE
(e) Anti-competitive Behaviour Legislation
The Competition Act 1998 is designed to make sure that businesses compete on an
equal footing. It is intended to eliminate collusion and price fixing by firms.
The Office of Fair Trading states that, in the UK, anti-competitive behaviour is
prohibited in two main ways:
(i) Anti-competitive agreements (such as cartels) between businesses are prohibited
by Chapter I of the Competition Act 1998 (CA98) and Article 81 of the European
Community Treaty.
(ii) Abuse of a dominant position in a market is prohibited by Chapter II of CA98 and
Article 82 of the EC Treaty.
The laws contained in the CA98 and Articles 81 and 82 of the EC Treaty are similar, but
not the same:
CA98 prohibits anti-competitive behaviour that affects trade in the UK.
Articles 81 and 82 prohibit anti-competitive behaviour that affects trade in the EU.
Anti competitive behaviour is taken very seriously:
The OFT has a wide range of powers to investigate businesses suspected of
breaching these laws and, for example, can force firms to cease offending
agreements or specific conduct.
Businesses that break the law can be fined up to 10% of their worldwide turnover
and third parties (including injured competitors, customers and consumer groups)
can bring damages claims against them.
Individuals found to be involved in cartels can be fined and imprisoned, currently
for up to five years. Directors of companies that breach the prohibitions can be
disqualified for up to 15 years.
Employee Protection
Government regards the rights of employees as an important area where some employers
would fail to act reasonably.
The basis of the legal relationship between an organisation and its employees is that of a
contract of employment (a voluntary agreement into which employer and employee freely
enter under the terms of common law). Both sides have a duty to behave reasonably and
responsibly.
Employees should give faithful and honest service
There should be a legal framework to ensure the fair treatment of employees at work
and to prevent discrimination on various grounds.
The interests of employees are sometimes channelled through trade unions, although this
has become less usual in recent years as UK legislation concerning trade union activities has
considerably weakened their involvement.
Firms, through their managers, need to ensure that they do not discriminate unfairly in the
decisions or actions that they may take in regard to employees, whether prior to or during
employment.
In the next section we consider the existing legislation which has been made to protect the
interests of employees.
ABE
D. EQUALITY AND DIVERSITY
Unequal treatment of individual employees often results from prejudices and preconceptions
of the people with whom they have to work. Within the United Kingdom, the following areas
are the main ones where unfair treatment has been experienced and which the Government
has addressed through legislation:
Sex/gender including people who are having or who have had a sex change,
transvestites and transgender people, and also covering pregnancy and maternity
Race/ethnicity
Disability which includes mental health and people diagnosed as clinically obese
Age including both older and younger workers
Marital status including civil partnerships
Religion and belief
Sexual orientation covering people who are gay, lesbian, bisexual or transgender.
Under the Equality Act 2010, these categories are termed "protected characteristics".
This Act combines and replaces most of the previous discimination legislation. The word
"discrimination" itself can be seen as having negative associations and has been replaced, in
some instances, by the term "less advantageous treatment" which perhaps has a broader
interpretation.
We shall consider the application of this term first, and then go on to review other aspects of
equality in the workplace.
Discrimination and Less Advantageous Treatment
Discrimination, or less advantageous treatment, may take place in relation to any of the
following work processes:
Recruitment and selection
Opportunities for training and development
Promotion and career development
Benefits, including pay
Dismissal.
The main forms of discrimination which may occur within these categories are:
Direct discrimination less advantageous treatment because of a protected
characteristic.
Indirect discrimination when a rule or policy that applies to everyone, disadvantages
a person with a protected characteristic. This includes, for example, the specification
of unnecessary conditions which certain groups are not able, or are unlikely, to meet.
There are circumstances where what would otherwise be unlawful discrimination is
permitted. These are where less favourable treatment may be justified on specific grounds
such as that the less favourable treatment cannot be removed or made non-substantial by a
reasonable adjustment on the part of either the employer or the employee.
There are also exemptions for particular types of employment where the holding of a specific
characteristic is a requirement of the job for example, women carers to work with women in
certain circumstances.
ABE
Note that the law applies not just to the actions which employers do take, but also to the
actions they omit taking.
Claims Against an Employer or a Potential Employer
In the event of a claim, the burden of evidence is upon the employer to prove that the person
was treated fairly the organisation must demonstrate fair and equal treatment in the case of
a claim of discrimination.
The legislation applies from the moment an individual has contact with an organisation as
s/he does not have to be employed currenty to be able to make a claim. This may apply, for
example, in respect of applications for employment.
It is not necessary for a claimant to demonstrate that the organisation committed unlawful
discrimination. They can claim if they suspect that treatment was for unlawful reasons.
Firms should keep complete written documentation on every aspect of interaction with the
employee or potential employee to protect their interests.
Equal Pay
This issue forms part of the Equality Act 2010. Although legislation dating back to 1970
has addressed it, this has had limited effect in bringing the pay of women in line with
that of men, as shown by in Figure 6.1.
Figure 6.1: Gender UK Pay Gap
Pay gap between women's and men's median hourly earnings excluding overtime
(employees on adult rates, pay unaffected by absence)

The Equal Pay Act 1970 was the first piece of legislation that attempted to promote
equality at work. It sought to address the issue of parity between the pay of men and
women who were doing work of equal value in the same employing organisation. This
does not necessarily mean simply doing the same job. The Act specifies the occasions
when the pay of a woman should be equal to that of a man as follows.
Like work
This is relevant when a woman can show that she is doing the same, or very
similar, work as a man that is, where two people of different sex are doing
exactly the same job.
30
25
20
15
10
5
0
-5
-10
1997 1999 2001 2003 2005 2007 2009
P
e
r
c
e
n
t
a
g
e
s

Full-time
Part-time
All
ABE
A good example of this is two teachers, one male and one female, each teaching
the same subject to children of the same age in either the same or different
schools. If the work is the same, so should the rate of pay.
Work rated as equivalent
This comes into force when a woman can show that the job she is doing could be
rated at the same level as that of different job held by a man and paid at a
different level. Different jobs are often grouped together in families where they
are considered equal, even though the actual tasks involved may vary.
Work of equal value
This term concerns work that may be shown to have an equivalence of value to
the organisation, such that to pay one job less, on the basis that a woman holds
it, would amount to unfair treatment. Women and men may claim equal pay
under this legislation, although the latter case is rare.
Disability
The Equality Act 2010 aims to protect disabled people and prevent disability discrimination.
In addition to employment rights, it provides legal rights for disabled people in the areas of:
Employment
Education
Access to goods, services and facilities including larger private clubs and land based
transport services
Buying and renting land or property
Functions of public bodies, for example the issuing of licences.
The Act also provides rights for people not to be directly discriminated against or harassed
because they have an association with a disabled person. This can apply to a carer or
parent of a disabled person. In addition, people must not be directly discriminated against or
harassed because they are wrongly perceived to be disabled.
Definintions
Under the Equality Act 2010, a person has a disability if:
S/he has a physical or mental impairment
The impairment has a substantial and long-term adverse effect on his/her ability to
perform normal day-to-day activities.
For the purposes of the Act, these words have the following meanings:
'Substantial' means more than minor or trivial
'Long-term' means that the effect of the impairment has lasted or is likely to last for at
least twelve months (there are special rules covering recurring or fluctuating conditions)
'Normal day-to-day activities' include everyday things like eating, washing, walking and
going shopping.
Individuals who have had a disability in the past that meets this definition are also protected
by the Act.
There are additional provisions relating to people with progressive conditions. People with
HIV, cancer or multiple sclerosis are protected by the Act from the point of diagnosis. People
with some visual impairments are automatically deemed to be disabled.
ABE
Some conditions are specifically excluded from being covered by the disability definition,
such as a tendency to set fires or addictions to non-prescribed substances.
Adjustments to Working Conditions and Practices
Legislation specifies there is a duty to make reasonable adjustments for disabled people.
This applies in cases in which an individual would be at a substantial disadvantage compared
to a non-disabled individual if the adjustment was not made. Such adjustments include
adaptating the premises, part time or modified work schedules and provision of readers,
personal assistants or interpreters.
The Disability Equality Duty
In addition to the less advantageous treatment considered above, since December 2006 all
public sector organisations have had a legal duty to promote equality of opportunity for
disabled people. Public sector organisations include:
Hospitals
Schools and colleges
National health service (NHS) Trusts
Police forces
Central and local government
The Disability Equality Duty (DED) covers everything public sector organisations do,
including policy making and services that are delivered to the public.
Managing Equality and Diversity in the Workplace
Establishing a culture of diversity needs commitment from the top and active encouragement
throughout the organisation. It needs to be supported by appropriate management policies
and practices.
For example, the development of more flexibility in working conditions can be a key feature
of enabling different groups to be involved in the organisation. This may be seen in the
growth of more flexible and individual contracts of employment, the introduction of career
breaks and the establishment of flexible working hours.
Most larger organisations try to formally integrate equality and diversity into their business
strategy. Most would see a commercial business case for being an equal opportunity
employer.
Such an approach would move beyond simply complying with the legislation. It involves
promoting equality and diversity, through its employment policies and encouraging the
concept of an integrated workforce by ceasing to treat the issue of equality separately.
E. FAIR TREATMENT OF EMPLOYEES
In addition to specific legislation about the treatment of groups with protected characteristic
status, there is also protective legislation for all employees in certain areas.
Dismissal
Employees should only be dismissed if, despite warnings, conduct or performance does not
improve to the required level within the specified time period. Dismissal must be reasonable
in all the circumstances of the case.
ABE
Unless the employee is being dismissed for reasons of gross misconduct, s/he should
receive the appropriate period of notice or payment in lieu of notice. Legislation in the UK
lays down minimum periods of notice.
Can an Employer Dismiss without Notice?
Employers should give all employees a clear indication of the type of misconduct that, in the
light of the requirements of the employer's business, will warrant dismissal without the normal
period of notice or pay in lieu of notice. So far as possible, the types of offences which fall
into this category of 'gross misconduct' should be clearly specified in the rules, although such
a list cannot normally be exhaustive.
No dismissal should be instant. A dismissal for gross misconduct should only take place after
the normal investigation and disciplinary meeting to establish all the facts. The employee
should be told of the complaint and be given the opportunity to state their case, as in any
other disciplinary meeting. The employee has the right to be accompanied at any such
meeting.
What is Gross Misconduct?
Gross misconduct is an action generally seen as serious enough to destroy the contract
between the employer and the employee, making any further working relationship and trust
impossible. It is normally restricted to very serious offences, for example, physical violence,
theft or fraud, but may be determined by the nature of the business or other circumstances.
Except in very exceptional circumstances, the full three-step statutory procedure (written
statement, hearing and appeal) should be used before deciding whether to dismiss.
Redundancy
Redundancy is dismissal which is not related to the conduct or capability of the individual or
to retirement or resignation. It may apply only if:
the business is ceasing to trade
the business is reducing in size
the purpose for which the employee was recruited is no longer required
the business is changing work location.
Employers are expected to have redundancy procedures in place. Failure to follow
appropriate and reasonable procedures could lead to employers being liable for claims of
unfair dismissal even if they have potentially good grounds for dismissal.
Employees that are threatened with redundancy should be are made aware of the contents
of any agreed procedure and of the opportunities available for consultation and to make
representations.
If the employees being made redundant belong to a trade union the employer should involve
the trade union in the redundancy plans as early as possible. Alternatively, employee
representatives should be notified.
The employee representatives or the unions should share the problem and explore the
options:
ways of avoiding the dismissals
reducing the number of employees to be dismissed
mitigating the effects of dismissals.
The employer must carry out this procedure with a view to reaching agreement with
appropriate representatives on these issues; it must not be pretence, even when the
employees to be made redundant are volunteers.
ABE
These procedures must be completed before any redundancy notices are issued. In the UK
there are statutory minimum time limits. The consultation process should precede any public
announcement of the redundancy programme and notices of termination should not be
issued until consultation has been completed.
Harrassment and Victimisation
Harassment and bullying in the workplace can be a major concern and result in claims being
made against the employer if the issue is not dealt with.
This is an awkward subject to define, but is usually interpreted to cover:
Unwanted actions or comments viewed as humiliating and unacceptable to the
recipient such actions including pushing, tipping up, gestures, etc. and comments
being either verbal, by email or text, or graffitti
Unwarranted actions or comments which are detrimental to the recipients dignity, such
as being isolated and contributions being ignored.
Note that, in both these circumstances, it is the perception of the recipient which is key to
determining whether the actions/comments complained of constitute harassment.
Victimisation is the act of the employer treating someone less advantageously because of
some characteristic unrelated to the reasons for the treatment complained of. This may be,
for example, because he/she had previously complained about a discriminatory act or had
supported someone else who had complained, or for trade union activities.
Health and Safety at Work
Employers are responsible for ensuring that they create a safe and healthy workplace for
their employees. There is specific legislation for each industry but in general, the employer is
responsible for
making the workplace safe and eliminating or controlling health risks
ensuring that plant and machinery are safe and that safe systems of work are set and
followed
ensuring that articles and substances are moved, stored and used safely
providing adequate welfare facilities
giving workers the information, instruction, training and supervision necessary for their
health and safety
consulting workers on health and safety matters.
The extent of the issue and the cost to employers and employees are demonstrated in the
figures released by the UK National Statistics Office in its 2009/10 Annual Report:
1.3 million people who worked during the last year were suffering from an illness (long
standing as well as new cases) they believed was caused or made worse by their
current or past work. 555 000 of these were new cases
152 workers were killed at work a rate of 0.5 per 100 000 workers
121,430 other injuries to employees were reported under RIDDOR (see below) a rate
of 473 per 100 000 employees
233,000 reportable injuries occurred, according to the Labour Force Survey a rate of
840 per 100 000 workers
28.5 million days were lost overall (1.2 days per worker) 23.4 million due to work
related ill health and 5.1 million due to workplace injury.
ABE
The Reporting of Injuries, Diseases and Dangerous Occurrences Regulations 1995
(RIDDOR) place a legal duty on employers, self-employed people and people in control of
premises to report:
Work related deaths
Major injuries or over-three-day injuries
Work related diseases
Dangerous occurrences (near miss accidents).
The Health and Safety at Work etc Act 1974
The Health and Safety at Work etc Act 1974, also referred to as HASAW or HSW, is the
primary piece of legislation covering occupational health and safety in the United Kingdom.
The Health and Safety Executive is responsible for enforcing the Act and a number of other
Acts and Statutory Instruments relevant to the working environment.
Important regulations have been created to cover areas including:
Hazardous substances
Noise
Manual handling (lifting and carrying)
Violence in the workplace
The Act was last updated in 2006 and its full content can be viewed at the HSE website.
Most of the developments in Health and Safety in the UK are now driven by European
legislation. Employers are required to keep records of all incidents as mentioned earlier.
The HSE provides information on the different types of records and explains exactly what the
employer needs to record and why.
Complementing Health and Safety legislation are Codes of Practice. These codes offer
practical advice to employers and others. Failure to comply with a code is not an offence in
itself.
Employers are expected to provide safety training. There are three methods of doing this:
Induction setting the scene for an organisation that is safety conscious.
On the job via colleagues and managers; at team meetings and in appraisals.
Through specialist training for those moving into jobs which are particularly vulnerable.
Many firms now use short videos which are viewed regularly by employees so that they are
reminded of the key points. Since there is a relatively high proportion of workers in the UK
who do not speak English as a first language, videos in the form of cartoons which
demonstrate the safety aspects simply are used to communicate all the key messages to
employees of all nationalities.
Trade Unions and Health and Safety
A recognised trade union has a legal right to appoint safety representatives and managers
must consult with these representatives. They can inspect, investigate complaints,
communicate with an HSE inspector and sit on the local H&S committee. The employer is
obliged to allow them reasonable time off for their activities, for training and cannot ban
someone from being a representative.
The HSE supports the role of unions and other employer health and safety representatives in
their contribution to maintaining and improving health and safety in the workplace. It
provided the TUC with the Brown Book (Safety Representatives and Safety Committees
Regulations 1977, Approved Code of Practice and guidance) for training purposes.
ABE
Working Time Regulations
The UKs Working Time Regulations limit the average working week to a maximum of 48
hours (unless the employee has voluntarily opted out), give a minimum of 20 days paid leave
and limit night working hours. The 48 hour week is averaged over 17 weeks. However, this
does not apply if the job is:
One where the employee can choose freely how long s/he will work for example, a
managing executive
In the armed forces, emergency services and police, although only in particular
circumstances
As a domestic servant in private houses
As a sea transport worker, a mobile worker in inland waterways or a lake transport
worker on board sea-going fishing vessels.
Anyone over 18 years of age can opt out of the 48 hour a week restriction, but this must be a
voluntary action and not applicable to all the firms workforce. Employees cannot be sacked
or unfairly treated for refusing to do so.
Acti vi ty 3
Answer Yes or No to the following questions, and note the reasons for your answers:
(a) Can an employer be guilty of discriminating against a person who is not an employee?
(b) Does the individual have to prove an accusation of discrimination?
(c) Does a company have to report workplace accidents to the HSE?
(d) Can a firm refuse to employ a disabled person?
(e) Does disability include learning difficulties and poor sight?
(f) Can a firm make you work a 65 hour week?
(g) Can an importer be responsible if you are injured by a faulty good?
(h) Do you have any rights when you buy goods from the internet?


ABE
SUMMARY
Business and individuals interact with government in an attempt to exert influence on
government policy affecting business.
Pressure groups use a variety of means to attract the attention of other members of the
public and to influence the actions of businesses and the government.
Businesses also attempt to influence government decision making through their role as
suppliers to government, or by direct representations using professional lobbyists or
intermediates such as their trade association.
Governments intervene when the market fails to provide goods and services that the public
needs.
It will examine the social efficiency of goods and services produced and will try to limit
the amount of market failure.
Externalities are a result of market failure and can be positive or negative. If the
marginal social cost of a good/service is greater than the marginal social benefit then
the externality will impact on the public in a negative manner.
Government intervenes in the activities of businesses in the interest of public well-being and
safety. It imposes legislation, taxes or subsidies in an attempt to discourage poor practice or
encourage better practice.
Taxes are often imposed to discourage the public and firms from doing social harm
such as emitting excessive pollution.
Subsidies will be given to firms to produce goods that are not available in sufficient
quantity.
Legislation on equality, consumer protection, health and safety and employee
protection are all examples of intervention into the working practices of firms so that
they operate in a responsible manner.

ABE
Activity 1
(a) (i) Litter negative
The person dropping the litter may get no adverse reaction, but the social cost to
others is that of making the environment unpleasant (and possibly a health
hazard) and the cost of the local authority employing someone to clean up.
(ii) Man made lakes positive or negative depends on circumstances
If the lake is artificial and trees and wildlife were removed to make room for it,
then it could be classed as negative as it has disturbed the eco-system and taken
away a lot of public pleasure.
If it is made to improve an area, for example where there was an old quarry, then
it will be positive. It will attract the public as somewhere pleasant to be and
wildlife will return to the area.
(iii) Official rubbish tips in general, positive
Although these have to be financed by the local authority, the cost is much lower
than collecting discarded items singly. If it is equipped to divide waste into
categories, then recycling can occur and sometimes discarded goods are suitable
for sale with money being raised for charities.
(iv) Drinking alcohol positive and negative
The amount is one issue. If it is in reasonable amounts it can give people
pleasure when eating a meal or socialising with friends, stimulating a relaxing
and pleasant atmosphere. These would be positive.
The negative externality arises through excess drinking of alcohol. There is a
health risk, of course, whereby the person may have an incident or accident and
have to use the facilities of a hospital, with a consequent cost to the health
service. There is also the fact that excess alcohol can often make people very
rude or violent so promote unpleasantness and harm to others.
(b) (i) The cost to the British employee of being unemployed while a non-British or and
EU citizen takes a job they could have done.
(ii) These may include:
The lack of opportunity to exchange ideas and improve learning
Britain may not be able to acquire the specific skills when it wants them
There is also the negative effect on relations between the two countries and
J apan could easily retaliate.

Activity 3
(a) Yes.
(b) No. The responsibility is on the employer to prove that it acted fairly and without any
discrimination.
(c) Yes, if the injured person is on sick leave for 3 days or more or if there are dangerous
incidents or diseases.
ABE
(d) Yes, but only if it is not possible to make reasonable adjustments to the physical
environment of the workplace or working practices in order to accommodate the
disabled person.
(e) Yes.
(f) Yes, if this equates on average with other weeks to a 48 week during a 17 week period.
Otherwise, the employer cannot enforce a 65 hour week without your written
agreement.
(g) Yes, if the importer brought the product into the EU. The manufacturer can also be
held liable.
(h) Yes. You must be given all terms and conditions, delivery and cancellation
arrangements in writing and are entitled to a 7 day cooling off period.

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163
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Chapter 7
Business in the Global Context

Contents Page
Introduction 164
A. The Characteristics of Global Business 164
International Trade 165
Comparative Cost Advantage 166
The Multinational Enterprise 167
B. Free Trade and Globalisation 168
Advantages and Disadvantages of Free Trade 168
Barriers to Free Trade 170
Trading Blocs 172
The Role of the World Trade Organization in Free Trade 174
C. Technology as a Driver of Globalisation 175
Impact of Technology on Global Business 175
Impact of Technology on Global Trade 176
Costs and Benefits of Changing Technology on Business 179
D. Theories of Globalisation 179
Porters Diamond 180
International Product Life Cycle 182
Summary 186

164 Business in the Global Context
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INTRODUCTION
In Chapters 1- 4 we focused our attention on national business and covered concepts that
will now be expanded in a different context. In the remaining chapters our concentration will
be on the facets of global business and what extra factors have to be considered in addition
to those of a firm that essentially operates in a national environment.
Here, we shall examine what is meant by a global business and the drivers and triggers that
influence firms to expand all over the globe.
Several aspects of those factors, positive and negative, will be explored in the context of real
world examples and you will be asked for your thoughts on the impact these factors have
made in your country and on your life style.
Lastly, you will have some case studies to look at, where you will apply what you have learnt
in the Chapter.
A. THE CHARACTERISTICS OF GLOBAL BUSINESS
Global business has the following distinctive characteristics:
Movement of people across borders
Movement of money across borders
Extensive trade across borders.
A global organisation must think global and act local if it is to succeed. These three
characteristics demonstrate how this can work in practice.
(a) Movement of people across borders generally occurs in managing projects or teams in
new locations. It is important to have cultural awareness and business understanding
from managers and leaders who can exchange practice and maximise performance.
Large companies with a global presence look for potential leaders who possess a world
view and are able to move from one location to another with ease. Multinationals such
as Coca Cola build up extensive experience in a variety of locations when developing
future managers.
(b) Money movement is demonstrated in many ways, but investment in company growth
illustrates this well. Whichever option(s) the organisation chooses for growth, financing
will be necessary for that growth. For example when Kraft, the American based
multinational acquired UK based Cadbury in 2010, it paid $18.9 billion.
Acquisitions and mergers in countries other than the firms head office location and the
purchase of offices and manufacturing facilities in other global locations indicate the
movement of money which is a characteristic of globalisation.
The impact of exchange rates on global profits is yet another indicator of global money
movement. For example, notes to a firms accounts might state The unfavourable
impact of currency fluctuations decreased net operating revenues by approximately 5
percent. The unfavourable impact of changes in foreign currency exchange rates was
primarily due to a stronger U.S. Dollar compared to most foreign currencies, including
the Euro, South African Rand, British Pound, Brazilian Real, Mexican Peso and
Australian Dollar, which had an unfavourable impact on the Eurasia and Africa, Europe,
Latin America and Pacific operating segments.
(c) Trade across borders can be indicated by the countries in which the firm operates and
by the data it produces to demonstrate market sector growth for products in various
countries. For example, in their 2009 Annual Report, Coca Cola stated Coca-Cola
Business in the Global Context 165
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Company is a truly global company, and we operate in over 200 countries around the
world. Its regional data from Africa and Eurasia demonstrates their global coverage
and market share growth: In 2009, our unit case volume grew 4 percent, led by 31
percent growth in India, 21 percent growth in Algeria, 17 percent growth in Pakistan
and 9 percent growth in Kenya.
International Trade
What is the difference between international trade and global trade?
As we mentioned earlier a global company is regarded as any company which owns
and controls the production of goods and/or services in several different countries.
This is often referred to as "direct investment" overseas. They are "multinational",
although this term is usually associated with very large companies. Leading
multinationals include BP, General Motors and Pepsico, which are giant enterprises. In
the past 20 years, though, this situation has been transformed by advances in
technology and many much smaller companies now operate across national
boundaries.
An International company, by contrast, is one that has a home base in a specified
country and simply owns shares or loan stock in foreign enterprises. It does not
directly control their activities. This type of arrangement is called portfolio investment".
Terms of Trade
The terms of trade are defined as the:
Average price of exports of and the average price of imports
These are measured by using an index which has a base year with an assumed value of
100.
If in a year the average price of imports has risen by 30% with respect to exports, the terms
of trade will be 70%. This will be a worrying situation as it will affect the balance of payments
(see later). The terms of trade will have worsened.
If the average price of exports rises faster than average price of imports, the terms of trade
will have been improved.
Acti vi ty 1
If the average price of exports in your country has risen by 50% with respect to the average
price of imports.
(a) What will the terms of trade be?
(b) Will this be a good or bad situation for your economy? Give a reason for your answer.

