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  • 1. Unit 1Developing newbusiness ideas 1
  • 2. Section 1: Characteristics of successful entrepreneurs Characteristics of entrepreneurs What motivates entrepreneurs? Leadership stylesSection 2: Identifying a business opportunity What makes a market? What should firms supply? Identifying what consumers want or needSection 3: Evaluating a business opportunity Researching demand for the business idea Is there a market for the business idea? Positioning the business idea Product trial Opportunity costs (developing one business idea as opposed to another)Section 4: Economic considerations Current economic climateSection 5: Financing the new business idea Sources of financeSection 6: Measuring the potential success of a business idea Estimation of sales levels, costs and profits Break-even revenue level Measurement of profitSection 7: Putting a business idea into practice Creation of a business plan2|Page
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  • 5. Resources|Page
  • 6. Section 1 see if their business is in a strong enough position to fill this gap. Characteristics of In order to make a success of the new entrepreneurs business venture, the entrepreneurIdentifying an Opportunity must be hardworking, ambitious, firm, decisive, organised, a good negotiatorIt is vital for the success of a business and must be able to recognise anthat it manages to identify an opportunity when it arises.unsatisfied consumer need in a marketand then produce a product, or provide Keywords: Initiative, creative,a service, which meets the consumers resilient, risk-taker, hard-worker, self-needs. The new product / service can protected against competition bythe use of copyrights and patents.These protect the owner / inventor Find out what thesefrom having their products, ideas, etc. words mean.copied and reproduced by other Watch the dragon´speople without their permission. den videos.Some of the most common reasons forstarting up a new business include theneed for independence; to achieveyour personal ambitions; being boredwith your current job; links with yourhobbies and interests; redundancyfrom your previous job.Many businesses which have startedin the UK over the past 25 years havefailed within the first 3 years of trading.To reduce the probability of failure, it isvital that businesses carry out marketresearch in order to establish if aprofitable gap exists in a market and to 6
  • 7. Motives for being an Beientrepreneur ng able to make aKeywords: Profit motives: survive, differencesales maximization, profit by offeringmaximisation a service to theNon-profit motives: being your own community such as a charity shopboss, working from home, helping or hospice.others (ethical) A new business needs its own name and a product. The challenge is to make goods and services that satisfy customers, are competitive and sell at a price that more than covers costs. (Risk) Problems of Start-upsWhat are the benefits of being ethical?– good publicity, additional sales, Most new businesses will face ahelping others. number of problems when they are starting up and if these problems areWhy start a business? (Motives) not tackled immediately, then they may lead to the insolvency and failure ofThe skill involved in wanting to start the new venture. Below are listedand run a business is called some of the major problems faced by aenterprise. The individual who sets up new company:their own business is called anentrepreneur.There are several reasons whyentrepreneurs are willing to take acalculated risk and set up a business.Possible motives include: Making a profit. A business does this by selling items at a price that more than covers the costs of Raising finance and meeting the production. Owners keep the profit repayments as a reward for risk-taking and Raising finance and meeting the enterprise. repayments is often cited as the major The satisfaction that comes from reason for the failure of many new setting up a successful business business ventures. It can often be and being independent.7|Page
  • 8. difficult for a budding entrepreneur to cash flow problemspersuade banks and other financial that the business isinstitutions to lend money to a new, and often they will only lendthe money at a high rate of interest. Paperwork and legal requirementsThese repayments can cripple thebusiness and eventually lead to its All businesses face a variety ofinsolvency. paperwork and legal requirements, and if any of these are overlooked orAs well as the repayments, the bank completed inaccurately, then this couldwill insist that some security (or lead to the failure of a new business.collateral) is provided by the business, Taxation and insurance payments areso that if the business defaults on the vital for the smooth running andloan repayments, then the bank will survival of new businesses. Anytake ownership of an asset of the oversight on these payments couldbusiness which will cover the amount land the entrepreneur with a large taxof the outstanding loan. bill or, perhaps worse, property and stock which will not be insured againstHaving a positive cash flow fire, theft, etc.Leading on from this previous point, Enticing consumers to try the newhaving a positive cash flow is vital for productthe survival of the business. Liquidity isthe financial term given to express the Enticing consumers to try the newability of a business to raise cash at product / service can also be a majorshort notice. Any new business must problem for any new business,have sufficient cash available to meet especially if there are already aits short-term needs (such as paying handful of established businessesemployees, paying suppliers, rent, which dominate the market. Ensuringutility bills, etc.). that consumers try your product and then buy it again at a later dateMany businesses have a lot of cash (consumer loyalty) can often only betied up in stocks, which are often done through extensive (and costly)difficult to sell and therefore the advertising and promotionalbusiness may find it difficult to raise quickly. Further to this, if thebusiness gives its customers credit(i.e. buy now, but pay us at a laterdate) then this will simply add to any8|Page
