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processes

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Section 1: Marketing

o Marketing Objectives and Strategy: o marketing mix (4 P´s) o Price Elasticity of Demand o Income elasticity of demand

Section 2: Managing operations

o Productivity and efficiency o Product or service design o Capacity Utilisation o Inventory Control o Lean production and Quality Management.

Section 3: Managing finance

o Budgets o Sales Forecasts o Managing Working Capital o Why businesses fail

Section 4: Managing people

o Organisational Structure o Recruitment, selection and training o Leadership styles o Motivation of staff o Reduction of labour costs

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Section 1: Marketing

1. Marketing objectives & strategy

Definition of marketing:

The management process responsible for sales promotion and for

identifying, anticipating and satisfying customer requirements profitably.

Marketing Objectives:

Based on market research, sales or profit forecasts.

Marketing objectives are the goals that a business is trying to achieve through its marketing. They could relate to profit or sales revenue or both. For example, many small businesses in the start-up phase will find a niche market where they can compete successfully with established businesses. Even so, they must make a profit to survive and must sell enough to cover costs. As they become established they may see expanding output as their primary objective, perhaps aiming at an eventual mass market. This will require very different strategies, perhaps including lower prices. Good decisions in both situations require the best possible market research. At every stage of development, the business will have targets for sales revenue. Marketing objectives relate to the decisions that must be made as to prices, product design and advertising. Examples include increasing sales, raising brand awareness, enhancing brand or corporate image and promoting brand loyalty.

EXAMPLES OF MARKETING OBJECTIVES

Let‘s face it. Of the four main functional areas of a business, marketing has to be the most important! Marketing is at the heart of a business. Remember the definition of marketing: “The process of identifying, anticipating (predicting) and satisfying customer needs profitably” Almost every activity that a business undertakes can be linked back to this definition, whether it is: Raising finance to support an investment in new product development Introducing quality assurance and lean production to improve product profitability Training staff to improve customer service standards Ultimately, almost every functional activity or objective can be linked back to marketing.

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A similar picture emerges when you consider how corporate objectives link to the functional objectives for marketing. Typical corporate objectives might be to: Be a market leader within 5 years To grow market share by 5% in core markets To become the most trusted and recognised brand in our industry Each of these has a strong marketing element. Marketing objectives need to be seen as part of a hierarchy of objectives, in the sense that they are shaped and informed by the corporate objectives. A corporate objective influences a marketing objective, which in turn shapes the marketing strategies and marketing tactics employed:

Objective area Example objectives

Maintaining or

increasing market

share

Achieve revenue growth of 15% per year for the next four

years Increase our market share in the UK by 4% by

2012 Improve the online order conversion rate from 65%

to 75% by 2011 Add 1,000 new customer accounts

generating at least £100,000 per account within three

years. Become the market leader in the UK educational

sector by 2013

Developing new

products /

innovation

Launch at least 25 new products into the industrial

channel in 2010 and 2011 Grow average first-year sales

of new editions by 25% in the Higher Education sector

Meeting the needs Achieve at least an 95% excellent customer service rating

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of customers each month Increase the proportion of sales bookings

from repeat business to 45% for the summer season

Entering a new

market / market

positioning

Supply a minimum of 50,000 trial downloads per

month Increase the number of customer enquiries from

the EU by 10,000 per month Recruit five suitable

distribution agents in the four target countries within 12

months

Gaining an

advantage over

competitors

Reduce average distribution costs to less than 5% of gross

revenue Reduce the order lead time by 15% Improve brand

recognition amongst the 25-34 age group

Marketing strategies:

Appropriate for different types of market eg niche or mass.

In most markets there is one dominant (mass) segment and several

smaller (niche) segments…

For example, in the confectionery market, a dominant segment would be

the plain chocolate bar. Over 90% of the sales in this segment are made

by three dominant producers – Cadbury‘s, Nestle and Mars. However,

there are many small, specialist niche segments (e.g. luxury, organic or

fair-trade chocolate).

Niche marketing can be defined as:

Where a business targets a smaller segment of a larger market,

where customers have specific needs and wants

Targeting a product or service at a niche segment has several

advantages for a business (particularly a small business):

• Less competition – the firm is a ―big fish in a small pond‖

• Clear focus - target particular customers (often easier to find and reach

too)

• Builds up specialist skill and knowledge = market expertise

• Can often charge a higher price – customers are prepared to pay for

expertise

• Profit margins often higher

• Customers tend to be more loyal

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The main disadvantages of marketing to a niche include:

• Lack of ―economies of scale‖ (these are lower unit costs that arise from

operating at high production volumes)

• Risk of over dependence on a single product or market

• Likely to attract competition if successful

• Vulnerable to market changes – all ―eggs in one basket‖

By contrast, mass marketing can be defined as:

Where a business sells into the largest part of the market, where

there are many similar products on offer

The key features of a mass market are as follows:

• Customers form the majority in the market

• Customer needs and wants are more ―general‖ & less ―specific‖

• Associated with higher production output and capacity (economies of

scale)

• Success usually associated with low-cost operation, heavy promotion,

widespread distribution or market leading brands

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2. Marketing Mix

Components of marketing mix: Price, Product, Promotion, Place

(4P´s)

The marketing mix deals with the way in which a business uses price, product,

distribution and promotion to market and sell its product.

The marketing mix is often referred to as the ―Four P‘s‖ - since the most important

elements of marketing are concerned with:

• Product - the product (or service) that the customer obtains

• Price - how much the customer pays for the product

• Place (distribution) – how the product is distributed to the customer

• Promotion - how the customer is found and persuaded to buy the product

It is known as a ―mix‖ because each ingredient affects the other and the mix must

overall be suitable to the target customer.

For instance:

• High quality materials used in a product can mean that a higher price is obtainable

• An advertising campaign carried in one area of the country (promotion) requires

distribution of the product to be in place in advance of the campaign to ensure there

are no disappointed customers

• Promotion is needed to emphasise the new features of a product

The marketing mix is the way in which a marketing strategy is put into action - in

other words, the actions arising from the marketing plan.

An example of the marketing mix in action can be seen from this example of Apple:

Product

Portable Computers – including Mac products such as Mac Book Pro, iMac,

MacBook Air, Mac Mini, Xserve

Servers – including Xserve, Xsan, MacOS X Ser, MobleMe.

Accessories – including MagicMouse, Keyboard, Led Cinema Display.

Wi-fi Based Stations - including Airport Express, Airport Extreme, Time Capsule.

Developer – including Developer Connection, Mac Program, iPhone Program.

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iPod – including iPod Shuffle, iPod Nano, ipod Classic.

iPhone – including iPhone3GS, iPhone3G, iPad.

iTunes – including movies, TV shows, audio books, games.

Periphal products – including Printers, Storage devices, digital videos and cameras.

Price

Apple is a premium brand computer that does not attempt to compete on price. The

company has reduced prices after some initial product launches. It uses skimming

and preimuim pricing strategies.

The AppleiPad is priced at a minimum of $499.

The Apple iPhone costs begin at $99.

The Apple iPod Classic is priced starting at $249.

The Apple iPod Nano costs $149.

The Apple Mac Book costs $999.

The Apple MacBook Pro is priced at $1199.

The Apple Quicktime Pro for Windows costs $29.99

Apples iPad pricing strategy includes the flexibility to lower the prices if consumer

response dictates such action. This would be consistent with a similar $200 price cut

on the iPhone in 2007.

In 2009 Apple announced a reduced cost pricing structure for iTunes - songs will

cost 69 cents, 99 cents or $1.29. He said the "vast majority" of the songs will cost 69

cents. Changes are said to be a response to a slower pace of music downloads.

Place

Apple, Inc Headquarters are located at is located at 1 Infinite Loop, Cupertino,

California.

The Apple Consultants Network includes independent professional service providers

and technology consulting firms that specialize in Apple and third-party solutions.

Certified on Apple technologies, these providers deliver on-site technology services

and support to home users and businesses of all sizes.

Apple service providers are certified technicians, who complete regular Apple

training and assessments, and offer repair services, and exclusive access to genuine

Apple parts.

They are located in Asia/Pacific, Africa, the Middle East Europe and Latin America.

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Apple has over 200 retail stores worldwide including the US, UK and Canada. Apple

recently opened a new retail store in Shanghai China.

Promotion

Apple, Inc offers special discounts on refurbished MacIntosh computers, iPod

Nanos, and the 8GB iPod Touch. In each case a 1 year warranty is included on the

all products.

Apple, Inc authorized Training Centers are located throughout the U.S. each

provides instruction in Mac systems, Mac OS X, and Apple‘s professional

applications. A wide range of certification exams and courses offer innovative

learning opportunities for IT and creative professionals, educators, and service

technicians—delivered exclusively by Apple Certified Trainers.

The Apple Consultants Network website provides a search tool allowing visitors to

locate nearby certified Mac product consultants in the U.S, Canada, and a number of

international locations.

The online Apple Store offers free shipping for orders over $50.

The online Apple store offers iTunes gift cards.

Apple provides a $100 rebate when you purchase a Mac or specific printers from the

online store.

Apple has packaged back-to-school offers, including some aimed at college

students.

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Identification of a marketing mix which meets the needs of a product or a service.

An effective marketing mix is one which…

• Meets customer needs • Achieves the marketing objectives • Is balanced and consistent • Allows the business to gain an advantage over competitors

The marketing mix for each business and industry will vary; it will also vary over time.

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Product Portfolio Analysis

Most businesses sell more than one product. Often they will produce several similar products that appeal to different customers. A collection of such products is known as a “product group” or “product range”.

Good examples of product groups include:

• Dell‘s range of desktop and laptop computers • Sony‘s range of DVD players and televisions

There are several advantages to having a product range rather than just one product:

• Spread the risk – a decline in one product may be offset by sales of other products • Selling a single product may not generate enough returns for the business (e.g. the market segment may be too small to earn a living) • A range can be sold to different segments of the market e.g. family holidays and activity holidays

However a greater range of products can mean that the marketing resources (e.g. personnel and cash) are spread more thinly.

Discover how many different products the coca cola company produce.

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Product Life Cycle

This shows the various stages that a

product is expected to pass through and it

also indicates the likely level of sales that

can be expected at each stage.

The length of the lifecycle will vary from

product to product and from industry to

industry (e.g. Oxo Cubes, Levi Jeans and

Kellogg's Cornflakes have lifecycles that

have lasted for over 50 years, but various

pop groups and childrens' toys have a lifecycle that can last less than 12 months).

Generally, there are six stages to the lifecycle - development, introduction,

growth, maturity, saturation and decline.

During the development stage, much time will be spent designing and testing the

product concept. A prototype will often be test-marketed, in order to assess the

potential sales and profitability of the new product. A decision will then be made

whether or not to launch the product. The business will, therefore, incur many

expenses during the development stage of the product lifecycle and the product will

produce a large, negative cash-flow.

It is estimated that only 1 in every 5 new products actually pass the development

stage and reach the introductory stage of the lifecycle.

The introduction stage commences with the launch of the product onto the market.

Sales are low and costs are still very high (especially advertising and distribution).

The product is, therefore, unprofitable at this stage. The length of this stage will vary

considerably according to the product. Some products will take a long time to reach

the growth stage of the lifecycle (e.g. new novels) whereas others will head straight

from introduction into growth in a matter of days (eg new pop-music album releases).

Once the business has made customers aware of the new product and it has

managed to achieve a high level of repeat-purchasers, then the product will head

into the growth stage of the lifecycle. This is where the product starts to become

profitable. Advertising is still extensive. Competitors may launch similar products to

cash-in on the successful new product. The business will try to prolong the growth

stage for as long as possible, but sooner or later it will reach the maturity stage of

the lifecycle. The growth in sales will start to slow down and the product will nearly

reach its maximum market share. There will be several competing products on the

market.

The saturation stage of the lifecycle will occur where the sales of the product have

reached their peak and the number of competing products will have grown

significantly. It is during this stage of the lifecycle that the business may decide to

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use an extension strategy to prolong the lifecycle and boost sales, sales revenue

and profits.

The final stage of the lifecycle is where the sales of the product go into decline. This

is usually an inevitable result of changing customer tastes and fashions, new

technology and the loss of market share to new products introduced by competitors.

Extension strategies

If a business believes that a product which has reached the saturation stage of the

lifecycle can still produce a higher level of sales, then it may choose to implement

one or more extension strategies to improve the product's ailing level of sales, such

as:

changing the appearance and the packaging of the product;

trying to find new uses for the product;

trying to find new markets for the product;

trying to entice customers to use the product more frequently;

Altering the ingredients of the product.

The purpose of the extension strategy is to delay the decline stage of the lifecycle

and produce extra sales and revenue for the business.

We define a product as "anything that is capable of satisfying customer needs. This

definition includes both physical products (e.g. cars, washing machines, DVD

players) as well as services (e.g. insurance, banking, private health care).

Businesses should manage their products carefully over time to ensure that they

deliver products that continue to meet customer wants. The process of managing

groups of brands and product lines is called portfolio planning.

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Examples

Set out below are some suggested examples of products that are currently at

different stages of the product life-cycle:

INTRODUCTION GROWTH MATURITY DECLINE

Third generation mobile phones

Portable DVD Players

Personal Computers Typewriters

E-conferencing Email Faxes Handwritten letters

All-in-one racing skin-suits

Breathable synthetic fabrics

Cotton t-shirts Shell Suits

iris-based personal identity cards

Smart cards Credit cards Cheque books

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Boston Matrix and the product portfolio.

The Boston Matrix

A Business with a range of products has a portfolio of products. However, owning a product portfolio poses a problem for a business. It must decide how to allocate investment (e.g. in product development, promotion) across the portfolio. A portfolio of products can be analysed using the Boston Group Consulting Matrix.

The Boston Matrix categorises the products into one of four different areas, based on:

• Market share – does the product being sold have a low or high market share? • Market growth – are the numbers of potential customers in the market growing or not

How does the Boston Matrix work? The four categories can be described as follows:

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Stars

Stars are high growth products competing in markets where they are strong

compared with the competition. Often Stars need heavy investment to sustain

growth. Eventually growth will slow and, assuming they keep their market share,

Stars will become Cash Cows

Cash Cows

Cash cows are low-growth products with a high market share. These are mature,

successful products with relatively little need for investment. They need to be

managed for continued profit - so that they continue to generate the strong cash

flows that the company needs for its Stars

Question Marks (sometimes also called “problem children”)

Question marks are products with low market share operating in high growth

markets. This suggests that they have potential, but may need substantial

investment to grow market share at the expense of larger competitors. Management

have to think hard about ―Question Marks‖ - which ones should they invest in? Which

ones should they allow to fail or shrink?

Dogs

Unsurprisingly, the term ―dogs‖ refers to products that have a low market share in

unattractive, low-growth markets. Dogs may generate enough cash to break-even,

but they are rarely, if ever, worth investing in. Dogs are usually sold or closed.

Ideally a business would prefer products in all categories (apart from Dogs!) to give it

a balanced portfolio of products.

Strategies:

Build Market Share: Make further

investments (for example, to maintain

Star status, or turn a Question Mark

into a Star)

Hold: Maintain the status quo (do

nothing)

Harvest: Reduce the investment (enjoy

positive cash flow and maximize profits

from a Star or Cash Cow)

Divest: For example, get rid of the

Dogs, and use the capital to invest

in Stars and some Question Marks.

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How current social trends affect the composition of the marketing mix:

Social Trends

There are a number of social factors that firms may wish to consider when designing

the marketing mix:

Ethical trading

No exploitation, pollution,

Online retailing

Location is not a concern, good websites, google search optimization, saturation

advertising.

Retailer purchasing power

Eg 4 supermarkets control 75% of the UK market.