The Benefits of International Trading
Global trade provides benefits for individual firms and countries including:
(a) Better supply of goods
A country may obtain goods which it could not have obtained otherwise. For instance,
Britain could not enjoy tropical fruit or manufactured goods made of copper, nickel, and
many other metals if it were not for the existence of international trade.
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(b) Lower costs
A country can obtain goods, which it could only grow or produce at higher cost than in
other countries. Opening up the whole world for trading purposes increases the size of
the markets for various goods. Production on a larger scale is then possible, allowing
full advantage to be taken of economies of scale.
For example, if Switzerland only made watches for its own comparatively small
domestic market, the cost of production per unit would be much higher than it is.
(c) Monopolies can be curbed
The existence of international trade is an obstacle to the development of monopolies.
Even if there are monopolies in existence in one country, their control over prices will
be limited by the ever present threat of foreign competition.
(d) Encouragement of international cooperation
The existence of international trade also leads to a greater degree of interdependence
between states and this should be a factor making for international peace and friendly
cooperation between nations.
(e) Shortages can be prevented
World trade reduces the likelihood of shortages of supply since it is possible to offset
temporary domestic shortages by getting additional supplies from abroad. One
significant outcome of this is that it makes famines less likely in trading nations.
Comparative Cost Advantage
Countries have different natural resources. They also differ in population density; age
ranges; skills, equipment and climate. Hence different countries will produce different types
of goods and services and the cost of producing the same good will vary. This gives rise to
one of the key concepts behind international trade.
Absolute advantage is a situation where a country can produce a good with fewer
resources than another country. Examples of absolute advantage would be the production of
grapes in Italy and wheat in Russia.
However, countries buy goods that they could produce themselves. According to economic
theory, this arises from the concept of comparative advantage.
In simple terms, comparative advantage occurs when a country specialises in the production
of a certain good because it can produce more of it at a lower price per unit than other
goods. It may then import the other goods that would cost it more to produce itself.
For example, imagine that two countries A and B that can both produce both copper and
wheat.
For a given outlay (which might be measured in terms of labour and money) their production
is as follows:
A can produce 300 units of wheat and 150 units of copper
B can produce 150 units of wheat and 100 units of copper.
Country A apparently has an advantage over country B in the production of both wheat and
copper as it can produce both more cheaply for the same cost.
Will there be any scope at all for trade between the two countries?
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The answer is yes provided that A's advantage over B is not proportionately the same for
both commodities:
For wheat the ratio A:B is 300:100 or 3.0:1
For copper the ratio A:B is 150:100 or 1.5:1.
Country A will thus tend to specialise in the production of those commodities in which it has
the greatest comparative advantage, or the least comparative disadvantage.
As A's comparative advantage in the production of wheat is greater than its advantage over B
in the production of copper, it will pay A to specialise in the growing of wheat and to leave
copper production to B.
Therefore, A will produce wheat and B will produce copper.
The law of comparative advantage states:
If countries are to gain competitive advantage they should trade goods in which
they have comparative advantage and import those in which they have
comparative disadvantage.
The Multinational Enterprise
Growth of the multinational enterprise has been stimulated by
Decrease in barriers to trade
Improvements in technology and communications
Efficient international capital markets
Encouragement by developing countries
Rising costs and production difficulties in the industrial nations
Extending the product life cycle.
We shall look at some of these triggers for change in more detail throughout this chapter.
Multinational enterprise involves a transfer of production capacity from one country to
another. It has consequences for the multinationals home country, the host countries where
new enterprises are established and for the whole pattern of global trade and production.
(a) Consequences for the Home Country
If a British manufacturing company decides to locate a new factory in Brazil rather than
in England, then England loses the investment to Brazil. From the British point of view,
this is called "divestment" that is, the loss of productive investment. The decision
may mean a loss of some capital.
In the home country there is consequently a loss of production work and jobs are lost.
Most of these jobs are likely to be in the routine work of manufacturing, in unskilled and
semi-skilled jobs and the work of supervision.
The more highly skilled manufacturing work, as well as research, planning, marketing,
etc. is still likely to take place at the home headquarters of the multinational company.
In the last few years there has been a trend to keep highly skilled manufacturing in the
developed country as, it is argued, the skills and attention to quality needed cannot be
reproduced in some overseas locations.
In the past, home country nationals were more likely to be asked to fill managerial and
skilled technical jobs in the overseas country. While this is still probable, the extent of
the practice has reduced. Key staff are difficult to find, are sourced from all over the
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world and are sent to work in other locations as part of their development. This results
in more management roles disappearing in the home country than in previous years.
Another consequence of divestment for the home country is that visible exports fall and
visible imports rise. Invisible earnings rise, as the overseas sections of multinationals
pay fees and royalties for patents and services and remit profits to the home country.
Of course, profits go to the owners of capital and there is a real possibility that the
profits will be reinvested in further foreign production and not used to develop business
at home.
(b) Consequences for the Host Country
The host country gains jobs and some capital investment. It will also gain export
earnings and saves some import payments by having producers of products for world
markets within its own economy.
There is doubt as to whether it gains the full value of production though, because the
home part of the multinational company may require heavy payments for technical and
managerial services, as well as a substantial share of profits.
Host countries gain benefits from importing managerial skills and technical know-how,
which may help in developing their own production capacity in the future.
It will usually be in the interests of the multinationals to keep factor costs low
particularly labour costs and for labour to be non-unionised and often with
substantially worse working conditions than those which would apply in the home
country. If factors (especially wage costs) do start to rise, then the multinational may
be able to transfer production to another country, leaving the original host country
worse off than before.
In addition, there will be little encouragement from the multinational enterprise for the
development of domestic industries which may prove to be competitors, both in selling
products and as employers of production factors.
(c) Consequences for Global Trade
The growth of multinational enterprise has radically changed the pattern of trade.
Visible trade is no longer a matter of a flow of basic materials to the western
industrialised countries and a counter flow from them of manufactured goods.
Manufacturing is now carried out in a very wide range of countries, although some of it
is still controlled by and relies on technology supplied by the advanced industrial
nations.
B. FREE TRADE AND GLOBALISATION
The barriers to free trade have reduced significantly in recent years. This has encouraged
firms to take advantage of the opportunities available in many countries.
Advantages and Disadvantages of Free Trade
(a) Advantages of Free Trade
The principle of comparative advantage shows that free trade and specialisation brings
gains to the participating countries. As long as a country has a comparative advantage
in producing something, it can benefit from specialising in its production and trading the
surplus for other materials and products from abroad.
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The advantages of free trade can be summarised as follows:
Countries can specialise and increase production, confident that they can export
any surpluses.
Resources can be allocated more efficiently.
Countries can export surpluses and import what they need.
Countries gain economies of scale as they are able to access to the world market
to sell more of their products.
Competition from imports increases efficiency as it encourages countries to
upskill their workforce, promote research and development and to gain access to
newer technologies.
Limits the creation of monopolies or oligopolies within the country that could keep
prices high.
It helps to keep inflation low.
Countries are able to diversify into producing other products and services making
them less dependent on just a few. For example, a single item, such as cotton or
coffee, for which the harvest is subject to climatic conditions, leaves the
population vulnerable.
Free movement of capital allows countries to develop their industries, economic
growth to occur and the nation becomes wealthier.
Political links develop between countries.
(b) Disadvantages of Free Trade
"Infant" industries or small new businesses can be crushed by foreign
competition before they have had time to develop.
Dumping of excess or low quality goods by other countries who may sell them
abroad at a lower price than at home. This is done partly to avoid swamping the
home market with a surfeit of goods which would bring down home prices. It may
also include products that are no longer acceptable to consumers in the country
of production.
Reduces demand for home produced products and may increase unemployment.
Free trade may not be in the interests of national security goods produced for
defence purposes, for example, need to be produced in the home country to
ensure that it is not dependent on foreign suppliers in times of conflict.
Foreign companies may create monopolies in the home market.
Externalities such as increased pollution from industry or heavy lorries used in
distribution.
Increases the influences of external consumer tastes and attitudes, such as
consumerism, reduction of community values and a tendency towards western
fast food.
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Barriers to Free Trade
All trading nations engage in some form of trade protection, as governments face political
pressures from powerful domestic interest groups. It is, though, very unlikely that a country
would ban international trade altogether.
By using a variety of devices to delay imports or make them more expensive, countries can
effectively create barriers to free trade. An example is to impose bureaucratic import
procedures with complicated documentation, so slowing down the completion of the import.
Formally imposing blanket restrictions on trade is rare as it would cause other nations to take
retaliatory action and court disapproval from the World Trade Organization (WTO).
Nevertheless, formal trade protection measures are still employed by individual countries and
regional groups such as the European Union.
The main measures are:
(a) Import tariffs
These are also known as customs duties and are taxes imposed on goods when they
enter a country or one of a group of countries, such as the EU. Tariffs are usually
applied to selected items.
The advantages of tariffs are:
(i) The objective of imposing the tariff is to raise the cost of the imported goods so
that importers have to raise prices or accept reduced profits
(ii) They raise money for the government
(iii) The tariff raises the price paid for the imported good by the domestic consumer
and reduces the quantity purchased hence, the imports suffer a competitive
disadvantage compared with home produced substitutes
(iv) Domestic producers supply more to the market and foreign suppliers provide less
than if there were no tariff.
Customs duties may be imposed as a specific duty of a fixed amount per item or per
tonne or by the total value. Specific duties work best for goods of low value and high
weight, such as iron. By-value is best applied to items like jewellery and those whose
prices change often.
The amount received by foreign exporters may be the same or less than before the
tariff.
(b) Import quotas
These are restrictions on the quantity of goods that can be imported. The purpose of
import quotas is to lay down the exact quantity of a commodity which may be imported
in a given period of time. Import quotas may be accompanied by customs duties.
(c) Embargoes
Embargoes are a total ban on imports or exports, usually applied for political reasons.
An example would be the export of arms to a certain country in a war zone.
(d) Non-tariff barriers
These are barriers applied through safety rules and administrative controls, as noted
above. They can be seen as a subversive method of protectionism.
(e) Exchange control
Control is enforced in many countries to redress an adverse balance of payments, by
requiring all buying and selling of foreign exchange to be done through the central
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bank. It limits the amount of foreign exchange purchases so that it is equal to the
amount of foreign exchange receipts.
Disadvantages of Trade Barriers
Trade barriers are usually introduced to protect domestic industry from foreign competition
and/or to control the balance of payments account of a country. There are, though,
significant problems with their use.
International retaliation Other nations are likely to take similar action, hence reducing
the opportunity of the protectionist country from trading its own goods easily.
Unemployment ultimately rises If all countries sought to reduce and impose barriers
against imports, total trade and production would fall and unemployment would
increase in all countries. Thus, the spread of protectionism would increase
unemployment overall.
Reduction in industrial efficiency Protecting domestic industry against foreign
competition makes firms less able to compete in world markets. The longer controls
last, the more they are needed and the country loses the variety of products provided
by imported goods. Its standard of living would fall with this loss of choice, as
increasingly inefficient firms required more and more resources to produce less and
less.
Cost and corruption Enforcing trade barriers is costly and officials are prone to taking
bribes from importers so that they can trade their goods in the country.
Think Point
Think about the benefits and disadvantages of free trade to your own country and to others
you may be familiar with.
(a) Does your own country operate a policy of free trade and, if so, what do you see as the
benefits and disadvantages of that policy for the country?
(b) Why do you think a country might be opposed to free trade?
(c) On a social level, what are the positive and negative aspects of free trade for you
personally?

You need to assess the application of the arguments about free trade to the countries you
have selected.
Some of the benefits include the opening up of markets and greater opportunities for
exporting, wider choice of products available at a lower price to consumers, increased
employment opportunities and increased skills levels in less developed countries. All these
factors are likely to increase GDP in all countries and lead to greater prosperity and higher
income levels.
The disadvantages, economically, tend to be the threat to domestic production by the import
of cheaper goods. This may lead to domestic business closures and rising unemployment.
If free trade has not been embraced, the decision may have been made so as to protect the
countrys own industries and/or its culture. The latter is often overlooked, but the influence
of, particularly, Western or American goods and ideas, can threaten the indigenous culture. It
may also be that the government wishes to continue receiving the income it gets from tariffs.
It is also important to consider the effects on society of free trade. On the one hand, we
probably all benefit from the variety of goods and services which become available and, at
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least for some, the generally higher standard of living and improved life styles. However,
there are problems created by the threat to domestic culture and traditions, and the
exploitation of lax labour laws and environmental protection in some less developed
countries,
Trading Blocs
The activities of trade blocs have huge importance in the economic and political scenarios of
the contemporary world. Trading blocs have played a major role in regulating the trend and
pattern of international trade.
Trade blocs are free trade zones designed to encourage trade activities across nations, while
making it difficult for non-members to trade there. The formation of trading blocs involves a
number of agreements on tariff, trade and tax.
What is included in the trading agreement depends on the political will of the members.
For example, they may be unwilling to expose a trade such as agriculture to competition or to
accept the full degree of international specialisation which goes with completely free trade.
Creating a trade bloc has two major effects on trade:
Trade creation whereby countries which previously placed tariffs on imports from
other members and produced the goods themselves, allows free trade in such goods
between members
Trade diversion whereby the removal of barriers inside the bloc results in trade being
switched from a more efficient producer outside the union to a less efficient one inside.
In addition to the benefits of trade creation there are other benefits from setting up a free
trade area:
Economies of scale develop because the member countries now have a much larger
"home" market.
Specialisation in products having a comparative advantage creates greater
opportunities for economies of scale.
Greater efficiency is enforced because the members' industries are exposed to more
competition.
Consumer welfare is increased as people have more, better quality and cheaper
goods, with more variety, to choose from.
Increased political cooperation as the member countries develop common policies and
become more dependent on each other.
The larger the trading bloc, the greater the potential benefits because of the better chance of
including the lowest cost producer and the bigger opportunities for economies of scale.
There will also be more opportunities for trade creation, whereas previously there was lot of
duplication and large cost differences between the production of the members.
In addition, the gains from specialisation will increase, especially if there were high tariffs
before the creation of the trade bloc. Previously there would then have been a lot of
domestic production for relatively small markets.
The lower the external tariffs imposed by the union the better, as this reduces the possibilities
of trade diversion.
One of the biggest disadvantages of trading blocs is loss of political and economic
independence because the countries must take into consideration the policies and rules of
the bloc when deciding their own policies. For example, the UK has had a number of
significant disagreements on policy with the European Union (EU) on matters such as
working hours and employee rights.
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The effects of trading blocs have to be carefully evaluated to see if they really do benefit the
citizens of the member countries and not just protect inefficient producers.
Examples of Trading Blocs
(a) EU The European Union
This began in the 1950s as the European Economic Community', comprising six
member states: Belgium, Germany, France, Italy, Luxembourg and the Netherlands.
They were joined by Denmark, Ireland and the United Kingdom in 1973, Greece in
1981, and Spain and Portugal in 1986. Reunification of Germany in 1990 brought in
the East German Lnder.
The Community was enlarged in 1995 to include Austria, Finland and Sweden, and a
further enlargement in 2004 brought in Cyprus, the Czech Republic, Estonia, Hungary,
Latvia, Lithuania, Malta, Poland, Slovenia and Slovakia. Bulgaria and Romania joined
in 2007.
Croatia, the former Yugoslav Republic of Macedonia and Turkey are currently
candidate countries.
The EU opened its common internal market on 1 J anuary 1993 with the following main
effects:
Citizens of the member countries can live and work anywhere in the EU
Capital can move freely and there is a continuing programme of harmonisation of
standards
Regulations permit the free flow of goods and services.
The 1991 Maastricht Treaty agreed a programme to move towards economic and
monetary union and to take the first steps towards political union by agreeing common
foreign policies. Since 2003, a single european currency, the Euro, has replaced the
previous national currencies of 15 member countries (in what is known as the
Eurozone).
(b) MERCOSUR
This is South America's leading trading bloc and is known as the Common Market of
the South. It aims to bring about the free movement of goods, capital, services and
people among its member states. It has been compared to the European Union but is
four times as big. The bloc's combined market encompasses more than 250m people
and accounts for more than 75% of the economic activity on the continent.
Its full members are Argentina, Brazil, Paraguay, and Uruguay. Associate members are
Bolivia, Chile, Colombia, Ecuador and Peru. Venezuela awaits ratification of its full
membership at time of writing. The combined GDP of the groups is US$ 1.1 trillion.
(c) NAFTA The North American Free Trade Agreement
This is a comprehensive trade agreement that sets the rules of trade and investment
between Canada, the United States and Mexico. Since the agreement came into force
on 1st J anuary, 1994, NAFTA has systematically eliminated most tariff and non tariff
barriers to free trade and investment between the three countries.
(d) ASEAN The Association of Southeast Asian Nations
This bloc aims to accelerate economic growth, social progress and cultural
development in the region and to promote regional peace and stability through the rule
of law and adherence to the principles of the United Nations Charter. ASEAN
comprises ten countries: Burma, Brunei Darussalam, Cambodia, Indonesia, Laos,
Malaysia, Philippines, Singapore, Thailand and Vietnam.
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A free trade agreement came into force between ASEAN and China in J anuary 2010,
creating the worlds third largest free trade bloc behind EU and NAFTA.
(e) BRIC
BRIC is not an official trading bloc, but a term used in economics to refer to the
combination of Brazil, Russia, India and China, which make up over 42% of the world's
population. These nations are progressively playing a major role in the future of global
economy. Examples of trade agreements are:
In the first six months of 2009, China became Brazils biggest single export
market for the first time.
In 2010, the China Development Bank and Sinopec, a Chinese oil company, lent
Brazils state-controlled oil company, Petrobras, $10 billion in return for up to
200,000 barrels a day of crude oil for ten years from the countrys deep sea
fields.
The Role of the World Trade Organization in Free Trade
The World Trade Organization (WTO) is responsible for the global rules of trade between
nations. Its main function is to ensure that trade flows as smoothly, predictably and freely as
possible.
Nearly all decisions in the WTO are taken by consensus among all member countries and
they are ratified by members' parliaments. Any conflict over trade is handled by the WTO's
dispute settlement process, where the focus is on interpreting agreements and commitments
and making sure that countries' trade policies conform to them. As a result of this, the risk of
disputes leading into political or military conflict is reduced.
By lowering trade barriers, the WTOs system also breaks down other barriers between
peoples and nations.
The WTOs agreements, which are known as the multilateral trading system, are contracts
guaranteeing member countries important trading rights. The terms are negotiated and
signed by a large majority of the worlds trading nations and ratified in their parliaments.
These agreements are the legal ground rules for international commerce and bind
governments to keep their trade policies within agreed limits.
Although agreements are negotiated and signed by governments, their purpose is to support
the producers, exporters and importers of goods and services in the conduct their business.
Acti vi ty 2
(a) What other trading blocs can you find? Look for those which include emerging
economies in particular.
(b) Why might emerging economies want to form a trade bloc without any advanced
developed countries as members?