  • 9. it is not very common in todays business world. Leadership DemocraticLeadership is the process of This involves managersinfluencing people so that they will and leaders taking intoperform a variety of tasks in an account the views of the workforceeffective manner. It is, therefore, before implementing any new system.crucial to have a strong leader who This can lead to increased levels ofcan inspire and motivate the morale and motivation amongst theemployees. workforce, but it can also result in farA leader is different to a manager, more time being taken to achieve thesince a manager is often appointed to results since many people are involveda position of power, whereas a leader in discussing the decision.may often emerge as the best to copein a given situation (i.e. an employee Laissez-fairewho is very competent at computing This is wheremay well be viewed as a leader, even employees are setthough he may be towards the bottom objectives, and thenof the organisational hierarchy). they have to decide howThere are a number of styles of best to achieve them using theleadership: available resources. This method of leadership can result in high levels ofAutocratic enthusiasm for the task in-hand, but it can at times rely too much on the skills This is often referred to of the workforce. as an authoritarian leadership style, and it basically means that the people at the top of an organisation make all thedecisions and delegate very littleresponsibility down to their Paternalisticsubordinates. This is fairly autocratic in its approachCommunication is top-down, with no to dealing with employees, althoughopportunity for feedback to the leader. their social and welfare needs areIt can cause much resentment and taken into account when a decision isfrustration amongst the workforce and made that will affect them. The leader is likely to consult the workforce before9|Page
  • 10. implementing any decision, but he is feedback.unlikely to listen to much of the Be well informed and knowledgeable about matters What makes a good leader or relating to the business manager? Possess an air of authority For many it is someone who Managers deal with their employees in can inspire and get the most different ways. Some are strict with from their staff. their staff and like to be in complete Be able to think creatively to control, whilst others are more relaxed provide a vision for the and allow workers the freedom to run company and solve problems their own working lives (just like the Be calm under pressure and different approaches you may see in make clear decisions teachers!). Whatever approach is Possess excellent two-way predominately used it will be vital to communication skills the success of the business. “An Have the desire to achieve organisation is only as good as the great things person running it”. Summary of management styles Description Advantages DisadvantagesAutocratic Senior managers Quick decision making No two-way take all the important communication so can be decisions with no Effective when de-motivating involvement from employing many low workers skilled workers Creates “them and us” attitude between managers and workersPaternalisticManagers make More two-way Slows down decision decisions in best communication so making interests of workers motivating after consultation Still quite a dictatorial or Workers feel their social autocratic style of needs are being met managementDemocratic Workers allowed to Authority is delegated to Mistakes or errors can be make own decisions. workers which is made if workers are not motivating skilled or experienced Some businesses enough run on the basis of Useful when complex majority decisions decisions are required that need specialist skills10 | P a g e
  • 11. McGregorExamined how managers´ attitudes affect how workers behave. Heidentified 2 extreme types of managers.TASK: Find out about McGregor´s theory1.1.1 Characteristics of Entrepreneurs: Text pp questions 1-5 may 2009 q1 Self-confident, creative, resilient, risk-taker, may 2010 q1 initiative hard-worker.1.1.2 What motivates Entrepreneurs? 1-5 Jan 2009 q2 Sample paper q9 Profit & non-profit motives May 2010 q91.1.3 Leadership Styles: 244-247 Jan 2009 q8 Effective leader, May 2010 q2 styles, factors affecting, theory x and y11 | P a g e
  • 12. Past paper questions12 | P a g e
  • 13. 13 | P a g e
  • 14. Section 2: Identifying a demanded than business opportunity at higher prices, ceteris paribus.What is a market? Basically, whenA shop is an example of a market the price is high demand is low and vice versa. Ceteris paribus means allBusinesses sell to customers in other things being equal. It is verymarkets. A market is any place where important that you state this conditionbuyers and sellers meet to trade when using demand curves. I willproducts - it could be a high street explain why under "determinants ofshop or a web site. Any business in a demand". First, lets have a look at themarketplace is likely to be in normal downward-sloping demandcompetition with other firms offering curve:similar products. Successful productsare the ones which meet customer In the diagram above, the demand forneeds better than rival offerings. CDs is fairly low at the relatively high price of fifteen pounds, but at theMarkets are dynamic. This means that bargain price of five pounds demand isthey are always changing. A business much higher.must be aware of market trends andevolving customer requirementscaused by new fashions or changingeconomic conditions.The theory of demandAt higher prices, a lower quantitywill be demanded than at lowerprices, ceteris paribus. At lowerprices, a higher quantity will be 14