Sustainability

Purchases are automatically replenished.

Food miles

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

Environmental factors

Carbon footprints, organic, pollution.

Re-cycling

Burn, bury or re-use the original materials.

Project: Select one of the “social trends” and

create a poster outlining the main concepts

associated with it!

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3. Price Elasticity of Demand

This is the responsiveness of demand for a product to a

change in the price of the product itself (i.e. when the

price of the product changes, by how much does

demand change?).

Elasticity of demand (Ped) =

% change in demand of good X / % change in price

of good X

If the PED is greater than one, the

good is price elastic. Demand is

responsive to a change in price. If for

example a 15% fall in price leads to a

30% increase in quantity demanded,

the price elasticity = 2.0

If the PED is less than one, the good is

inelastic. Demand is not very

responsive to changes in price. If for

example a 20% increase in price leads

to a 5% fall in quantity demanded, the

price elasticity = 0.25

If the PED is equal to one, the good

has unit elasticity. The percentage

change in quantity demanded is equal

to the percentage change in price.

Demand

changes proportionately to a price

change.

If the PED is equal to zero, the good is

perfectly inelastic. A change in price

will have no influence on quantity

demanded. The demand curve for

such a product will be vertical.

If the PED is infinity, the good is

perfectly elastic. Any change in price

will see quantity demanded fall to zero.

This demand curve is associated with

firms operating in perfectly competitive

markets

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A relatively inelastic demand curve

Factors that determine the value of price elasticity of demand

1. Number of close substitutes within the market - The more (and closer)

substitutes available in the market the more elastic demand will be in response to a

change in price. In this case, the substitution effect will be quite strong.

2. Luxuries and necessities - Necessities tend to have a more inelastic demand

curve, whereas luxury goods and services tend to be more elastic. For example, the

demand for opera tickets is more elastic than the demand for urban rail travel. The

demand for vacation air travel is more elastic than the demand for business air

travel.

3. Percentage of income spent on a good - It may be the case that the smaller the

proportion of income spent taken up with purchasing the good or service the more

inelastic demand will be.

4. Habit forming goods - Goods such as cigarettes and drugs tend to be inelastic in

demand. Preferences are such that habitual consumers of certain products become

de-sensitised to price changes.

5. Time period under consideration - Demand tends to be more elastic in the long

run rather than in the short run. For example, after the two world oil price shocks of

the 1970s - the "response" to higher oil prices was modest in the immediate period

after price increases, but as time passed, people found ways to consume less

petroleum and other oil products. This included measures to get better mileage from

their cars; higher spending on insulation in homes and car pooling for commuters.

The demand for oil became more elastic in the long-run.

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4. Income elasticity of demand

Income elasticity of demand measures the relationship between a change in quantity demanded and a change in income. The basic formula for calculating the coefficient of income elasticity is: Percentage change in quantity demanded of good X divided by the percentage change in real consumers' income Normal Goods Normal goods have a positive income elasticity of demand so as income rise more is demand at each price level. We make a distinction between normal necessities and normal luxuries (both have a positive coefficient of income elasticity). Necessities have an income elasticity of demand of between 0 and +1. Demand rises with income, but less than proportionately. Often this is because we have a limited need to consume additional quantities of necessary goods as our real living standards rise. The class examples of this would be the demand for fresh vegetables, toothpaste and newspapers. Demand is not very sensitive at all to fluctuations in income in this sense total market demand is relatively stable following changes in the wider economic (business) cycle. Luxuries on the other hand are said to have an income elasticity of demand > +1. (Demand rises more than proportionate to a change in income). Luxuries are items we can (and often do) manage to do without during periods of below average income and falling consumer confidence. When incomes are rising strongly and consumers have the confidence to go ahead with ―big-ticket‖ items of spending, so the demand for luxury goods will grow. Conversely in a recession or economic slowdown, these items of discretionary spending might be the first victims of decisions by consumers to rein in their spending and rebuild savings and household financial balance sheets. Many luxury goods also deserve the sobriquet of ―positional goods‖. These are products where the consumer derives satisfaction (and utility) not just from consuming the good or service itself, but also from being seen to be a consumer by others. Inferior Goods Inferior goods have a negative income elasticity of demand. Demand falls as income rises. In a recession the demand for inferior products might actually grow (depending on the severity of any change in income and also the absolute co-efficient of income elasticity of demand). For example if we find that the income elasticity of demand for cigarettes is -0.3, then a 5% fall in the average real incomes of consumers might lead to a 1.5% fall in the total demand for cigarettes (ceteris paribus)

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Within a given market, the income elasticity of demand for various products can vary and of course the perception of a product must differ from consumer to consumer. The hugely important market for overseas holidays is a great example to develop further in this respect. What to some people is a necessity might be a luxury to others. For many products, the final income elasticity of demand might be close to zero, in other words there is a very weak link at best between fluctuations in income and spending decisions. In this case the ―real income effect‖ arising from a fall in prices is likely to be relatively small. Most of the impact on demand following a change in price will be due to changes in the relative prices of substitute goods and services.

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The income elasticity of demand for a product will also change over time – the vast

majority of products have a finite life-cycle. Consumer perceptions of the value and

desirability of a good or service will be influenced not just by their own experiences

of consuming it (and the feedback from other purchasers) but also the appearance of

new products onto the market. Consider the income elasticity of demand for flat-

screen colour televisions as the market for plasma screens develops and the income

elasticity of demand for TV services provided through satellite dishes set against the

growing availability and falling cost (in nominal and real terms) and integrated digital

televisions.

Product ranges and longer term trends

Income elasticity of demand will vary within a product range. For example the Yed

for own-label foods in supermarkets is less for the high-value ―finest‖ food ranges.

There is a general downward trend in the income elasticity of demand for many basic

products, particularly foodstuffs. One reason is that as a society becomes richer,

there are changes in tastes and preferences. What might have been considered a

luxury good several years ago might now be regarded as a necessity? How many of

you regard a Sky sports subscription or an iPhone5, an iPad2 or a new Blackberry

as a necessity?

The table below shows estimated price and income elasticity of demand for a

selection of foods:

Product

Share of budget

(% of household

income)

Price elasticity of

demand (Ped)

Income elasticity of

demand (Yed)

All Foods 15.1 n/a 0.2

Fruit juices 0.19 -0.55 0.45

Tea 0.19 -0.37 -0.02

Instant coffee 0.17 -0.45 0.16

Source: DEFRA www.defra.gov.uk

The income elasticity of demand for most types of food is low – occasionally negative

(e.g. for margarine) and likewise the own price elasticity of demand for most

foodstuffs is also inelastic.

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How do businesses make use of estimates of income elasticity of

demand?

Knowledge of income elasticity of demand helps firms predict the effect of an

economic cycle on sales. Luxury products with high income elasticity see greater

sales volatility over the business cycle than necessities where demand from

consumers is less sensitive to changes in the cycle.

Income elasticity and the pattern of consumer demand

As we become better off, we can afford to increase our spending on different goods

and services. The income elasticity of demand will also affect the pattern of demand

over time.

For normal luxury goods - income elasticity of demand exceeds +1, so as incomes

rise, the proportion of a consumer‘s income spent on that product will go up.

For normal necessities (income elasticity of demand is positive but less than 1) and

for inferior goods (where the income elasticity of demand is negative) – then as

income rises, the share or proportion of their budget on these products will fall

For inferior goods as income rise, demand will decline and so too will the share of

income spent on inferior products.

A good example of a product with a negative income elasticity of demand is tobacco

products. Many factors affect demand for cigarettes and related products – not least

the level of indirect tax placed on them by the government and also the effects of

health campaigns and bans on smoking in public places.

Even allowing for this, as the chart above shows, real spending on tobacco has

fallen in nearly every year since 1980 and is now less than half the level at the start

of the 1980s.

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Section 2: Managing the provision process

Product Design

Market Orientation

Types of design – standard/bespoke

Design Mix – function, aesthetic, economy.

Improve efficiency through design – technology, materials.

The Design Mix

The process of achieving a balance between Function, Costs

and Aesthetics of a product.

There are 3 aspects to the deign mix:

•Function (How the product operates)

•Cost (The cost of the product)

•Aesthetics (How the product looks)

Cost

Depends on the market in which it is being sold and the nature of the product.

Most businesses aim to keep costs to a minimum.

E.g. Primark

Function

Usually function is taken for granted, However, at the R&D (Research and

Development) stage it is of paramount importance (If it does not work, it is useless).

E.g. Sellotape, Washing Machines

Aesthetics

This is where looks of the product are important.

E.g. Fashion items,

Companies can affect each element of the design mix through use of technology,

new materials and skilled labour.

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Capital & labour Intensity:

Methods of production

Production is at the heart of all industry and is

the process of using the resources of a firm to

convert ‗inputs‘ into ‗outputs‘, which are

products or services desired by customers.

Job production

Job production is used to create one-off orders or ‗jobs‘

especially made for the purpose. This might be a relatively

small job such as bespoke suit or a sandwich made to order

in a café, or it could be a massive job such as a cruise liner

or the Arsenal‘s new stadium.

Job production helps ensure that the product or service

matches the customer‘s exact needs, as closely as the firm

is able, because it is literally ‗custom-made‘. In many cases,

skilled or specialised staff make products of very high

quality, or which have individual character that might have less appeal if they were

mass-produced.

Job production is a relatively expensive process because it requires specialised and

skilled staff who concentrate on the individual job or project. It is therefore labour

intensive, although some projects – such as the cruise liner – may also need a lot of

expensive capital equipment.

Small businesses that are built on the skills of the owner, such as a window cleaner

or a hairdresser, use job production techniques.

Batch production

As the name suggests, products are produced in

small or large batches. This process is useful to a firm

that makes a number of different variations of

basically similar products. Examples would include; a

bakery, a car exhaust pipe factory or a toothpaste

manufacturer.

If the sandwich shop mentioned above wanted to speed up production, instead of

making sandwiches to order, it might be able to benefit by making the day‘s

sandwiches in batches of all the different types and have them available for sale,

pre-packed.

A toothpaste manufacturer will set its weekly batches of production of each product

according to the orders from the supermarkets and wholesalers. The same

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machinery is used for each product but the ingredients, packaging an/or size is

changed for each batch as required. It is crucial that the machinery can be quickly

cleaned and re-configured for each new batch to minimise unproductive time.

In a factory that uses flow production (see below), it is quite common for component

parts to be made in batches enough for a week‘s production.

Flow production

This is a production line method, where product

is continuously produced, flowing from one

stage of production to the next. Workers and,

increasingly robots, carry out individual repetitive

tasks aiming to work as quickly as possible

without loss of quality. This is the method

pioneered by Henry Ford for his Model T car,

and the efficiencies he gained enabled him to

produce large numbers of cars at low cost. Any

product made in high volumes will almost certainly be made on a flow production

line.

This approach to production has close links with FW Taylor and his ‗Scientific school

of management‘ – Taylor‘s motivational theories were all about creating the

workplace and forms of reward to maximise efficiency. This in turn led to very boring

work and contributed to industrial unrest over the years where workers‘ interests

were overlooked.

More modern, lean production techniques have at least partly recognised the fact

that this type of work can be extremely boring, and ideas such as cell production and

quality circles can help improve the workplace as workers become multi-skilled, take

more responsibility for quality and can contribute their ideas for improvements.

Flow production systems are typically capital intensive and it is important to keep

them running smoothly with high levels of capacity utilisation, so that these high

overhead costs are spread over as many units as possible.

Once set up properly, flow production lines can in some cases produce millions of

consistently high quality products.

27

Methods of production

Complete the blanks using the following terms:

mass Time-Consuming expensive Inflexible Stock

Specialised Productivity Labour-Intensive. capital-Intensive

Economies of Scale monitored division of labour order stage

The types of goods and size of potential orders will affect the method of production

used. There are three methods of production you need to be familiar with:

Job production

This method is used when a customer makes an ……………………. for something to

be made to his or her own specifications, for example a made-to-measure wedding

dress, a personally designed house, a motorway or a passenger cruiser.

L…………………-I……………………

requires specialist, skilled labour very e…………………….. s……………………… projects with high added-value.

T………………………………

High production costs.

Batch production

This method is used when the size of the market for a product is

not clear, and where there is a range within a product line. A certain number of the

same goods will be produced to make a up a batch or run, for example clothes

(where a batch of size 12 clothes in blue might be made, then a batch of size 10 in

red), or carpets. This method involves using estimates.

Production is m………………………

Output is adjusted accordingly.

E……………………………..of S…………………………..

Cheaper unit production costs than job production.

High s……………………….levels.

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Mass or flow production

Large-scale production benefits from economies of scale, such as d………………….

of l……………………. and specialisation. This method is used when there is a

m…………….. market for a large number of identical products, for example, cars,

computers, chocolate bars or toasters. The product passes from one

s………………… of production to another along a production line.

C……………………………………I ……………………………..

low cost per unit & high p……………………………...

expensive, but efficient equipment is needed.

I……………………………….. (difficult to produce a different product)

29

It is important to distinguish between capital-intensive and labour-intensive methods

of production.

Capital-intensive

‗Capital‘ refers to the equipment, machinery, vehicles and so on

that a business uses to make its product or service.

Capital-intensive processes are those that require a relatively

high level of capital investment compared to the labour cost.

These processes are more likely to be highly automated and to be used to produce

on a large scale.

Capital-intensive production is more likely to be associated with flow production (see

below) but any kind of production might require expensive equipment.

Capital is a long-term investment for most businesses, and the costs of

financing, maintaining and depreciating this equipment represents a

substantial overhead.

In order to maximise efficiency, firms want their capital investment to be fully utilised

(see notes on capacity utilisation).

In a capital-intensive process, it can be costly and time-consuming to increase or

decrease the scale of production.

Labour-intensive

‗Labour‘ refers to the people required to carry out a process in a business.

Labour-intensive processes are those that require a relatively high level of labour

compared to capital investment.

These processes are more likely to be used to produce individual or personalised

products, or to produce on a small scale

The costs of labour are: wages and other benefits, recruitment, training and so on.

Some flexibility in capacity may be available by use of overtime and temporary staff,

or by laying-off workers.

Long-term growth depends on being able to recruit sufficient suitable staff.

Labour intensive processes are more likely to be seen in Job production and in

smaller-scale enterprises.

30

Capacity Utilisation

A firm‘s productive capacity is the total level of output or

production that it could produce in a given time period.

Capacity utilisation is the percentage of the firm‘s total

possible production capacity that is actually being used.

Capacity utilisation (%) =

actual output per month (or per annum) x 100%

_______________________________

maximum possible output per month (or per annum)

For example, if a firm could produce 1200 units per month, but is actually producing

600 per month, its capacity utilisation is as follows:

Capacity utilisation % = 600 units per month x 100% /

1200 units per month

= 50%

Financial implications

A firm‘s level of capacity utilisation determines how much fixed costs should be

allocated per unit, so as a firm‘s capacity utilisation increases, the fixed costs (and

therefore also, total costs) per unit will decrease. For example, if the firm above had

fixed costs of £12,000 per month, the fixed costs per unit would be £20 per unit at

50% capacity utilisation, but only £10 per unit at 100% capacity utilisation.

It therefore follows that a firm should be most efficient if it is running at 100%

capacity utilisation. However, if a firm is running at full capacity, there are a number

of potential drawbacks:

There may not be enough time for routine maintenance, so machine breakdowns

may occur more frequently and orders will be delayed

It may not be possible to meet new or unexpected orders so the business cannot

grow without expanding its scale of production

Staff may feel under excessive pressure, leading to increased mistakes,

absenteeism and labour turnover

If the factory space is overcrowded, work may become less efficient due to the untidy

working conditions

31

It may be necessary to spend more on staff overtime to satisfy orders, increasing

labour costs

In general, businesses would feel most comfortable at something between 80 to 90%

capacity utilisation because fixed costs per unit are relatively low and there is some

scope to meet new orders or carry out maintenance and training. A firm that has just

invested in major new facilities in anticipation of major growth could take some time

before reaching a good level of utilisation, so it is important to consider sales trends

when discussing capacity utilisation.