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C. TECHNOLOGY AS A DRIVER OF GLOBALISATION
The development of technology over the past 20 years has made a transformational impact
on communication and management and has triggered the fast growth in global business.
Consider the following forms of technological change:
(a) Email which has made fast internal and external communication possible and
become a significant marketing tool.
(b) The internet which has become the promotional showcase for many businesses who
can now advertise themselves to the world very economically. Consumers can interact
with each other and with businesses in a variety of ways, resulting in growing
consumer power.
(c) Management Information Systems which are capable of collecting and analysing
huge amounts of data, providing reports on a variety of subjects in real time at the
desktop of company personnel.
(d) Manufacturing technology which has become so sophisticated that less people are
required to do most jobs and robots can be employed for many manufacturing tasks.
(e) Travel which is faster and less expensive and, using mobile phones and portable
computing devices, individuals can do business globally while travelling.
Technology has not only assisted the global growth of businesses but changed practices
dramatically, allowing control of the global company to be effective and hence it has impacted
on performance. Global communication, using the whole range of techniques described
above, has enabled this transition.
Impact of Technology on Global Business
Examples of the contribution to growth, business performance, innovation and management
are listed below.
(a) Instant feedback Companies can gain customer feedback quickly and directly, and
this assists in managing the quality of products and the research, development and
designing of new ones. They can also advertise their products in all media and take
views on proposed new ventures.
(b) Strategic decision making Company data can be input and analysed in real time,
allowing managers to make quicker decisions, track the growth of market share and
sales by product and country. This has a big impact on making strategic decisions.
(c) Virtual working People working in remote locations can quickly and effortlessly
communicate with other staff or managers around the world, using a variety of
techniques, such as:
Web, video or telephone conferences, which allow teams dispersed across
distant locations to discuss issues in real time
Email, phones and the internet to maintain contact to the workplace and to
access company information and feed information back to the company.
The technology also allows managers to maintain contact with staff working remotely
and monitor their performance, ensuring that management control is not lost.
(d) Purchasing, sales and customer relations The internet has allowed consumers
and businesses to access data on the products and services of other organisations.
This has resulted in customers and commercial purchasing staff being able to compare
price and quality, which then enables them to negotiate more effectively. It provides
access to more choices.
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Companies are able to interact directly and quickly with customers, and customers can
also interact with each other to recommend a companys products and services or to
deter others from the use of a certain product or service. Company websites, email
and social networking sites all contribute to this two way process
(e) Process and Systems Management The speed of information transfer makes it
possible to access costs and revenue instantly and to estimate the profit and loss on a
project at any time, compare the efficiency of processes, identify sales trends and
hence profit margins on each type of product and service, track foreign currency
fluctuations and their effect on profit levels, and so on. The accurate measurement of
resource use is crucial to costing the manufacture of any product or service, accurately
pricing it and forecasting sales volumes and hence profit. Management Information
Systems enable a quick accurate calculation. In a fast moving global environment, this
type of information is necessary to maintain competitive advantage; examining where
cost savings could be made, which products to produce more, how to maintain quality
levels.
(f) Knowledge management and competences This is a key tool in ongoing success
and there are many definitions of such capacity within the companys workforce.
GlaxoSmithKline define it as: "The capabilities by which communities within an
organisation capture the knowledge that is critical to them, constantly improve it and
make it available in the most effective manner to those who need it, so that they can
exploit it creatively to add value as a normal part of their work.
The firm needs to estimate what it has, how to retain it and how to best use it for
competitive advantage. Storage of information electronically, sharing through internal
blogs or recorded VOIP or telephone conferences are all useful in this quest to
maximise the capability of the organisation.
(g) Organisational learning Improved communication channels allow firms to access
information directly from stakeholders of every kind. This assists in improving overall
performance and the value chain. In contrast to traditional employee developmental
learning, employees can gain access to virtual learning resources 24 hours a day at
their convenience and take part in developmental activities alone or in groups using
electronic means. Instant feedback of the level of learning can be given.
Impact of Technology on Global Trade
Two main aspects are discussed here the trade channels that have been developed, and
the advances in engineering that allow more goods, of better quality, to be produced more
quickly and at lower cost.
(a) E-commerce
The development in electronic communication forms the basis of a huge and continuing
growth of trade by electronic means or e-commerce. This has enabled individuals and
firms to interact between locations anywhere in the world, where the technology is
available. Firms are able to promote their products through the internet, on their
websites and on social networking sites. Other electronic means such email and sms
messages support website promotions. By promoting their products using search
engines such Google and Yahoo, individual consumers or purchasing organisations are
enabled to find accurate details of firms that supply the products and services they
want within seconds. All these promotions can also be accessed through mobile
devices such as the mobile phone.
Customers can interact with the firm to make enquiries, order and pay online, and
complete a transaction within minutes. They can also provide feedback on the
product/services that assists in the development of higher quality and/or more
sophisticated versions. Customers data is automatically stored and can be processed
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over time to indicate individual preferences for marketing appropriate further products
and services. Firms can measure the success of their websites as a promotional tool
by using web analytics to provide information on:
the number of times the site is visited
which are the most popular pages
how long individuals spend on each page
how the individual has found the website, such as search engine uses.
(b) Manufacturing Techniques
The continuous advancement of technology has also transformed manufacturing.
Manufacturing technology is at the heart of all production of goods and has been since
the days of the Industrial Revolution in the 18th century. The tools which enable
manufacturing magnify the effort of individual workers and give an industrial nation the
power to turn raw materials into the affordable, quality goods which are now essential
to society. As they have developed, they have also given us affordable agricultural
products, efficient transportation, innovative medical procedures, communication
systems of increasing power and scope, space exploration and all the everyday
conveniences we now take for granted.
Production tools include machine tools and other related equipment and their
accessories which are used to perform specific operations on man made materials to
produce durable goods or components. Related technologies include Computer Aided
Design (CAD) and Computer Aided Manufacturing (CAM) as well as assembly and test
systems to create a final product.
(i) Robots
Modern industrial robots are marvels of modern engineering. A robot the size of
a person can easily carry a load over 50 kilograms and move and position it very
quickly with a repeatability of +/-0.015 cm. They can work 24 hours a day
repeating exactly the same task for years without failure, and in many cases are
reprogrammable so that they can perform a range of different tasks.
They have been used in car manufacturing in this way for many years and have
significantly increased production of a more consistent product, at a significantly
cheaper cost. In the 1970s, UK and American car manufacturers were maligned
for the poor quality and bad engineering of their vehicles. Robotic manufacturing
now allows a car to be made with much more precise welds, closer tolerances
and more accurate engineering overall than could be achieved by human means
alone. Robots reduce labour costs and have no sick days, strikes, work
slowdowns or other problems as humans do. They have also reduced worker
injuries. They can also work with a minimum of human supervision.
(ii) Advanced manufacturing
Advanced manufacturing is a term that has been used to explain many of the
manufacturing operations that have reached a level of sophistication not easily
replicated by competitors. It is most commonly referenced as the use of high-
technology processes, often involving factory automation, or the development of
innovative products. A few of the technologies that fit into the advanced
manufacturing category are:
Nanotechnology
Direct digital fabrication
Micro manufacturing.
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Another definition of advanced manufacturing is that it includes operations that:
create advanced products
use innovative techniques in their manufacturing
invent new processes and technologies for future manufacturing.
Advanced manufacturing is also described as the process of mass producing
products on demand, using the latest technology. Although most manufacturing
processes can be easily executed by what has been traditionally referred to as
"unskilled labour," this higher level of manufacturing requires specialised training.
For this reason, levels of skill available in some third world countries would not be
appropriate for using cheaper labour.
Advanced manufacturing is a more flexible technique than traditional methods, as
it can be specifically adjusted to changing needs. Instead of manufacturing to put
products into stock for later sale, advanced manufacturing takes a different
approach. It builds for immediate, or nearly immediate, sale. This means
products being produced are not months or years old at the point of sale or first
use. In contrast, they may be just days or weeks old, depending on how far they
must travel to get to their final destinations. Advanced manufacturing facilities
are often suited to produce more than one thing. When demand slows for one
product, staff can be redeployed to manufacture another.
(iii) Computer simulations and scenario planning
Technology is used in decision making as a forecasting tool and in scenario
planning. In a rapidly changing and turbulent external environment, important
future threats may be overlooked. Scenario planning is a technique to consider
all the potential changes that may impact on a business in the future by building
alternative scenarios and planning how the firm will deal with each one should it
arise. Shell was one of the first companies to develop scenario planning as a
business tool and was able to deal with the oil shock that occurred in 1973 and
greatly improved its competitive advantage in subsequent years.
Among the many challenges facing industry executives and high level decision
makers are those of envisioning how policy, market, technology and other
uncertainties will affect future economic, environmental and social conditions and
the associated needs for science and technology.
Companies need to make strategic decisions that will be sensible for all plausible
futures. No matter what future then takes place, a company and its management
team is much more likely to be ready for it and influential in handling it, if it has
seriously thought about possible scenarios and has potential plans to minimise or
maximise them to the benefit of the business.
In an increasingly fast moving global environment, organisations will have to
make more complex predictions and this is where technology has radically
facilitated this process.
The process begins by defining the scope of the scenario gathering information
on the key stakeholders, analysing trends and identifying driving forces and
critical uncertainties. The companys strategy can be continuously monitored for
signals and adjusted as required. Modelling is used as a complementary,
quantitative approach for planning in the face of uncertainty, by using computer
simulations of how the future might unfold under alternative policy, market,
technology and other contingencies.
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Costs and Benefits of Changing Technology on Business
We have touched on many of the positive effects earlier such as:
Performance evaluation of every part of the business has become possible. This
allows firms to act to maximise opportunities and minimise risks ahead of the
competitors and so to maintain competitive global position.
The value chain has been considerably strengthened, allowing costs and wasted
resources to be identified and minimised.
Communication is possible in a variety of ways, allowing company personnel,
customers, suppliers and other stakeholders to interact more effectively and rapidly.
As the hardware and software have advanced, the costs have decreased and many
companies now have more computing power than the majority of their employees will
ever need.
Negative effects include:
The technology used in the firm must be constantly reviewed and this can mean
incurring considerable and sometimes unnecessary cost, as many employees already
have more computing power than they will ever use.
The speed of change makes it imperative that firms identify changes in the external
environment and adapt their working practices. This may be impossible if the
workforce does not accept the need for any change.
A firm must ensure that the skills of the workforce are developed to use new
technological advances and so retain competitive position.
Security issues have become a major problem, particularly keeping key information
both about the company and about its customers secure from external hackers or
internal theft. Ensuring the security of information has now become one of the most
important aspects of an IT managers role.
Information overload can occur, with too much data being generated for individuals to
handle efficiently, as with the problem of too many emails.
Communication is instant and shocks to one economy immediately affect other
economies, as in the world economic crisis of 2008.
J ob stress and reduced quality of life caused by a variety of factors such as
(i) Always being connected employees receive emails at all times of day and night
and are under pressure to provide quick responses
(ii) Personnel are contactable even when on holiday or at weekends
(iii) Personnel feel pressurised to work outside of the agreed hours because the job
can be done anywhere anytime
(iv) Change is more rapid and constant.
D. THEORIES OF GLOBALISATION
New theories of international trade have been developed, to explain some of the changes in
the patterns of world trade we have seen in recent years. These reflect on some of the
marketing and competitive strategy aspects that have contributed to the changes in the way
trade has taken place.
There are many problems with the standard theory of factor comparative advantage when
applied to modern trading practices. The theory of comparative advantage assumes:
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There are no economies of scale
Technologies everywhere are identical
Products are undifferentiated
The pool of national factors is fixed
Factors such as labour and capital remain unmoved
All companies follow the same strategy.
It also makes no allowance for the competitive forces that operate within industries.
Amongst the most important theories to emerge as a result of these shortcomings are the
Diamond developed by Michael Porter and Raymond Vernons theory of an International
Product Lifecycle .
Porters Diamond
Michael Porter developed this theory as he was not satisfied with the scope of comparative
advantage based on factors of production to explain changes in trade. He concluded that, at
best, comparative advantage theory is useful primarily for explaining broad tendencies in the
patterns of trade for example, its average labour or capital intensity rather than whether a
nation exports or imports in individual industries. His "diamond" attempts to explain why
some nations achieve international success in a particular industry.
Figure 6.1: Porters Diamond

Source: M.E Porter (2008), On Competition
The four broad attributes that shape the competitive environment and that help or hinder the
creation of competitive advantage are placed at the four points of the diamond. These are:
Factor conditions the types, availability and quality of the factors of production
Demand conditions the demand patterns in the domestic market for the companys
product or service
Strategy,
structure and
rivalry
Related
and supporting
industries
Demand
conditions
Factor
conditions
Government
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Related and supporting industries the existence or otherwise of internationally
competitive companies that provide components, systems and other services
Company strategy, structure and rivalry this point includes much of Porters original
work on the competitive forces facing companies in an industry:
How are companies created, organised and managed?
What are the competitive pressures in the country for this industry?
A significant factor appears to be the development of sufficient expertise and support to
enable the industry to grow.
However, the growth must be accompanied by the strong shaping force of competition. In
this way the industry becomes internationally competitive and will be able to export goods
and services to other countries.
Acti vi ty 3
Consider the following case study about the Italian fashion industry and then answer the
question that follows.
Case Study 1: The Italian Fashion Industry
The Italian fashion industry is one of the largest in the world, with revenues of 48
billion euro, 70,000 companies and 700,000 people employed. This makes Italy
the most active in the world and, in terms of quantity, second only to China and
holding leadership in the prt--porter market. However, Italy is not favoured by
significant resources of raw materials or the cost of its labour force.
50 years ago, Italy had virtually no fashion industry and no Italian designer
enjoyed an international reputation. The countrys wealthy commissioned their
exclusive hand made clothes from tiny specialist tailors in Rome, and most
Italians found their dressmaking requirements met by small, local, businesses.
Gentlemen ordered suits from traditional bespoke tailors, while their wives and
daughters patronised whichever local dressmaker exhibited the greatest skill in
replicating the latest fashions from Paris. Italian women with less income had to
search the markets for fabric and sew their own clothes at home.
The war years changed everything and provided opportunities. There were three
significant developments at this time. After the Second World War, an investment
plan, the Marshall Plan, was implemented to rebuild Europe and to create a
stronger economic foundation. New factories were built in Italy which employed
skilled craftspeople who came from the small hill towns of the north and the
vanishing villages of the south and who needed to find work. The combination of
the very latest machinery with an exceptionally skilled workforce created an
unparalleled garment manufacturing capability.
The designers no longer followed the French lead by copying their style, but
created a fashion identity that seemed distinctively Italian. This benefited greatly
from the huge trend to acquire everything Italian, from espresso coffee to leather-
goods, which was particularly noticeable in America throughout the post-war
years. Unlike the French sophistication, the Italian clothes emphasised wearable
elegance, which was particularly appreciated by the Americans. Actresses such
as Audrey Hepburn favoured the glamorous evening dresses and the stylish but
simple daywear.
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At the same time the emerging Italian fashion industry quickly developed a
natural marketing flair, together with something what would now be called brand
focus. Talented new designers certainly showed impressive commercial
expertise in addressing an important emerging fashion consumer who was, as
yet, poorly served by more established fashion centres the post-war working
woman.
They also developed an unrivalled ability to produce high quality apparel in
luxurious fabrics which led British, French and American designers to entrust the
production of their garments to Italy, even though nowadays there are very much
cheaper labour markets.
700,000 Italian professionals represent the basic pieces for a process which still
needs quality, specialisation and ability to deliver.
Italians have a reputation for many other fashion items, one of these is leather
goods including shoes. A recent study by the Italian bank Banca Nazionale di
Lavoro (BNL) said that the Italian shoe industry " is the largest in the world and
accounts for 14.5 percent of footwear production globally". Despite the number
of large global companies that that can produce shoes cheaply, the Italian
companies are surviving even after a decline in the 1990s for three years,
production fell significantly, dropping by more than 10 percent in 1999, but since
2001 the country's footwear industry has been on a rebound.
However, the downturn caused some smaller businesses to close while others
were forced to join bigger groups to survive. It also stimulated the Italian industry
to reflect on how new technology and design techniques could improve their
business performance.
"A significant part of the recovery in the Italian industry can be seen in the move
to increase the quality of the shoes. The companies reacted to the downturn by
investing in research and design so that innovation in models and colours was a
feature of last year's production," said Pulisia Di Falco, one of the two authors of
the BNL study.
Italian shoemakers believe that the Italian artisan approach can be adapted to
more modern production techniques without losing any of its tradition or style.

Question
Identify the four attributes that explain the Italian Fashion Industrys national advantage
according to Michael Porter.

International Product Life Cycle
The standard product life-cycle (PLC) concept was applied in the 1960s to international
markets by Raymond Vernon. The basic idea was a trickle down from advanced countries
to the less advanced countries.
It assumes that advanced countries will innovate products and services. Over time, these
new products will mature in their domestic markets and will, then, be introduced into the
developing and the less-developed countries. Thus, products would be developed in, say,
the USA, but the PLC for that product would overlap with the export of the product to less
developed markets.
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Figure 6.2: The Shower Approach

The concept of the international PLC needs further modification to take account of changes
that have occurred in 21st century and the full global trading environment that now exists. In
particular, note that:
The original concept of the product life cycle, as discussed in Chapter 3, will operate for
each product in each country market:
New products and services are being developed in many different countries, not just
advanced countries.
There are significant differences in preferences and tastes even within the current
trading environment.
Environmental and social factors have a major impact on what is produced and how.
As result of many changes, it has become possible for the first time for tens of thousands of
companies to offer manufactured products to customers across the whole six continents. For
many of these "global products", there are potentially more than a billion customers. There is
an enormous opportunity for increased sales and profits, but the new environment is not
easy to manage and the risks are high.
Among the challenges companies have to resolve are:
Meeting the various requirements of customers from a range of countries
Choosing the most suitable locations for the different stages of development and
manufacturing
Deciding what can be global and what must be local
Implementing suitable processes and systems
Accommodating different national regulations
Efficiently dividing the workload between diverse sites.
Product Lifecycle Management is now used worldwide to manage the innovation,
development and support of global products. This key new business activity manages a
product anywhere in the world, at any time in its life and from the first idea through to
recycling and disposal.
An example of this is Coca-Cola. Its original beverage produces enormous profits that
provide the finance needed for research and development of new beverages that will satisfy
the varying tastes and changing preferences of global buyers. The original Coca-Cola
products life itself has been extended continuously by, for example, adding different flavours,
reducing sugar and producing no calorie versions. Some of these flavoured Coca-Cola
drinks are only sold in specified locations where they can still make revenue for the company.

Co-ordinated
Launch Programme
Advanced Country
(e.g. US)
Developing
Countries
Less Developed
Countries
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Acti vi ty 4
Finally in this chapter, we present a further case study for you to consider.
Case Study 2: Petrobras
Petrobras has operations all around the world, with recent ventures in Portugal
and Turkey, where it seeks to get involved in the energy battle around the Black
Sea. It generates and distributes electricity and side products from oil production
such as synthetic rubber. In 2008, a big oil field was discovered in the deep
waters off the Brazilian coast. The oil is located 7000m under the sea. That
makes the extraction very difficult and poses many risks to the fragile ecologic
system at that depth. But the third largest oil field of course means a lot of
money and power. In the reformation of the economic world order this is an
important asset for Brazil to have.
Petrobras raised $10 billion from Chinas government earlier this year, in return
for promising Sinopec, a Chinese state oil firm, a guaranteed supply of up to
200,000 barrels of oil a day for ten years. Mr Gabrielli, the CEO, wants more
such deals. Apart from the sub-salt fields, Petrobras is exploring 270 blocks in the
Gulf of Mexico and over 200 more onshore in Brazil, and may approach China to
fund this, too.
Despite the adverse working conditions, there have been several big deepwater
discoveries in recent years. Until the mid-1990s there was a general view that
successful offshore oil-drilling operations were limited to a water depth of around
600m, but advances in computing at the exploration stage have become
important when it comes to tapping deepwater oil. In this most physically
demanding of industries, software, as much as hardware, is changing the game.
Striking an oil reservoir with a drill pipe is like hitting a coin at the base of the
building with a strand of human hair. The penalties for getting it wrong are
enormous. An industry rule of thumb puts the cost of drilling a deepwater dry
hole, i.e. a well that does not strike oil, at around $100m. BP says it can be as
high as $200m. BPs recent fortunes in the Gulf of Mexico have reinforced the
financial, social and political risks of deep sea drilling as well the impending raft
of new regulations that are likely to occur as a result of the disaster.
With the stakes so high and the margin for error so small, the knowledge takes
the form of precise data on the composition and structure of the geological
formations beneath the seabed, which provide insight into the areas likely to hold
oil deposits. The mechanics of new acquisition techniques are simple compared
with the challenge of making sense of the resulting vast amount of data
produced. The amount of computing power used for such calculations is
staggering. BPs computer centre in the Gulf of Mexico operates 270 trillion
calculations per second, nearly 3,000 times faster than a decade ago.
Petrobras declares that its advanced technological know-how for deepwater
ultra-deep exploration is one of its competitive strengths. In developing its
offshore operations over the past 36 years, Petrobras has acquired recognised
know-how in drilling techniques and technology for developing deepwater
production.
The companys know-how in drilling, exploration, development and production in
deep waters has been instrumental in achieving high rates of success and
production and a reduction in lifting costs. Reduced costs have also been
achieved due to operations being executed on a large scale and to the integrated
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nature of its operating segments for example, the location of the larger part of
the companys refineries in the Southeast region close both to the Campos Basin
(which has significant proven reserves) and of the most densely industrialised
and populated markets in the country, and the relative equilibrium between its
current production, refining efficiency and the Brazilian markets total demand for
hydrocarbon products.
The company believes that these cost efficiencies arising from its integrated
nature, existing infrastructure and equilibrium allow it to compete effectively with
other sector companies and imported products.
Another Petrobras activity is the extraction of ethanol from crops such as soy,
corn, wheat sugar cane. The latter is the most popular as it is the cheapest to
produce.

Questions
(a) To what extent could Petrobras be considered a global company?
(b) Describe the options that Petrobras has used to grow its operations? Please give
examples.
(c) Explain how technology has influenced Petrobras operations.
(d) How does this case illustrate the economic strength of the BRIC countries?
(e) What competences does Petrobras have to give it competitive advantage over other oil
companies?

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SUMMARY
A global company has operations located in all areas of the world, its people move across
borders regularly and it finances its new and existing operations by transferring money from
one location to another.
The growth in companies with a global presence has been driven by factors such as:
Development in technology making communication fast and effective
The access to physical and human resources at lower cost
Global capital markets making finance available for expansion throughout the world
The lowering to trade barriers and access to free trading globally
The sales and marketing opportunities using e-commerce
The opportunities to increase shareholder value.
Free trade has also improved the economic growth of countries throughout the world, and
also developed the skills of their workforce.
Trade blocs between groups of countries have allowed them to share resources and know-
how, providing access to economies of scale and preferential trading agreements.
However free trade and globalisation also bring negative aspects to countries such as: the
death of infant industries, the danger of monopolies being created by powerful companies
who enter the country and undesirable changes in the local culture.
The changes in international trade and the dominance of certain countries have been studied
extensively. Michael Porters theory of national advantage is one such attempt to explain
why some nations have specialisations that make them dominate world markets.

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Activity 1
(a) The terms of trade are 150%. (The average price of imports/average price of exports.)
(b) The terms of trade have improved; fewer exports have to be sold to purchase any
given quantity of imports.

Activity 2
(a) Two other trading blocs that include emerging economies are:
OPEC Organization of Petroleum Exporting Countries. This was made by the
petroleum producing countries in the year 1960. The member countries of this
group are Algeria, Ecuador, Gabon, Indonesia, Iran, Kuwait, Libya, Nigeria, Qatar,
Saudi Arabia, United Arab Emirates and Venezuela.
SAARC South Asian Association For Regional Cooperation. Countries such as
India, Bangladesh, Pakistan, Nepal, Bhutan, Maldives and Sri Lanka have formed
SAARC with an objective of making better trade in the region.
(b) Developed countries may be viewed as wishing to exploit the resources and local
knowledge with little concern for the poorer nations' business culture and national
values.

Activity 3
(i) Factors of production
Land, labour and capital were acquired after the second world war: Capital was given
by the Marshall Plan, factories were built of land devastated by the war and highly
skilled labour was available locally from small hill towns.
(ii) Related Supporting Industries
There was an existing shoe making industry. Fabrics were obviously easily available
(not stated) as there was a thriving tailoring and home made clothes industry. Design
flair could also come into this category as talented new designers are mentioned.
(iii) Demand conditions
These were already in place before the factories came into existence, with individual
tailors for men and women making clothes in the latest fashion at home. Since the
products made by the factories were stylish and distinctive this appealed to the new
consumer.
(iv) Company Strategy, Structure and Rivalry
The case states that marketing strategy and design flair were two of the strategic
thrusts of the fashion companies. There was a wearable elegance about the clothes
and designers had the commercial expertise in addressing the emerging fashion
consumer. Innovation and entrepreneurship were key factors. The ability to change
strategy is shown by the comment on the rebirth of the Italian shoe industry. The
companies appear to have been well structured and organised with new factories and
skilled labour with commercial competences, plus capital and a welcoming market
sector. The competitive pressures at the time internally were low, but people were
buying French and American garments which were more costly and did not fully
complement the Italian stylish but less formal culture.
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Activity 4
(a) Petrobras has trade in several other countries Portugal and Turkey are mentioned
here and is also trading in oil with China. It appears that expansion by organic
growth is taking place in the Gulf of Mexico where Petrobras is carrying out oil
exploration activities. There is no evidence in this of people movement. Hence we do
not have enough evidence for a definite statement on its status as a global company,
but with the limited information available it does appear to be global.
(b) Petrobras has operations in two other countries, according to the case. However, we
cannot determine the growth option used for those operations from the evidence given.
Petrobras has a trading agreement with China which has provided the finance for
Petrobras to explore for oil and for China to be supplied with the product.
(c) It is made clear in the case that the advanced technology has enabled Petrobras to
consider drilling in areas that would otherwise have been impossible that is, under
the sea bed. It has precise data on the form and composition of the structure below
the sea bed. The description acknowledges that without advanced computing power it
would be impossible to make any sense of all the data it has collected. It has also
developed technology for deep underwater exploration.
(d) The case shows the close relationship between Brazil and China and, although there is
no formal trade bloc, huge trading agreements are being made. China is acquiring
very critical, scarce resources by providing Petrobras with the finance to acquire them.
(e) Petrobras has competence in deep sea drilling for oil. It has the acquired the technical
know-how in the operations necessary to accomplish the task of extracting oil from sea.
It is innovative and extremely competent in the use of technology to problem solve.
It has also developed a tight value chain with low costs and high integration. In
addition, it appears to have exceptional competencies in energy production from a
variety of sources including extracting ethanol from crops.