  • 15. The determinants (factors) of CD prices are likely to rise in the neardemand future, perhaps due to the lack of competition in the retail market, so you It is fairly obvious so far may increase your demand in the that the price of a good current time period. is a pretty strong determinant of its Advertising. Although many of you demand, but there are probably doubt the effectiveness ofmany other things that will affect some of the appalling adverts on thedemand too. TV, one assumes that these companies would not spend fortunesReal income. If ones real income rose on these adverts if they did not expect(real means allowing for inflation), one to see a significant rise in demand forshould be able to afford more CDs. the product in question (Virgin and Our Price are always trying to sell you CDsThe price of other goods. If the price via the TV.)of CD players rose then one wouldexpect demand for CD players to fall, Population. Quite obviously, aand so would the demand for CDs. significant rise in the number of peopleThese goods are complements. If the in a given area or country will affectprices of rock concerts rose then one the demand for a whole host of goodswould expect the demand for these and services. Note that a change inconcerts to fall. Perhaps those who the structure of the population (wedecided against the concert might buy have an ageing population) willa CD instead. These goods increase the demand for some goodsare substitutes. but reduce the demand for others.Tastes and preferences. A slightly Interest rates and creditobscure but very important conditions. If interest rates aredeterminant. As you get older, you relatively low then it is cheaper tomay lose interest in the repetitive borrow money that can then be currently in the charts and try This is not so applicable to CDs, butsome original sounds from the 60s, will certainly affect the demand for big70s or 80s. Changing preferences will ticket items such as cars and majoraffect your demand for a product electrical goods. In boom time (like theregardless of its price. late 80s) it is often easier to obtain credit regardless of the rate of interest.Expectations of future prices. If youthink that the price for CDs is likely to The normal downward-sloping demandfall in the near future, perhaps curve shows the relationship betweenbecause of reduced production costs the price of the good and itsor competition from the US, you may demand, all other things beingdelay some purchases which will equal. Those all other things are thereduce demand in the current time list above: incomes, prices of otherperiod. Alternatively, you may feel that goods, etc. If you do not make this15 | P a g e
  • 16. assumption, then you could have a versa. Again, in is important to assumesituation when the price of CDs falls, that all other things remain constant.but at the same time ones income falls Any change in one of the otherby such a large amount that one determinants of supply will cause theactually demands fewer CDs. In other curve to shiftwords, one does not want toconfuse shifts in the demand While it is fairly obvious why thecurve and movements along a demand curve is downward sloping, itdemand curve. is not so clear why the supply curve should be upward sloping. Basically, The theory of supply the producer will make higher profits as the price per unit sold increases. Imagine that a brewer produced a lager and a bitter. Assume, not unreasonably, that the costs of production are the same per pint produced, whether it is a pint of lager or a pint of bitter. If the price of lager then rose relative to the price of bitter, it would seem sensible for the brewer to transfer resources from making bitter towards the production of lager, thereby increasing the supply of lager as its price rises.Just like with demand, where it onlybecame effective if it was backed upwith the ability to pay, supply isdefined as the willingness and ability ofproducers to supply goods andservices on to a market at a givenprice in a given period of time. Withdemand, the downward-sloping curvereflected an inverse relationshipbetween price and quantity demanded.The opposite is true of supply. Intheory, at higher prices a largerquantity will generally be suppliedthan at lower prices, ceterisparibus, and at lower prices asmaller quantity will generally besupplied than at higher prices,ceteris paribus. So this time we havehigher supply at higher prices and vice16 | P a g e
  • 17. The determinants (factors) of actually pays the tax. Granted, we endsupply up paying the tax indirectly when the price of petrol goes up, but the actualAs with the demand curve, there are tax bill goes to the firm. This again,many things that affect supply as well therefore, represents an increase inas the price of the good in question. the cost to the firm and the supplyNotice how similar many of these curve will shift to the left. The oppositefactors are in comparison to the factors is true for subsidies as they arethat affect demand. Notice also that handouts by the government to firms.nearly all of these factors affect the Now the firm can make more units offirms costs. Given that the firms output at any given price, so thesupply curve is its marginal cost curve supply curve shifts to the right.(see the costs and revenues topic)then it is of no surprise that a cost Labour productivity.changing measure will shift the supplycurve. This is defined as the output per worker (or per man-hour). If labourPrices of other factors of productivity rises, then output perproduction. An increase in the price worker rises. If you assume that theof, say, hops, will increase the costs of workers have not been given a paya brewing firm and so for any given rise then the firms unit costs mustprice the firm will not be able to brew have fallen. Again, this will lead to aas much beer. Hence, the firms supply shift to the right of the supply curve.curve will shift to the left. The samewould be true for changes in wage Price expectations.costs or fuel costs. Just as consumers delay purchases ifTechnology. they think the price will fall in the future, firms will delay supply in theyThe supply curve think prices will rise in the future. Itsdrawn above the same point but the other wayassumes a round.constant state of technology. But aswe know, there can be improvements Entry and exit of firms to and fromin technology that tend to reduce firms an industry.unit costs. These reduced costs mean If new entrants are attracted into anthat more can be produced at a given industry, perhaps because of highprice, so the supply curve would shift profit levels (much more on this in theto the right. topic Market structure), then theIndirect taxes and subsidies. supply in that industry will rise at all price levels and the supply curve will When the chancellor shift to the right. If firms leave the announces an industry then the supply curve will shift increase in petrol to the left. tax, it is the firm who17 | P a g e