Causes of under-utilisation of capacity

There are a number of reasons why a firm might be experiencing low capacity

utilisation, including the following:

New competitors taking market share or causing over-supply in the market

Fall in market demand due to changes in consumer tastes or fashion

Unsuccessful marketing – one or more aspect of the marketing mix may simply

mean that the firm is not successful

Seasonal demand – this is especially apparent in the tourist industry where firms like

hotels and leisure parks are full in the summer but see much lower utilisation at other

times of the year

Exam hint: In examination questions on this subject, look for clues as to the root

causes of under-utilisation so that you can assess whether it is a long term problem

or not, and what the firm could do to remedy the

situation

Problems arising from low capacity utilisation

Higher fixed costs per unit mean reduced profitability; if

prices were raised to cover these costs, this would

probably lead to reduced sales unless the product was

price inelastic

Spare capacity can portray a negative image,

particularly in a business where it can be seen that it is no longer busy – such as a

shop or a health club - signifying loss of popularity

Staff can become bored and demoralised if they don‘t have as much to do,

especially if they fear losing their jobs

Benefits of low capacity utilisation

32

Low capacity utilisation is unlikely to be desirable in the long term as the higher unit

costs will make it difficult to compete. However it is not all bad news and possible

short term benefits include:

A firm may have more time for maintenance and repairs and for staff training, to

prepare for an upturn in trade

There may be less stress for employees than if they were working at full capacity

The firm can cope with new orders; firms in expanding markets may expect to have

low utilisation whilst they build their sales

Increasing and reducing productive capacity

Dealing with high capacity utilisation

If a firm is struggling to keep up with demand, it could use the following approaches:

Extra shifts or longer opening hours - using extra labour in the form of staff

overtime or additional staff. This is how many firms address short term increases in

demand, for example if one very large order is required. As long as it doesn‘t go on

for too long, staff may welcome the extra pay – which is usually at a higher rate.

There will be an increase in labour and other fixed costs – such as extra heating and

lighting - and the firm might find there is insufficient time for maintenance and

training. It is nevertheless a suitable approach to meet increased demand while the

firm determines whether there will be a longer term need for extra capacity.

In some industries, local residents might object to additional noise and traffic caused

by night or weekend working.

Seasonal workers – if the capacity shortage is seasonal, then temporary staff may

be taken on to meet the need. This is common in industries such as retail at

Christmas, and in leisure and farming in the summer. The main problem is finding

enough good temporary workers who have the right skills to maintain the firm‘s

levels of service and quality.

Outsourcing or subcontracting – this means passing

one or more aspect of the production process to

another firm. For example an engineering firm could

send components to another specialist firm for plating

and concentrate itself on the other aspects of

production. Motor manufacturers have increasingly

sourced bodywork panels and other components

through subcontractors, concentrating on assembly and finishing of vehicles.

This is a practical approach adopted by many firms that allows the firm to

concentrate on what it does best. The partner firm may be more efficient at the

33

outsourced operation. However, there are logistical challenges and costs associated

with this and it does depend on the reliability of the partner firms.

This approach is also used as a primary mode of expansion by many large

manufacturers. Apple, for example, very quickly out-sourced the manufacture of

iPods to Chinese firms and Dyson outsourced vacuum cleaner manufacture to

Korea.

Expansion – investment in larger or additional factories, new machinery, further

shops or offices. This will involve recruitment and training of new employees.

Although there is considerable expense involved, this may be an appropriate

strategy if demand is growing steadily and is expected to be sustained.

Dealing with low capacity utilisation

If a firm cannot find enough orders, it will be suffering from increased fixed costs, or

overheads, per unit of production. Some possible solutions include:

New business - of course, the most obvious solution is to try and find new business

or change the marketing proposition so that the firm‘s product or service is more

competitive!

However, if this is not successful, other measures may have to be taken to cut

overheads, such as:

Rationalisation – or ‗downsizing’ - this means shutting down or selling off parts of

the business. Staff may have to be made redundant, losing skilled and trained staff,

so long term expectations must be taken into account before taking such drastic

measures.

Short-time working – cutting out a shift or reducing working hours. This will mean

either reducing the workforce, or asking them to accept reduced wages and/or a loss

of overtime. Obviously, this is likely to damage staff morale but might be preferable

to permanent job losses – as long as there is the possibility of an upturn in trade.

Laying off workers – this will reduce labour costs but not other fixed costs unless

other actions are also taken.

34

Capacity Concerns at Ice Delights

Bill Brown is the Operations Manager at Ice Delight Ice Creams.

He is responsible for overseeing all aspects of the production

process, from checking that the necessary ingredients arrive in

time at the factory, to staffing the production line. His job is made

more difficult by the fact that levels of production often fluctuate,

due to the nature of the product, but is under pressure from the

Directors of Ice Delight to improve efficiency and lower cost per unit for the tubs of

ice cream they produce.

The machinery that Ice Delight own and use for producing their ice cream products is

somewhat outdated, and Bill often finds himself having to halt production whilst

engineers fix problems with the conveyor belt. However production levels are

generally high enough to fulfil most of the orders Ice Delights receive each month,

and current levels of output are around 12,000 tubs per week. Based on current shift

patterns, and the supposed maximum output of the machinery, Bill has calculated

that Ice Delights could potentially produce a further 3,000 tubs per week.

Many of Bill‘s staff have been working for Ice Delights for many years and are good

at their jobs, however most have young families and prefer to only work their

contracted hours, with no overtime added on.

1. Calculate the Capacity Utilisation for Ice Delights (3 marks)

2. Are they currently operating below or above full capacity? (2 marks)

3. What implications are there for Ice Delights of operating at this level? (6 marks)

4. Evaluate the options available to Bill when responding to the requests of the Directors (8 marks)

35

Capacity utilisation and intensity

1. Missing words

Capacity is the v_____________ of output a firm is capable of producing. Capacity utilisation

measures actual output as a percentage of the firm‘s capability. If the maximum capacity is

10,000 units a month and the actual output is 6,500 units, capacity utilisation is _______%.

As fixed (o__________________) costs are related to maximum capacity, if the firm has low

capacity utilisation, its fixed costs per unit will be ______________ and so too will be its

average total costs per unit.

Capital intensity raises a separate issue. To what extent are the total costs of the business

weighted towards fixed capital (such as machinery)? Or is the business labour intensive, i.e.

labour costs form a high proportion of total costs? The former case is more likely to be true

of large firms (especially in the manufacturing sector) whereas the labour intensive firms are

more likely to be ______________ firms especially in the _________________ sector.

2. True or False?

2.1 Low capacity utilisation means low unit costs.

2.2 Low capital intensity means high labour costs per unit.

2.3 High labour intensity may mean high costs but high flexibility and good customer service.

2.4 High capacity utilisation keeps unit costs down as machinery and staff are being used

productively.

2.5 An increase in capital intensity might lead to redundancies.

36

3. Calculations

3.1 Six months ago, John Collins started up a retail business with overheads of £4,000 per

week, including £900 on staff, £700 on rent and the rest on the cost of leasing a state-of-the-

art automated supply system. This enables customers to order over the phone, the internet

or in person, and a robotic stock-picking system finds the item and delivers it to a collection

bay. Current unit sales of 7,200 per week are close to the system‘s maximum capacity of

8,000 units.

a) Calculate the firm‘s % capacity utilisation _______________________

b) Calculate the capital intensity of John Collins‘ business.

_______________________________

A rival retailer has a labour intensity of 70%. Identify one advantage and one disadvantage

to John Collins of its capital intensity.

_________________________________________________________________________

_______________________________________________________

3.2 JT Co‘s fixed overheads of £600,000 a month pay for a maximum capacity of 200,000

units. Variable costs are £2 per unit, the selling price is £8 and current demand is for

120,000 units.

a) What is JT Co‘s capacity utilisation?

b) Calculate JT Co‘s fixed costs per unit at 120,000 units and at maximum capacity

c) Explain how the above data enable you to know that JT Co‘s profit margin is £1 per

unit at sales of 120,000 units, but £3 per unit at maximum capacity.

d) Calculate the % increase in the firm‘s total profit that would result from a sales

increase from 120,000 to 200,000 units.

37

Capital Intensive and Labour Intensive Businesses

A capital intensive business is one which needs a large

amount of capital (eg equipment, machinery, buildings,

vehicles) in order to run. An example of a capital intensive business

is a car factory, where there are many expensive items of

machinery, such as robots and conveyor belts.

A labour intensive business is one which relies more on

people than machines. Service industries, eg the hotel

industry, and creative businesses, eg art studios, are labour intensive.

Exercise

Decide whether each business below is capital (C) or labour (L) intensive, giving

your reasons for each answer.

Business (C) or

(L)

Reason

Hairdresser

Railway

company

Oil refinery

Private

hospital

38

Restaurant

Wheat Farm

Painter &

Decorator

Airline

39

Stock Control

Managing stock effectively is

important for any business,

because without enough stock,

production and sales will grind to a

halt. Stock control involves careful

planning to ensure that the

business has sufficient stock of the

right quality available at the right

time.

Stock can mean different things

and depends on the industry the

firm operates in. It includes:

Raw materials and components from

suppliers

Work in progress or part finished

goods made within the business

Finished goods ready to dispatch to

customers

Consumables and materials used by

service businesses

In order to meet customer orders,

product has to be available from stock

– although some firms are able to

arrange deliveries Just in Time, see

below. If a business does not have the

necessary stock to meet orders, this

can lead to a loss of sales and a

damaged business reputation. This is

sometimes called a ‗stock-out‘.

It is important therefore that a business

either holds sufficient stocks to meet

actual and anticipated orders, or can

get stocks quickly enough to meet

those orders. For a high street retailer,

in practice this means having product

on the shelves.

However, there are many costs of

holding stock, so a business does not

wish to hold too much stock either.

The costs of holding stock include:

The opportunity cost of working

capital tied up in stock that could have

been used for another purpose

Storage costs – the rent, heating,

lighting and security costs of a

warehouse or additional factory or

office space

Bank interest , if the stock is financed

by an overdraft or a loan

Risk of damage to stock by fire, flood,

theft etc; most businesses would

insure against this, so there is the cost

of insurance

Stock may become obsolete if buyer

tastes change in favour of new or

better products

Stock may perish or deteriorate –

especially with food products

40

Stock Control - application and

evaluation

Re-Order Levels

This is the minimum amount of

stock that a business will hold

before it re-orders from its

suppliers. The re-order level will vary

from business to business and from

industry to industry.

For example, a supermarket is likely to

have a higher re-order level than a car

dealer, since in the time taken to

receive its supplies, a supermarket is

likely to sell far more stock than a car

dealer.

Re-Order Quantities

The re-order quantity is the amount of

stock and raw materials that a

business orders from its suppliers

each time it reaches its re-order

level. This again will vary from

business to business and from industry

to industry.

For example, a business selling fast-

moving consumer goods (e.g.

chocolate bars or baked beans) is

likely to order a far larger amount of

stock from its suppliers than a

manufacturer of goods with a slower

stock turnover (e.g. televisions or

washing machines).

There are several factors which will

influence the amount of stock which

a business orders, including:

Lead times.

The expected level of customer

demand.

The costs of stockholding.

The type of stock, whether it is

perishable or durable.

Buffer Stocks

This is the minimum stock level which

will be held by a business to meet any

unexpected occurrences.

For example, A sudden large order

from a customer, deliveries of raw

materials not arriving on time, or

computer re-ordering systems

breaking down.

Lead Times

This is the amount of time that elapses

between a business placing an order

with a supplier for more stock or raw

materials, and the delivery of the

goods to the business.

The business will wish the lead-time to

be as short as possible, so that it can

meet its customer orders and minimise

the time between paying for the stock

and receiving the revenue from the

customer.

However, this may not happen due to

a number of factors, such as delays in

the supplier receiving the order, or the

breakdown of the suppliers' lorries

delivering the stock to the business.

41

Stock control charts

A stock control chart is a graphical

illustration of a simple approach to

stock management over time. This

‗saw tooth‘ shaped diagram is normally

shown as if sales were steady

throughout each month. Whilst this

oversimplifies the situation for many

businesses, the principles can be

adapted to most situations.

The key features and terms are:

Maximum stock level – this is the

maximum amount of stock a business

would wish to hold. This could

represent enough stock for a month or

a week, it might be as much as the

warehouse has space for, or it might

depend on the order size needed to

qualify for a quantity discount – known

as the Economic Order Quantity

(EOQ). On the diagram below, the

maximum stock level is 600 units, and

the usual order quantity is 500 units

Re-order level – this acts as a trigger

point, so that when stocks fall to this

level, the next order should be placed.

This helps take account of fluctuations

in sales levels over time. When an

order is placed, there is a lead time

that the supplier needs to meet that

order. Ideally this new order will arrive

just before stocks fall below the

minimum stock level. On the diagram

below, 300 units

Lead time – the amount of time

between placing the order and

receiving the stock On the diagram

below, just under two weeks

Minimum stock level – this is the

minimum amount of product the

business would want to hold in stock.

Assuming the minimum stock level is

more than zero, this is known as buffer

stock – see below. On the diagram

below, 100 units

Buffer stock – an amount of stock

held as a contingency in case of

unexpected orders so that such orders

can be met and in case of any delays

from suppliers.

42

From this diagram, it can be seen that:

The re-order level (i.e. the amount of stock remaining when an order is placed) is

…………………………units.

The re-order quantity (i.e. the amount of stock ordered from a supplier) is ……..units.

The buffer stock (i.e. the minimum stock holding) is ………. units.

The lead-time (i.e. the time delay between placing an order for stock and receiving it)

is ……. days.

43

Stock Rotation

Many businesses use a stock rotation system. This is the process of ensuring that

the older batches of stock are used first rather than the newer batches, in order to

avoid the possibility that the older stocks will become obsolete or go past their sell-

by-date.

This is often referred to as a First In First Out (F.I.F.O) system, to encourage the

older batches of stock to be used first, therefore avoiding the possibility that the older

stock will be left in a warehouse, possibly becoming unusable.

Exercise: (Use Excel) Enter the following data in a new Excel spreadsheet & complete the column for Balance.

Item Date Amount Balance

Stock level 01/01/2013 500 units 500

Order 05/01/2013 200 units 300

Order 06/01/2013 100 units 200

Re-order stock 08/01/2013 250 units 450

Re-order stock 10/01/2013 250 units

Order 12/01/2013 200 units

Order 14/01/2013 200 units

Re-order stock 16/01/2013 250 units

Order 18/01/2013 200 units

Order 20/01/2013 200 units

Order 22/01/2013 200 units

Re-order stock 24/01/2013 250 units

Order 26/01/2013 200 units

Order 28/01/2013 200 units

Re-order stock 31/01/2013 250 units

Draw a Stock chart showing the balance and the Date. Insert an appropriate title.

44

Lean Management

Lean production is the term given to a range of measures traditionally used by

Japanese businesses in an attempt to reduce waste and costs in production.

Just-In-Time

This is a method of manufacturing products which aims to minimise:

the production time

the production costs

the amount of stock held in the factory.

Raw materials and supplies arrive at the factory as they are required, and

consequently there is very little stock sitting idle at any one time. Each stage of the

production process finishes just before the next stage is due to commence and

therefore the lead-time is significantly reduced.