189
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Chapter 8
Going Global

Contents Page
Introduction 190
A. Growth Options in a Global Perspective 190
J oint Venture 190
Merger with or Acquisition of Companies 191
Organic Development 191
Franchising and Licensing 192
B. The Global Financial Environment 193
Currency 193
Exchange Rates and Exchange Rate Systems 194
Financing Growth Options 197
C. Globalisation and Culture 198
What is Culture? 198
Our Collective Programming 199
Cultural Aspects of Globalisation 202
Impact of Globalisation on Local Culture 205
D. Limitations to Globalisation 205
Global Transportation Infrastructure 205
Demographics 205
Natural Resources 206
Technological Development 206
The Anti-global Lobby 206
Summary 210

190 Going Global
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INTRODUCTION
This chapter builds on the previous one and looks at the methods companies use to actually
make global trade happen. We examine more closely the advantages and disadvantages of
the options to achieve that growth, a topic that we looked at first in Chapter 3. We also revisit
and expand the financial perspective of trading globally including the impact exchange rates
have on the business.
As companies expand into other nations, the subject of culture becomes an important factor
to the success of the venture. If the organisation is unable to integrate its business practices
and values with that of the new nation, then the firm is likely to make a loss or even fail to
survive.
Finally we will look at the potential limitations of globalisation and the opposition to the whole
globalisation concept.
A. GROWTH OPTIONS IN A GLOBAL PERSPECTIVE
In Chapter 3 we looked at expansion options in outline. In this section, we will examine the
opportunities and challenges that each option offers.
Firms that wish to expand their operations into other countries and continents, by having a
physical rather than a virtual presence, have four main options:
J oint Venture
Merger and Acquisition
Organic Growth
Franchising and Licensing.
For very large companies, all of these options may well be used and the appropriate option
will be chosen according to trading conditions in the particular location.
Joint Venture
A joint venture is defined as an entity formed between two or more parties to undertake
economic activity together. The parties agree to create a new entity by both contributing
equity, and they share in the revenues, expenses, and control of the enterprise. The venture
can be for one specific project only, or may be a continuing business relationship.
The advantages of joint ventures are seen as:
Investment risk shared by all partners
Complementary resources and know how are combined.
Such arrangements may also be a necessary governmental condition for market entry into a
particular country, as was the case with India in the past.
The difficulties with joint ventures are perceived to be:
Identifying an appropriate partner and/or agreeing appropriate contractual terms
Managing the relationship with the foreign partner
Loss of competitive advantage through imitation that the other party might implement
later
Limits to the ability to integrate and co-ordinate activities across national boundaries.
Going Global 191
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Merger with or Acquisition of Companies
First, we should distinguish between the two:
A merger is said to occur when the firms are of comparable size and form a single new
company. The shares of both companies are replaced by shares in the new company.
When one company is actually purchased by another, this is very often called a merger,
if the Chief Executive Officers agree it is in the best interest of both companies to state
this.
Acquisitions tend to take place when a stronger company with a larger market share
buys another. The target company often knows it cannot survive. After acquisitions,
only the buyers shares continue to trade. A hostile merger is also regarded as an
acquisition.
The rationale for mergers/acquisitions is shareholder driven in other words, to improve
shareholder return.
The advantages of mergers/acquisitions are seen as being:
The new entity has full control of all resources and capabilities and potential for
economies of scale
Facilitation of integration and co-ordination of activities across national boundaries
Rapid market entry
Making first new investments allow development of state of the art facilities and can
attract financial support from the host government.
Mergers/acquisitions are seen as being problematic since:
Substantial investment in and commitment to the host country can lead to economic
and financial exposure
Acquisition may result in problems of integration and co-ordination
Substantial potential for cultural clash
Entry time consuming and less predictable in cost especially if a first investment in new
location.
Organic Development
This is internal development where strategies are developed by building on and developing
the organisations own capabilities for example, a company may open a manufacturing plant
in a new location, funding the whole venture itself.
This strategy is usually suitable for a situation
Where partners or acquisitions are not suitable or available
Where the company wishes to build on its own existing capabilities, particularly in
respect of learning and competence development
Where there are existing cultural influences within the company
Where there is political support.
Organic growth can be problematic if there is likely to be political unease.
Note that, foreign direct investment (FDI), whether through acquisition of a company in a new
location or by organic growth, is likely to involve making greenfield investments by
developing the facilities from base level.
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Franchising and Licensing
First, we should distinguish between the two:
A franchise is a right granted to an individual or group to market a company's goods or
services within a certain territory or location. McDonald's, Subway and Domino's Pizza
are well known examples. There are many different types of franchises including
automotive, cleaning and maintenance, health and fitness, and financial services.
Licensing can be defined as a written contract under which the owner of a copyright,
know-how, patent, service mark, trademark or other intellectual property, allows a
licensee to use, make, or sell copies of the original.
Such agreements usually limit the scope or field of the licensee and specify whether
the license is exclusive or non-exclusive, and whether the licensee will pay royalties or
some other consideration in exchange.
Licensing agreements are also used by franchisers to promote sales of goods and services.
Licensing can be useful as a global growth option particularly to companies who do not see
investment through acquisition or organic growth in a new country as justifiable the actual
investment is much reduced, as is financial and political risk. However, a problem with
licensing can be lack of control over the way in which products are made or used elsewhere,
or the cost involved in imposing that control.
Acti vi ty 1
Consider the following short summary of Coca Cola's strategy and then answer the questions
that follow.
Case Study 1: The Coca Cola Company
Many of Coca Colas bottling partners operate under licensing agreements
which assures global coverage for the Company. Coca Cola also has
some joint ventures with bottlers but rarely owns them bottlers outright
In 2010 it acquired its North American bottling partners as a direct result of
the same action by its main competitor Pepsico. This was a change of
policy. In doing so, Coca Cola hoped to integrate capabilities and reduce
costs as well as improving its value chain.

Questions
(a) Why do you think Coca Cola uses different growth strategies with its bottlers?
(b) Go to the Coca Cola website and find examples of the growth options that the company
has used to expand.

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B. THE GLOBAL FINANCIAL ENVIRONMENT
When one country sells goods to another it wishes to be paid in a form of money (currency),
which it can readily use to purchase its own goods elsewhere, or which it can change into its
own currency to pay its own workers and suppliers at home.
You might think that it would all be a lot simpler if every country in the world used exactly the
same currency, which would then be universal and which would not be identified with any
one nation.
The problem with any form of international currency is that there must also be some system
of international control which all countries will accept. This immediately introduces political
implications, which so far have proved impossible to reconcile.
Consequently, the great mass of world trade has to be conducted in the normal national
currencies of the world. Some of these are more acceptable than others, chiefly because
some countries have stronger economies than others and some governments have firmer
control over their national economic and financial systems than others.
Currency
Three classes of currency across the world are considered below:
(a) The United States Dollar
The US dollar is the most widely acceptable currency and it is used throughout the
world. Many of the world's commodities and services are valued in dollars, most
particularly oil. Dollars are also widely used in the internal trade of many countries
whose own currencies are very weak because of severe domestic inflation.
(b) Other Major Trading Currencies
The currencies of many of the other leading trading nations of the world have a wide
acceptability, though not as universal and general as the US dollar. When the dollar
itself is under pressure and losing some of its exchange value, one or more of these
currencies become a refuge for international finance. Among the main trading and
reserve currencies in this group are the Euro, the J apanese Yen, the British Pound and
the Swiss Franc.
(c) Currencies with Limited Acceptability
Some currencies may be acceptable within a particular region. There are also many
currencies, especially those of African countries and those of North Korea and
Myanmar/Burma, that have almost no circulation or acceptability outside their national
boundaries (and often are not popular within the country either).
Sometimes national governments discourage international exchange, involving its
currency, as a means of keeping greater control and preventing the export of wealth.
In other cases, the currency is too weak to support any external trade, or the official
value in exchange for other currencies maintained by the national government is so
unrealistic that no one who can possibly avoid it is willing to exchange foreign money at
that rate.
People generally feel happier to stay with a currency they know and understand. Trade may
often be conducted by barter arrangements with some countries with weak currencies. For
these agreements, some form of acceptable valuation is necessary. Again the basis of this
tends to be the United States dollar, either directly or indirectly (for example, through oil).
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Exchange Rates and Exchange Rate Systems
Since various national currencies are used for global trade we must now examine a little
more closely what is involved when one currency is exchanged for another.
The exchange rate is the rate at which the national currency can be exchanged for the
currencies of other countries. Therefore, there is not one rate but many, relating to all the
different currencies in the world. The principal rate which is of interest to most countries is
the one relating to the main currency in global trade, the US Dollar. For this reason, we will
concentrate on the relationship between the US Dollar and the British Pound (GBP) or
Sterling to illustrate the operation of exchange rates.
If the exchange rate is $1.50 =1, then 1 can be exchanged for $1.50 (ignoring dealing and
other costs of exchange). Thus: 100 =$150.
However, if the rate changes to $1.10, then 100 becomes worth only $110.
Effect of Exchange Rate Changes
Suppose there is a fall in the value of the pound in terms of US Dollars, so that in the space
of a few months, the rate falls from $1.30 to $1.10. There is then an immediate effect on the
prices at which traders are prepared to trade in international markets.
Take the example of a manufacturer that is prepared to sell a motor vehicle, provided it
receives 5,000:
At the rate of $1.30 (again ignoring transactions costs), the manufacturer could sell the
car in the USA for $6,500 (5,000 1.30).
If the pound falls in value and is worth only $1.10, the manufacturer will accept $5,500
(5,000 1.10) if it still wishes to receive 5,000 for the car.
This simple calculation shows us that a fall in the currency value makes exports cheaper in
foreign prices.
Cheaper goods are likely to be easier to sell and provided the increase in sales is
proportionately more than the change in dollar price, exporters can hope to receive more
revenue for their exports.
Therefore, devaluation (lowering the value of a currency) may be used to help in correcting a
balance of payments deficit. There will be more exports and they are cheaper for overseas
consumers to purchase, but imports to the home country become more expensive for
example, suppose the vehicle manufacturer buys steel from another country and pays for it
in US dollars: each $1,000 worth of steel, which used to cost 769.23 ($1,000/1.30), now
costs 909.09 ($1,000/1.10).
Most manufactured goods contain materials imported from other countries, so manufacturing
costs inevitably rise following a fall in the exchange rate transactions, even if actual
payments are made in a national currency.
There will also be other effects on business:
A high proportion of British food and many consumer goods come from overseas and
so they rise in price.
Living costs are pushed up and workers seek wage increases to try to maintain their
living standards.
If they succeed, then labour costs rise alongside manufacturing costs, meaning that
prices are also likely to rise, making the goods harder to sell abroad.
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Acti vi ty 2
Imagine you came to the UK last year for your holiday and you saw an iPad that you wanted
to buy. Last year when 1 was equivalent to 1 Euro, you would have had to pay 600 for the
iPad. This year the rate of exchange is 1 is equivalent to 1.20 euro
Will you pay more euros or less for the iPad than last year? How many euros will you need?

The Formation of Exchange Rates
The exchange rate represents the price of the national currency, and like any other price it is
formed ultimately by the forces of supply and demand. Supply and demand result from the
trade flows of imports and exports.
To pay for imports priced in US Dollars, the United Kingdom has to earn dollars by selling
British goods and services to other countries. The more Britain can export, then the more
dollars the country earns.
However, British firms want to receive their payments in pounds. To obtain pounds to pay for
British goods and services, foreign firms have to sell their own currencies in the markets for
foreign exchange and buy pounds. So the greater the demand for British products in world
markets, the higher is the demand for pounds in the currency exchanges.
Conversely, the higher the demand in Britain for foreign products, the more pounds have to
be sold to obtain the foreign currencies needed to pay for them.
It is evident, therefore, that one immediate cause of a change in currency exchange rates is
the way the balance of payments is changing.
If the balance is in surplus, then revenue from exports is greater than that paid for
imports and the supply of foreign pounds is high. So the pound is likely to rise in
exchange value.
A balance of payments deficit has exactly the reverse result; the exchange rate will
decrease.
The weaker the balance of payments, the weaker the pound is likely to be.
The views of traders and bankers about future movements in trade flows and currency
exchange rates will also have an effect. For instance, traders often have to hold large sums
of money for a few days or weeks, in anticipation of having to make large payments. They
cannot afford to have money lying idle, so they lend it out in return for interest. They do not
want to see the interest earned being lost through a fall in the exchange value of their money.
This means that any suspicions that the pound is likely to fall will persuade the traders that
their money is more safely kept in some other currency. This reduces the demand for
pounds and increases the demand for foreign currencies.
This type of behaviour also adds to the pressure resulting from a weak balance of payments.
Exchange Rate Structures
There are basically two types of exchange rate system fixed and floating exchange rates.
There may be variants on these, but the basic principles remain the same.
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(a) Fixed Exchange Rates
It is very rare to have an exchange rate structure that is rigidly fixed against some
standard. Some movement within a band either side of a central rate is normal.
Usually a number of countries agree to work to this kind of system.
The more confident governments are that they can maintain the agreed rates, the
narrower the band within which floating is permitted. A movement towards either the
floor or the ceiling of the band requires action to correct the rate.
The usual short-term action is to change interest rates to attract, or to discourage,
capital movements. If the government is unable or unwilling to take action to restore
the agreed exchange rate, or if its action is unsuccessful, then the rate will have to be
changed.
If member countries cannot agree on a satisfactory change the whole structure
becomes unstable.
The problem with any fixed exchange rate structure is reconciling the desired level of
stability with sufficient flexibility to allow changes to take place as economic conditions
change.
(b) Floating Exchange Rates
When the price of the currency in terms of every other currency is set by demand and
supply in the market, the country is said to have a freely floating exchange rate. Under
these conditions, there are no exchange controls and the government does not
intervene in the market.
If the demand increases and the supply remains the same, the exchange rate rises
(appreciates); should the supply increase faster than demand, the rate falls
(depreciates).
Demand
If Britain's exports increase there will be more demand from importers to
exchange their currencies into sterling.
The pound will also be in demand if people want to invest more in the UK, either
in deposits and shares or in physical assets.
Suppl y
More sterling will be supplied if importers in Britain are buying more from
overseas and require more foreign currency.
UK investment abroad increases the supply of pounds. J ust as in any other
market, an increase in demand for pounds, with supply unchanged, will cause the
price of sterling to rise or appreciate more dollars have to be paid for each
pound.
Conversely an increase in supply, with demand remaining the same, would cause
the currency to depreciate.
Government Intervention
A government may intervene in the market to buy or sell its currency because it wants to hold
down a rise in the rate, which would affect international competitiveness, or to support a rate
which is falling, to keep foreign investments. One example of this is, in 2010, China was
accused by the United States of artificially holding down its exchange rate so that it can
export more.
There have been attempts by the major industrial countries to influence the exchange rate of
the US Dollar. Many commodities and raw materials, especially oil, are priced worldwide in
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dollars, so a rise in the value of the dollar for speculative reasons unconnected to trade could
cause inflation.
Even when all the major central banks act together, they cannot have a significant effect on
the foreign exchange market. The sheer size of the market's daily dealings makes the
reserves of the industrialised countries look small.
Effect of Exchange Rates and other Financial Measures on Global Trade
Fluctuation in exchange rates are a major issue in terms of costs and profit for companies
that trade or invest internationally. For example, the exchange rate could move adversely or
a country may impose exchange rate controls. In addition, there is the risk that countries
may raise business taxes or interest rates to impose tighter financial controls.
The risk associated with such changes in another country is known as "sovereign risk", and it
can affect the financial position of companies quite dramatically. For example the 2009 Coca
Cola Annual Report states
Foreign currency exchange gains and losses are primarily the result of the re-
measurement of monetary assets and liabilities from certain currencies into
functional currencies. The Venezuelan government announced a currency
devaluation and Venezuela was determined to be a hyperinflationary economy.
Based on the carrying value of our assets and liabilities denominated in
Venezuelan Bolivar as of December 31, 2009, we anticipate recognizing an
initial remeasurement loss of approximately $100 million in the first quarter of
2010.
Financing Growth Options
Firms have a variety of options for financing growth. The option they choose will depend to a
certain extent on their size and present legal status.
Taking the example of a private limited company that wishes to expand globally, there would
be a number of choices:
(a) Financing from their own funds
This option allows the directors to have complete control, but means more risk for each
of them should the venture prove not to be successful. They may have to take on
personal liabilities to raise the capital.
(b) Raise expansion capital by offering new shares in the private limited company
This would allow the directors some choice in recruiting investor(s) who could add
value to the business in terms of the skills they bring (or alternatively an investor who
does not wish to play an active management role) without the existing ones losing
major control.
Finding the right investor may take too long or be difficult depending on the economic
climate, etc.
(c) Floating on stock market to raise capital
This would enable the directors to raise capital without taking on personal risk if there is
business failure that is, the directors would not personally bankrupt or prevented from
starting up another limited company.
Also being a plc usually results in suppliers and customers having greater confidence
as they are able to make credit checks and so on.
The structure of the business would change and the present directors would become
employees of the company and must pay Income tax and NI on their earnings, as they
draw a salary and dividends after tax. In addition, all company assets would belong to
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the company and could be used only for company business. There will also be stricter
accounting rules, with accounting costs becoming far higher.
(d) Long term loans
This option allows the management to remain in control while not stretching the
finances of directors in the short term.
A long term loan (up to 25 years) would be advisable for any major factory expansion
and capital equipment, with shorter term loans (of 3-5 years) for items such new office
furniture, computer equipment, vehicles, etc. This would allow the cost to be spread
with interest rates controlled.
The lending organisation is likely to ask for collateral as security against the loan. If the
company defaults on payment the owners would lose the business.
Large multinationals are likely to raise the finance needed using a combination of different
options. Obtaining the most appropriate mix will be of great importance.
Short and long term loans
Issuing debentures (debt)
Using retained earnings.
Using retained earnings is a very positive option as it does not dilute the value of the shares
belonging to existing shareholders or reduce their control. However, the amount will be
limited by the companys previous profits and the firm may wish to invest more capital to
make faster profits.
Shareholders will expect the return on these funds to be equal at least to interest the firm
could have made on the money in other investments since retained profits represent the
deferred dividends of owners (shareholders).
Selecting the currency in which to borrow is an important factor. Usually this will be the same
as the currency in which the investment is to be made risk is minimised by the liability
being in the same currency as the income received from the project.
Deciding whether to take a fixed or floating interest rate for the loan is another key decision.
Under a floating interest rate, repayments are subject to increases in the interest rate which
affects the repayments, but a fixed rate would eliminate that concern.
E. GLOBALISATION AND CULTURE
When companies go global they have to take into account the different norms and values of
people from other nations. Unless this happens, the investment made is likely to yield slower
returns. This could be through a lack of understanding of different tastes and preferences of
consumers, lack of ability to integrate the companys working practices with an acquired
company or to induct employees of greenfield businesses fully into what the firm requires.
What is Culture?
There are many aspects to culture some are very explicit but others are more deep-rooted
and difficult to identify. We now tend to think of culture as having two distinct meanings:
The achievements of civilised society, particularly in terms of the arts
The way people think, feel and act within society or large social groups.
The second meaning is particularly important to organisations, both internally (as in
"organisational culture") and how they relate to the external social environment within which
they are located. This is obviously relevant to working in a global context
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Schein (1985) defined organisational culture as "a pattern of basic assumptions invented,
discovered, or developed by a given group as it learns to cope with its problems of external
adaptation and internal integration that has worked well enough to be considered valid and,
therefore, to be taught to new members as the correct way to perceive, think, and feel in
relation to those problems".
Geert defined culture in general as "the collective programming of the mind distinguishing the
members of one group or category of people from another". The "category" can refer to
nations, regions within or across nations, ethnicities, religions, occupations, organisations, or
gender.
According to Hostede a simpler definition is 'the unwritten rules of the social game'.
Our Collective Programming
The collective programming we have all acquired is a result of our socialisation through
childhood and puberty. In that period we are heavily influenced by our families and friends
and have an extremely high capacity to absorb information and to conform to the norms of
our social environment. The physical environment in which we find ourselves also has an
impact rich or poor, safe or threatening, level of technology, degree of communication, etc.
Culture at this level revolves around basic issues that have to do with group membership,
authority, gender roles, morality, anxiety, emotions and drives. Culture affects our personal
lives, our social lives and our professional lives at work.
Culture is what enables a group to function smoothly, and this is highly important to
organisations.
We can see a number of different types of culture or perhaps more correctly, different
cultures in each society, and organisations need to be aware of all these and their impact
on the way in which they operate and the types of goods and services they produce.
National culture
There are approximately 200 nations globally. Some nations are culturally identical
(monocultural), but others, especially large ones such as Brazil, China and India and
Indonesia, are made up of culturally very different regions.
Research has shown that national cultures usually differ significantly at the level
unconscious, broad preferences for one state of affairs over others that is, the values
held by a majority of the population. These values are acquired in childhood and are
deep-rooted, unconscious ones. This makes national culture extremely stable over
time it only changes slowly, over generations. The external signs of changes of
culture such as symbols, heroes and rituals, do not make any impact on changing the
underlying values.
Thus, the differences between countries remain virtually the same over many
centuries.
Organisational culture
During our working lives we spend a lot of time working in organisations. We become
accustomed to the particular norms and values of the organisation in which we work.
Research shows that organisational cultures differ mostly at the level of practices the
way things are done around here. These are more superficial and more easily learned
and unlearned than the values that form the core of national cultures. When we
change organisations we can adapt relatively easily to the practices of the new
organisation.
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Since organisational cultures are rooted in practices, they are more susceptible to
change; national cultures are deep rooted in values and hence present a more
substantial challenge when it comes to change.
The culture of an organisation also reflects aspects of its development and its external
environment for example:
(a) The values and beliefs of the founder may still pervade the organisation's mission
for example, Anita Roddick's (Body Shop) commitment to the use of natural
ingredients.
(b) The company's stage of development and, particularly for long established
organisations, its administrative heritage for example, Ford has a history of
vertical integration and centralised control, whereas General Motors' heritage is
of mergers and diversification
(c) The nature of the product or industry for example, we can see a number of
different features between the banking and technology industries as follows.
Cultural feature Banking Technology
Behaviours Formal interactions
Smart dress code
Informal interactions
Casual dress
Management Hierarchical Flat structures
Values Procedural reliability
Financial expertise
Conformity (to external
regulation)
Innovation
Intellectual capacity
Flexibility

Occupational culture
When you enter a particular profession such as a doctor, engineer, teacher or
accountant you undergo a period of mental programming. Occupational cultures have
symbols, heroes and rituals in common with organisational cultures, but they also often
imply holding certain values and convictions as an engineer for example, you would
learn to work with precision, to be especially careful about certain aspects of safety,
dress in an accepted way and learn the specific technical language that enables you to
communicate with other engineers.
Occupational cultures in this respect take a position in between national and
organisational cultures for example, the culture of management as an occupation
contains both national and organisational elements.
Professional cultures also take into account:
Level of education, including a distinction between generalists and specialists
Degree of training
Selection into an "elite" group, which may include having attended the right
schools or training institutions
Socialisation into the values and proper behaviours of the group.
In different nations, particular professions or training will be ranked as being most
valuable, for example:
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Professions Most Rated by Nation
Nation Profession/Training
USA MBAs
Britain Accountants
Germany Engineers
The Netherlands Sales
France Marketing

Gender culture
Gender differences are not usually described in terms of cultures, but in each society
there is usually a male culture that differs from a women's culture.
Women and men are often technically able to perform the same jobs, but they do not
respond to the same symbols, do not look up to the same heroes, and do not share the
same rituals. The degree of gender differentiation in a country is also highly dependent
on its national culture.
We can then imagine culture as resembling an onion.
Figure 8.1: Rousseaus Layers of Culture