  • 18. Case Study director of the AmericaUS alcohol retailers find law changes n Beverahard to swallow ge LicenseJon Genderson is gearing up for a big es, which represents 20,000 smallincrease in internet sales retailers across 34 states.The US consumes more bottles ofwine than any other nation in the Prices of alcohol are below saleworld. But almost 80 years after the cost all over England, sometimesend of Prohibition, buying a drink less than a bottle of water. Andcan still be tricky. theres terrible binge drinking. We look at that and say: WhatsIts illegal, for instance, to buy vodka in different about our system?”Delaware to take to a party in Craig WolfWine and SpiritsPennsylvania. And retailers in Wholesalers of AmericaMaryland are not allowed to shipalcohol to anybody living in another Hes particularly concerned about newstate. laws in the state of Washington which take effect in June. State controlled off-licences are closing, and grocery stores and supermarkets will be allowed to sell alcohol instead. But the biggest threat to small businesses comes from a measure which says an alcohol retailer must operate from stores no smaller thanThats because of the 4,000 or so 10,000 sq feet.different laws that govern the alcoholindustry and give individual statesunprecedented rights to regulate sales "Whats happened in Washingtonand consumption within their borders. state is scary," says Chuck Ferrar, owner of Bay Ridge Wine andThe protections have often favoured Spirits in Annapolis, Maryland.small businesses, but many now feartheyre under threat from cross-border "[The alcohol industry] is the lastwine sales on the internet, and the end bastion of small businesses, 50% ofof state monopolies that could lead to our businesses are owned by Asianderegulation. minorities because its one of the few remaining industries whereScary somebody can start a small business"The worst-case scenario is that you and see it grow and thrive.have a reduction of competition,removal of small businesses from the "But Washington will drive the smallmarketplace or potentially not having business under. And I think it willsmall businesses in the marketplace at eventually happen here, that alcoholall," says John Bodnovich, executive18 | P a g e
  • 19. will be sold in groceries and But Jon Genderson, managing directorsupermarkets." of Schneiders of Capitol Hill, a wine and liquor store in Washington DC,Public demand believes wholesalers are opposedAnother big change affecting the because theyre worried aboutindustry is the internet. In 2005 the increased competition in their tier ofSupreme Court ruled that wineries the market.could ship direct to their customersanywhere in the country, regardless of "The wholesalers are worried aboutindividual state legislation. That left these things, but its change thatmany states scrambling to change benefits the consumer and thats why Itheir laws. think its going to happen," he says.Chuck Ferrar says small retailers will "Its the natural evolution of thebe driven out of alcohol sales in business. It just makes sense andWashington when things make sense and the current laws dont make sense I think"Its coming because the consumer that eventually theyll be changed. Iwants it," says Joe Conti, chief think were smart enough to makeexecutive of the Pennsylvania those changes," he says.Liquor Control Board. "Consumerswill be able to buy from a winery in He says the internet still represents aCalifornia and have it sent to their small percentage of sales, but hishome in Pennsylvania - that will be business is gearing up for thehappening within months. Thats a anticipated change.good thing for the consumer and we "Were in the process of revamping ourembrace that type of competition." website for a third time, modernising and making it more interactive. ImBut the Supreme Court ruling did hoping it will be easier and easier, andnot include small retailers, and the that there will be more and more statesWine and Spirits Wholesalers of well be allowed to ship to," he says.America (WSWA) remains opposedto direct shipping. Checks and balances Moves to deregulate alcohol in the US"Its a black market because you go to the heart of debates about itsdont have the regulatory power to role in society and the concerns thatfind out who is ordering from led to prohibition. Mr Wolf says manywhere," says WSWA presidentCraig Wolf."Once you open the door to directshipping and you dont go through alicensed wholesaler, you dont knowwhether taxes are being paid, whetherminors are getting alcohol, and youdont know if its an illegal source," hesays. Americans have grandparents who19 | P a g e
  • 20. remember what the country was like big retailers controlling thebefore controls were established. suppliers.Californian wineries will soon be able "Prices of alcohol are below saleto ship direct to homes in cost all over England, sometimesPennsylvania less than a bottle of water. And"There is a fear that if you tinker theres terrible binge drinking. Weand mess with it, you dont know look at that and say whats differentwhat youre going to end up with - about our system?and it could be very bad," he says. "Ours is a much more regulated"We dont want to cast aspersions system. There are many moreon England - but if you look very checks and balances, not onlycarefully at what happened, there between market players but alsowas deregulation. There are now from government on the market24/7 sales there, theres vertical players."integration there with big box storescontrolling the retail operation - or1.2.1 What makes a market? 13 may 2009 q1 Buyers & sellers1.2.2 What should firms supply? 14-15 Jan 2009 q1 Supply, factors of supply1.2.3 Identifying what consumers want or need: 13-17 May 2009 q3/q4 Demand, factors of demand, Jan 2009 9d market-orientation. Sample paper q820 | P a g e
  • 21. Past paper questions21 | P a g e