With a just-in-time production system, the level of production is related to the

demand for the output (i.e. the number of orders) rather than simply producing

finished goods and waiting for orders. This means that raw materials and stock only

needs to be ordered from suppliers as required - this reduces the amount of money

tied up in stocks, and leaves more money available for investment elsewhere.

The advantages of a just-in-time production system are:

Cash flow is improved, as less money is tied up in raw materials, work-in-progress

and finished goods.

Less need for storage space for raw materials and finished goods.

The business builds up strong relationships with its suppliers.

Communication and co-operation between the marketing and the production

departments are improved.

Competitive advantage gained through reduced lead-times!

The disadvantages of a just-in-time production system are:

The business may struggle to meet orders if their suppliers fail to deliver the raw

materials on time. The business is unlikely to 'bulk-buy' its raw materials and,

therefore, it may lose the benefit of achieving economies of scale.

Buffer stocks are minimal and this may lead to the business having to reject

customer orders requiring delivery immediately.

45

Benchmarking

This refers to a business finding the best methods and processes that are used by

other businesses, and then trying to emulate these in order to become more efficient

in its operations.

Benchmarking can be used in all areas and processes in a business, not just for

production.

For example, it can be used to improve customer service, advertising campaigns,

Human Resource Management, and budgeting procedures.

Data for benchmarking is collected and used with the full co-operation of the other

businesses, and often the results will help both businesses to improve their systems

and procedures.

There are several stages involved in implementing a benchmarking system:

Researching the areas in a business which need improving.

Deciding how an improvement in these areas can be measured.

Identifying 'best practice' in other businesses.

Agreeing the exchange of information with other businesses.

Comparing the 'best practice' with the existing processes, systems and procedures

in the business.

Altering the processes, systems and procedures in order to improve performance.

46

Evaluating how successful the changes have been.

In order for benchmarking to be successful, the business must ensure that firstly

every employee is committed and involved in the system, (from senior management

to shop-floor employees), and secondly that sufficient time and finance is available

for the gathering of data and the implementation of new procedures.

Benchmarking will fail to deliver improvements to the business if there is a lack of

willingness by other businesses to disclose information, or if the systems and

procedures used by the 'best practice' businesses are not appropriate for the

business in question.

In summary, benchmarking can help a business identify those areas in its operations

which need improvement, as well as considering alternative processes and

procedures for achieving its objectives. 'Best practice' can be emulated and the

competitiveness of the business should improve as it strives to improve and become

more efficient.

A business which can develop and launch more products in a shorter time

than its competitors will benefit from a number of advantages:

If the business is the first to launch a product on the market, then it can charge a

premium price to reflect the innovative nature of the product.

Premium prices help to quickly recoup R&D costs, as well as earning the business a

significant profit-margin per unit sold.

Brand loyalty is likely to develop - enabling the business to use this strong customer

base as a 'launch pad' for new products in the future.

The diversity of products that are on sale will increase the product portfolio of the

business, as well as reduce the risk of business failure should one or two of the

products prove unsuccessful.

TQM - reducing lead times;

competitive advantage.

This is a specific approach to quality

assurance that aims to develop a

quality culture throughout the firm. In

TQM, organisations consist of ‗quality

chains‘ in which each person or team

treats the receiver of their work as if

they were an external customer and

adopts a target of ‗right first time‘ or

zero defects.

47

Although the philosophy was developed by Japanese companies, it was originally

put forward by an American, Edward Deming whose 14-point plan applies to

management in general, but is especially useful in respect of quality. This is the

attempt by a business to stop errors and waste from occurring at all levels within

the organisation, and to try to encourage all employees to make 'quality' paramount

within their daily activities (whether in production, marketing or personnel). There are

a number of components of T.Q.M:

Internal relationships between workers and their superiors and subordinates are

seen to be as important as the external relationships that exist between the business

and its customers and suppliers.

TQM must be seen to be a policy that is followed by, and has the commitment of, all

workers, from senior management to shop floor employees.

The business must monitor all its activities and processes in order to identify any

areas for improvement and to ensure that quality is being achieved.

Team-working is important, since a group of people working together will develop a

wider range of skills, co-operation, and higher motivation than if workers were

performing repetitive tasks on their own.

Regular market research must be undertaken to ensure that customers are happy

with the level of service that they receive (any complaints can be used to improve the

existing systems).

48

Quality Management Techniques

What is quality?

Quality is important to businesses but can be quite hard to define. Customers want

quality that is appropriate to the price that they are prepared to pay and the level of

competition in the market.

Key aspects of quality for the customer include:

Good design – looks and style

Good functionality – it does the job well

Reliable – acceptable level of breakdowns or failure

Consistency

Durable – lasts as long as it should

Good after sales service

Value for money

‗Value for money‘ is especially important, because in most markets there is room for

products of different overall levels of quality, and the customer must be satisfied that

the price fairly reflects the quality. For example, the car maker Skoda is now part of

the Volkswagen group which is well-known for quality cars, but prior to this, Skoda

owners were amongst the most loyal because even though the cars fell short of most

others in style, comfort and performance, they were tough, reliable and very good

value for money.

Some products and services are marketed as ‗basic‘, having none of the extra

features and benefits of more expensive alternatives. Good examples would be

Easyjet and George at Asda clothing ranges. Even though it may be ‗low quality‘ in

terms of style or features, these products still give good value for money for their

overall level of quality.

For the firm, good design is fundamental, so that the product can be produced

efficiently, reliably and at the lowest possible cost. Also see the revision note on

Quality Improvement. If products are being made for other, large firms, then the

quality standards may be dictated by the firm placing the order.

Why is quality important?

Quality helps determine a firm‘s success in a number of ways:

Customer loyalty – they return, make repeat purchases and recommend the product

or service to others.

49

Strong brand reputation for quality

Retailers want to stock the product

As the product is perceived to be better value for money, it may command a

premium price and will become more price inelastic

Fewer returns and replacements lead to reduced costs

Attracting and retaining good staff

These points can each help support the marketing function in a business. However,

firms have to work hard to maintain and improve their reputation for quality, which

can easily be damaged by a news story about a quality failure. How is quality

measured?

Aside from achievement of standards like BSI, firms can measure quality aspects

such as:

Failure or reject rates

Level of product returns

Customer complaints

Customer satisfaction – usually measured by a survey

Customer loyalty – evident from repeat purchases, or renewal rates

A detailed analysis of areas such as these would be an important part of Quality

Improvement – see the separate revision note for more details

Some areas for evaluation

Quality is subjective, it is a matter of personal opinion and what constitutes an

acceptable level of quality will vary from one individual to another.

Not all aspects of quality are tangible – for example the degree of assurance given

by a firm‘s name or reputation can be very important even though it is hard to

measure.

Quality is always evolving because of things like improved technology, better

materials, new manufacturing techniques and fresh competitors. No firm can afford

to stand still as far as quality is concerned.

Whilst controlling quality has benefits to the firm, it can also be costly to do, so it is

important that the benefits outweigh the costs in the long term

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Quality Improvement

Quality control

This method checks the quality of

completed products for faults. Quality

inspectors measure or test every

product, samples from each batch, or

random samples – as appropriate to

the kind of product produced.

Advantages - inspection is intended to

prevent faulty products reaching the

customer. This approach means

having specially trained inspectors,

rather than every individual being

responsible for his or her own work.

Furthermore, it is thought that

inspectors may be better placed to find

widespread problems across an

organisation.

Disadvantages – individuals are not

necessarily encouraged to take

responsibility for the quality of their

own work. Giving workers

responsibility for their own work helps

to improve motivation by increasing

the interest and variety in the job, so

quality assurance tends to be

preferred for this reason as well. Other

approaches to quality (such as TQM,

see below) mean that there is much

less need for quality control if the

whole process is geared towards ‗zero

defects‘ or getting it right first time.

Rejected product is expensive for a

firm as it has incurred the full costs of

production but cannot be sold as the

manufacturer does not want its name

associated with substandard product.

Some rejected product can be re-

worked, but in many industries it has to

be scrapped – either way rejects incur

more costs,

A quality control approach can be

highly effective at preventing defective

products from reaching the customer.

However, if defect levels are very high,

the company‘s profitability will suffer

unless steps are taken to tackle the

root causes of the failures.

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Quality Assurance

Aims to achieve quality by organising every process to

get the product ‗right first time‘ and prevent mistakes

ever happening. This is also known as a ‗zero defect‘

approach.

In quality assurance, there is more emphasis on ‗self-checking‘, rather than checking

by inspectors. Advantages include:

Costs are reduced because there is less wastage and re-working of faulty products

as the product is checked at every stage.

It can help improve worker motivation as workers have more ownership and

recognition for their work (see Herzberg).

It can help break down ‗us and them‘ barriers between workers and managers as it

eliminates the feeling of being checked up on.

With all staff responsible for quality, this can help the firm gain marketing advantages

arising from its consistent level of quality.

Quality Benchmarking

Benchmarking is a general approach to business improvement based on best

practice in the industry, or in another similar industry. It can provide a useful quality

improvement target for a business.

This can be a helpful approach for services as well as for products – for example a

fast food business selling fish and chips could decide that it wanted to aim to equal

McDonalds‘ speed of meeting customer orders for takeaway food. A financial

services firm might want its call centre staff to answer 95% of telephone calls within

six rings, if this is the practice of the best in the industry.

In some cases, firms can use internal benchmarking in which best practice may be

set with reference to another department, or by a similar factory in a different

location.

BS5750 is a British Standard for quality assurance and ISO 9000 is the international

equivalent.

This approach requires that firms set out clear procedures for all business processes

– usually these are set out in manuals and reinforced through staff training. Regular

audits are carried out to ensure that processes are being carried out consistently

according to standards. Many firms achieved substantial benefits from this process,

by reduction in waste and an improved reputation for quality.

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However, BS5750 can result in a rigid and inflexible, process-driven approach to

providing products and services to customers. It can mean that employees are not

encouraged to take ownership for improvement. Furthermore, just because a firm

holds BS5750 and is delivering a consistent service, it does not guarantee that the

service is better than a firm that does not have the award.

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TQM and Culture: 1. Missing words

Total Quality M _________________________ is the attempt to create a workplace culture

in which everyone cares about the quality of service provided to every customer or supplier.

Strictly speaking, it means inside the business as well as outside, e.g. treating the cleaners

with as much respect as the customers. This makes it different from Quality C

________________, which means checking that quality standards are correct before the

product is sent to customers, or Quality A ____________________, which is a paper-based

system of checking that quality is delivered consistently at each stage in the production

process.

2. What should the company do, if it has a real culture of quality?

SITUATION WHAT SHOULD THE

COMPANY DO?

WHAT DID THE

BUSINESS DO?

2.1 British Airways cancels a

flight, puts its passengers on

a different flight. One

passenger has already paid

£150 extra for BA Premium

Economy, but has to travel

Air China Economy.

Nothing. They did not even

email/phone to apologise,

let alone return the £150.

Their call centre provided

no help when phoned.

TQM culture? I don‘t think

so.

2.2 A factory making

chocolate finds, when quality

testing, that there are tiny

amounts of salmonella (food

poison) present in the

chocolate.

It carried on producing for

6 months until approached

by a government

department looking into

unusually high levels of

salmonella food poisoning

2.3 When a new form of

exam was launched by an

exam board, the telephone

switchboard was jammed by

teachers with queries. They

want to speak to the subject

experts.

Left the phones off the

hook, then set up a call

centre to make sure that

teachers are unable to get

through directly to the

people they want to speak

to.

3. True or False?

3.1 Business culture means corporations sponsoring events such as the ballet or the opera.

3.2 A culture of quality would be when everyone in the business has the same, positive

attitude to serving customers.

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3.3 Company culture involves the attitudes and behaviour that have become custom and

practice in the workplace.

3.4 A TQM culture could be built up through staff involvement in kaizen groups.

3.5 Self-checking is when firms get staff to check themselves in during the morning.

4. Data response. Comment on these real quotes from within businesses

WHAT WORKERS ACTUALLY DO IS THIS TQM? (YOU EXPLAIN)

―We have a great laugh at work. Last

week we all agreed that we‘d try to say

‗rhinoceros‘ when talking to customers. It

was a scream!‖

―My big thrill is when a whole day‘s van

deliveries all end up on-time with the

customers‖

―We need a new system that tells staff

how to carry out each task, they checks

what they do at every stage in the

process. If they‘re not checked they may

not bother.‖

―Oh I can‘t wait until the end of term. I

love this school best of all when there are

no students around. Summer holidays:

roll on.‖

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Quality Circles

This is a group of workers that meets at regular intervals during the working week in

order to identify any problems with quality within production, to consider the

alternative solutions to these problems, and to then recommend to management the

solution that they believe will be the most successful.

The members of the quality circle are also involved in the implementation and

monitoring of the solution.

This should help to improve the level of motivation amongst the workers because it

makes each person in the group feel valued and that they are making a significant

contribution to the improvements on the factory-floor.

Zero Defects

This is the ultimate objective for a business, to produce every product with no

defects, therefore eliminating waste and the time taken to correct mistakes.

Zero defects can lead to an improved business and customer reputation, as well as

increasing levels of both sales and profitability. In order for the objective of zero

defects to be achieved, it requires the involvement of every employee in the

business, making sure that they are all committed and suitably trained.

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Continuous Improvement (Kaizen)

Kaizen is a Japanese word which means 'change for the better'.

This forms part of the ‗Japanese‘ approach to management, or ‗Lean Production‘.

Kaizen , or ‗Continuous Improvement’ is a policy of constantly introducing small incremental changes in a business in order to improve quality and/or efficiency. This approach assumes that employees are the best people to identify room for improvement, since they see the processes in action all the time. A firm that uses this approach therefore has to have a culture that encourages and rewards employees for their contribution to the process.

Kaizen can operate at the level of an individual, or through Kaizen Groups or Quality Circles which are groups specifically brought together to identify potential improvements. This approach would also be compatible with Team working or Cell Production, as improvements could form an important part of the team‘s aims.

Key features of Kaizen:

Improvements are based on many, small changes rather than the radical changes that might arise from Research and Development

As the ideas come from the workers themselves, they are less likely to be radically different, and therefore easier to implement

Small improvements are less likely to require major capital investment than major process changes

The ideas come from the talents of the existing workforce, as opposed to using R&D, consultants or equipment – any of which could be very expensive

All employees should continually be seeking ways to improve their own performance

It helps encourage workers to take ownership for their work, and can help reinforce team working, thereby improving worker motivation

As Kaizen is characterised by many, small improvements over time, it contrasts with the major leaps seen in industry when radical new technology or production methods have been introduced. Over the years, the sheer volume of Kaizen improvements can lead to major advances for a firm, but managers cannot afford to overlook the need for radical change from time to time. For example, many UK manufacturers and service companies have found it necessary to outsource processes to cheaper centres such as India and China – these changes would be unlikely to arise from Kaizen.

Whilst staff suggestions can help to enrich the work for many employees, Kaizen can be seen as an unrelenting process. Some firms set targets for individuals or for teams to come up with a minimum number of ideas in a period of time. Employees can find this to be an unwelcome pressure, as it becomes increasingly difficult to find further scope for improvement. Some firms, especially Japanese-owned, conduct quality improvement sessions in the workers‘ own time, which can lead to resentment unless there is appropriate recognition and reward for suggestions.

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For Kaizen to be effective there has to be a culture of trust between staff and managers, supported by a democratic structure and a Theory Y view of employees. Good two-way communications and a de-layered organisation would also support this approach. Nevertheless, some workers might see the demands as an extra burden rather than an opportunity and it can take time to embed Kaizen successfully into an organisation‘s culture.

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Section 3: Managing Finance

Budgets

A budget is a financial plan for the future concerning the revenues and costs of a

business. However, a budget is about much more than just financial numbers.