The inner rings are the deepest feelings of culture fundamental beliefs, values and
behavioural norms. These relate to national culture.
The outer rings are the more visible signs of culture patterns of behaviour and artefacts.
These relate to organisational and professional culture.
Artefacts
Patterns of behaviour
Behavioural norms
Values
Fundamental
beliefs
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Cultural Aspects of Globalisation
The aspects of culture mentioned above demonstrate the challenging task for companies
who globalise, whether their growth is by joint venture, merger or acquisition, organic growth
or licensing. We noted at the beginning of the last chapter, that global companies involve the
movement of people across borders, and this necessarily means developing strategies to
ensure that differences in national, organisational and occupational cultures do not stand in
the way of maximising business performance.
We can see the problems in terms of organisational culture through the example of Kraft's
acquisition of Cadbury in 2010. When companies acquire other companies they often quote
huge cost advantages, and Kraft stated that: it could register pre-tax cost savings of around
$675 million annually by the end of 2012. However, within months, key staff were leaving
the company because Kraft had failed to integrate the cultures of the two organisations.
Krafts culture was bureaucratic as every major decision had to be signed off at corporate
headquarters, whereas former Cadbury employees had been programmed to work in a
culture where they had autonomy. One of these managers was quoted as saying that a
presentation she once made had to go through 20 drafts and be checked by eight people
before it was acceptable: "that wouldnt have happened at Cadbury".
Integration and Diversity
The key, then, is to integrate cultures, but not at the expense of one over the other.
Integration must embrace cultural diversity, so that whilst all employees understand and work
within the organisation's own values and objectives, their own cultural identity is not denied.
The most fundamental action is to have a strategy for integration and diversity. In tune with
best practice, it is likely that this will be led by the central HR department in close
collaboration with the senior management teams. Approaches to global integration which
have been devised in this way include:
Inducting staff in new countries or acquired companies into the practices and
processes of the organisation
New and original staff working together on joint projects and learning from each other
Recruiting staff on a global basis so that global teams are multicultural
Conducting training and development in multicultural teams
Providing employees with assignments in other countries so that they appreciate and
learn from how other cultures work and also transfer new practices to the team in that
location
Having open feedback sessions, workshops, one to one meetings and internal surveys
to gauge the progress of integration
Using outside or inside change agents who work solely to assist in making the change
happen.
The following case study of Coca Cola's approach illustrates this.
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Case Study 2: The Coca Cola Company
Coca Cola demonstrate a strategic approach maximising opportunities from
diversity and integration:
Coca Cola have role models who have been recognised as adding
value to the Companys success and have progressed in their
careers within the Company for example, one Executive Vice
President was originally based in Nigeria and the CEO is originally
from the UK.
Each of them had roles in other countries prior to taking on the senior
position. This type of action reduces potential conflict between senior
managers when making global decisions and projects an inclusive
global approach. Coca Cola main offices are designed to be
multicultural and multifunctional, providing the environment for cross
cultural and cross functional learning. A global environment created in
this way promotes cultural differences as a positive force for change
through associates experiencing the value of a diversity of people. It
helps to reduce conflict on the basis of cultural diversity,
That's why at our headquarters in Atlanta we have over 50 different
nationalities represented at our corporate centre alone. It's why we
have Latin Americans assigned to top level jobs in Asia.
The Companys fast track leadership training programme forces
potential leaders to embrace change in a positive way, learning how
to leverage their cross cultural and cross functional experience to
develop the business.
We pick 20 to 30 high-potential managers from all over the world for
special stretch assignments that benefit our business. We place them
far outside their comfort zones and deep into interesting new roles.
An example is one team, for instance, was sent to a Southeast Asian
nation to develop a 5-year market-entry plan.
They have a clearly expressed local and global attitude investing in
each country and its employees, for example, through its partners
and associates around the world. It invests in its bottlers (training,
marketing, etc) and is able to change their approaches to business
while listening to the local issues and making adjustments for them.
Involving the workforce in ideas about change reduces conflict when
change happens. Coca Cola has had an annual employee survey
since 2007 and used this to involve employees as well as to obtain
new ideas. This has proved a positive force for change.
Use of outside consultants to provide a more objective view on how
change can be implemented in a positive manner. As a result of a
global strategic realignment, Coca-Cola Brazil was going through a
major business model change. The company believed middle-
management was a key for implementing the changes. The client
identified behavioural problems with this group including lack of
accountability and initiative as well as resistance to new ways of
conducting business. Coca-Cola Brazil used consultants to resolve
these issues and to develop and provide training modules to address
these needs.
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Management
For the global manager there are a range of challenges to overcome in organising and
directing operations within an integrated but diverse cultural environment.
(a) How to adopt not only the recognised managerial competences of the parent
organisation, but demonstrate abilities as a champion of international strategy, cross-
border coach, intercultural mediator and change agent.
(b) How to adapt to different professional cultures and maximise the opportunities
available from diversity:
What are the challenges and opportunities created by integrating different
professional cultures?
How do you attract and value people with diverse educational, professional and
cultural backgrounds?
How can a culturally diverse group be best managed and used as a resource to
tap into?
(c) How to use the appropriate key competencies at the organisational level to realise
multicultural synergies and provide services which create stakeholder value:
Developing pathways to resources, especially through networking
Mediating knowledge from anywhere
Developing a learning support structure to facilitate organisational learning.
(d) How to communicate and integrate personnel and activities effectively:
Cultivate an intra- and inter-organisational bonding process
Implement multi-task exchange processes
Inter-cultural knowledge sharing
Network locally and globally
Encourage collaborative learning
Communicate across linguistic and cultural boundaries
Identify and restrict the undesirable effects of noise
Embrace cross-cultural networking behaviour for creating productive
interpersonal exchanges of ideas and experience.
Branding Corporate and National Culture
Some companies have promoted aspects of their national culture to underpin perceptions of
their characteristics, irrespective of location:
LVMH (Louis Vuitton Mot Hennessy) stressing French refinement and elegance.
IKEA with their low-cost, home-assembly, simple lines reflecting Scandinavian
egalitarian and pragmatic values.
BMW and Audi who emphasise the values of German engineering.
On the other hand, other companies respond to the culture of their locations by adapting their
corporate characteristics. For example, Disneyland J apan has a distinctive J apanese
culture, emphasising J apanese values such as the drive towards perfection, courtesy,
efficiency and cleanliness. This is partly a reflection of the way in which Disney licenses its
operations into other countries, but also builds on its experience when it first exported the
Disneyland parks to France it suffered huge losses because it did not take into account the
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very different cultural values of the French and just built the American model and expected it
to thrive.
Impact of Globalisation on Local Culture
The impact on local culture has been huge to such an extent that Western products and
ideas can be found almost anywhere in the world.
Globalisation has resulted in the desire of individuals throughout the world to increase their
standard of living and enjoy foreign products and ideas, adopt new technology and practices,
and participate in a "world culture". Regional economies, societies and cultures have also
become integrated through a global network of political ideals through communication,
transportation and trade.
There is a downside to this in the increasingly homogenised nature of goods and services,
and the domination of Western cultural values and philosophies, resulting in a "swamping" of
indigenous cultures and values. In some parts of the world, this has given rise to a sharp
sense of real or perceived injustices in the access to, control and use of the worlds
resources.
Think Point
How has global culture impacted on the local culture in your country? To what extent is this
positive and what have been the negative effects? Has there been any backlash against the
threat to national culture?

F. LIMITATIONS TO GLOBALISATION
The expansion of globalisation in the future is likely to be limited by a number of factors
including the following.
Global Transportation Infrastructure
The increasing globalisation of the worlds economy has helped firms to reduce their costs
dramatically, by allowing them to search the world for suppliers who can offer them the best
goods at the most competitive prices.
At the same time, it has also stretched companies supply chains and with just in time
manufacturing techniques, has made them much more vulnerable to problems created by
any inefficiencies or breakdown in infrastructure around the world.
The worldwide cost of developing and maintaining infrastructure to meet growing demand
over the next 20 years has estimated at more than US$41 trillion. Apart from increasing
trade flows, changing demographics are set to put further pressure on infrastructure.
It is estimated that by 2030, 60% of the worlds population will live in cities, straining existing
road and railway networks to and probably beyond their limits. India, for example, is likely to
need huge additional sums spent on improving and increasing its infrastructure, as its
population density, already one of the worlds highest, is forecast to grow by a further 22% by
2030.
Demographics
World population in 2015 will be 7.2 billion, up from 6.1 billion in the year 2000 and in most
countries, people will live longer.
206 Going Global
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Ninety-five percent of the increase will be in developing countries, nearly all in rapidly
expanding urban areas. Increasing lifespan will have significantly divergent impacts.
In the advanced economies and a growing number of emerging market countries, declining
birth-rates and ageing will combine to increase health care and pension costs while reducing
the relative size of the working population. This will strain the social contract and leave
significant shortfalls in the size and capacity of the work force. There will be an increasing
requirement for health care services and immigrant workers.
In some developing countries, these same trends will combine to expand the size of the
working population and reduce the youth bulge, increasing the potential for economic
growth and political stability.
Aging will put a huge premium on skilled workers and will shift the wealth of nations to
countries with younger, educated populations. The global hunt for already scarce talent will
become even more of a preoccupation of companies and countries.
Natural Resources
Of all the categories of resource whose depletion is likely to bring an end to globalisation, the
most likely to be limiting in the short term is energy. The linkage between energy availability,
price and distribution is a major challenge.
Water scarcities and allocation will pose significant challenges to governments in the Middle
East, Sub-Saharan Africa, South Asia, and northern China. Regional tensions over water will
be heightened. There has already been tension between Indian farmers and firms such as
Coca Cola over water rights. Three billion individuals who will be living in water-stressed
regions from North China to Africa heighten the implications for conflict.
In addition to this exhaustion of resources, the growing public awareness of the potential
damage to the environment and to the treatment of workers and communities in poorer
countries of the world has become a limiting factor.
Technological Development
Technological advances are capable of reducing energy consumption for most applications.
However, the process of testing, accepting and incorporating new technologies on a global
scale is slow; this is especially true in the developed world, where the mass of existing
technology creates inertia to further development that is difficult to overcome.
It is also true in the Third World, where cultural barriers to technological change have their
own inertia.
Technological development is highly dependent on both energy and wealth. For example,
nuclear power plants take years before they recover the energy investment of oil required to
build them.
Therefore, the lack of foresight to continue developing some technologies could result in a
slowdown in global expansion.
The Anti-global Lobby
There is a significant range of pressure groups, with little or no cohesion between them at
present, campaigning against globalisation. The reasons for such anti-global movements
include
Growing consumerism/materialism and the resulting loss of spiritual values.
Individual languages and cultural practices are being abandoned for a global culture
based on western tastes.
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The worlds resources are being consumed by the richest nations and companies. If
trade is an important indicator of globalisation, then the global economy is essentially
concentrated on a few nations and a small number of elite within these nations.
Only 10 countries account for 60% of global merchandise trade, with another 40
countries accounting for a further 30%. The remaining 150 odd nations of the world
share just 10% of world trade. The returns are then further concentrated in the hands
of a small percentage of the population, in both rich and poor nations.
The growing power of multinational companies with turnover greater than the GDP of
some countries. Such companies are accused of seeking to maximise profit at the
expense of work safety conditions and standards, recruitment and reward standards,
environmental conservation principles and the integrity of national legislative authority
and independence.
The loss of employment from developed countries as low technology, labour intensive
productions shift to low wage countries.
The opening of free markets may result in unrestricted competition affecting domestic
industries which are not mature enough to compete.
Environmental impact as ever increasing natural resources are used and human
activities damage the environment for example, the increase of carbon emissions
from cars, planes and boats used to transport people and products around the globe.
An Oxfam International briefing paper, Harnessing Trade for Development, states that world
trade rules have been developed by the rich and powerful on the basis of their narrow
commercial interests and that trade rules should be judged on their contribution to poverty
reduction, respect for human rights, and environmental sustainability.
Acti vi ty 4
Finally in this chapter, we present a summary of the development of the Georgio Armani
fashion empire with which we can explore aspects of the development of global operations.
Consider the following case study and then answer the questions that follow.
Case Study 3: Armani The Ultimate Fashion Brand
Giorgio Armani, 74, is CEO of the Armani Group and sole shareholder of
Giorgio Armani SpA (Armani), one of the world's leading fashion and
lifestyle design houses, with 5,000 direct employees, 13 factories, and a
direct network of 500 exclusive retail stores in 46 countries worldwide. The
company is one of the few remaining independent, privately-owned
companies in its sector.
The company was founded in Milan in 1975 and later that year, the first
ready-to-wear collection was presented. 1978 marked an important turning
point in the company's history when it established a licensing agreement
with GFT (Gruppo Finanziario Tessile Textile Finance Group). GFT was
the world's largest manufacturer of designer clothing competing at the
highest end of the fashion business, its success is rooted in its history,
cutting edge technologies and well-organised labourforce. GFT had single-
handedly revolutionised the way artistic clothing was conceived,
manufactured, marketed, and distributed. It was alert to social trends and
208 Going Global
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needs, keeping it way ahead of its competitors. This licensing agreement
resulted in Armani obtaining the opportunity to invest in a new headquarters
including showrooms and press offices, and to expand the manufacturing
side through GFTs expertise.
In 1979, overseas expansion began by establishing the Giorgio Armani
Corporation in the United States and by the end of the 70s Armani had
emerged as one of the leading international fashion houses. In the early
80s the company established an important licence agreement with L'Oreal
(formerly Helena Rubinstein) for fragrances and launched the Emporio
Armani and Armani J eans collections.
In the second half of the 80s, Armani continued its overseas expansion by
opening Giorgio Armani J apan through a joint venture with J apanese Itochu
Corporation and the Seibu Department Store, followed by the signing of a
licensing agreement for eyewear with Luxottica Group Spa.
In 1999, a new Accessories Division was created including a first e-
commerce presence with www.armaniexchange.com in the United States.
As part of its strategy to maintain control over product quality and
distribution, Armani initiated a series of share investments, which today
include Intai Spa (100%), Antinea Srl (100%) and the manufacturing
company Simint Spa (100%), the complete acquisition of which was
finalised in 2001.
In the five years from 1998 to 2003 the Armani Group spent Euro 600
million of internally generated funds on strategically important activities,
including the evolution of its manufacturing base, the expansion and
renovation of its retail network, the diversification of its product lines and
enhancement of its headquarters facilities in Milan.
In 2000, Giorgio Armani's, 25th anniversary year, the company launched its
global website. In 2001, continuing with the Group's strategy to take
greater control over all aspects of its manufacturing, distribution and retail
activities and to further focus on the 'Made in Italy' content of its brands, a
joint venture company with Vestimenta SpA (manufacturers and distributors
of Italian tailored mens and womens apparel and one of the Armani
Group's licensees since 1979) was formed for the production and
distribution of the men's and women's Giorgio Armani top line. In 2002, the
Group's retail investment programme continued at a fast pace with 16 store
renovations and 30 new store openings in strategically important cities
worldwide, including the second Armani multi-brand store covering 3,000
square metres in Hong Kong, which also signalled the launch of a strategic
retail expansion programme for China.
In 2002 Armani purchased IT based store systems for 28 of its US retail
stores. These were used for store operations management, supporting
critical store level activities including receiving, stock adjustments and
transfers. The systems were deployed throughout the stores in a wireless
environment, and deployed using handheld devices within the store.
"Providing our customers with high levels of service is very important," said
Stephen Culver, Chief Information Officer with Giorgio Armani, US. The
system has provided Armani with a strong store operations solution that
enables real-time information to flow between the store and headquarters.
With this information, we have been able to reduce inventory, improve
labour management, and most importantly, improve customer service.
Going Global 209
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On the manufacturing front, two important acquisitions were completed in
2002: Deanna SpA for the production of high quality knitwear and Guardi,
which controlled four specialist shoe makers, to support the further growth
of the Group's shoe business.
In 2005, A|X Armani Exchange purchased a web-based product lifecycle
management and production tracking system, e-SPS, to streamline and
integrate product development and global sourcing. This provided real-
time visibility into merchandising, design and production activities from
product concept to delivery, streamlining its entire supply chain process.
At the end of October 2008, a global beauty website
www.giorgioarmanibeauty.com was launched, demonstrating the
company's commitment to embrace fashion and beauty within the online
sphere.
During the same year, a strategic marketing agreement was signed
between Giorgio Armani and Samsung to develop high-end electronic and
consumer products, including the launch of a Giorgio Armani mobile phone,
the Armani/Samsung Television and the Emporio Armani Samsung mobile,
"Night Effect ".
From initial sales of $14,000 in its first year, 1975, the company grew to
sales of $100m only a decade later. Today it has an annual turnover of
close to $2bn.

Questions
(a) (i) Describe instances where Armani has used mergers and acquisition, and
licensing or joint venture, for growth.
(ii) What do you notice about the use of these options so far as business operations
are concerned?
(b) Explain how Armani has used information technology to:
(i) Support major business operations
(ii) Continue its national and global competitive advantage.

210 Going Global
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SUMMARY
Firms have a range of choices for growing globally. The growth option they take will depend
on the conditions in their location of choice. J oint ventures and acquisitions/mergers provide
for the opportunity of easier entry into a new market through the existence of an established
business there and also because resistance by the public and the government is likely to be
lower. Organic growth is more risky financially, but the difficulties of integrating processes
and systems are much reduced. This type of growth is more likely when the political and
environmental factors are more stable. Licensing and franchising provide a method of
obtaining global coverage with lower financial risk and may be a good initial way of entering a
new market.
Globalisation brings with it the challenge of financial management, where to borrow and in
what currency. Treasury management is very important if large losses are to be avoided by
swings in interest and exchange rates plus country devaluations.
One of the main contributions to successful business performance is to ensure that cultural
factors are taken into account and planned for. Recruitment, employment, training and
employee feedback all need to be customised to the particular needs of the location and the
national and professional culture of employees as well as to the organisational culture.
Marketing too must adapt their communication channels and methods to maximise
opportunities to connect with local populations effectively. Management techniques need to
broaden to encompass all the necessary people and organisational skills specific to working
with global teams.
Globalisation is limited by factors such as lack of infrastructure, growing scarcity of resources
such as energy and water, and opposition by pressure groups of various kinds. The power
and influence of multinational companies and the narrow distribution of the wealth created
have created wider gaps between rich and poor.
Going Global 211
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Activity 1
(a) Coca Cola uses different growth strategies with its bottlers depending on the location
in which they are based. It decided to take full ownership of the North American
bottlers because of the competitive threat from Pepsi. It needed to be in full control of
the operation to ensure efficiency and drive down costs.
In many other cases it uses licensing as this gives the company a wide global coverage
without huge capital investment. It can still keep control as the bottlers have signed
agreements regarding quality, delivery, price and so on.
J oint ventures may be used to gain entry into certain countries where Coca Cola would
have difficulty getting permission to trade. The joint venture also puts part of the risk of
a new operation on the other organisation to ensure that the alliance succeeds.
(b) There are many examples, including the following:
Coca-Cola plans to invest more than $5 billion in bottling operations in Mexico and
Brazil over the next five years. This appears to be organic growth as there is no
mention of acquisitions, but some of the total amount could be split between several
options.
Coca Cola has a joint venture agreement with Illy Caffe SpA.
It has invested huge sums in China both for organic growth and in a joint venture with
a Chinese company, its bottling partner Cofco Coca-Cola, which is 65 per cent owned
by a state-owned food company, and whose management has ties to the central
government. In 2010, it was reported that its $2bn investment will exceed the
companys total investment in China since 1979, which amounts to $1.6bn.

Activity 2
The IPad will cost you more euros than last year because the exchange rate has changed
and the is a stronger currency than the euro at this point. You will pay 600/1.2 = 720.

Activity 3
(a) (i) The case study identifies the following three acquisitions:
Simint Spa
Deanna Spa
Guardi
Examples of the instances where Armani has used licensing and joint venture
are:
GFT licensing agreement
Helena Rubinstein licensing agreement
Samsung licensing agreement
Luxottica Group Spa licensing agreement
Vestimenta SpA joint venture
Itochu Corporation joint venture
Seibu Department Store joint venture
212 Going Global
ABE
(ii) Armani has used strategic alliances since the early period of his business.
These have been very important to the foundation and the expansion of the
business.
Armani has used strategic alliances such as licensing as a means of expansion
and globalisation through diversification using well known global brand names.
For example he was able to diversify into fragrances by using a licensing
agreement with Helena Rubinstein and into electronics by using a contractual
agreement with Samsung.
However Armani has expanded its manufacturing by acquisition and joint venture,
usually with Italian companies in the supporting industries, such as shoes and
knitwear which seems to align with the underlying "Made in Italy" theme while
providing a means to grow and control the business expansion.
(b) (i) Armani seems to have been relatively alert in using state of the art information
technology to support business systems. As early as 2002, its US stores were
using wireless hand held devices to check stock levels and hence able to provide
a more effective service to customers and check stock excesses or low points.
Armani has also used technology to manage and improve its supply chain
generally, from sourcing to life cycle management.
(ii) Upgrades and relentless improvement are needed to retain competitive edge and
Armani seems to have adopted electronic technology before many other
organisations. The company has used technology extensively and in a variety of
ways to retain competitive edge not only in the core brands, but in its
diversification strategy. (The strategy of bringing together two leading names on
one product to strengthen and continue the competitiveness of both brands can
be seen with the collaboration with Samsung.) Examples are:
As early as 1999 the company had set up a US website with e-commerce
facilities.
New products such as sports shoes and mobile phones bearing the Armani
Brand were developed
Armani moved into the electronics market by developing and marketing its
own branded phones and televisions with Samsung.