  • 22. Section 3: Evaluating a business opportunityMarket Research • Technologies that may threaten existing productsMarket research involves gathering • New product developmentand analysing data from themarketplace in order to provide goods Information about Pricing in the Marketand services that meet their needs. • Estimates and testing of price elasticity A wide • Trends in pricing over recent years variety of • Analysis of revenues, margins and informatio profits n used to • Customer perceptions of “just or fair” support pricing marketing • Competitor pricing strategies decisions can be Information about Promotion in the obtained Market from market • Effectiveness of advertising research. • Effectiveness of sales force (personal A selection selling) of such • Extent and effectiveness of salesuses are summarised below: promotional activities • Competitor promotional strategiesInformation about the size andcompetitive structure of the market Information about Distribution• Analysis of the market potential forexisting products (e.g. market size,growth, changing sales trends)• Forecasting future demand forexisting products• Assessing the potential for newproducts• Study of market trends• Analysis of competitor behaviour andperformance• Analysis of market sharesInformation about Products• Likely customer acceptance (or in the Marketrejection) of new products• Comparison of existing products in • Use and effectiveness of distributionthe market (e.g. price, features, costs, channelsdistribution) • Opportunities to sell direct• Forecasting new uses for existingproducts • Cost of transporting and 22
  • 23. warehousing products measuring the effect of each of these• Level and quality of after-sales on consumers. For example, testservice marketing, where a new product is launched in a small, geographical areaPrimary research and then the response of consumers towards it will dictate whether or notThis is research designed to gather the product is launched nationally.primary data, that is, information whichis obtained specifically for the study in Secondary researchquestion. It can be gathered in threemain ways - observation, This is the collection ofquestionnaires and experimentation. secondary data, which has previously beenObservation involves watching people collected by others andand monitoring and recording their is not designedbehaviour (e.g. television viewing specifically for the studypatterns, cameras which monitor traffic in question, but isflows, retail audits which measure nevertheless relevant. Secondary datawhich brands of product consumers is far cheaper and quicker to gatherare purchasing). than primary data, but it can be out-of-Questionnaires are a means of direct date by the time that it is with consumers and can take a The main sources of secondary datavariety of forms. Personal are reference books, governmentquestionnaires (such as door-to-door publications and company reports.interviewing), postal questionnaires, The primary and the secondarytelephone questionnaires and group research will provide the business withquestionnaires (such as asking for the much data relating to its markets andattitudes of a group of consumers its consumers. This data can then betowards a new product). used to describe the current situationQuestionnaires can be a very in the marketplace, to try to predictexpensive and time-consuming what will happen in the future in theprocess and it can be very difficult to marketplace, and to explain the trendseliminate the element of bias in the that have occurred.way that they are carried out. It is The business may also use the marketimportant that every respondent must research data to segment the asked the same questions in thesame order, with no help or emphasis This involves breaking the marketbeing placed on certain questions / down into distinct groups of consumersresponses. who have similar characteristics, so as to offer each group a product whichExperimentation involves the best meets their needs.introduction of a variety of marketingactivities into the marketplace and then23 | P a g e
  • 24. The main ways of segmenting a Quantitative research can also bemarket are: used to measure customer awareness and attitudes to different manufacturers and to understand overall customer behaviour in a market by taking a statistical sample of customers to understand the market as a whole. Such techniques are extremely powerful when combined By consumer characteristics: with techniques such segmentation this involves investigating their analysis and mean that key audiences attitudes, hobbies, interests, can be targeted and monitored over and lifestyles. time to ensure the optimal use of the By demographics: their age, marketing budget. sex, income, type of house, and socio-economic group. At the heart of all quantitative research By location: the region of the is the statistical sample. Great care country, urban -v- rural, etc. has to be taken in selecting the sample and also in the design of the sampleEffective segmentation of the market questionnaire and the quality of thecan lead to new opportunities being analysis of data collected.identified (i.e. gaps in the market for aproduct), sales potential for products Market research involves the collectionbeing realised and increased market of data to obtain insight andshare, revenue and profitability. knowledge into the needs and wants of customers and the structure andQuantitative vs Qualitative research dynamics of a market. In nearly all cases, it would be very costly andQuantitative research time-consuming to collect data from the entire population of a market.Quantitative research is Accordingly, in market research,about measuring features of a market extensive use is made of samplingand quantifying that measurement with from which, through careful design anddata. Most often the data required analysis, marketers can drawrelates to market size, market share, information about the market.penetration, installed base and marketgrowth rates. However, quantitative There are several types of sampleresearch can also be used to measure that can be used to gathercustomer attitudes, satisfaction, quantitative data:commitment and a range of otheruseful market data that can tracked Market research involves the collectionover time. of data to obtain insight and knowledge into the needs and wants of customers and the structure and24 | P a g e