Budgetary control is the process by which financial control is exercised within an

organisation.

Budgets for income/revenue and expenditure are prepared in advance and then

compared with actual performance to establish any variances.

Managers are responsible for controllable costs within their budgets and are

required to take remedial action if the adverse variances arise and they are

considered excessive.

There are many management uses for budgets. For example, budgets are used to:

Control income and expenditure (the traditional use)

Establish priorities and set targets in numerical terms

Provide direction and co-ordination, so that business objectives can be turned

into practical reality

Assign responsibilities to budget holders (managers) and allocate resources

Communicate targets from management to employees

Motivate staff

Improve efficiency

Monitor performance

Whilst there are many uses of budgets, there are a set of guiding principles for good

budgetary control in a business.

In an effective budget system:

Managerial responsibilities are clearly defined – in particular the responsibility

to adhere to their budgets.

Individual budgets lay down a plan of action

Performance is monitored against the budget

Corrective action is taken if results differ significantly from the budget

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Departures from budgets are permitted only after approval from senior

management

Unaccounted for variances are investigated

Budget variances and management by exception

A key word to understand when you are looking at budgets is “variance”

A variance arises when there is a difference between actual and budget figures

Variances can be either:

Positive/favourable (better than expected) or

Adverse/unfavourable ( worse than expected)

A favourable variance might mean that:

Costs were lower than expected in the budget, or

Revenue/profits were higher than expected

By contrast, an adverse variance might arise because:

Costs were higher than expected

Revenue/profits were lower than expected

Should variances be a matter of concern to management? After all, a budget is just

an estimate of what is going to happen rather than reality. The answer is – it

depends.

The significance of a variance will depend on factors such as:

Whether it is positive or negative – adverse variances (negative) should be of

more concern

Was it foreseen?

Was it foreseeable?

How big was the variance - absolute size (in money terms) and relative size

(in percentage terms)?

The cause

Whether it is a temporary problem or the result of a long term trend

―Management by exception‖ is the name given to the process of focusing on

activities that require attention and ignoring those that appear to be running smoothly

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Budget control and analysis of variances facilitates management by exception since

it highlights areas of business performance which are not in line with expectations.

Items of income or spending that show no or small variances require no action.

Instead concentrate on items showing a large adverse variance.

Are all adverse variances bad news?

Here is a point that students often find hard to understand – or believe!

An adverse variance might result from something that is good that has happened in

the business.

For example, a budget statement might show higher production costs than budget

(adverse variance). However, these may have occurred because sales are

significantly higher than budget (favourable budget).

Remember, it is the cause and significance of a variance that matters – not

whether it is favourable or adverse.

Zero-based budgeting

• Start each budget period afresh-not based on historical data

• Budgets are zero unless managers make the case for resources-the relevant manager must justify the whole of the budget allocation

• It means that each activity is questioned as if it were new before any resources are allocated to it.

• Each plan of action has to be justified in terms of total cost involved and total benefit to accrue, with no reference to past activities.

• Zero based budgets are designed to prevent budgets creeping up each year with inflation

Advantages of ZBB

• Forces budget setters to examine every item.

• Allocation of resources linked to results and needs.

• Develops a questioning attitude.

• Wastage and budget slack should be eliminated.

• Prevents creeping budgets based on previous year‘s figures with an added on percentage.

• Encourages managers to look for alternatives.

Disadvantages of ZBB

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• It a complex time consuming process

• Short term benefits may be emphasised to the detriment of long term planning

• Affected by internal politics - can result in annual conflicts over budget allocation

Incremental budget

• This is a budget prepared using a previous period‘s budget or actual performance as a basis with incremental amounts added for the new budget period

• The allocation of resources is based upon allocations from the previous period.

• This approach is not recommended as it fails to take into account changing circumstances

• Moreover it encourages ―spending up to the budget‖ to ensure a reasonable allocation in the next period. It leads to a ―spend it or lose‖ mentality.

Advantages of incremental budgeting

• The budget is stable and change is gradual.

• Managers can operate their departments on a consistent basis.

• The system is relatively simple to operate and easy to understand.

• Conflicts should be avoided if departments can be seen to be treated similarly.

• Co-ordination between budgets is easier to achieve.

• The impact of change can be seen quickly.

Disadvantages of incremental budgeting

• Assumes activities and methods of working will continue in the same way.

• No incentive for developing new ideas.

• No incentives to reduce costs.

• Encourages spending up to the budget so that the budget is maintained next year.

• The budget may become out of date and no longer relate to the level of activity or type of work being carried out.

• The priority for resources may have changed since the budgets were set originally.

• There may be budgetary slack built into the budget, which is never reviewed-managers might have overestimated their requirements in the past in order to obtain a budget which is easier to work to, and which will allow them to achieve favourable results.

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Variances illustrated

Consider the following budget statement:

Item Budget Actual Variance Favourable

£'000 £'000 £'000 or Adverse

SALES REVENUE

Standard product 75 90 15 F

Premium product 30 25 -5 A

Total sales revenue 105 115 10 F

COSTS

Wages 35 38 3 A

Rent 15 17 2 A

Marketing 20 14 -6 F

Other overheads 27 35 8 A

Total costs 97 104 7 A

Profit 8 11 3 F

What do the numbers in the budget statement tell us?

Looking at the sales revenue section, you can see that actual sales of standard

product were £15k higher than budget – this is a positive (favourable) variance.

Turning to the costs section, actual wages were £3k higher than budget – i.e. an

adverse (negative) variance.

Overall, the profit variance was positive (favourable) – i.e. better than budget

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Limitations of budgets

Whilst budgets are widely used to in business, you should appreciate that they have

some important limitations. In particular:

Budgets are only as good as the data being used to create them. Inaccurate

or unreasonable assumptions can quickly make a budget unrealistic

Budgets can lead to inflexibility in decision-making

Budgets need to be changed as circumstances change

Budgeting is a time consuming process – in large businesses, whole

departments are sometimes dedicated to budget setting and control

Budgets can result in short term decisions to keep within the budget rather

than the right long term decision which exceeds the budget

Managers can become too preoccupied with setting and reviewing budgets

and forgetting to focus on the real issues of winning customers

Budgets can also create some behavioural challenges in a business

Budgeting has behavioural implications for the motivation employees

Budgets are de-motivating if they are imposed rather than negotiated

Setting unrealistic targets adds to de-motivation

Budgets contribute to departmental rivalry - battles over budget allocation

Spending up to budget: it can result in a ―use it or lose it‖ mentality - spend up

to the budget to preserve it for next year

Budgetary slack occurs if targets are set too low

A ―name, blame and shame‖ culture can develop - but managers should be

answerable only for variations that were under their control

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Sales Forecasting

Methods – correlation, past-sales data, probability.

Sales forecasting is a difficult area of

management. Most managers believe they are

good at forecasting. However, forecasts made

usually turn out to be wrong! Marketers argue

about whether sales forecasting is a science or

an art. The short answer is that it is a bit of both.

How can sales be increased?

A sales forecast is an attempt by management to estimate the likely revenues of a

product, business unit or market over a future period.

Sales forecasting is a difficult area of management. Most managers believe they are

good at forecasting. However, forecasts made usually turn out to be wrong (or

perhaps it is fairer to say ―inaccurate‖) Marketers argue about whether sales

forecasting is a science or an art. The short answer is that it is a bit of both.

A sales forecast is part of the marketing planning process. Businesses are forced to

look well ahead in order to plan their investments, launch new products, decide when

to close or withdraw products and so on. The sales forecasting process is a critical

one for most businesses. Key decisions that are derived from a sales forecast

include:

- Employment levels & organisational skills required (workforce planning)

- Promotional and distribution mix

- Whether existing and future production capacity is sufficient to meet anticipated

demand

- Management of stocks

Why is sales forecasting important? Because the consequences of getting a sales

forecast wrong can be severe for a business.

For example, a widely inaccurate forecast of likely demand for a new product, or in

response to a changed promotional strategy, may leave a firm with excess capacity

and stocks.

So the key role for sales forecasting is to help managers make decisions about

what resources the business needs in the future.

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Sales Forecasting exercise

Objective: purpose of sales forecasts

to help managers make decisions about what resources the business

needs in the future.

Objective: difficulties of estimation

Changes in the economy, competition,

Methods: extrapolation, correlation, probability.

Enter the following data

Insert a chart from the data. (Ideally a line graph)

Insert a line of best fit (trend line)

Following on from this what would be the expected Sales (forecast) for 2011 & 2012

1. Correlation Is there a Correlation (link) between Advertising and Sales?

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Enter the above data in Excel and create a scatter graph.

Add a trend line/line of best fit. Is there a correlation (+ve/-ve) or non.

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2. Probability

Decision Trees – using expected values and probabilities to determine the success or failure of a project. Eg A company has a choice:

1. Develop a new product 2. Modify the existing one.

If it creates a new product the chance of it being a success are 0.7 and expected sales will be 3 million euros. This gives an expected value of (0.7 * 3) = 2.1 million € The chance of failure of the new product is (0.3) and a loss of -1million €. This gives an expected value of (0.3*-1) = -0.3 € The expected vale of the New Product is 2.1 + (-0.3) = 1.8 million € If it modifies the existing product the chance of it being a success are 0.6 and expected sales will be 2million euros. This gives an expected value of (0.6 * 2) = 1.2 million € The chance of failure of the new product is (0.4) and sales of only 500k €. This gives an expected value of (0.4*0.5) = 0.2 million € The expected value of modifying the existing product is 1.2 + (0.2) = 1.4 million € So choose New product as the value is higher! 1.8 compared to 1.4 million euros! On a decision tree:

Draw a decision tree based on the following:

A company has 2 options A and B.

1.8

1.4

0.7 * 3

0.3 * -1

0.6 * 2

0.4 * 0.5

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Option A has a probability of success of 0.5 and expected returns of 500, 000 euros.

It has a probability of failure of 0.5 and expected loss of (-100,000)

Option B has a probability of high success of 0.2 and expected returns of 200,000

and a probability of low success of 0.8 and expected returns of 100,000.

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Superdry is a large clothes retailer in the UK who sell to a young market

(18-25) year old male and female. Competition is Hollister, Abercrombie,

Levis. Prices are similar.

They have been badly affected by the economic crisis and sales (revenue)

has decreased by 25% over the last 2 years.

Outline a Sales strategy (not profit) that Superdry could adopt to increase

sales.

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Managing Working Capital

Working Capital

Definition of working capital

The net working capital of a business is its current assets less its current

liabilities

Current Assets include:

- Stocks of raw materials - Work-in-progress - Finished goods - Trade

debtors - Prepayments - Cash balances

Current Liabilities include: - Trade creditors - Accruals - Taxation payable -

Dividends payable - Short term loans

Every business needs adequate liquid resources in order to maintain day-to-

day cash flow. It needs enough cash to pay wages and salaries as they fall

due and to pay creditors if it is to keep its workforce and ensure its supplies.

Maintaining adequate working capital is not just important in the short-

term. Sufficient liquidity must be maintained in order to ensure the survival

of the business in the long-term as well.

Even a profitable business may fail if it does not have adequate cash flow to

meet its liabilities as they fall due.

Therefore, when businesses make investment decisions they must not only

consider the financial outlay involved with acquiring the new machine or the

new building, etc, but must also take account of the additional current assets

that are usually involved with any expansion of activity.

Increased production tends to engender a need to hold additional stocks of

raw materials and work in progress. Increased sales usually means that the

level of debtors will increase. A general increase in the firm’s scale of

operations tends to imply a need for greater levels of cash.

Working capital needs

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Different industries have different optimum working capital profiles, reflecting their methods of doing business and what they are selling.

• Businesses with a lot of cash sales and few credit sales should have minimal trade debtors. Supermarkets are good examples of such businesses;

• Businesses that exist to trade in completed products will only have finished goods in stock. Compare this with manufacturers who will also have to maintain stocks of raw materials and work-in-progress.

• Some finished goods, notably foodstuffs, have to be sold within a limited period because of their perishable nature.

• Larger companies may be able to use their bargaining strength as customers to obtain more favourable, extended credit terms from suppliers. By contrast, smaller companies, particularly those that have recently started trading (and do not have a track record of credit worthiness) may be required to pay their suppliers immediately.

• Some businesses will receive their monies at certain times of the year, although they may incur expenses throughout the year at a fairly consistent level. This is often known as ―seasonality‖ of cash flow. For example, travel agents have peak sales in the weeks immediately following Christmas.

Working capital needs also fluctuate during the year

The amount of funds tied up in working capital would not typically be a constant figure throughout the year.

Only in the most unusual of businesses would there be a constant need for working capital funding. For most businesses there would be weekly fluctuations.

Many businesses operate in industries that have seasonal changes in demand. This means that sales, stocks, debtors, etc. would be at higher levels at some predictable times of the year than at others.

In principle, the working capital need can be separated into two parts:

• A fixed part, and

• A fluctuating part

The fixed part is probably defined in amount as the minimum working capital requirement for the year. It is widely advocated that the firm should be funded in the way shown in the diagram below:

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The more permanent needs (fixed assets and the fixed element of working capital) should be financed from fairly permanent sources (e.g. equity and loan stocks); the fluctuating element should be financed from a short-term source (e.g. a bank overdraft), which can be drawn on and repaid easily and at short notice.

The working capital cycle

As an introduction to the working capital cycle, here is a quick reminder of the main types of cash inflow and outflow in a typical business:

Inflows Outflows

Cash sales to customers Purchasing finished goods for re-sale

Receipts from customers who

were allowed to buy on credit

(trade debtors)

Purchasing raw materials and other

components needed for the

manufacturing of the final product

Interest on bank and other

balances

Paying salaries and wages and other

operating expenses

Proceeds from sale of fixed

assets

Purchasing fixed assets

Investment by shareholders Paying the interest on, or repayment

of loans

Paying taxes

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Cash flow can be described as a cycle:

The business uses cash to acquire resources (assets such as stocks) The resources are put to work and goods and services produced. These are

then sold to customers Some customers pay in cash (great), but others ask for time to pay.

Eventually they pay and these funds are used to settle any liabilities of the business (e.g. pay suppliers)

And so the cycle repeats

Hopefully, each time through the cash flow cycle, a little more money is put back into the business than flows out. But not necessarily, and if management don‘t carefully monitor cash flow and take corrective action when necessary, a business may find itself sinking into trouble.

The cash needed to make the cycle above work effectively is known as working capital.

Working capital is the cash needed to pay for the day to day operations of the business.

In other words, working capital is needed by the business to:

Pay suppliers and other creditors Pay employees Pay for stocks Allow for customers who are allowed to buy now, but pay later (so-called

―trade debtors‖)

What is crucially important, therefore, is that a business actively manages working capital. It is the timing of cash flows which can be vital to the success, or otherwise, of the business. Just because a business is making a profit does not necessarily mean that there is cash coming into and out of the business.

There are many advantages to a business that actively manages its cash flow:

It knows where its cash is tied up, spotting potential bottlenecks and acting to reduce their impact

It can plan ahead with more confidence. Management are in better control of the business and can make informed decisions for future development and expansion

It can reduce its dependence on the bank and save interest charges It can identify surpluses which can be invested to earn interest

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Why business fail?

poor sales estimates, Cash flow problems, Poor stock

contro,Changing market conditions.

A loss arises when total costs are more than total

revenues in a period.

Over time, losses generally result in a cash outflow from a business. If the business

does not have sufficient sources of finance to fund these losses, then it will not

survive.

It is important to remember that losses are fairly common in business – particularly

for start-ups or for businesses that are investing in a new product or market.

It is often the case that a business has to incur substantial costs (e.g. research,

design, promotion) before it is able to generate revenues for a new business or

product.