213
ABE
Chapter 9
Introduction to the Socio-cultural Business Environment

Contents Page
Introduction 214
A. Demographic Trends and Business 214
Forecasting Global Demographics 214
Economic Growth, GDP and Wealth Distribution 214
The Workforce of the Future 219
B. Business Ethics 225
Different Cultural Perspectives on Business Ethics 225
Ethics and Management 229
The Potential for Unethical Behaviour 232
Corruption and Bribery 232
Ethics and Conflicting Stakeholder Interests 235
C. Corporate Social Responsibility 237
Costs and Benefits of CSR 239
How Pressure Groups Influence CSR 242
Regulation and Review of CSR in Organisations 243
D. Whistle-blowing and Corporate Responsibility 245
The Cases For and Against Whistle-blowing 245
Public Interest Disclosure Act 1998 246
Key Examples of Whistle-blowing 246
Summary 249

214 Introduction to the Socio-cultural Business Environment
ABE
INTRODUCTION
This final chapter is concerned with the social and cultural changes taking place that will
increasingly impact on how business is conducted in the future. In Chapter 8 we touched on
culture and demographic changes, and we will now look at these factors in a little more
detail.
In the first section we focus on the implications of demographic trends for business and what
these may mean for future economies, consumers and the workforce.
In the second section of the chapter we compare business ethics in different areas of the
world, how this affects planning and success in the global company and the underlying
ethical principles of corporate social responsibility.
Corporate responsibility and its interaction with company performance has become an issue
of major importance to global organisations and the public in general. Firms are being forced
to take responsibilities for conserving the scarce resources of the planet and taking more part
in ensuring that all individuals have the basic needs for life.
We look at the ways in which companies may gain competitive advantage and maintain
market share whilst implementing corporate responsibility strategies. However, we shall note
that the tension between the main aim of Anglo American companies of increasing
shareholder value while caring for the planet and its people is an ongoing challenge.
A. DEMOGRAPHIC TRENDS AND BUSINESS
Forecasting Global Demographics
Forecasting future populations, their locations and age profiles is not an easy task. Despite
all the advances in technology it is difficult to obtain accurate statistics, so making an
estimation of demographics in twenty to thirty years is a challenge. In some countries,
census information is not available or up to date.
Figure 9.1: Forecast Population Aged 20 60 Years by Region, 2000-2100

Source: www.redgreenandblue.com
0.65
0.6
0.55
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2000 2020 2040 2060 2080 2100 2120
Russia
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Eastern Europe
Introduction to the Socio-cultural Business Environment 215
ABE
Even with the forecasts we have, many companies take no account of likely demographic
changes even though the number of people in a country, their distribution within it, ethnic mix
and age profile are vital to developing a robust business strategy.
The current age structure of the world's population can be seen from the following table.
Age Demographics by Gender
Age Range % of
Total
Male Female
0-14 27.0 944,987,919 884,268,378
15-64 65.3 2,234,860,865 2,187,838,153
65 and over 7.6 227,164,176 289,048,221
Source: CIA World Factbook, 2010
However, when we look at future projections, a rather different picture emerges.
Global population growth is forecast to rise by 80 million people each year. This is further
complicated by movements of people between areas of the world and between regions within
countries, with increasing urbanisation being a particular feature. The age structure is also
projected to change radically, with the advanced industrialised countries having an ageing
population.
The age structure of a population has a significant effect on the socio-economic issues that a
nation faces. For example:
Countries with young populations (high percentage under age 15) need to invest more
in schools.
Countries with older populations (high percentage ages 65 and over) need to invest in
services such as health care.
Rapid growth of a young adult population may lead to mass employment, particularly if
concentrated in particular areas (especially given the growth of urbanisation predicted)
and this may lead to social and political unrest.
The urban population currently represents 50.5% of world total, and is growing at a rate of
1.85% annually (2010). The largest cities in the world already have enormous populations
and it is unclear how they will cope with this level of future growth:
Tokyo (J apan) 36,669,000
Delhi (India) 22,157,000
Sao Paulo (Brazil) 20,262,000
Shanghai (China) 16,575,000
Karachi (Pakistan) 13,125,000
The movement of people from disadvantaged locations to wealthier countries has always
been a feature of demography. As the economic strength of different countries change in
relation to each other, people will seek to better themselves by migrating to regions or
countries offering more opportunities. In the 19th and 20th centuries the USA was one of the
most popular destinations for migrants. The opening of the EU to Eastern European
countries resulted in waves of immigrants to a United Kingdom already rich in immigrants
from its former colonies. In the future, this trend may affect China and India, where
populations will be ageing and they will require immigrant workers from the poorer nations to
sustain their economies.
ABE
Given these changes in the global population, the present problems of underemployment,
pollution, waste disposal, epidemics, water shortages, famine, over fishing of oceans,
deforestation, desertification and depletion of non-renewable resources will continue to grow.
Businesses will have to take account of the impact of this on the way in which they operate,
and governments will need to examine the extent, cost and types of interventions that will be
required to provide the protection and services required where these cannot be guaranteed
by the market.
Economic Growth, GDP and Wealth Distribution
The National Intelligence Unit, which manages information forecasting for the USA, forecast
the changing economic order and potential issues that could result in Case Study 1.
Case Study 1: The Changing Economic Order
Forecast to 2025 by National Intelligence Unit
Although many of Latin Americas major countries will have become middle
income powers by 2025, others, particularly those such as Venezuela and
Bolivia that have embraced populist policies for a protracted period, will lag
behind and some, such as Haiti, will have become even poorer and less
governable.
Overall, Latin America will continue to lag behind Asia and other fast-
growing areas in terms of economic competitiveness.
Asia, Africa, and Latin America will account for virtually all population
growth over the next 20 years; less than 3% of the growth will occur in the
West. Europe and J apan will continue to far outdistance the emerging
powers of China and India in per capita wealth, but they will struggle to
maintain robust growth rates because the size of their working-age
populations will decrease.
The US will be a partial exception to the ageing of populations in the
developed world because it will experience higher birth rates and more
immigration. The number of migrants seeking to move from disadvantaged
to relatively privileged countries is likely to increase.
The number of countries with youthful age structures in the current arc of
instability is projected to decline by as much as 40%. Three of every four
youth-bulge countries that remain will be located in Sub-Saharan Africa;
nearly all of the remainder will be located in the core of the Middle East,
scattered through southern and central Asia and in the Pacific Islands.
Many other countries will fall further behind, economically. Sub-Saharan
Africa will remain the region most vulnerable to economic disruption,
population stresses, civil conflict and political instability. Despite increased
global demand for commodities for which Sub-Saharan Africa will be a
major supplier, local populations are unlikely to experience significant
economic gain.
China is poised to have more impact on the world over the next 20 years
than any other country. If current trends persist, by 2025 China will have
the worlds second largest economy and will be a leading military power. It
also could be the largest importer of natural resources and the biggest
polluter.
India probably will continue to enjoy relatively rapid economic growth and
will strive for a multi polar world in which New Delhi is one of the poles.
ABE
China and India must decide the extent to which they are willing and
capable of playing increasing global roles and how each will relate to the
other.
Russia has the potential to be richer, more powerful, and more self-assured
in 2025 if it invests in human capital, expands and diversifies its economy,
and integrates with global markets. On the other hand, Russia could
experience a significant decline if it fails to take these steps and oil and gas
prices remain in the $50-70 per barrel range. No other countries are
projected to rise to the level of China, India, or Russia, and none is likely to
match their individual influence.

If we contrast the GDP of countries in the recent past with those forecast to 2050 there is a
very different spread of share by nation.
Figure 9.2(a): Share of World GDP, 1969-2009

1975 =26.3%
2009 =26.7%
40
35
30
25
20
15
10
5
0
1970 1975 1980 1985 1990 1995 2000 2005
EU15
USA
Asia/Oceania
Latin America
Middle East +Africa
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ABE
Figure 9.2(b): Predicted GDP Growth Rates BRIC, 2000-2050

Source: Dreaming With BRICs: The Path to 2050, Goldman Sachs
As the emerging economies further dominate the global economy, income structures will
also change. Many western based multinationals have already forecast this and have
stepped up their operations and started make enhancements to their product range to meet
the differing tastes and preferences in these countries. Pepsico and Coca Cola are two
companies that have invested vast sums to take advantage of the increasing disposable
income in China, Brazil and Russia.
Figure 9.3: Projected Changes in Household Incomes 2000-2020
Number of households with annual disposable income of $5,000 - $15,000
(Note: data for 2010 and 2020 are forecasts)

Source: Euromonitor International, from national statistics
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China
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Indonesia Brazil Egypt Ukraine Vietnam Russia
200
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2000 2010 2020
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ABE
Changing Economic Models
In 2010 the Chinese government barred Coca Cola from acquiring of one of its largest
beverage manufacturers, having been influenced by opposition from strong nationalists.
China is described as using an economic model known as state capitalism. Although this
term has various different meanings, it is usually described as a society wherein the
productive forces are controlled and directed by the State in a capitalist manner. The State
owns controlling shares of publicly listed firms and acts effectively as a capitalist company
itself. For example the Chinese government has a majority ownership stake in China
Eastern Airlines (61.64%), while some shares are publicly held.
Another example is Coca-Colas bottling relationships with partner Cofco Coca-Cola, which is
65 per cent owned by a state-owned food company and whose management has close ties
to the central government.
The Workforce of the Future
Impact on Skill Levels for Future Business
Successful business strategies rely on having accurate data about the labour force and its
skills available. Even in 2010, there is often insufficient talent for multinational companies to
secure their future success, and there is constant competition for the best graduates and
skilled labour. Overseas locations provide a wealth of unskilled labour, but without sufficient
numbers of employees with higher level skills, business growth will falter.
As noted above, the advanced industrialised countries have an ageing population and
therefore the skilled workers of the future are likely to be more concentrated in emerging
countries with a lower average age population.
Figure 9.4: Labour Force Growth in Age 15 64, 2000-2050

Source: US Census Bureau, International Division
The education of these future employees is crucial to those economies through the success
of their businesses.
UNESCO predicts that over the next 15 years, illiteracy rates of people 15 years and older
will fall, but they will still be 17 times higher in poor and developing countries than those in
OECD countries. Furthermore, illiteracy rates among women will be almost twice as high as
those among men. At the time of writing, UNESCO notes that "close to 20% of all Brazilians
who are 15 or older are unable to read or write their own names". In addition to the chronic
0%
15%
30%
45%
-15%
-30%
-45%
2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050
United States, 42%
China, -10%
Europe, -25%
Korea, -30%
J apan, -44%
ABE
lack of funds and unprepared teachers, there are science manuals that "have not been
updated in 10 years, in some instances even 40 years".
This type of information emphasises the present gap between skill levels in the advanced
economic countries and some of the emerging ones.
Some companies such as the Brazilian oil giant Petrobras are growing their own future
workforce by concentrating on the personal development of their own employees at all levels.
It has its own university and its degrees are validated by Ministry of Education as equivalent
to those of Brazilian Universities. In 2008, Petrobras had 190,923 staff places taken up at its
university, with the average training provided, per employee, being 103 hours (compared to
30 hours in USA and Asia).
Acti vi ty 1
(a) Which countries will be most affected by ageing populations in the next 20 years?
(b) How will this affect business operations and how will companies solve the issues?
(c) Why are multinational companies investing heavily in countries such as Brazil, China,
India and Russia?

Women in the Workplace
The population statistics show that almost half the working population is female. In the past
thirty years, women in the western economies have made up an increasingly significant part
of the workforce. This pattern has been influenced by several factors:
The growth of household labour saving devices
New laws and practices that make part time and flexible working hours possible,
particularly improved leave arrangements for parents and carers
Virtual working owing to growth of technology
Global talent scarcity with firms competing for the most skilled employees
Lower birth rates
Changing values including the growth of consumerism.
The research from the NIU suggests that by 2020 women generally will have gained more
rights and more freedom in terms of education and workforce equality, but that the gender
gap will not have disappeared, even in advanced economies. It is also forecast that the pay
differentials which exist today (see Figure 9.5) will persist into the future.
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Figure 9.5: Gap in Pay Levels Between Male and Females by Country
Percentage gap between median men's and women's wages
for all full-time workers (2006 or latest year available)

Several factors are likely to improve the status of women in the workforce.
According to World Bank analysis, increases in the level of information and communication
technology infrastructure tend to improve gender equality in education and employment.
Currently, there are few women heads of state, but the involvement of more women in local
and regional politics is rising and should improve the legislation and opportunities for growing
numbers of women in the workplace in Europe.
However, there are a number of issues that will slow equality in employment for women. In
regions where there are high populations of young people coupled with a history of male
domination, if there are limited public resources, competition for those resources will be
huge, leading to an increased probability that females will not receive equal treatment. This
will begin at the education stage if schools cannot educate all, boys are likely to be given
first priority. In countries where there is a preference for male children, girls risk infanticide
and the female population is disproportionately low. Countries already unable to provide
employment for male job seekers are not likely to improve employment opportunities for
women.
Certainly some MNCs have given special emphasis to developing women leaders as they
recognise their link with women consumers in particular. The CEOs of Kraft, Pepsico and
Xerox are among the prominent women business leaders, and Coca Cola has a womens
development programme (although it is promoted and chaired by the male CEO).
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The Generational Challenge
Since the 1960s the advances in wealth and the technology in the UK, USA and other
advanced industrial economies, have influenced the ideas of successive generations about
what they consider as acceptable work practices, terms and conditions and career
opportunities. These developments pose challenges for managing business performance in
future.
The theory of generations was initially developed in the early 1990s by Neil Howe and
William Strauss, both US sociologists. Generation theory views society as consisting of
successive generations, the three most recent of which are the:
Baby Boomers born between 1943 and 1963
Generation X born between 1964 and 1981
Generation Y born between 1982 and 2000.
Milleniums born 2001 onwards will be entering the workforce within 10 years and are
expected to have yet another different perception of work and career.
Each generation has its own unique character shaped by the economic, social and cultural
forces current during its formative years. By examining these forces it is possible to
understand what motivates each generation and gives it a unique outlook on life.
(a) Baby Boomers grew up in the post World War Two era of rationing. They generally
possess a "live to work" attitude, appreciate job stability and security, and enjoy making
decisions and working with clear goals and responsibilities. A high proportion expected
to stay in the same organisation for their entire career and to obtain promotion and
salary rises steadily as a reward for their longer service. Many tend to be task
oriented, preferring formal ways of communicating, such as face-to-face meetings,
memos and emails.
(b) Generation X place great importance on work-life balance, are resourceful and
independent, but collaborative and adaptable. Family life for this generation was much
less secure that for the previous generations, with divorce, working mothers and
parental job insecurity in the 1980s recession promoting traits of independence,
resilience and adaptability. Other characteristics include:
Adapt well to digital technologies
Thrive in multicultural settings
Have a desire for some fun in the workplace
Pragmatic approach to getting things done
Build interpersonal relationships through different forms of communication
roundtable discussions, phone calls or emails.
The work profile for Generation X is given as follows.
(i) Many of them also started work in the early 1980s, when the economy was in a
downturn. Hence they are not loyal to any company, only to the team they work
with and the boss they work for.
(ii) If a Generation X individual is unhappy, s/he looks for and accepts the best offer
s/he can find at another organisation.
(iii) Generation X takes employability seriously, but there is no planned career path.
Rather, their career is more fluid there is a career matrix and they can move
laterally, stop and start.
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(iv) At the same time, this generation expects immediate and ongoing feedback and
is equally comfortable giving feedback to others. Generation X dislikes authority
and rigid work requirements.
(c) Generation Y grew up with more disposable income than previous generations as well
as being able to spend more time in full-time education. Their characteristics include:
Most IT literate generation and very assertive
Avoid commitments to employers and institutions
Extremely brand conscious, possibly because brands have been such a constant
feature of the Generation Y experience
Better educated, more competent with technology and quicker to adapt than
previous generations
Refuse to conform to traditional standards and time honoured institutions without
very good reason.
In the workplace:
(i) They do not respond to formality, in particular bureaucratic hierarchies and
traditions.
(ii) Generation Ys want to be treated as equals with the rest of their older colleagues.
(iii) They crave a flexible working lifestyle and are more interested in making their
jobs accommodate their family and personal lives.
(iv) They want jobs with flexibility, telecommuting options and the ability to go part
time or leave the workforce temporarily when children are born.
(v) They seek the freedom to develop and advance themselves, and are not
intimidated by authority or afraid to speak up.
(vi) Generation Ys hold high expectations of their career and want their work to be
challenging and meaningful they do not expect to stay in any job for too long.
(vii) They are quite prepared to walk away from organisations that are unable or
unwilling to match their values and concerns.
(viii) They are more aware of corporate social responsibilities and of the environment
than Generation X or Baby Boomers.
In the UK the Association of Graduate Recruiters found that 72% of final year students
(Generation Y) said they would have to feel happy with an employer's ethical record
before agreeing to work for them.
Challenges for Employers
Many employers have all three generations working in the same location. Their different
aspirations, expectations and working practices are a challenge.
(a) Recruitment
Despite the recent rise in student numbers, many top firms are locked in a struggle to
recruit and retain top graduate talent. This worsens each year, not because there are
not enough applicants for each role, but that there appears to be a mismatch between
what employers want and what graduates want to do, reflecting the features of the
generations mentioned above.
Companies recruiting Generation Y have to ensure that the package they offer is
appropriate and so are their practices culture, incentives, contacts and development
opportunities.
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MNCs continuously compete for the same individuals and it will be a question of
whether the company fits the requirements of the individual Generation Y rather than
the other way round.
(b) Management
Once recruitment has taken place, management of Generation Y becomes the next
challenge. Many older colleagues may prefer a traditional, less collaborative style of
working, and employers find tensions building up between the generations with older
workers being dismissive of younger workers' abilities and younger employees
dismissive of the competence of their older co-workers.
In 2010, the Chartered Management Institute (CMI) and the Chartered Institute of
Personnel and Development (CIPD) examined how line managers and HR managers
were adapting to an ageing workforce.
Only 14% of UK managers consider their organisation well prepared to cope with
an ageing workforce and the fact that a third of UK workers will be aged over 50
by 2020.
93% of managers taking part in the study recognised that older workers bring
valuable knowledge to organisations.
Only 7% of organisations offer training to line managers on managing older
workers, yet 47% of respondents think such training is needed.
59% think that young managers find it hard to manage older workers.
In another study, Management in 2018, CMI's key findings included:
The working population will be more diverse.
Changing expectations of work and the impact of new technologies will require
managers and leaders to develop a new range of skills that focus on emotional
and spiritual intelligence, judgement and the ability to stimulate creative thinking
to improve productivity.
Personal responsibilities will increase and so will peoples private needs.
Attending to these needs will inevitably lead to blurring boundaries between work
and life as people try to cope with numerous urgent demands.
Work-life balance will be superseded by work-life integration.
Talent markets will become more complex in that they will be more diverse in
regard to age, generational issues and culture.
Organisations will have to address the growing power of the employee and the
need for personalised working patterns and benefits.
They also predicted that more organisations would be wholly virtual and that those
organisations that maintain physical premises would be run by by managers who
create a sense of control and calm.
Managers would need to focus on individual employees and their needs when
developing work technologies and motivate people creatively. They would need to
provide flexible, tailored support for work-life integration. Strengthening an organisation
will require enhancing agility, clarity, flexibility, genuineness, innovativeness and
openness. Finally, taking the notion of unforeseen events seriously, thinking these
through diligently and investing in contingencies may prove to be business life saving in
the long run.
ABE
Think Point
In your country, do several different generations work together?
What tensions may arise in the work place between different generations of employees, and
how might management adapt its approach to deal with these?

It is likely that different generations work together in most countries. This has been a
traditional feature of family businesses, but is becoming much more common in larger
companies.
The tensions are likely to vary with different national, organisational and occupational
cultures. For example, in Asian countries, older people have traditionally been respected
and perceived as people to learn from. Whether this will remain true in the future workplace
is unclear.
Management is likely to have been forced to adapt somewhat as western culture has
affected young people. In particular, where skilled young workers have returned from studies
in the US/UK they may have different ideas on how businesses should be run and these may
conflict with existing cultural values. Has management had to start to listen to them and take
into account some of their ideas?
B. BUSINESS ETHICS
The power and influence in business and society is greater than ever before. Business plays
a large role in society by providing goods and services that the public wishes to purchase,
provides employment and supports economic growth. When businesses act inappropriately,
this can have a very harmful affect on individuals, communities and society in general.
Stakeholders including owners, employees, customers and suppliers, and the public at
large are increasingly demanding transparency in business operations, and are concerned
that organisations treat them fairly.
The subject of business ethics includes issues of conflict of interest, financial and accounting
integrity, corruption, advertising standards, corporate and individual privacy and bioethics.
Different Cultural Perspectives on Business Ethics
Business ethics can be defined as:
the study of business situations, activities and decisions where issues of right and
wrong are addressed.
Right and wrong, in this definition, mean morally right or wrong. Morality is concerned with
the norms, values and beliefs embedded in the social processes that define right or wrong to
an individual or a community. Ethics, then, is the application of this sense of right or wrong
(morality) to the rules of conduct of the individual or community.
Another definition is:
how a company integrates core values into its policies practices and decision making.
We can see that just between these two definitions there is a different emphasis on the
meaning of ethics the first is a more general one, addressing right and wrong in terms of
what is socially acceptable, and the second demonstrates the perception related to the
values that the company has defined for itself.
The perception of morality varies from one nation to another, and from one community to
another. However, most business texts focus on the Anglo American business and
ABE
management models and theories. With the growing influence of other economies, it is
imperative that we examine and compare these different perceptions of ethics and how they
are demonstrated in the way operations and relationships are managed. For example,
differences in legislation, cultures and practices between societies have made the application
of ethical standards subject to what might be termed "ethical dilemmas". These occur when
there are conflicts between what is a morally right action and the potential for the outcome of
such action to be morally wrong for example, child labour is perceived by western cultures
to be morally wrong. but although to ban it may be morally correct, the child and his/her
family may be left starving.
Note, though, that ethical issues apply to all companies in all societies and are not only
encountered by global companies, so they must be understood in terms of their cultural
setting.
There are three broad ethical models:
Anglo-American
European
Asian Pacific
Anglo-American Business Ethics
In this model, the individual employee is expected to be responsible for ethical conduct within
the business with the organisation providing guidelines for such behaviour, focusing on:
The primacy of increasing shareholder value
Misconduct and morality in single decision situations
Key issues such as privacy, workers rights and salaries
Whistle-blowing by individuals and groups as a control/monitoring mechanism.
The ethical guidelines for business conduct are usually given in corporate codes of conduct.
Acti vi ty 2
Here we present the Xerox Code of Conduct as an example of the Anglo-American model.
Consider the following summary of its content and then answer the question that follows.
Case Study 2: The Xerox Code of Conduct
We are committed to conducting our business responsibly and in the best
interests of our customers, employees, shareholders and the communities
in which we work and live. We have had an employee Code of Conduct in
place for nearly 40 years and all of our employees acknowledge their
comprehensive understanding of it each year.
Key topics include:
Conflicts of interest
Legal and financial requirements and controls
Employee and customer information privacy, including data protection
and security, record retention and proper classifications of
information
Intellectual property
ABE
Proper use of information systems and company assets
Environment, health and safety
Diversity and inclusion
Harassment
Use of alcohol and controlled substances
Violence-free workplace
Gifts and entertainment
Guidelines for dealing with government customers
Community and political activities
Supplier guidelines
Fair competition, antitrust, international trade and export control
Bribery, improper payments, insider trading and money laundering
Collusive bidding and kickbacks.

Question
Describe, with examples, three ways in which this code of conduct illustrates the features of
the Anglo American model.

The European Model of Business Ethics
In the European model, the government, trade unions and corporate associations play a
major role in defining business ethics. The ethical guidelines are in the form of a negotiated
legal framework. The individual and the single company are not expected to be responsible
for ethical decisions, but there is a collective responsible for the issues.
These issues focus on social issues in organising the framework of the business and are less
driven by shareholder value and the interlocking relations between companies and banks.
The Asian Pacific Model of Business Ethics
Here, the approach is that the senior managers of the company are held responsible for
ethical conduct within the firm where the emphasis is on:
Accountability for mismanagement and corruption (corporate governance)
Responsible organisation of business
Businesses are owned and financed internally
Greater managerial discretion giving rise to a more flexible approach to ethics
Emphasis on personal virtues and collective responsibility
Predominant focus on providing jobs that pay a living wage
Production of products and services at affordable prices.
For example, in China it is unethical to make people redundant in an economic downturn and
mismanagement of the business can result in arrest for corruption and even execution.
ABE
In Asia the guidelines are left to managerial discretion and based on trust and implicit duty
rather than formal governance arrangements.
The Asian Pacific Approach is illustrated by the following extract from Tatas Code of
Conduct.
Acti vi ty 3
Consider this first clause in Tata's Code of Conduct and then answer the questions that
follow.
Case Study 3: Tata Code of Conduct
This comprehensive document serves as the ethical road map for Tata
employees and companies, and provides the guidelines by which the group
conducts its businesses.
Clause: 1
National interest
The Tata group is committed to benefit the economic development of the
countries in which it operates. No Tata company shall undertake any
project or activity to the detriment of the wider interests of the communities
in which it operates.
A Tata companys management practices and business conduct shall
benefit the country, localities and communities in which it operates, to the
extent possible and affordable and shall be in accordance with the laws of
the land.

Questions
(a) Describe how this clause differs from that of Xerox given previously. Discuss why this
is so.
(b) Now find the complete Code of Conduct at www.tata.com.
(i) What do you notice about some of the 26 clauses?
(ii) What do you think might be the reason for your answer to part (a)?