  • 25. dynamics of a market. In nearly all also helps guard against sample biascases, it would be very costly and in a way that selecting by judgement ortime-consuming to collect data from convenience cannot.the entire population of a market.Accordingly, in market research, Defining the Populationextensive use is made of samplingfrom which, through careful design andanalysis, marketers can drawinformation about the market.Designing the sampleSample design covers the method ofselection, the sample structure andplans for analysing and interpreting theresults. Sample designs can vary fromsimple to complex and depend on the The first step in good sample design istype of information required and the to ensure that the specification ofway the sample is selected. the target population is as clear and complete as possible to ensure that allSample design affects the size of the elements within the population aresample and the way in which analysis represented. The target population isis carried out. In simple terms the more sampled using a sampling frame.precision the market researcher Often the units in the population canrequires, the more complex will be the be identified by existing information;design and the larger the sample size. for example, payrolls, company lists, government registers etc. A samplingThe sample design may make use of frame could also be geographical; forthe characteristics of the overall example postcodes have become amarket population, but it does not have well-used means of selecting ato be proportionally representative. It sample.may be necessary to draw a largersample than would be expected from What size should the sample be?some parts of the population; forexample, to select more from a For any sample design deciding uponminority grouping to ensure that the appropriate sample size willsufficient data is obtained for analysis depend on several key factorson such groups. (1) No estimate taken from a sample isMany sample designs are built around expected to be exact: Anythe concept of random selection. This assumptions about the overallpermits justifiable inference from the population based on the results of asample to the population, at quantified sample will have an attached margin oflevels of precision. Random selection error.25 | P a g e
  • 26. (2) To lower the margin of error usually usually representative of therequires a larger sample size. The population as a whole.amount of variability in the population(i.e. the range of values or opinions) Cluster sampling - this normallywill also affect accuracy and therefore involves the consumers being groupedthe size of sample. into geographical groups (or clusters) and then a random sample being(3) The confidence level is the carried out within each location.likelihood that the results obtained Stratified sampling - the consumersfrom the sample lie within a required are grouped into segments again (orprecision. The higher the confidence strata) based upon some previouslevel, that is the more certain you wish knowledge of how the population isto be that the results are not atypical. divided up. The number of peopleStatisticians often use a 95 per cent chosen to be interviewed from eachconfidence level to provide strong strata is proportional to the populationconclusions. as a whole.(4) Population size does not normally Qualitative researchaffect sample size. In fact the largerthe population size the lower the Qualitative market research is aboutproportion of that population that investigating the features of a marketneeds to be sampled to be through in-depth research thatrepresentative. It is only when the explores the background and contextproposed sample size is more than 5 for decision making. There are twoper cent of the population that the main qualitative methods - depthpopulation size becomes part of the interviews and focus groups. Howeverformulae to calculate the sample size. qualitative research can also include techniques such as usability testing,Random sampling - this gives each brainstorming sessions and “vox pop”member of the public an equal chance surveys.of being used in the sample. Therespondents are often chosen by Depth Interviewingcomputer from a telephone directory offrom the Electoral Register. Depth interviews are the main form of qualitative research in most businessQuota sampling - this method markets. Here an interviewer spendsinvolves the consumers being grouped time in a one-on-one interview findinginto segments which share certain out about the customer’s particularcharacteristics (e.g. age or gender). circumstances and their individualThe interviewers are then told to opinions.choose a certain number ofrespondents from each segment. The majority of business depthHowever, the numbers of people interviews take place in person, whichinterviewed in each segment are not has the added benefit that the26 | P a g e
  • 27. researcher visits the respondent’s consumer, or part of a team evaluatingplace of work and gains a sense of the technology, group discussions can beculture of the business. However, for an effective way of understanding whatmulti-national studies, telephone depth customers are looking for, particularlyinterviews, or even on-line depth at more creative stages of research.interviews may be more appropriate. Niche MarketingFeedback is through a presentationthat draws together findings across a This involves a business selling itsnumber of depth interviews. In some product(s)circumstances, such as segmentation in small,studies, identifying differences oftenbetween respondents may be as lucrative,important as the views that customers segmentsshare. of a market. ItThe main alternative to depth is theinterviews - focus group discussions - opposite strategy to mass marketing.are typically too difficult or expensive Many small businesses can identifyto arrange with busy executives. unsatisfied consumer needs in aHowever, on-line techniques particular segment within a largeincreasing get over this problem. industry, and they can develop products to meet these needs.Focus Group Discussions This allows the small businesses to Focus groups exist in industries that are dominated are the by large businesses (e.g. Classic FM mainstay of in the radio broadcasting industry, consumer SAGA in the holiday industry). research. Here However, if larger rivals appear within several the niche market, the smaller customers are businesses will often find it difficult to brought compete effectively with these well- together to take resourced businesses.part in a discussion led by a It is also dangerous for a business toresearcher (or “moderator”). These offer just one product within thegroups are a good way of exploring a market, since any larger rivals aretopic in some depth or to encourage likely to be more diversified and have acreative ideas from participants. wider product portfolio. Theses larger businesses could, therefore, reduceGroup discussions are rare in business their prices to such a low level that themarkets, unless the customers are small business cannot competesmall businesses. In technology where the end user may be a27 | P a g e