However, sustained or substantial losses place a business in trouble. A high

proportion of start-ups go out of business because they fail to reach profitability. In

other words, they do not manage to reach the break-even output.

Why might a business experience a loss when the business plan or budget expected

a profit? The main reasons are:

• Revenues are lower than expected (the most likely) – entrepreneurs tend to be

over-optimistic with their forecasts for revenues

• The business proves to be less productive or efficient than planned – e.g. it suffers

from a higher degree of wastage during production, or suffers from too much

capacity

• Unexpected costs arise – ether costs that were not planned at all (e.g. a customer

or supplier dispute) or where costs turn out to be much higher than expected

• The business suffers from unexpected changes outside its control – e.g. a rise in

bank interest rates, a sudden change in consumer confidence, poor weather

The response to a loss should include:

- Reviewing the profit and cash flow forecasts to ensure that the business has

sufficient cash to remain viable

- Looking at all major cost categories to see where savings can be made which do

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not damage revenues

- Renewed marketing activities to boost revenues – particularly in the short-term if

cash flow is a problem

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Section 4: Managing people

A Organisational Structure

All businesses are organised into groups of people. This is so the employees can be

organised and controlled to make sure the necessary work is one efficiently. These

groups have managers responsible for them.

There are different ways of organising the business into groups, and each way has

its advantages and disadvantages. There are additional benefits of organising

people into groups, such as making it clearer how communications should be

organised. The development of team-spirit also usually improves motivation and

productivity.

Organisational structure - charting the hierarchy

The simplest way to show how a business is organised is to look at an organisation

chart. This shows the management hierarchy in a business and works from top to

bottom. Here is an example organisational chart:

Hierarchy

The levels of hierarchy refer to the number of layers within an organisation.

Traditional organisations were tall with many layers of hierarchy and were

often authoritarian in nature.

The organisation chart above shows a business with four levels of hierarchy – from

the Managing Director at the top, to assistants and team members at the bottom.

Below is another organisation chart, which shows a taller hierarchy.

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De-layering

Many businesses are moving towards flatter organisational structures through de-

layering.

De-layering involves removing one or more levels of hierarchy from the

organisational structure.

Frequently, the layers removed are those containing middle managers. For example,

many high-street banks no longer have a manager in each of their branches,

preferring to appoint a manager to oversee a number of branches. Some schools

adopt this policy too – with a director of studies looking after several schools in a

local area.

De-layering can offer a number of advantages to business:

It offers opportunities for delegation, empowerment and motivation as the

number of managers is reduced and more authority is given to shop-floor

workers.

It can improve communication within the organisation as messages have to

pass through fewer levels of hierarchy.

It can remove departmental rivalry if department heads are removed as the

workforce is organised in teams.

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It can reduce costs as fewer employees are required and employing middle

managers can be expensive.

But disadvantages exist too, making a decision to delayer less clear cut:

Not all organisations are suited to flatter organisational structures - mass

production industries with low-skilled employees may not adapt easily.

De-layering can have a negative impact on motivation due to job losses,

especially if it is really just an excuse for redundancies.

A period of disruption may occur as people take on new responsibilities and

fulfil new roles.

Those managers remaining will have a wider span of control which, if it is too

wide, can damage communication within the business.

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Organisational structure - span of control

The span of control is the number of subordinates for whom a manager is directly

responsible. The two diagrams below illustrate two different spans of control:

A span of control of 7 would be considered to be quite wide. Contrast this with a

span of 3 below, which would be considered ―narrow‖

Is there an ideal span of control? The answer is generally no – a suitable span of

control will depend upon a number of factors:

The experience and personality of the manager

The nature of the business. If being a line manager requires a great deal of

close supervision, then a narrower span might be appropriate

The skills and attitudes of the employees. Highly skilled, professional

employees might flourish in a business adopting wide spans of control

The tradition and culture of the organisation. A business with a tradition of

democratic management and empowered workers may operate wider spans

of control

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Should spans of control be wide or narrow? Here is a summary of the relative

advantages and disadvantages of each:

Narrow Span of Control Wide Span of Control

Allows for closer supervision of employees Gives subordinates the chance for more

independence

More layers in the hierarchy may be

required

More appropriate if labour costs are

significant – reduce number of managers

Helps more effective communication

Organisational structure - Centralisation v Decentralisation

One of the issues that a business needs to address is where decision-making power

resides in the organisational structure.

Decision-making is about authority. A key question is whether authority should rest

with senior management at the centre of a business (centralised), or whether it

should be delegated further down the hierarchy, away from the centre

(decentralised)

The choice between centralised or decentralised is not an either/or choice. Most

large businesses necessarily involve a degree of decentralisation when it starts to

operate from several locations or it adds new business units and markets.

The issue is really how much independence do business units or groups within a

business have when it comes to the key decisions?

Centralised structures

Businesses that have a centralised structure keep decision-making firmly at the top

of the hierarchy (amongst the most senior management).

Fast-food businesses like Burger King, Pizza Hut and McDonalds use a

predominantly centralised structure to ensure that control is maintained over their

many thousands of outlets. The need to ensure consistency of customer experience

and quality at every location is the main reason.

The main advantages and disadvantages of centralisation are:

Advantages Disadvantages

Easier to implement common policies and

practices for the business as a whole

More bureaucratic – often extra layers in

the hierarchy

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Prevents other parts of the business from

becoming too independent

Local or junior managers are likely to much

closer to customer needs

Easier to co-ordinate and control from the

centre – e.g. with budgets

Lack of authority down the hierarchy may

reduce manager motivation

Economies of scale and overhead

savings easier to achieve

Customer service does not benefit from

flexibility and speed in local decision-

making

Greater use of specialisation

Quicker decision-making (usually) –

easier to show strong leadership

Decentralisation

In a decentralised structure, decision-making is spread out to include more junior

managers in the hierarchy, as well as individual business units or trading locations.

Good examples of businesses which use a decentralised structure include the major

supermarket chains like WM Morrison and Tesco. Each supermarket has a store

manager who can make certain decisions concerning areas like staffing, sales

promotions. The store manager is responsible to a regional or area manager. Hotel

chains are particularly keen on using decentralised structures so that local hotel

managers are empowered to make on-the-spot decisions to handle customer

problems or complaints.

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The main advantages and disadvantages of this approach are:

Advantages Disadvantages

Decisions are made closer to the

customer

Decision-making is not necessarily

―strategic‖

Better able to respond to local

circumstances

More difficult to ensure consistent practices

and policies (customers might prefer

consistency from location to location)

Improved level of customer service May be some diseconomies of scale – e.g.

duplication of roles

Consistent with aiming for a flatter

hierarchy

Who provides strong leadership when

needed (e.g. in a crisis)?

Good way of training and developing

junior management

Harder to achieve tight financial control –

risk of cost-overruns

Should improve staff motivation

Matrix Structures

The matrix structure was first used in the USA and has become more popular within

the UK. This type of structure combines the traditional departments seen in

functional structures with project teams.

For example, a project or task team established to develop a new product might

include engineers and design specialists as well as those with marketing, financial,

personnel and production skills. These teams can be temporary or permanent

depending on the tasks they are asked to complete. Each team member can end up

with two line managers - their normal departmental manager as well as the manager

of the project.

Matrix structures have advantages and disadvantages.

Advantages

Can help to break down traditional department barriers, improving

communication across the entire organisation.

Can allow individuals to use particular skills within a variety of contexts.

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Avoid the need for several departments to meet regularly, so reducing costs

and improving coordination.

Disadvantages

Members of project teams may have divided loyalties as they report to two

line managers. Equally, this scenario can put project team members under a

heavy pressure of work.

There may not be a clear line of accountability for project teams given the

complex nature of matrix structures.

Chain of command

In an organizational structure, ―chain of

command‖ refers to a company's

hierarchy of reporting relationships --

from the bottom to the top of an

organization, who must answer to

whom. The chain of command not only

establishes accountability, it lays out a

company‘s lines of authority and

decision-making power. A proper chain

of command ensures that every task, job

position and department has one person

assuming responsibility for performance.

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Recruitment & Training

The Recruitment Process

For most businesses, large or small, the task of identifying what work needs doing

and who should do it is a continuous challenge!

It is rare that a business of any size operates for long without having to recruit or

remove employees. For example, consider why a business might need to recruit

staff:

Business expansion due to

o Increasing sales of existing products

o Developing new products

o Entering new markets

Existing employees leave:

o To work with competitors or other local employers

o Due to factors such as retirement, sick leave, maternity leave

Business needs employees with new skills

Business is relocating – and not all of existing workforce want to move to new

location

The world of work is also changing rapidly:

Increase in part-time working

Increased number of single-parent families

More women seeking work

Ageing population

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Greater emphasis on flexible working hours

Technology allows employees to communicate more effectively whilst apart

People rarely stay in the same job for life

Businesses need to understand and respond to these changes if they are to recruit

staff of the right standard – and keep them!

So what is workforce planning?

Workforce planning is about deciding how many and what types of workers are

required

There are several steps involved in workforce planning:

The workforce plan establishes what vacancies exist

Managers produce a job description and job specification for each post

Job description

Detailed explanation of the roles and responsibilities of the post advertised

Most applicants will ask for this before applying for the job

Refers to the post available rather than the person

Job specification

Sets out the kind of qualifications, skills, experience and personal attributes a

successful candidate should possess.

A vital tool in assessing the suitability of job applicants

Refers to the person rather than the post

Internal and external recruitment

A manager can recruit in two different ways:

Internal recruitment is when the business looks to fill the vacancy from within

its existing workforce

External recruitment is when the business looks to fill the vacancy from any

suitable applicant outside the business

Of course, the option to use BOTH internal and external recruitment can be used.

This is often the case for senior management appointments.

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Advantages Disadvantages

Internal

Recruitment

Cheaper and quicker to recruit Limits the number of potential

applicants

People already familiar with the

business and how it operates

No new ideas can be introduced

from outside

Provides opportunities for promotion

with in the business – can be

motivating

May cause resentment amongst

candidates not appointed

Business already knows the

strengths and weaknesses of

candidates

Creates another vacancy which

needs to be filled

External

Recruitment

Outside people bring in new ideas Longer process

Larger pool of workers from which to

find the best candidate

More expensive process due to

advertising and interviews

required

People have a wider range of

experience

Selection process may not be

effective enough to reveal the

best candidate

The four most popular ways of recruiting externally are:

Job centres – Government agencies to help the unemployed find jobs or get

training

Job advertisements - the most common form of external recruitment. Where

a business chooses to advertise will depend on the cost of advertising and the

coverage needed (i.e. how far away people will consider applying for the job)

Recruitment agency - Provides employers with details of suitable candidates

for a vacancy and can sometimes be referred to as ‗head-hunters‘. They work

for a fee and often specialise in particular employment areas e.g. nursing,

financial services, teacher recruitment

Personal recommendation - Often referred to as ‗word of mouth‘ and can be a

recommendation from a colleague at work. A full assessment of the

candidate is still needed however but potentially it saves on advertising cost

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When recruiting externally, the business will almost certainly have to produce a job

advertisement. The objectives of the advertisement are to:

Inform audience of potential candidates about opportunity

Provide enough information to both inform and interest possible applicants

Help ―screen‖ or dissuade unsuitable applicants

Obtain most number of suitably qualified applicants for post advertised

.

Other selection tests can increase the chances of choosing the best applicant and so

minimise the high costs of recruiting the wrong people. Examples of these tests are

aptitude tests, intelligence tests and psychometric tests (to reveal the personality of a

candidate).

Managers selecting candidates for a high level post in an organisation may even

send applicants to an assessment centre. In such centres candidates undergo a

variety of tests, role-plays and simulations for a number of days.

Once the best candidate has been selected and agreed to take up the post, the new

employee must be given an employment contract. This is an important legal

document that describes the obligations of the employee and employer to each other

(terms and conditions) as well as the initial remuneration package and a number of

other important details.

Job analysis: The management of a business need to determine what work needs

to be done. Job analysis is a key part of this need.

Job analysis concentrates on what job holders are expected to do. It provides the

basis for a job description, which in turn influences decisions taken on recruitment,

training, performance appraisal and reward systems.

A job analysis would typically contain:

Job purpose What is the job meant to do - and how does this related to

other parts of the business?

Job content Duties and responsibilities

Accountabilities What results / outputs is the job holder responsible for?

Performance criteria How will the job holder's performance be measured?

Resource E.g. equipment, location

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requirements

How is a job analysis carried out?

Several techniques should be used to complete an effective job analysis:

- Research business documents - e.g. procedures manuals

- Ask relevant managers about the requirements and purpose of the job; what are

the key activities; what relationships does the job have with other posts. Develop a

comprehensive profile through these discussions

What is a person specification?

A person specification describes the requirements a job holder needs to be able to perform the job satisfactorily. These are likely to include:

- Education and qualifications

- Training and experience

- Personal attributes / qualities

How does this compare with a job description?

A job description describes the job; a person specification describes the person needed to do the job. A person specification can, therefore, form the basis for the selection of the most suitable person to fill the job.

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Training (introduction)

The process of increasing the knowledge and skills of the workforce to enable them to perform their jobs effectively

Training is, therefore, a process whereby an individual acquires job-related skills and knowledge.

Training costs can be significant in any business. However, many employers are prepared to incur these costs because they expect their business to benefit from employees' development and progress.

Training takes place at various points and places in a business. Commonly, training is required to:

Support new employees (―induction training‖) Improve productivity Increase marketing effectiveness Support higher standards of customer service and production quality Introduction of new technology, systems or other change Address changes in legislation Support employee progression and promotion

Effective training has the potential to provide a range of benefits for a business:

Higher quality Better productivity Improved motivation - through greater empowerment More flexibility through better skills Less supervision required (cost saving in supervision) Better recruitment and employee retention Easier to implement change in the business Effective training starts with a ―training strategy‖. The three stages of a

training strategy are: Identify the skills and abilities needed by employees Draw up an action plan to show how investment in training and development

will help meet business goals and objectives Implement the plan, monitoring progress and training effectiveness Given the costs involved, you might not be surprised to learn that many

businesses do not invest enough in training. Some firms don‘t invest anything in training! Here are the most common

reasons for under-investment in training: They fear employees will be poached by competitors (who will then benefit

from the training) A desire to minimise short-term costs They cannot make a justifiable investment case Training takes time to have the desired effect – management are impatient! Sometimes the benefits of training are more intangible (e.g. morale) than

tangible – so they are harder to measure

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Induction training

Induction training is training given to new employees.

The purpose of the induction period (which may be a few hours or a few days) is to help a new employee settle down quickly into the job by becoming familiar with the people, the surroundings, the job and the business.

It is important to give a new employee a good impression on the first day of work. However, the induction programme should not end there.

It is also important to have a systematic induction programme, spread out over several days, to cover all the ground in the shortest effective time.

Devising an effective induction training programme

The induction programme should be drawn up in consultation with all those involved. Depending on the size and complexity of the business this may include:

• Senior management (including directors)

• Supervisors or line managers

• Personnel officers

• Health and Safety managers

• Employee or trade union representatives

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What induction training involves

Usually induction involves the new employee meeting and listening to different people talk about aspects of the business.

Other methods include written information, audio visual aids and group discussion.

The following items should be covered in an effective induction programme:

• Introduction to the business/department and its personnel/management structure

• Layout of the buildings (factory / offices)

• Terms and conditions of employment (explaining the contract of employment)

• Relevant personnel policies, such as training, promotion and health and safety

• Business rules and procedures

• Arrangements for employee involvement and communication

• Welfare and employee benefits or facilities

On-the-job training

With on the job training, employees receive training whilst remaining in the workplace.