Other Regions
Africa and Latin America have a similar approach as both regions have traditional tribal and
small family-based communities which tend to ensure that the individual is involved in
collective decisions.
Latin American ethics tend to be based around decisions made by the many small family
owned firms where the key stakeholder is also the employee.
Africa and some Latin America countries tend to have ethical guidelines set by Non
Government Organisations (NGOs) often because the countries are under funded, lack
education or highly corrupt as we will see in the next sections.
ABE
Ethics and Management
Management ethics concerns the behaviour of those individuals in the organisation who have
the power to make decisions.
It is the legal duty of individual managers in UK not to pursue their own interests (or the
interests of others) where these are not the interests of the organisation and its shareholders,
or where these offend against the general moral norms of society.
What Standards of Behaviour Should Managers Observe?
Although there may be a high degree of consensus in society as to what constitutes ethical
behaviour (honesty, fairness, etc.) there are sometimes questions about how to apply these
in practice, particularly where ethical obligations may conflict with each other.
There are many ways of expressing what we understand by ethical behaviour. They are all
concerned with highlighting societal expectations about how organisations and individual
managers should act in their dealings with others. We could take the central elements of this
to be:
(a) Always to act within the law
The obligation to act legally may too obvious to be an issue of ethics at all. However,
there are many grey areas, for example:
Is minimal compliance with the letter of the law enough for example, in safety or
equalities issues or does an ethical approach imply more proactive
commitment?
Is it unethical to pay bribes as the only means of securing an export order which
will be in the interests of the firm's shareholders and workers? This is now illegal
under UK law but is believed to be still practised (see below).
Is it ethical to adopt off shore tax avoidance schemes which are not illegal, but
which can result in firms paying very low UK taxes and thus failing to meet their
social responsibilities to their home country? Conversely, in Anglo American
terms, given the legal requirement for companies to be run for the benefit of
shareholders, would it be proper for the managers not to take advantage of
opportunities for tax avoidance, which is in the interests of shareholders?
There may be different interpretations of the law and what is illegal may only be
determined in the courts after the event. The question of legality is often related to the
concept of what may be reasonably foreseeable as the consequences of actions.
(b) " Do unto others as you would be done by"
The principle that you should treat others with respect, as you would expect to be
treated yourself, gives rise to a number of expectations of behaviour in respect of
interactions between:
the managements of different organisations
individual managers and the organisation
individual managers and their colleagues and subordinates.
There are number of ways in which this general principle may condition behaviour
when it is put in the context of self interest:
(i) Not to deprive others of the true facts about a situation, to which they are entitled,
in order to pursue self interest or that of the organisation. This may be to cover
up misdeeds or mistakes, or the misrepresentation of the financial position to
shareholders (or to the government, for taxation reasons).
ABE
(ii) Not to use one's own power to exploit others in the pursuit of self interest or that
of the organisation, or to use them for one's own gain. This includes:
misrepresenting the views of others, such as in claiming the responsibility for
others' work or making misleading claims in order to obtain sales. It also applies
to cases of sexual harassment by managers of subordinates.
(c) Not to pursue own interests at the organisation's expense
Managers must not take advantage of their position in an organisation and the power
and information which may come from that, to further their own interests.
This clearly includes taking bribes and may extend to the acceptance of any personal
favours associated with, for example, dealings with particular suppliers.
It also includes using information which is confidential to the organisation to make
personal gains such as through speculation in shares (insider dealing), unauthorised
disclosure of information (for financial gain or otherwise) or the use of inside
information to set up a rival business. (This obligation may also extend beyond the
period of employment. Contracts of employment may forbid key personnel not to work
for rival companies for a period after resigning, in order to protect the inside information
which they possess. The fairness of such contracts can be challenged in the courts.)
There are also concerns that senior managers and directors may act in their own
interests rather than those of shareholders. Not only has the pay of top management
risen far faster than pay levels generally (see Figure 9.6), but there are also allegations
that the prospect of large bonus payments tempts managers to take risks which bring
them immediate rewards, but which may be against the organisation's longer term
interests.
Figure 9.6: Comparison of CEO Pay with that of Other Employees and Other
Indicators
Cumulative percentage change in economic indicators, 1990-2005

Source: www.financialsense.com
-9.3% Minimum Wage
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
0%
-50%
50%
100%
150%
200%
250%
300%
350%
400%
450%
Corporate
Profits
409.2%
298.2%
Average
CEO pay
S&P
500 Index
326.6%
260.8%
106.7%
4.3% Average Worker Pay
ABE
As long as returns on investment are satisfactory, shareholders may take too relaxed a view
towards managers' behaviour. This practice, particularly prominent in the USA, is not
considered good corporate governance practice. Anglo American corporate governance
guidelines suggest that a CEO should not also act as Chairman of the Board and set his/her
own bonus levels.
Role of Professionals in Organisational Ethics
Professionalism can be seen as an important element in the consideration of management
ethics, since most professional bodies are rigorous about adherence to what they define as
acceptable standards of behaviour for a practitioner in that profession. Indeed, some
professions, such as the legal and medical professions, have the power to remove an
individual's licence to practice in extreme cases of malpractice.
Therefore, professional ethics and standards may assume a dominant role in conditioning
the behaviour of members of that profession. The Code of Conduct for Nurses and Midwives
is an example:
Case Study 4: The Code of Conduct for Nurses and Midwives
Standards of conduct, performance and ethics for nurses and midwives
The people in your care must be able to trust you with their health and well-
being.
To justify that trust, you must:
Make the care of people your first concern, treating them as
individuals and respecting their dignity
Work with others to protect and promote the health and wellbeing of
those in your care, their families and carers, and the wider community
Provide a high standard of practice and care at all times
Be open and honest, act with integrity and uphold the reputation of
your profession.
As a professional, you are personally accountable for actions and
omissions in your practice and must always be able to justify your
decisions.

Each of the above points can be read in more detail on the nurses and midwives website:
www.nmc-uk.org. Similarly, the Chartered Management Institute has a code of practice for
managers which can be found at www.managers.org.uk.
One effect of this is that professionals may see loyalty to their profession as more important
than loyalty to the goals of the organisation for which they work.
Although the role and expertise of the professional must be acknowledged, there are many
areas of professional judgement which can be fruitfully opened up to scrutiny for example,
accounting and financial management in terms of creative accounting and other practices
which present a company's accounts in a more favourable light.
However, challenging the dominance of the professions is not easy, since the necessary
information and its interpretation require the specialist skills of the professional.
ABE
The Potential for Unethical Behaviour
The forces driving towards unethical behaviour are:
The pursuit of the organisation's goals, in particular, profitability
The individual's goals, which may be many and varied.
Three core factors that increase the temptation to act unethically can be identified:
(a) Level of competition
The more intense the competition, the greater the pressure to act unethically in seeking
a competitive advantage. This may also increase the pressure to achieve high
performance, resulting in managers being tempted to 'take short cuts' to achieve
financial targets or simply to misrepresent their achievements.
(b) Organisational culture
The more liberal the culture and the more autonomy of decision making and action it
allows, the greater the opportunity for acting with self interest. Cultures which focus on
outcomes rather than processes can imply that the ends justify the means. One of the
purposes of the rule-bound bureaucratic structures typically found in public service is to
prevent officials from having discretion to favour particular service users and so
minimise the possibility of corruption. However, in such autocratic and bureaucratic
cultures, there may be a tendency to cover up mistakes and obscure the truth of
situations.
(c) Degree of dependency between organisations and/or individuals
Where one party relies on the other for supplies or approvals (as in the case of
regulatory bodies), there is the potential for bribes and payoffs.
Corruption and Bribery
Corruption is defined as a lack of integrity or honesty in the use of a position of trust for
dishonest gain, especially susceptibility to bribery. It is considered to be one of the main
global business issues and it is thought that more than $1 trillion is paid in bribes each year,
amounting to approximately 3.3% of World GDP.
The corruption perception index, produced by Transparency International, compares the
levels of corruption in various countries. This is summarised in the following table.
Figure 9.7: Corruption Indices
Corruption Perception Index (CPI) 2005
From 0 = Highly Corrupt, to 10 = Highly Clean
Out of 158 countries
Low corruption

High corruption

1 Iceland 9.7 151 Angola 2.0
2 Finland 9.6 152 Cote d'lvoire 1.9
New Zealand Equatorial Guinea
4 Denmark 9.5 Nigeria
5 Singapore 9.4 155 Haiti 1.8
6 Sweden 9.2 Myanmar
7 Switzerland 9.1 Turkmenistan
8 Norway 8.9 158 Bangladesh 1.7
9 Australia 8.8 Chad
10 Austria 8.7
ABE
Bribe Payers' Index (BPI) 2002
From 0 =High Level of Bribery, to 10 =Low level
Out of 21 Countries
Low propensity to bribe High propensity to bribe
1 Australia 8.5 15 Malaysia 4.3
2 Sweden 8.4 Hong Kong
Switzerland 17 Italy 4.1
4 Austria 8.2 18 South Korea 3.9
5 Canada 8.1 19 Taiwan 3.8
6 Netherlands 7.8 20 China 3.5
Belgium 21 Russia 3.2
8 United Kingdom 6.9
9 Singapore 6.3
Germany

Sources: Internet Center for Corruption Research and Transparency International
The CPI Index refers to corruption in the public sector
Contracts for public works present the biggest source of corruption. Arms and defence,
energy, aerospace and banking are the industries in which the highest level of corruption
takes place.
Gifts received on overseas business trips are also potentially a form of bribery and many
multinationals now forbid acceptance of these in their codes of conduct not only for
employees but suppliers. However, in some cultures not accepting a gift may be considered
an insult. Tata makes provision for this in its code as follows:
Case Study 5: Tata Guidelines on Gifts and Donations
A Tata company and its employees shall neither receive nor offer or make,
directly or indirectly, any illegal payments, remuneration, gifts, donations or
comparable benefits that are intended, or perceived, to obtain
uncompetitive favours for the conduct of its business. The company shall
cooperate with governmental authorities in efforts to eliminate all forms of
bribery, fraud and corruption.
However, a Tata company and its employees may, with full disclosure,
accept and offer nominal gifts, provided such gifts are customarily given
and/or are of a commemorative nature. Each company shall have a policy
to clarify its rules and regulations on gifts and entertainment to be used for
the guidance of its employees.

Why Does Corruption Take Place?
We can identify five situations:
When procedures for allowing the market to bid for contracts in a transparent manner
are replaced by executive authorisation, thus reducing competitiveness.
Where this is careless or loose audit practice, allowing such behaviour to remain
undisclosed.
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Where there is underfunding within the public sector for example, underpaid public
officials, lack of suitable financing of political parties, undersupply of public goods for
education.
Where social and cultural factors, including nepotism, support the practice. Not all
countries view corruption and bribery as being unacceptable.
Where there is a disparity between the resources available to the parties to a
transaction. Abundant resources are an incentive for bribery, and developing countries
are likely to have scarce resources. A link between GDP and corruption has been
made and Figure 9.8. demonstrates the link with average pay levels.
Figure 9.8: Corruption Levels Linked to Pay

Source: www.evolvingexcellence.com
What are the Effects of Corruption?
Four effects can be identified:
It reduces the taxes paid to governments, resulting in loss of public investment which
would ultimately be used for the social good.
It discourages foreign investment because of the additional cost incurred by paying the
bribe, so it also reduces economic growth of some developing countries.
Employees within companies lose their sense of professional integrity.
The money is often linked to criminal activity.
Anti Corruption Measures
Individual global firms issue guidelines to their stakeholders and have statements that urge
those suspecting corruption has taken place to contact them (see also the section on whistle
blowing below).
There are also a number of national and international organisations working to reduce the
levels of business corruption both globally and locally all over the world. Three prominent
ones, and their key missions, are:
Australia Germany UK USA China India Indonesia Vietnam
0
20
40
60
80
100
120 Average Hourly Wage
Corruption Rating
Corruption Rating is from best
(low rating) to worst (high rating)

Wages are from high (low rating)
to low (high rating)
15
8
23
16
21
20
7
23
82
70
80
107
102
100
108
106
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(a) Transparency International an NGO based in London
"leading the fight against corruption, TI brings people together in a powerful worldwide
coalition to end the devastating impact of corruption on men, women and children
around the world. TIs mission is to create change towards a world free of corruption."
(b) The World Bank
"Corruption sabotages policies and programmes that aim to reduce poverty, so
attacking corruption is critical to the achievement of the Bank's overarching mission of
poverty reduction. We believe that an effective anti-corruption strategy builds on five
key elements:
Increasing political accountability
strengthening civil society participation
creating a competitive private sector
institutional restraints on power
improving public sector management.
To reduce the corrosive impact of corruption in a sustainable way, it is important to go
beyond the symptoms to tackle the causes of corruption.
Since 1996, the World Bank has supported more than 600 anticorruption programs and
governance initiatives developed by its member countries."
(c) International Chambers of Commerce (ICC)
The ICC provides rules of conduct to combat extortion and bribery in international
business. The ICCs Anti-corruption Commission encourages self-regulation by
enterprises in confronting issues of extortion and bribery and provides business input
into international initiatives to fight corruption.
Ethics and Conflicting Stakeholder Interests
Ethics operate at two basic levels those of the individual manager and the wider ethics of
the whole organisation. Managers bring a set of values into their work situations and these
operate in conjunction with the ethical culture of the organisation, usually revealed in general
terms in their values and mission statements..
One of the key problems facing managements when pursuing higher ethical standards of
decision making is the clash of interests between the various stakeholders of the
organisation.
The duty of managers to the owners of the enterprise (shareholders) is indisputable. If the
owners do not receive a return on capital, they will withdraw the capital or close the business,
cutting their losses if necessary. However, there are many entrepreneurs who support
socially responsible policies (such as the late Anita Roddick, founder of the Body Shop) and
these may also have to be taken into account.
However, modern day businesses must take account of broader responsibilities:
(a) Employees
Irrespective of the kind of organisation, the interests of the employees must be
considered. Employers have certain statutory obligations to safeguard the interests of
workers (for example, a duty to promote safe working practices), but moral obligations
also exist. These moral obligations will be influenced by prevailing social attitudes that
may be as compelling as the legal obligations.

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(b) Customers
There are very few true monopolies, largely due to the abundance of substitute
products and brands. Competition tends to preserve the objective of customer
satisfaction in firms to a far greater degree than would otherwise be the case. The
customer clearly desires low prices, conflicting with the profitability objective.
Managerial decisions have to reconcile customers interests with those of the
organisation. The legal responsibilities of an organisation to its customers fall into two
broad areas to provide consumer choice and to ensure fair dealing. However,
influential pressure groups have emerged in the area of consumerism in recent years
which demand that businesses take account of customer concerns in the wider sense
for example, not trading with countries with oppressive human rights records, as was
the case with campaigns against the Apartheid regime in South Africa.
(c) Suppliers
Most organisations depend upon an external source of supply and it is in their interests
that this should be served by a fair and open market. This emphasises the mutual
interdependence of commercial bodies, and fair and equal treatment of all potential
external suppliers is therefore vital to their well being.
(d) Society
Current belief is that all organisations have an obligation to contribute to the well being
of the countrys economy and society as a whole. This may be thought of as an
obligation of the government of the day, but expectations now extend to all types of
organisations. Managers should demonstrate awareness of responsibilities to society
in general.
Despite deregulation and a general contraction of state involvement in enterprise, there
are boundaries of tolerance shown by governments to certain practices. For example,
many western Governments impose a greater financial burden on businesses whose
activities result, directly or indirectly, in divergence between social costs and private
costs such as private motoring and smoking with increases in tax making their
products more expensive.
The media, both within an organisation but more particularly within society as a whole,
has an ever increasing role in helping society answer its ethical questions and reporting
on alleged unethical behaviour by organisations.
(e) Local communities
Organisations often have a significant impact upon the local communities in which they
trade where products are grown, processed, distributed and sold. In employment
terms, this extends employers' ethical relationship with residents to the broader travel-
to-work areas of their organisations.
To help decision making given these conflicting interests, two models have been developed.
These attempt to provide a framework for an organisation to address ethical issues where
there may otherwise be no guidelines upon which managers may draw in decision making.
The Ethical Decision Model (EDM)
This approach takes the form of an analysis of what is at stake in the ethical issue
being considered, taking the Anglo American model as the basis. In summary,
management should pursue the principles of justice, integrity and decency while still
building long-term value for the firm.
The analysis emphasises consideration of how an issue affects the organisation and
what the external constraints on ethical behaviour are. The findings of the analysis are
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applied to the ethics of each functional area of the organisation and are drawn together
into an ethical audit. For example:
Ethical approaches to human resources include promoting employee health,
safety and welfare, tackling racism, ageism and bullying in the workplace,
counselling for social problems and career development, not making use of
surveillance technology for spying on workers or reading their emails.
Ethical approaches to customers include quality and service considerations,
improved labelling to give customer information, fair treatment in all dealings.
Ethical approaches to environment impact include pollution control, recycling
waste paper, used bottles and cans from offices and works restaurants,
conservation of natural resources and energy.
Ethics, Values and Responsibility (EVR) Congruence
The concept of EVR congruence emphasises that all three elements have to be
deployed in order to add value to the production process of turning raw materials into
goods and services that meet customers expectations. Thus, for example, it is not
socially responsible to produce goods, no matter how efficiently, if it means harming the
natural environment.
EVR has implications for the quality of products and the quality of life of employees and
all who come into contact with the organisation.
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What does your organisation do to help managers make ethical decisions?
Are there company guidelines for dealing with employees, customers and suppliers? For
example, does it have written policies on not taking bribes from suppliers who want the
companys business? Is there a policy about, describing its products and services
accurately? What actions does it take to ensure managers treat employees fairly?
What is the organisational culture in respect of ethical issues? For example, is stealing from
the organisation tolerated? Do managers take credit for ideas that have come from other
employees?
Do you feel that the organisation has high or low ethical standards?
To what extent to the standards of the organisation reflect those of the national culture?

C. CORPORATE SOCIAL RESPONSIBILITY
The concept of corporate social responsibility (CSR) is closely linked to ethics, but has a
narrower focus in respect of the responsibilities of organisations to society. There are a
number of different terms used to describe this corporate responsibility, corporate
citizenship, social enterprise, sustainability, triple-bottom line and corporate ethics and a
number of definitions, including:
"treating the stakeholders of the firm ethically or in a responsible manner"
"the obligations of firms to society or more specifically to those affected by corporate
policies and practices"
The Harvard Kennedy School states that "corporate social responsibility encompasses not
only what companies do with their profits, but also how they make them. It goes beyond
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philanthropy and compliance, and addresses how companies manage their economic, social,
and environmental impacts, as well as their relationships in all key spheres of influence: the
workplace, the marketplace, the supply chain, the community and the public policy realm."
Lascerre (2007) demonstrates the links between global firms and the range of stakeholders
to which it interlinks and has ethical responsibilities. He calls this the "Ethical Web", as
shown in Figure 9.9.
Figure 9.9: The Global Ethical Web

However we define it, CSR is now an accepted part of the business environment and CSR
policies form an integral part of business operations.
CSR policy is disparate and organisations take different views on what it means for
example, Starbucks focus on employee issues while the Body Shop focuses on human
rights. Other examples of key focuses include:
Child labour
Recycling
Use of scarce resources
World social problems such as obesity
Sustainable development and farming
International
Institutions
Governments
Public
opinions
Non-government
organisations
Global firms
Financial
Markets
Industry
associations
Front-line
managers
Corporate
executives
Shareholders
SRI Funds
Press TV Churches Academia
Transparency
International
Corpwatch
Greenpeace
Amnesty
International
Caux
CSR
World Bank
IMF
European Union
United
Nations
Host
countries
Investors'
countries
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Treatment of employees, including their well being
Emissions, including reducing the organisation's carbon footprint
Paying a fair price to the producers of ingredients such as cocoa, coffee, milk, etc.
J ust as organisations have different perceptions of what CSR issues are important the same
is true of countries. Research has shown that:
Chinese CSR is focused on production of high quality, safe products
South Africa is more concerned with contribution to social needs such as education and
health
US, Italy, France, Switzerland and much of South America concentrate on fair
treatment of employees
UK, Australia, Canada and Indonesia are most concerned with environmental aspects
of CSR.
Costs and Benefits of CSR
Developing, implementing and promoting CSR policies is a cost to the business when its
primary function is to maximise shareholder value. Adopting CSR policies requires
resourcing such as personnel to design, implement, monitor and control the policies and
keep them updated. New processes need to be adopted and, for manufacturers, this can
entail significant Research and Development expense.
Set against this, it is argued that, where public pressure about CSR issues is strong,
consumers may abandon the firm and move their business to a competitor. However, the
research on links between CSR, business performance and customer loyalty is far from
complete and it is currently impossible to make a robust case for its contribution to
shareholder value.
Competitive Advantage
Some organisations, have managed to find ways to promote their social responsibilities and
making them work to their competitive advantage.
The Coca Cola 2020 vision (see below), for example, focuses partly on preserving the planet
and looking after its people while retaining its commitment to shareholder value as its number
one priority. Both Coca Cola and Pepsico have modified their main beverage products to
reduce sugar content to meet the growing pressure from the public and global health groups
concerned about obesity levels. This has helped them to maintain their market position.
They have both set up well-being sections on their websites.
Case Study 6: Coca Colas 2020 Vision Linked to CSR
Our vision serves as the framework for our Roadmap and guides every
aspect of our business by describing what we need to accomplish in order
to continue achieving sustainable, quality growth.
People Be a great place to work where people are inspired to be
the best they can be.
Portfolio Bring to the world a portfolio of quality beverage brands
that anticipate and satisfy people's desires and needs.
Partners Nurture a winning network of customers and suppliers,
together we create mutual, enduring value.
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Planet Be a responsible citizen that makes a difference by helping
build and support sustainable communities.
Profit Maximize long-term return to shareowners while being
mindful of our overall responsibilities.
Productivity Be a highly effective, lean and fast-moving
organization.

Further examples of instances where CSR seems to be linked to competitive advantage
include:
(a) By finding ways to develop bottles from natural materials that lower its dependency on
scarce resources and opening its own recycling operation, Coca-Cola has managed to
reduce cost and improve its value chain which maximises shareholder value.
(b) Kraft Foods is another multinational company that has produced a range of lower fat
and lighter range products to meet the needs of both health conscious consumers and
the obesity lobby.
(c) Kraft through its Cadbury acquisition now contributes to the Fairtrade sustainability
projects that assist farmers to obtain fair prices for their products and improve the
quality and density of the crop. This not only ensures supply, but encourages
consumers who are concerned with sustainability to buy Kraft products rather than
those of its competitors.
(d) Hotel Chocolat set up its business around Fairtrade by producing its own cocoa and
manufacturing its chocolate in St Lucia. It introduced sustainable cocoa farming and
worked with agricultural experts from Reading University to produce better strains of
crop. It has since developed the site further and opened Hotel Chocolat on the
plantation owing to the customer loyalty it has built up at least partly as a result of its
ethical approach to business and commitment to corporate responsibility.
Case Study 7: Hotel Chocolate CSR and Competitive Advantage
In St Lucia, we are pursuing our passion for chocolate by becoming one of
the worlds few origin chocolatiers growing our own cocoa. The restoration
of the historic Rabot Estate (pronounced ra-BOW) is continuing at pace,
with new trees being planted and record quantities of cocoa being
harvested. But were also reaching out to the wider cocoa community in St
Lucia through our Engaged Ethics Cocoa Programme.
For 20 years cocoa farming in St Lucia has been in decline, something
weve started to change by guaranteeing to buy local cocoa at prices 40%
above those previously achieved. Our early results are promising with
interest in cocoa on the up, weve already helped create one hundred new
jobs to date. Local farmers now have a secure income and feel confident
enough to breathe new life into their farms through investment.