  • 28. Nevertheless, during periods of knowledge = market expertiseeconomic growth and higher consumer • Can often charge a higher price –spending, then niche markets can offer customers are prepared to pay fora very lucrative opportunity to many expertisesmall businesses to offer a • Profit margins often higherpersonalised, high value-added • Customers tend to be more loyalservice/product. The main disadvantages of marketing to a niche include:What is the difference between • Lack of “economies of scale” (theseniche and mass marketing? are lower unit costs that arise from operating at high production volumes)In most markets there is one dominant • Risk of over dependence on a single(mass) segment and several smaller product or market(niche) segments… • Likely to attract competition ifFor example, in the confectionery successfulmarket, a dominant segment would be • Vulnerable to market changes – allthe plain chocolate bar. Over 90% of “eggs in one basket”the sales in this segment are made by By contrast, mass marketing can bethree dominant producers – Cadbury’s, defined as:Nestle and Mars. However, there aremany small, specialist niche segments Where a business sells into the (e.g. luxury, organic or largest part of the market, where fair-trade chocolate). there are many similar products on offer Niche marketing can be defined as: The key features of a mass market are as follows: Where a business targets a smaller • Customers form the majority in the segment of a larger marketmarket, where customers have • Customer needs and wants are morespecific needs and wants “general” & less “specific” • Associated with higher productionTargeting a product or service at a output and capacity (economies ofniche segment has several scale)advantages for a business (particularly • Success usually associated with low-a small business): cost operation, heavy promotion,• Less competition – the firm is a “big widespread distribution or marketfish in a small pond” leading brands• Clear focus - target particularcustomers (often easier to find andreach too)• Builds up specialist skill and28 | P a g e
  • 29. Competitive Advantage Create a poster identifying how the product (Mercedes Class M) or brand (Gilette) has gained this competitive advantage. Eg Apple Ipod and imageDefinition: A competitive advantage isan advantage over competitors gainedby offering consumers greater value,either by means of lower prices or byproviding greater benefits and servicethat justifies higher prices.How: Location, Value for money,Brand name, Facilities, Image ,Taste,Customer service . Competitive AdvantageChoose one of the methods of how acompany could gain a competitiveadvantage over its competitors. Selecta well-known product or brand.29 | P a g e
  • 30. Adding Value operate profitably. Why? Remember the definition of adding value: where The increase in the the selling price is greater than the benefits of a good or costs of making the product. service which are created at each stage By definition, a business that is adding of production. substantial value must also be operating profitably. Methods – changing raw materials, Quite simply, it can make thepackaging, branding (using difference between survival andpersonalities or famous logos) failure; between profit and loss.For example, businesses can add The key benefits to a business ofvalue by: adding value include:Building a brand – a reputation for - Charging a higher pricequality, value etc that customers are - Creating a point of difference fromprepared to pay for. Nike trainers sell the competition.for much more than Hi-tec, eventhough the production costs per pair - Protecting from competitors trying toare probably pretty similar! steal customers by charging lower pricesDelivering excellent service – high - Focusing a business more closely onquality, attentive personal service can its target market segmentmake the difference betweenachieving a high price or a mediumoneProduct features and benefits forexample, additional functionality indifferent versions of software canenable a software seller to chargehigher prices; different models ofmotor vehicles are designed toachieve the same effect.Offering convenience – customerswill often pay a little more for a productthat they can have straightaway, orwhich saves them time.A business that successfully addsvalue should find that it is able to30 | P a g e
  • 31. Positioning the Business Idea Identify Gaps in the market – market mapping.This is the process of creating an Try to gain a competitiveimage for the product in the minds of advantage.customers. Add value Identify the competition. Market mapping consists of identifying Identify their strengths and key variables about a product, plotting weaknesses. where existing brands or suppliers are Identify how to differentiate your in terms of combining the variables, product. then identifying any gaps in the market”.Positioning and Market Examples of those dimensions mightmapping be: High price v low priceOnce an entrepreneur has identified Basic quality v High qualityan appropriate segment of the market Low volume v high volumeto target, the challenge is to Necessity v luxuryposition the product so that it meets Light v heavythe needs and wants of the target Simple v complexcustomers. Lo-tech v high-tech Young v OldOne way to do this is to use a “marketmap” (you might also see this called Let’s look at an illustrated example of aby its proper name – the “perceptual market map. The map below showsmap”). one possible way in which the chocolate bar market could be mappedThe market map illustrates the range against two dimensions – quality andof “positions” that a product can take in price:a market based on two dimensionsthat are important to customers. 31
  • 32. How might a market map be used?One way is to identify where there are “gaps in the market” – where there arecustomer needs that are not being met.For example, in the chocolate bar market, Divine Chocolate (a social enterprise)successfully spotted that some consumers were prepared to pay a premium price forvery high quality chocolate made from Fairtrade cocoa. Green & Black’s exploitedthe opportunity to sell premium chocolate made from organic ingredients. Both thesebrands successfully moved into the high quality / high price quadrant (see above)before too many competitors beat them to it.The trick with a market map is to ensure that market research confirms whether ornot there is actually any demand for a possible “gap in the market”. There may bevery good reasons why consumers do not want to buy a product that might,potentially, fill a gap. 32