The main methods of one-the-job training include:

Demonstration / instruction - showing the trainee how to do the job Coaching - a more intensive method of training that involves a close working

relationship between an experienced employee and the trainee Job rotation - where the trainee is given several jobs in succession, to gain

experience of a wide range of activities (e.g. a graduate management trainee might spend periods in several different departments)

Projects - employees join a project team - which gives them exposure to other parts of the business and allow them to take part in new activities. Most successful project teams are "multi-disciplinary"

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The advantages and disadvantages of this form of training can be summarised as follows:

Advantages Disadvantages

Generally most cost-effective Employees are actually productive Opportunity to learn whilst doing Training alongside real colleagues

Quality depends on ability of trainer and time available Bad habits might be passed on Learning environment may not be conducive Potential disruption to production

Off-the-job training: occurs when employees are taken away from their place of

work to be trained. Common methods of off-the-job training include:

Day release (employee takes time off work to attend a local college or training centre)

Distance learning / evening classes

Block release courses - which may involve several weeks at a local college

Sandwich courses - where the employee spends a longer period of time at college (e.g. six months) before returning to work

Sponsored courses in higher education

Self-study, computer-based training

The main advantages and disadvantages of this form of training can be summarised as follows:

Advantages Disadvantages

A wider range of skills or qualifications can be obtained Can learn from outside specialists or experts Employees can be more confident when starting job

More expensive – e.g. transport and accommodation Lost working time and potential output from employee New employees may still need some induction training Employees now have new skills/qualifications and may leave for better jobs

.

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Motivation of staff

What is Motivation?

"Motivation is a decision-making process, through which the individual chooses the desired outcomes and sets in motion the behaviour appropriate to them".

Motivation can therefore be thought of as the degree to which an individual wants AND chooses to engage in certain behaviours.

For example: are you motivated to study? The answer lies in whether you

(1) Want to study - what are the reasons, if so?

(2) Choose to study? - Why are you reading these revision notes? What factors mean that you have taken the decision to study? How much effort do you put in?

Individual behaviour is at the heart of human motivation

Why is individual behaviour so important in trying to understand and then influence motivation?

- Every individual has a set of needs and a different set of goals

- Individuals behave in a way as to satisfy their needs and fulfil their goals

- Therefore, individuals behave differently!

- Businesses, as organisations, are in a position to offer some of the satisfactions that individuals seek:

E.g. - Relationships; sense of belonging; intellectual stimulation; mental & physical challenge; self-development

Why is motivation important for businesses?

It is often said that the best businesses have the best motivated workers. Why might this be important? Because well-motivated employees are usually characterised by:

- Higher productivity (i.e. they produce more for a given level of resources than poorly-motivated workers)

- Better quality work with less wastage

- A greater sense of urgency (things happen quicker - when they need to)

- More employee feedback and suggestions made for improvements (motivated workers take more "ownership" of their work")

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More feedback demanded from superiors and management

Working at 80-95% of their ability

Motivation in theory - Maslow's hierarchy of needs

Maslow's Hierarchy of Needs is a "content theory" of motivation" (the other main one is Herzberg's Two Factor Theory).

Maslow's theory consisted of two parts:

(1) The classification of human needs, and

(2) Consideration of how the classes are related to each other

The classes of needs were summarised by Maslow as follows:

How does the Hierarchy Work?

- A person starts at the bottom of the hierarchy (pyramid) and will initially seek to satisfy basic needs (e.g. food, shelter)

- Once these physiological needs have been satisfied, they are no longer a motivator. the individual moves up to the next level

- Safety needs at work could include physical safety (e.g. protective clothing) as well as protection against unemployment, loss of income through sickness etc)

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- Social needs recognise that most people want to belong to a group. These would include the need for love and belonging (e.g. working with colleague who support you at work, teamwork, communication)

- Esteem needs are about being given recognition for a job well done. They reflect the fact that many people seek the esteem and respect of others. A promotion at work might achieve this.

- Self-actualisation is about how people think about themselves - this is often measured by the extent of success and/or challenge at work

Maslow's model has great potential appeal in the business world. The message is clear - if management can find out which level each employee has reached, then they can decide on suitable rewards.

Applying Maslow to business

Maslow's hierarchy Business examples

Step 5 - Self-actualisation

Opportunities for creativity and personal growth, promotion

Step 4 - Esteem needs

Fancy job title, recognition of achievements

Step 3 - Social needs

Good team atmosphere, friendly supervision

Step 2 - Safety needs

Safe working conditions, job security

Step 1 - Physiological needs

Salary, decent working environment

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Problems with the Maslow Model

There are several problems with the Maslow model when real-life working practice is considered:

- Individual behaviour seems to respond to several needs - not just one

- The same need (e.g. the need to interact socially at work) may cause quite different behaviour in different individuals

- There is a problem in deciding when a level has actually been "satisfied"

- The model ignores the often-observed behaviour of individuals who tolerate low-pay for the promise of future benefits

- There is little empirical evidence to support the model. Some critics suggest that Maslow's model is only really relevant to understanding the behaviour of middle-class workers in the UK and the USA (where Maslow undertook his research).

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Motivation in theory - Herzberg two factor theory

Herzberg analysed the job attitudes of 200 accountants and engineers who were asked to recall when they had felt positive or negative at work and the reasons why.

From this research, Herzberg suggested a two-step approach to understanding employee motivation and satisfaction:

Hygiene Factors

Hygiene factors are based on the need to for a business to avoid unpleasantness at work. If these factors are considered inadequate by employees, then they can cause dissatisfaction with work. Hygiene factors include:

- Company policy and administration

- Wages, salaries and other financial remuneration

- Quality of supervision

- Quality of inter-personal relations

- Working conditions

- Feelings of job security

Motivator Factors

Motivator factors are based on an individual's need for personal growth. When they exist, motivator factors actively create job satisfaction. If they are effective, then they can motivate an individual to achieve above-average performance and effort. Motivator factors include:

- Status

- Opportunity for advancement

- Gaining recognition

- Responsibility

- Challenging / stimulating work

- Sense of personal achievement & personal growth in a job

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There is some similarity between Herzberg's and Maslow's models. They both suggest that needs have to be satisfied for the employee to be motivated. However, Herzberg argues that only the higher levels of the Maslow Hierarchy (e.g. self-actualisation, esteem needs) act as a motivator. The remaining needs can only cause dissatisfaction if not addressed.

Applying Hertzberg's model to de-motivated workers

What might the evidence of de-motivated employees be in a business?

- Low productivity

- Poor production or service quality

- Strikes / industrial disputes / breakdowns in employee communication and relationships

- Complaints about pay and working conditions

According to Herzberg, management should focus on rearranging work so that motivator factors can take effect. He suggested three ways in which this could be done:

- Job enlargement

- Job rotation

- Job enrichment

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Motivation in Theory - Taylor & Scientific Management

Taylor developed his theory of "scientific management" as he worked his way up from a labourer to a works manager in a US steelworks.

From his observations, Taylor made three key assumptions about human behaviour at work:

(1) Man is a rational economic animal concerned with maximising his economic gain;

(2) People respond as individuals, not as groups

(3) People can be treated in a standardised fashion, like machines

Taylor had a simple view about what motivated people at work - money. He felt that workers should get a fair day's pay for a fair day's work, and that pay should be linked to the amount produced (e.g. piece-rates). Workers who did not deliver a fair day's work would be paid less (or nothing). Workers who did more than a fair day's work (e.g. exceeded the target) would be paid more.

The implications of Taylor's theory for managing behaviour at work were:

- The main form of motivation is high wages, linked to output

- A manager's job is to tell employees what to do

- A worker's job is to do what they are told and get paid accordingly

Weaknesses in Taylor's Approach

The most obvious weakness in Taylor's approach is that it ignores the many differences between people. There is no guarantee that a "best way" will suit everyone.

Secondly, whilst money is an important motivation at work for many people, it isn't for everyone. Taylor overlooked the fact that people work for reasons other than financial reward.

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Elton Mayo

Elton Mayo (1880 – 1949) believed that workers are not just concerned with money but could be better motivated by having their social needs met whilst at work (something that Taylor ignored). He introduced the Human Relation School of thought, which focused on managers taking more of an interest in the workers, treating them as people who have worthwhile opinions and realising that workers enjoy interacting together.

Mayo conducted a series of experiments at the Hawthorne factory of the Western Electric Company in Chicago

He isolated two groups of women workers and studied the effect on their productivity levels of changing factors such as lighting and working conditions.

He expected to see productivity levels decline as lighting or other conditions became progressively worse

What he actually discovered surprised him: whatever the change in lighting or working conditions, the productivity levels of the workers improved or remained the same.

From this Mayo concluded that workers are best motivated by:

Better communication between managers and workers ( Hawthorne workers were consulted over the experiments and also had the opportunity to give feedback)

Greater manager involvement in employees working lives ( Hawthorne workers responded to the increased level of attention they were receiving)

Working in groups or teams. ( Hawthorne workers did not previously regularly work in teams)

In practice therefore businesses should re-organise production to encourage greater use of team working and introduce personnel departments to encourage greater manager involvement in looking after employees‘ interests. His theory most closely fits in with a paternalistic style of management.

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Motivation in theory - McGregor Theory X & Theory Y

Introduction

McGregor developed two theories of human behaviour at work: Theory and X and Theory Y.

He did not imply that workers would be one type or the other. Rather, he saw the two theories as two extremes - with a whole spectrum of possible behaviours in between.

Theory X workers could be described as follows:

- Individuals who dislike work and avoid it where possible

- Individuals who lack ambition, dislike responsibility and prefer to be led

- Individuals who desire security

The management implications for Theory X workers were that, to achieve organisational objectives, a business would need to impose a management system of coercion, control and punishment.

Theory Y workers were characterised by McGregor as:

- Consider effort at work as just like rest or play

- Ordinary people who do not dislike work. Depending on the working conditions, work could be considered a source of satisfaction or punishment

- Individuals who seek responsibility (if they are motivated0

The management implications for Theory X workers are that, to achieve organisational objectives, rewards of varying kinds are likely to be the most popular motivator. The challenge for management with Theory Y workers is to create a working environment (or culture) where workers can show and develop their creativity.

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Motivation in practice - financial incentives

Although some theorists like Herzberg believe that money is not a positive motivator (although lack of it can de-motivate), pay systems are designed to motivate employees.

The scientific / Theory X approach, in particular, argues that workers respond to financial rewards.

Getting employee pay right (often referred to as the ―remuneration package‖) is a crucial task for a business.

Why is pay important?

• It is an important cost for a business (in some ―labour-intensive‖ businesses, payroll costs are over 50% of total costs)

• People feel strongly about it. Pay helps to satisfy many needs (e.g. security, esteem needs, resources to pursue self-actualisation)

• Pay is the subject of much important business legislation (e.g. national minimum wage; equal opportunities legislation)

• It helps attract reliable employees with the skills the business needs for success

• Pay also helps retain employees – rather than them leave and perhaps join a competitor

• For most employees, the remuneration package is the most important part of a job – and certainly the most visible part of any job offer.

There are many methods of financial reward (these are covered in separate revision notes)

• Time-rate pay • Piece-rate pay • Commission • Performance-related pay • Bonuses • Shares and options • Benefits in kind (“fringe benefits”) • Pensions

Because pay is a complex issue, there are several ways in which businesses determine how much to pay, and which methods to use:

• Job evaluation / content; this is usually the most important factor. What is involved in the job being paid? How does it compare with similar jobs?

• Fairness – pay needs to be perceived and be seen to match the level of work

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• Negotiated pay rates – the rate of pay may have been determined elsewhere and the business needs to ensure that it complies with these rates.

• Market rates – another important influence – particularly where there is a standard pattern of supply and demand in the relevant labour market. If a business tries to pay below the ―market rate‖ then it will probably have difficulty in recruiting and retaining suitable staff

• Individual performance – increasingly, businesses include an element of ―performance-related‖ reward in their pay structures.

However, it is important to remember that pay is only one element of motivation and will work best where management also give attention to:

• Developing good management and supervision; • Designing jobs and organising work groups to make them as satisfying as possible; • Providing feedback to staff about their performance and training and development; • Making effective arrangements for communications and consultation.

Financial motivation - Structuring the Pay Package

With so many methods of pay available, how should a business decide to structure the pay package it offers to employees, and what rate of pay should it use?

Start with the “Market Rate”

The starting point is usually to find out what the ―market rate‖ is. Paying the market rate involves careful job evaluation (it helps to know what is being compared to what!).

Factors that help determine the market rate for a job include:

• Whether the skills that are required are widely available • The overall level of unemployment in the employment ―catchment area‖ • Whether the job requires specialised (or even highly specialised) skills

There are several ways in which a business can obtain data on market rates:

• Local employment agencies • Job centres • Job adverts in national newspapers of specialist publications (e.g. professional journals) • Commission (or contribute towards) a specific salary survey in the industry

More or Less?

The next question is – should the business pay MORE or LESS than the market rate? Factors to consider here include:

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• Does the business need above-average employees (e.g. salesmen with an industry reputation for being strong performers) • Does the business need trained employees or is it prepared to invest in training beginners? • Are the skills wanted by the business needed urgently (in which case – the business would probably want to pay more) • Do factors affecting the mobility of labour need to be addressed – e.g. are there transport problems that need to be solved (e.g. pay for a rail season ticket) or relocation allowances to be offered to encourage new employees to move home?

Structure

The third important question is how to structure the remuneration package.

• Should employees be paid on the basis of time spent working (e.g. time-rates) or the amount they produce (e.g. piece rates) or some other measure of performance?

• Should the remuneration package be a combination of approaches (e.g. some basic pay per month + a commission-related incentive)?

• What kind of remuneration package is used by competitors - this may provide a useful guide as to how to structure the package (and it may also influence what employees expect)

In deciding the answers to these questions, a business should try to construct a pay structure that is simple (to help employees understand it), logical and fair.

Financial motivation - time-rate pay

Time rates are used when employees are paid for the amount of time they spend at work. This is the most common method of payment in the UK.

The usual form of time rate is the weekly wage or monthly salary. Usually the time rate is fixed in relation to a standard working week (e.g. 35 hours per week).

The employment contract for a time-rate employee will also stipulate the amount of paid leave that the employee can take each year (e.g. 5 weeks paid holiday).

Time worked over this standard is known as overtime. Overtime is generally paid at a higher rate than the standard time-rate – reflecting the element of sacrifice by an employee. However, many employees who are paid a monthly salary do not get paid overtime. This is usually the case for managerial positions where it is generally accepted that the hours worked need to be sufficient to fulfil the role required.

The main advantages of time-rate pay are:

• Time rates are simple for a business to calculate and administer

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• They are suitable for businesses that wish to employ staff to provide general roles (e.g. financial management, administration, maintenance) where employee productivity is not easy to measure

• It is easy to understand from an employee‘s perspective

• The employee can budget personal finance with some certainty

• Makes it easier for the employer to plan and budget for employee costs (e.g. payroll costs will be a function of overall headcount rather than estimated output)

The main disadvantages of time-rate pay are:

• Does little to encourage greater productivity – there is no incentive to achieve greater output

• Time-rate payroll costs have a tendency to creep upwards (e.g. due to inflation-related pay rises and employee promotion.

Financial motivation - piece rate pay

Piece-rate pay gives a payment for each item produced – it is therefore the easiest way for a business to ensure that employees are paid for the amount of work they do. Piece-rate pay is also sometimes referred to as a ―payment by results system‖.

Piece-rate pay encourages effort, but, it is argued, often at the expense of quality. From the employee‘s perspective, there are some problems. What happens if production machinery breaks down? What happens if there is a problem with the delivery of raw materials that slows production? These factors are outside of the employee‘s control – but could potentially affect their pay.