CSR and Talent Management
In Section A we discussed the requirements of Generation Y when they seek an employer.
They are much more likely to be attracted to an ethical employer that not only meets their
standards as an employee, through career opportunities, excellent training and development
and reward policies, but also demonstrates a robust CSR policy. The websites of many
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MNCs promote their policies for career seekers and they also do so on the social networking
sites that Generation Y are likely to spend a considerable amount of their time.
Negative Publicity
There are numerous instances of companies being shown to be acting in violation of the
standards expected of them by the public and their customers, and of their own stated CSR
policies, primarily in less developed nations. This has attracted huge negative publicity in the
western countries which are their home locations and has resulted, in some instances, in
consumer boycotts. However, the effect does not appear to have any permanent effect on
their market position.
Examples include the following.
Unilever was accused by Greenpeace of destroying Indonesian rainforests for palm oil,
which is a vital ingredient for its soap and margarines. It immediately reversed its
position and stated that it would only buy palm oil from suppliers that could
demonstrate they did not cut down forests. Research has shown that organisations
that have been proven guilty of such actions are then quick to add a CSR initiative to
their corporate goals.
Primark sells low cost items since its manufacturing costs are kept low, but the
company promotes itself as being ethical and socially responsible. However, it was
discovered that child labour was being used and that some suppliers were employing
workers paid as little as 9p an hour. In addition these individuals were working 90
hours a week in extremely poor conditions. There are many other cases where
companies have declared themselves dedicated to corporate responsibility issues only
to later be found operating unethical practices in distant locations.
Coca-Cola was reported to be using 6 litres of precious water to make a litre of its
famous beverages when that water is scarce and needed by local farmers to grow their
crops for survival. At the same time the Company supported water conservation. The
company has had trouble shaking off its negative corporate history and, despite all its
recent actions on sustainability, has not convinced consumers of its sincerity. In the
past 10 years it has had negative publicity about its treatment of workers in Columbia
and China, and its role in fuelling child obesity. This has resulted in its products being
banned on several university campuses in the USA.
Another high profile example is Gap which was found still to be using child labour in
2007 despite a previous discovery being made in 2004.
Case Study 8: Gap's CSR Failures
Gap and Corporate Irresponsibility
Gap yesterday admitted to widespread problems from unsafe machinery
to child labour violations in the thousands of factories it uses around the
world to produce clothing for its retail chains.
Seeking to combat its image as a sweatshop operation, the company
detailed the findings in its first social responsibility report. The full 42-page
document was posted on its website. Gap said it has a team of more than
ninety compliance officers who conducted about 8,500 factory visits last
year. The company produces garments in 3,000 factories located in 50
countries. Gap said it cancelled supply deals with 136 plants last year
because of various violations. Contracts were terminated with 42 plants in
China, another 42 in south-east Asia, 31 on the Indian subcontinent and
nine in Europe.
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In two factories at which contracts were terminated, Gap identified under-
age workers though in both cases they were older than 14. The most
frequent violations of Gap's code of conduct included factories not
complying with local laws on annual leave, failure to pay the minimum
wage, working weeks in excess of 60 hours, inaccurate record keeping and
machinery lacking safety devices.
On its website in 2007 the company stated that all individuals who work in
garment factories deserve to be treated with dignity and are entitled to safe
and fair working conditions and not since 2000, when a BBC Panorama
investigation exposed the firm's working practices in Cambodia, have
children been associated with the production of their brand.
Behind the youngsters, huge piles of garments labelled Gap complete
with serial numbers for a new line that Gap concedes it has ordered for
sale later in the year lie completed in polythene sacks, with official
packaging labels, all for export to Europe and the United States in time for
Christmas.
J ivaj, who is from West Bengal and looks around 12, told The Observer that
some of the boys in the sweatshop had been badly beaten. "Our hours are
hard and violence is used against us if we don't work hard enough. This is
a big order for abroad, they keep telling us that. Last week, we spent four
days working from dawn until about one o'clock in the morning the following
day. I was so tired I felt sick", he whispers, tears streaming down his face.
"If any of us cried we were hit with a rubber pipe. Some of the boys had
oily cloths stuffed in our mouths as punishment."
Manik, who is also working for free, claims unconvincingly to be 13.
"I want to work here. I have somewhere to sleep," he says looking furtively
behind him. "The boss tells me I am learning. It is my duty to stay here.
I'm learning to be a man and work. Eventually, I will make money and buy
a house for my mother."
The discovery of the sweatshop has the potential to cause major
embarrassment for Gap. Last week, a spokesman admitted that children
appeared to have been caught up in the production process and rather
than risk selling garments made by children it vowed it would withdraw tens
of thousands of items identified by The Observer.
Source :www.guardian.co.uk

How Pressure Groups Influence CSR
There are many pressure groups acting globally and nationally to encourage organisations to
be more socially responsible in their use of physical and human resources and attention to
reducing the poverty gap. Many have social networking sites where individuals can interact
and give their views. Three of the most well known are:
Greenpeace an environmental pressure group that campaigns for change about
many environmental issues such as protecting forests, banning whaling and
encouraging sustainable trade. Greenpeace campaigns for many things, but they all
centre on the ability to sustain life in its diversity around the world.
Coca Cola and others have started working with Greenpeace as an outward
demonstration of their commitment to CSR. The promotion of such arrangements is,
for the companies concerned, an important way of attracting and retaining customers.
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Friends of the Earth campaigns for solutions to environmental problems; climate
change, green economy and natural resources are a few of their areas of interest.
Amnesty International campaigns for the human rights of people around the globe. It
states that "Our purpose is to protect people wherever justice, fairness, freedom and
truth are denied. We work to bring change for people across the globe". They are
concerned with rectifying business actions which threaten human rights, as in the Niger
Delta in Nigeria, where they consider Shell's practices are stripping local people of their
human rights.
Such high profile pressure groups have a strong influence on businesses and governments,
and keep strong links with the press to ensure that issues are communicated globally.
Regulation and Review of CSR in Organisations
The financial goals of Anglo American organisations still take precedence over social
concerns, and the vested interests of certain stakeholders remain likely to hold sway over
wider social responsibilities. In addition, managers are not rewarded for improving social
responsibility and there is evidence that employees are also unaware of what actions the
organisation pursues regarding CSR.
Given this situation, it would appear that CSR will only develop through external pressure.
However, whilst most government and regulatory bodies have stressed the importance of
corporate social responsibility, little has been done to embed it into the framework within
which businesses operate.
The UN Global Compact (GC) is a voluntary corporate citizenship initiative that
engages businesses with civil society and labour organisations, governments,
academic institutions and other stakeholder groups. It is based on ten universal
principles that address the areas of human rights, labour, environment, and anti-
corruption. The GC provides business participants with tools to create changes in their
practices and they must submit Communications on Progress, which are reports on
their sustainability efforts. Many multinationals are members of the GC.
In the UK, CSR itself falls within the scope of the Department for Business, Innovation
and Skills formed in J une 2009, but there is no formal regulation issued about the
subject. The government did set up the CSR Academy (now simply the CR Academy)
to provide training, support and advice on aimed at developing CR professionals and
action plans in organisations. The Companies Act 2006 defines directors duties to
include the likely consequences of any decision in the long term in the interests of the
companys employees and to foster the companys business relationships with
suppliers, customers and others.
The EU is reported to be considering regulation, but although health and safety,
discrimination and pollution are already regulated, there appears to be little case for
enforcement of CSR on business enterprises.
Regulation is, in reality, based on the idea that government has a reasonable degree of
certainty over what is right for all companies. However, there is little agreement about the
concept of CSR in general or the way in which any particular approach might develop
towards its enforcement, and especially any that takes account of the individuality of different
companies and their search for a uniquely sustainable competitive advantage.
Nevertheless, companies are taking the issue increasingly seriously. A KPMG report shows
that 35% of a sample of companies they researched in 1999 published corporate
responsibility reports, and that this rose to 52% in 2005. The same survey identified the
drivers for CSR reporting as follows:
economic considerations 74%
ethical considerations 53%
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innovation and learning 53%
employee motivation 47%
risk management and risk reduction 47%
access to capital or increased shareholder value 39%.
A survey of professional investors reveals a similar trend. A total of 81% of those surveyed
said corporate responsibility was currently a central or important consideration in their
investment decisions, compared with 34% five years ago.
This highlights an important shift from the directors concerns solely being for the shareholder
to an obligation to be mindful of the needs of all their stakeholders.
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Fairtrade is used by some companies to show their commitment to corporate social
responsibility and to sustainability of the world's resources. However, there is another view
of Fairtrade as shown by the following article:
"The core aim of Fairtrade is to improve the lot of small farmers - including their long-
term income stability. Crop prices are notoriously volatile.
Yet the likes of the educational development charity, Worldwrite, claims that an
obsession with small is beautiful' is a missed opportunity. By focusing on achieving a
fair price for poor farmers, adherents fail to address issues of mechanisation and
industrialisation radical changes that might allow farmers in the developing world to
stop doing back breaking work and break out of the poverty cycle.
Equally, Fairtrade has been accused of promoting a state of dependence in the farmers
it is meant to help. This view is articulated by the free market advocate, the Adam
Smith Institute: "the (Fairtrade) movement effectively makes farmers 'prisoners to our
market'. They become dependent on us continuing to pay premium prices for their
goods."
The fact that the certification itself is very tightly and centrally controlled in-house by the
Fairtrade Labelling Organisation (FLO) seems to support that view.
The certification process is also accused of being complex to set up - needing
cooperatives of small farmers to come together for certification to be viable. These
groups must be managed democratically, have transparent administration and be
politically independent. Noble principles but ones that demand time, capacity and
money to establish and the cost of the certification has to be borne by the members."
(a) Research the key benefits of Fairtrade to growers as specified by the companies that
support Fairtrade and describe them.
(b) How are these in conflict with the opinions given in the passage above.
(c) How does this conflict reflect the view that companies are not sincere about CSR, but
are more interested in making bigger profits for their shareholders?

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D. WHISTLE-BLOWING AND CORPORATE
RESPONSIBILITY
Whistle-blowing may be defined as intervention by an employee to bring the wrongs (or
perceived wrongs) of the employer to the attention of the owners of the company, the
government, or the public at large. This is a controversial practice which has become the
subject of much debate since the 1990s.
Although most people agree on what is right or what is wrong, there are many different
attitudes to whistle-blowing, particularly as to how far employees should go in speaking out
and the degree to which that should be protected from the consequences of so doing.
The issue is confused by the conflicting obligations on most workers by a duty of
confidentiality imposed by the contract of employment, as well as common law and the wider
ethical responsibility to the company and the public at large.
So, should an employee keep quiet about a situation which he or she believes to be wrong,
or should his or her conscience take over and 'blow the whistle'? This is usually a matter for
individual judgment or conscience. As all employees are different, they will react in various
ways as well as interpreting situations differently.
The Cases For and Against Whistle-blowing
The primary case for whistle-blowing insists that employees have a moral duty not just to
their work and their immediate boss, but to the company and society as a whole. Thus, there
is an obligation to report wrongdoing and it is matter of conscience.
Other motivations and arguments include:
If a wrong is seen by a person, there may be other things happening, which are
unacceptable it might be the 'tip of the iceberg'.
If unacceptable behaviour is allowed to persist without redress, others will believe they
can get away with the same thing.
Note that, in certain situations, whistle-blowing is actually required by law for example,
where health and safety at work rules are being breached.
On the other hand, if information is given to someone outside the organisation, this can be a
breach of contract and render the whistle-blower liable to dismissal or even criminal action. It
is common practice in many organisations for the terms and conditions of employment to
bind the employee to secrecy, even after s/he leaves.
Other arguments against disclosure include:
The belief that the employee should concentrate on doing her/his job and that the
actions of others are nothing to do with him/her.
Situations may be misinterpreted, or an employee can overrate the importance of the
perceived misdemeanours of others, and what may be seen as a breach of company
rules or policy may in fact be perfectly legitimate.
Some employees are reluctant to 'blow the whistle' due to a 'snitching' mentality, where
it is considered bad to tell tales on others.
To counter the threat to job security and the personal consequences of whistle-blowing, it can
sometimes be done through a third party for example, trade union representative can often
handle what might be a difficult situation without exposing the individual to recriminations.
Unions are becoming more aware of the need to act as moral policemen. In late 1997, one
such organisation stated that it was going to compile a 'rogues' gallery' of employers and
publicise their actions. Aimed primarily at identifying bad employment practices, this initiative
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would appear to be an open door through which potential whistle-blowers could move if they
believe a case has to be answered.
Public Interest Disclosure Act 1998
In the UK, the Public Interest Disclosure Act 1998 is designed to give protection to individuals
who disclose information which is perceived to be in the public interest. The stated intention
of the Act was to end the 'cover-up culture' that prevails in some organisations, where
workers fear victimisation if they tell their bosses of a major problem.
The Act lists a number of protected disclosures which qualify the individual making the
disclosure for protection under the Act. The disclosures can be summarised as:
(a) That a criminal act has been, is being, or is likely to be committed
(b) That a person has failed, is failing or is likely to fail to comply with any legal obligation
(c) That a miscarriage of justice has occurred, is occurring, or is likely to occur
(d) That the health and safety of any individual has been, is being, or is likely to be
endangered
(e) That the environment has been, is being, or is likely to be damaged
(f) That information tending to show that any matter falling within the items above has
been, is being, or is likely to be deliberately concealed.
Under the Act an individual who makes a protected disclosure has a right not to suffer
detriment by the employer's resulting action. An employee dismissed as a result of making a
protected disclosure can take a case to an employment tribunal.
It is not only employees that the Act is designed to protect. Companies in the past have paid
the price of ignoring employees who tried to point out wrongdoings. The Act has a deeper
aim in encouraging businesses to behave ethically. In several previous public enquiries into
rail and maritime disasters causing loss of life, it was shown that staff had tried to warn of
dangers but had not felt able to raise the matter internally. If they had had the protection of
the Act they might well have felt able to discuss the safety matters with their organisations
and hence the disasters might not have happened.
Key Examples of Whistle-blowing
There have a large number of very high profile cases over many years, including the
following:
Daniel Ellsberg an employee of the US State Department who, in 1971, leaked secret
details of the Vietnam War (known as the Pentagon Papers) to the New York Times,
revealing deception by governments in their public statements over several years. He
faced charges of espionage and the prospect of 115 years in prison, but all charges
were subsequently dropped after evidence of government misconduct and illegal
wiretapping were disclosed in the run up to the trial.
Mordechai Vanunu an employee of the secret Israeli nuclear weapons programme
who revealed details to the British press in 1986. He was subsequently kidnapped by
the Israeli secret service and spent over fifteen years in prison.
J effrey Wigand a former Vice President of Brown & Williamson Tobacco, who
revealed on television in 1996 that the company knew exactly how addictive and lethal
cigarettes were, yet knowingly increased the amount of nicotine in them. He was sued
by the company, although the case was later dropped. The whole incident was the
subject of the 1999 film The Insider.
Karen Silkwood a union activist and technician at the Kerr-McGee nuclear plant who
alleged there were numerous violations of health and safety regulations at the plant in
ABE
1974. She died under mysterious circumstances shortly after. Her story was also
filmed, as Silkwood, in 1983.
Sherron Watkins and Cynthia Cooper employees of Enron and Worldcom
respectively, who revealed details of corrupt corporate financial practices at their
companies in 2002.
One of the key examples in the UK was the Sarah Tisdale case.
Case Study 9: Sarah Tisdalls Disclosure
One of the highest profile examples of whistle-blowing occurred in the UK
Civil Service in 1983. A civil servant, Sarah Tisdall, discovered that
government policy on nuclear missiles was at odds with its public
pronouncements on the issue. Apparently driven by her own conscience to
do what she believed to be right, she leaked documents to the press. The
consequences of her action were dismissal from the Civil Service and
prosecution for offences under the Official Secrets Act. She eventually
served a custodial sentence when the case was proven against her.

In late 2010, the WikiLeaks website disclosed thousands of classified documents causing
furore amongst governments, which then put pressure on internet providers to cut off access
to the site. Excerpts are given in Case Study 10.
Case Study 10: WikiLeaks Discloses Confidential Documents
"WikiLeaks directed readers to a web address in Switzerland on Friday
after two U.S. Internet providers ditched it in the space of two days and
Paris tried to ban French servers from hosting its leaked data.
The Internet publisher directed users to www.wikileaks.ch after the
wikileaks.org site on which it had published classified U.S. government
information vanished from view for about six hours.
The United States is furious about WikiLeaks' publication of hundreds of
confidential diplomatic cables that have given unvarnished and sometimes
embarrassing insights into the foreign policy of the United States and its
allies.
WikiLeaks has released about a quarter-million confidential American
diplomatic cables most sent during the last three years, which the website
christened as Cablegate. The cables, which date from 1966 up until the
end of February this year, contain confidential communications between
274 embassies in countries throughout the world and the State Department
in Washington. The question is why, when America makes claims about its
technological prowess, has not been able to devise a foolproof system to
save it and its friends from embarrassment. After 9/11, America had
changed its communication systems including the codes used, the question
is how it was possible for WikiLeaks to decode the messages.
ABE
Amazon denied it was under pressure from lawmakers, saying WikiLeaks
had breached its terms by not owning the rights to the content it was
publishing. But U.S. Senate Homeland Security Committee chairman J oe
Lieberman questioned Amazon about its relationship with WikiLeaks on
Tuesday and called on other companies that host websites to boycott
WikiLeaks."

Those who have the experience of working in diplomatic missions know that internal
reporting between embassy and the government is often frank and candid, but its veracity
depends on the reliability of the diplomat and of those who provide the information. Against
this backdrop, one would not know if all that has been quoted by WikiLeaks is correct. It has
been portrayed as an effort to create strained relations between the US and other countries.
However, WikiLeaks has caused ripples throughout the world, as the private insinuations
from US diplomats about the leaders of other countries have hit the headlines. The leaking
of confidential documents not only caused embarrassment for the individuals who made
personal remarks about high level government officials, but also provided ammunition that
could be used against the US by unfriendly governments.
This was also one of the first whistle-blowing events involving the internet, and caused a
number of apparently innocent companies such as Amazon to get into conflict with the US
government. There is a potential threat that this could cause governments to look at ways of
regulating and restricting the currently free circulation of information on the internet (at least
in most countries).
Think Point
What are your own views on whistle-blowing?
Would you do it, especially given the risks to yourself both in terms of employment and
potential for legal action?
To what extent should whistle-blowers be protected

ABE
SUMMARY
The world population will continue to grow over coming decades. However, industrialised
countries are likely to have less population growth and an ageing workforce.
The typical level of education and skills in the countries that have the fastest growing
population are very low. Sub Saharan Africa is forecast to have exploding population growth.
The level of disposable income will rise rapidly in many of the now emerging economies,
providing MNCs with exceptional opportunities for growing their businesses and profit levels.
The characteristics of the workforce are changing. The number of women in the workplace
has increased owing to less demanding domestic tasks, higher levels of education and the
possibility of work virtually. However, in some cultures the opportunities for women to work
inside or outside the home environment will continue to be severely restricted.
In western industrialised countries significant generational differences in expectation have
arisen, which companies are trying to manage. The key characteristics of the newest
generations of workers, known as Generation Y, are:
Technologically competent and connected 24 hours, 7 days a week
Self-confident and opinionated
Entrepreneurial, educated, bored by routine
Environmentally and ethically focused
Success-driven, goal orientated
Diverse
Lifestyle centred.
There are also changes in career expectations among Generation Y as a result of the
economic and social environment in which they have grown up:
Long-term career development and multiple experiences within a single organisation
Sense of purpose and meaning to the work
Access to mentors and other company champions
Work-life flexibility
Tech-savvy work environment
Primary loyalty is to networks before their employers.
Greater prominence given to these differences has resulted in challenges for managers and
a need for new management approaches to capitalise on the differing talents and
requirements of each generation so as to maximise the benefits for the firm.
Business ethics concerns the idea of right and wrong transferred to the business setting.
These ideas vary by cultures as do aspects of morality. There are three main models in
which the content is focused in different ways and the responsibility for ensuring ethical
practice varies.
Managers often face ethical dilemmas in doing what is right morally, but which may affects
others in a negative way. There are guidelines for managers to follow to ensure that they are
behaving in as ethical a manner as possible.
Corruption is one of the biggest unethical practices. This has been linked to different cultural
approaches and to country GDP and average pay levels.
Firms can follow ethical principles by ensuring that there is an ethical approach through the
publication of and training about its code of conduct. Some firms have extended this code of
ABE
conduct to their suppliers and will only contract with suppliers who comply with their
standards.
Corporate social responsibility has links to business ethics. However, there is no clear
definition of the term which is consequently interpreted in different ways.
There is substantial evidence that Anglo American companies, in particular, adopt
socially responsible practices that will assist them to achieve their corporate goals.
Although in many cases, the recipient of the socially responsible practice do gain some
benefits, the firm gains cost savings and innovative ideas which provide it with better
performance and increase in market share. There have been a number of reported
incidents of unethical practice by these same companies that promote themselves as
socially responsible.
Scepticism about the benefits of corporate responsibility is pronounced. Many
managers do not see that there is any benefit to the firm, merely a cost. As managers
targets are all focused on increasing shareholder value, there is no commitment to
promoting socially responsible practices.
Regulation and some legislation have been introduced to encourage better practice,
but generally a firm makes the decision to demonstrate corporate responsibility on a
voluntary basis. CSR is rarely integrated with strategic goals and often dealt with by
PR people in the organisation.
Recent research indicates that more organisations are publishing Corporate
Responsibility strategies and joining together in voluntary groups such as the UN
Global Compact which commits firms to report on standards within their organisation.
Whistle-blowing is a practice that is encouraged in Anglo American firms. This allows
individuals to reveal company practices and information, which they regard as unethical. The
original practice was an internal company one, but in recent years employees have revealed
these wrong doings to the press. The recent scandals about MPs expenses in the UK are a
further example of the growing pressure for transparency of practices in organisations.

ABE
Activity 1
(a) The forecast is that UK, J apan, China, South Korea and Europe will all have ageing
populations in the next 20 years and their working populations will fall.
(b) There will be too few skilled young people to take up jobs, and companies and
countries are likely to depend on immigrant workers. Many young people from
developing countries currently have low levels of literacy and poor access to education.
Some companies such as Petrobras are educating their workforce to raise skill levels.
(c) They know that disposable income will increase in these countries which also have
large populations. These two factors provide significant opportunities for growth of
turnover and increases in shareholder value.

Activity 2
There are groups of clauses on workers rights, whistle-blowing, personal conduct and
morality for example:
Workers rights are referred to in diversity and inclusion, harassment, health and safety.
Whistle-blowing is inferred in references to insider trading and harassment.
Misconduct and morality are referred to in bribery and corruption, fair competition,
money laundering.

Activity 3
(a) It describes a focus on the collective good of the country instead of on the individual or
shareholder value.
Tata expects all its employees to respect the culture they find themselves in and act in
an ethical way towards those communities. The community and the way the company
can help members of that community is put at the centre of its business approach.
(b) (i) The detail of the individual clauses are very similar to those in the Xerox Code of
Conduct for example, it covers gifts and entertainment, shareholder value,
ethical conduct. It seems to have been heavily influenced by the Anglo American
ethics model, but it is interesting to note that the company is the subject of many
clauses rather than the individual. In the Asian Pacific style of ethics, it is senior
management who are held responsible for the ethics of the company.
(ii) Tata is a global company and many or its operations take place in the Anglo
American economy.

Activity 5
(a) The Fairtrade website states that the benefits of fair-trade are:
That farmers receive a fair and stable price for their products.
That extra income is provided for farmers and estate workers to improve their
lives.
That a greater respect for the environment is engendered.
That small farmers have a stronger position in world markets.
That there is a closer link between consumers and producers.
ABE
(b) There are two main issues of conflict brought up by the article:
The improvement in their lives does not extend to the development of the work
practices which may make them more efficient producers.
Rather than making their trading position stronger and helping the farmers to
achieve independence and to be able to negotiate in the market themselves,
Fairtrade makes them dependent on the buying firms to achieve a reasonable
price for their crops.
(c) The passage, when compared to the text on the Fairtrade website and that given by
MNC websites, reflects well the potential insincerity of the companies claiming to act
responsibly. Although the companies are paying higher prices, they also lock the
farmers into producing for them. This gives the companies a potential competitive
advantage of being able to acquire supplies when their competitors cannot, of those
ingredients being of a higher quality (through assistance given to improve crops) and
their production more sustainable. In other words, the companies can potentially
guarantee their future crop resources while keeping the farmers dependent on them
and appearing to be socially responsible.

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