The answer to these problems is that piece-rate pay systems tend, in reality, to have two elements:

• A basic pay element – this is fixed (time-based)

• An output-related element (piece-rate). Often the piece-rate element is only triggered by the business exceeding a target output in a defined period of time

• Production of garments and shoes • Assembly of electronic, plastic and metal components • Many kinds of packing work • Weaving and dyeing of textiles in the traditional sectors • Handicraft work • Sewing and knitting garments • Assembling toys • Data-processing

It used to be thought that home-based work was an old-fashioned form of employment that would die out with the rise of modern industry. However, over the

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last 20 years much large-scale industry has reorganised its production, subcontracting work to smaller companies, often in other countries. At the end of the chain there are often informal workshops and home-based workers.

Subcontracted homework is a form of production which allows companies to reduce their costs by:

• Outsourcing production to lower-paid workers, usually without formal contracts, employment and social protection or even a regular supply of work

• Passing on some of the costs of heating, lighting and storage to the workers themselves

• Avoiding responsibility for health and safety for these workers

• Using home-based workers as a source of flexible labour

Some of the problems faced by home-based workers include:

• Irregular work – and therefore irregular income • Earnings well below average • No economic or social security for sickness, maternity or old age • Long working hours • Potential health problems caused by repetitive processes and inadequate health and safety

Motivation in practice - commission

Commission is a payment made to employees based on the value of sales achieved. It can form all or part of a pay package. Commission is, therefore, a form of “incentive pay‖ (see also performance-related pay, bonuses).

Commission, like piece-rates, is a reward for the quantity or value of work achieved. In most cases, the employee is paid a flat percentage of the value of the good or service that is sold.

The rate of commission depends on the selling price and the amount of effort required in making the sale.

For example, commission rates could range from 5% where the product sells easily (e.g. household goods sold door-to-door) to 30% where the effort is substantial.

Advantages of Commission

The main advantage of commission from an employee‘s point-of-view is that it enables high performing sales people to earn huge amounts.

The main advantage to the employer is that the payroll cost is related to the value of business achieved rather than just the amount produced. After all, businesses exist

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to sell goods and services for profit – not just to make things (piece rates simply reward amounts produced, not sold).

Disadvantages of Commission

There are several drawbacks with using commission payments:

• Sales people may cut corners to make sales (e.g. not explain the product or service in enough detail to potential customers). This was a major problem in the recent pensions mis-selling scandal in the UK

• High commission earnings enjoyed by some of the sales team may be resented elsewhere in the business – particularly if the sales actually depend on a team effort

• It is difficult to change what proves to be an over-generous commission structure without upsetting and demoralising the sales team

• Once commission payments have been made, the sales force may lose some motivation until they begin to focus on the next payment (which might be up to 12 months away)

As a result of the above disadvantages, most businesses that use commission as an incentive payment method offer a basic pay plus a moderate commission level. In this way, if sales and profits justify the change, the commission rate can always be increased slightly.

Recent research suggests that the use of commission is reducing in comparison with the growth of other incentive payment methods.

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Financial motivation - Performance related pay

Performance-related pay is a financial reward to employees whose work is:

• Considered to have reached a required standard, and/or

• Is above average

Performance related pay is generally used where employee performance cannot be appropriately measured in terms of output produced or sales achieved. Like piece-rates and commission, performance related pay is a form of incentive pay.

Whilst the detail of performance-related schemes varies from business to business, there are several common features:

• Individual performance is reviewed regularly (usually once per year) against agreed objectives or performance standards. This is the performance appraisal.

• At the end of the appraisal, employees are categorised into performance groups – which determine what the reward will be (if any)

• The method of reward will vary, but traditionally it involves a cash bonus and/or increase in wage rate or salary.

Performance-related pay has grown widely in recent years – particularly in the public sector. This is part of a movement towards rewarding individual performance which reflects individual circumstances.

According the Equal Opportunities Commission, a well-designed performance-related pay scheme would have the following elements:

• Objective setting • Communication and understanding of objectives • Consideration of performance against objectives • Translation of evaluation into performance rating • A link between ratings and the determination of pay • A separate appeals procedure

Disadvantages of Performance Related Pay

There are several problems with performance-related pay:

• There may be disputes about how performance is measured and whether an employee has done enough to be rewarded

• Rewarding employees individually does very little to encourage teamwork

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• It may encourage unhealthy rivalry between managers

• There is much doubt about whether performance-related pay actually does anything to motivate employees. This may be because the performance element is usually only a small percentage of total pay.

Financial motivation - share options

Offering employees shares in a business is an increasingly popular part of pay packages – particularly for businesses whose shares are traded on a stock exchange.

Offering shares is a more complicated kind of reward than paying employees cash. However, it can be much more effective in linking the objectives of the business (e.g. profit maximisation) and the objectives of employees (e.g. make a large gain on the value of shares held).

This payment method also encourages employees to commit to the business in the longer-term.

There are various schemes available which companies can use to offer shares as part of the remuneration package:

Employee Share Ownership Plans (“ESOP’s”)

ESOP‘s involve setting up a trust into which a company offers shares in the business. In the UK, a company using an ESOP can give employees shares worth up to £3,000 each year. The gains made on these shares are free of tax (capital gains tax) as long as they are held in trust for more than five years.

Share Option Schemes

These are popular ways of incentivising senior management and key employees. Under a share option scheme, selected employees are given the right to buy shares at their current price, at a later date. If the shares increase in value in the meantime, employees will make an immediate profit when the ―exercise‖ their options.

In the UK, employees may hold options on shares worth up to £30,000. The option can be exercised after three years but not later than ten years. Again, there is no tax paid on any gains made by exercising these options.

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Non-financial motivation

What is Job Rotation?

Job rotation involves the movement of employees through a range of jobs in order to increase interest and motivation.

Job rotation can improve ―multi-skilling‖ but also involves the need for greater training.

In a sense, job rotation is similar to job enlargement. This approach widens the activities of a worker by switching him or her around a range of work.

For example, an administrative employee might spend part of the week looking after the reception area of a business, dealing with customers and enquiries. Some time might then be spent manning the company telephone switchboard and then inputting data onto a database.

Job rotation may offer the advantage of making it easier to cover for absent colleagues, but it may also reduce' productivity as workers are initially unfamiliar with a new task.

Why is Job Rotation Important?

Job rotation is seen as a possible solution to two significant challenges faced by business:

(1) Skills shortages and skills gaps, and

(2) Employee motivation

Skills shortages occur when there is a lack of skilled individuals in the workforce.

Skills gaps occur when there is a lack of skills in a company‘s existing workforce which may still be found in the labour force as a whole.

According to the Treasury and DfES, both skills shortages and gaps are major problems acting as major barriers to economic growth and the reduction in long-term unemployment in the UK.

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What is Job Enlargement?

Job enlargement (sometimes also referred to as ―horizontal loading‖) involves the addition of extra, similar, tasks to a job.

In job enlargement, the job itself remains essentially unchanged. However, by widening the range of tasks that need to be performed, hopefully the employee will experience less repetition and monotony that are common on production lines which rely upon the division of labour.

With job enlargement, the employee rarely needs to acquire new skills to carry out the additional task, and the motivational benefits of job enrichment are not usually experienced.

One important negative aspect is that job enlargement is sometimes viewed by employees as a requirement to carry out more work for the same amount of pay.

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Motivation - Delegation & Empowerment

Delegation involves the assignment to others of the authority for particular functions, tasks, and decisions. The main advantages and disadvantages of delegation can be summarised as follows:

Advantages Disadvantages

Reduces management stress and workload Allows senior management to focus on key tasks Subordinates are empowered and motivated Better decisions or use of resources (potentially) Good method of on-the-job training

Cannot / should not delegate responsibility Depends on quality / experience of subordinates Harder in a smaller firm May increase workload and stress of subordinates

Empowerment Empowerment is giving employees the power to do their job. The aim of empowerment is that

The concept of empowerment is closely linked to motivation and customer service. Employees need to feel that their actions count – and empowerment is about making this happen.

Empowerment is a catch-all term that covers:

Giving authority to make decisions to front-line staff (e.g. hotel receptionist, call centre assistant)

Encouraging employee feedback Showing more trust in employees

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Reduction of labour costs

Objectives: flexible employment, flexible working, reducing

staff costs.(dismissal/redundancy)

What is a temporary worker?

A temporary worker is someone employed for a limited period whose job is usually

expected by both sides to last for only a short time. Temporary workers may be

employed directly by the employer or by private agencies. Agencies will recruit,

select and sometimes train temporary workers and hire them out to employers.

Temporary workers are sometimes employed on fixed term contracts. A fixed term

contract is a contract of employment for a definite period, set in advance.

Employment ends when the contract expires and no notice need be given by the

employer. Employment contracts may also be agreed which end on the completion

of a particular task rather than on a specific date.

What are the legal aspects of temporary working?

UK employment law makes no distinction between ‗permanent‘ and ‗temporary‘

employees. To qualify for various employment rights, however, employees must

have served a minimum period of continuous employment with their employer.

Most temporary workers will have insufficient service. However, some employment

rights – such as the right not to be discriminated against on the grounds of race, sex

or disability – have no minimum service qualifications.

Employees on fixed term contracts have the right to be paid the same rate as similar

permanent employees working for the same employer and in general terms should

not be treated less favourably than permanent employees. This means that

employees on fixed term contracts will have broadly the same rights to statutory

redundancy payments, written reasons for dismissal and the right not to be unfairly

dismissed as permanent employees.

Advantages of Temporary Working

- Temporary workers can provide greater flexibility because the number employed

can vary to take account of changes in demand for the product or service

- Temporary workers can also provide cover for permanent staff on holiday,

maternity leave or sick leave

- Temporary employees can provide specialist skills to carry out specific projects

- Some businesses use temporary fixed term contracts as a screening device for

potential recruits to the permanent workforce

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Disadvantages of Temporary Working

- Some employers find that temporary workers lack motivation and commitment

- Businesses which use agency ‗temps‘ depend on the screening and testing

methods used by the agency

- Agency workers can sometimes receive higher pay than their permanent

counterparts, which can cause resentment amongst employees and trade unions.

Making a Success of Using Temporary Workers

There are several things a business should do if it is to make temporary working a

successful part of its workforce planning:

- Avoid using temporary contracts when the job is in reality permanent

- Consider the likely cost of using temporary workers compared to permanent

workers

- Consult with managers to determine their views on the possible effects of

employing temporary workers

- Agree proposals to use temporary workers with recognised trade unions

- Where temporary workers are recruited through an employment agency, contact

several agencies to compare the services they provide, including their screening and

testing methods

- Provide temporary workers or the employment agency with job descriptions and

information on company benefits, rules and regulation

- Give temporary workers a written statement of their main terms and conditions of

employment.

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What is "labour turnover"?

Labour turnover refers to the movement of employees in and

out of a business. However, the term is commonly used to refer

only to ‗wastage‘ or the number of employees leaving.

High labour turnover causes problems for business. It is costly, lowers productivity

and morale and tends to get worse if not dealt with.

Measuring labour turnover

The simplest measure involves calculating the number of leavers in a period (usually

a year) as a percentage of the number employed during the same period. This is

known as the "separation rate" or "crude wastage rate" and is calculated as follows:

= Number of leavers / average no employed x 100

For example, if a business has 150 leavers during the year and, on average, it

employed 2,000 people during the year, the labour turnover figure would be 7.5%

Labour turnover will vary between different groups of employees and measurement

is more useful if broken down by department or section or according to such factors

as length of service, age or occupation.

Patterns of labour turnover

The highest rate of labour turnover tends to be among those who have recently

joined an business.

Longer-serving employees are more likely to stay, mainly because they become

used to the work and the business and have an established relationship with those

around them.

Causes of labour turnover

A high level of labour turnover could be caused by many factors:

• Inadequate wage levels leading to employees moving to competitors

• Poor morale and low levels of motivation within the workforce

• Recruiting and selecting the wrong employees in the first place, meaning they leave

to seek more suitable employment

• A buoyant local labour market offering more (and perhaps more attractive)

opportunities to employees

Costs of labour turnover

High rates of labour turnover are expensive in terms of:

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- Additional recruitment costs

- Lost production costs

- Increased costs of training replacement employees

- Loss of know-how and customer goodwill

- Potential loss of sales (e.g. if there is high turnover amongst the sales force)

- Damage that may be done to morale and productivity (an intangible cost)

Benefits of labour turnover

Labour turnover does not just create costs. Some level of labour turnover is

important to bring new ideas, skills and enthusiasm to the labour force.

A "natural" level of labour turnover can be a way in which a business can slowly

reduce its workforce without having to resort to redundancies (this is often referred to

as "natural wastage".

A system of flexible working hours gives employees some choice over the actual

times they work their contracted hours. Such a system can be a good way of

recruiting and retaining staff - since it provides an opportunity for employees to work

hours consistent with their other commitments (e.g. child care).

Most flexible working hours schemes have a period during the day when employees

must be present. This is known as "core time". A typical core time would be 10 00

a.m. to 4.00 p.m.

Other than the core time, employees may choose when they start and finish work

within flexible bands at the beginning and end of each day. These bands are typically

08:00–10:00 and 16:00–18:000. However, there is wide scope for variation

depending on the core time, the hours the work place is open and the nature of the

business.

Some schemes also have a flexible band during the middle of the day so that

employees have some choice over the time they take their lunch break.

Contracted hours (the total hours an employee must work according to their

employment contract) are achieved by employees working the core time plus hours

of their choice during the flexible bands over an agreed period. This period is known

as the accounting period and is typically four weeks long. Some schemes allow for

an excess or deficit (within set limits) to be carried over to the next accounting

period. Hours are credited for absences such as sickness or holidays.

How to introduce a flexible working hours scheme

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The introduction of a flexible working hours scheme requires care and needs to be

carefully planned by all those likely to be affected. Experience suggests that a joint

"working party" comprising representatives of management and employees is

usually the best approach and any recognised trade union should be fully involved.

The working party should consider:

• Whether the scheme is to be voluntary or compulsory

• What type of recording system should be used (eg manual, clocking or

computerised)

• How flexibility should be built into the bands

• How sickness, absence and late attendance should be treated

• Arrangements for managing and monitoring the scheme (e.g. monitoring the effect

on production or customer service levels)

When the details have been agreed there should be a trial period of, perhaps, three

months to help identify and eliminate any problems.

Disadvantages of flexible working hours

• Costs involved in administering the scheme

• If the premises are open longer, there may be increased costs for lighting and

heating

• Employees will not be in work at certain times and therefore it may not be suitable

for organisations where continuous cover is necessary.

How can a business improve its labour productivity? Here are some possible

approaches;

- Measure performance and set targets – it is often claimed that ―what gets

measured, gets done!‖ if employees and management are focused on the desired

level of productivity, they may be more likely to act and take decisions which are

consistent with achieving the productivity targets. However, a business needs to

ensure that productivity targets are realistic and attainable - otherwise they may have

an undesired effect (e.g. lower employee motivation, or poorer quality and customer

service)

- Streamline production /operational processes: this makes sense, particularly in

service sector industries or other processes which are labour-intensive.

Improvements in labour productivity can be achieved by removing unnecessary

complexity from the product or process

- Invest in capital equipment (automation + computerisation): many processes

traditionally performed by people can now be effectively undertaken by automated

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machinery. By reducing the labour input into production, a given level of output can

be achieved for lower level of labour cost

- Invest in employee training: employees are often unproductive because they do

not have the skills or experience to work efficiently.

- Make the workplace conducive to productive effort:there are many tangible and

intangible steps that can be taken to improve the quality of the workplace; from

better heating and lighting to provision of leisure or childcare facilities.

Ending employment

Termination by notice

Redundancy

Dismissal

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