  • 33. Complete a Market Map for a local shop or restaurant in Valencia.33 | P a g e
  • 34. Product trial customers. It is much better if customers can be encouraged to The first become loyal to the product – even step for a better, to recommend the product to new their friends and family! business or product is to Achieving a high level of repeat attract trial purchase is good news for a business. purchases. So what is required? A new Firstly, the product should be of themagazine may run special offers to get right quality. A sub-standard or lowcustomers to try the first issue, hoping quality product is sure to disappoint first-time customers. They are unlikelythat repeat sales are generated. Themagazine will soon close if customers to buy again or recommend thefail to buy future issues. The aim of a product to others.special offer scheme is to convert trial Secondly, a business should do all itpurchases into repeat sales. can to develop an effect relationshipRepeat business is all about with existing customers. This includesencouraging customers who buy for activities such as:the first time to buy again and again!A business invests a lot of effort and - Regular communication (e.g. email newsletters)cash in trying to get a customer topurchase a product for the first time.This is known as product trial. Much - Incentives for loyalty (e.g.advertising is aimed at encouraging promotional discounts)customers to try a new product, orswitch from an existing competitor. - Research into customer needs andAfter a new product has been tried wants (e.g. through customer surveys)once, its success can be measured inhow quickly, how often, and in whatquantity it is repurchased. Repeatpurchase refers to the number orpercent of customers who purchase asecond time, or to how often they buyagain.The problem with advertising is that itis very expensive. A business isunlikely to be successful and profitableif it has to keep advertising heavily inorder to generate demand from new 34
  • 35. StakeholdersThere are many groups of peoplewho have an interest, financial orotherwise, in the performance ofa business - these differentgroups are known asstakeholders. The mainstakeholders are considered tobe: functions and tasks of the businessShareholders (producing output, meeting deadlinesThese people have a clear financial and delivery dates, etc.) and overinterest in the performance of the recent years their traditional role hasbusiness. They have invested money started to change. They are often nowinto the company through purchasing encouraged to become involved inshares and they expect the company multi-skilled team-working, problemto grow and prosper so that they solving and decision making - thusreceive a healthy return on their having a significant input to theinvestment. The return that they workings of the business.receive can come in two forms. Firstly, Customersby a rise in the share price, so thatthey can sell their shares at a higher Customers are vital to the survival ofprice than the purchase price (this is any business, since they purchase theknown as making a capital gain). goods and services which provides theSecondly, based on the level of profits business with the majority of itsfor the year, the company issues a revenue. It is therefore vital for aportion of this to each shareholder for business to find out exactly what theevery share that they hold (this is needs of the consumers are, and toknown as a dividend). The produce their output to directly satisfyshareholders are also entitled to vote these needs - this is done througheach year at the A.G.M. to elect the market research. The goods andBoard of Directors, who will run the services must then be promoted incompany on their behalf. such a way as to appeal to the target market and to inform them of theEmployees availability, price, etc. Once the goodsThis group also has an obvious and services have been purchased byfinancial interest in the company, since the customer, it is essential that after-their pay levels and their job security sales service is offered and that thewill depend on the performance and customer is happy with his/herthe profitability of the business. It is purchase. The business must try toemployees who perform the basic keep the customer loyal so that they35 | P a g e
  • 36. return in the future and become a since the repayments will now berepeat-purchaser. significantly higher). However, businesses can also benefit fromSuppliers government incentives and initiatives, such as new infrastructure, jobWithout flexible and reliable suppliers, creation schemes and businessthe business could not guarantee that relocation packages, offering cheapit will always have sufficient high rent, rates and low-interest loans.quality raw materials which theyrequire to produce their output. It is The Local Communityimportant for a business to maintaingood relationships with their suppliers, Businesses are likely to provideso that raw materials and components significant amounts of employment forcan be ordered and delivered at short the local community and often willnotice, and also so that the business produce and sell much of their outputcan negotiate good credit terms from to the local residents. The sponsorshipthe suppliers (i.e. buy now, pay at a of local events and good causes (suchlater date). as local charity work) can also help the business to establish itself in theThe Government community as a caring, socially responsible organisation. ManyThe government affects the businesses develop links with localworkings of businesses in many schools and colleges, offeringways: sponsorships and resources to these1. Businesses have to pay a variety of under-funded institutions. However,taxes to central and local government, businesses can also cause manyincluding Corporation tax on their problems in local communities, suchprofits, Value-Added Tax (V.A.T) on as congestion, pollution and noise, andtheir sales, and Business Rates to the these negative externalities may oftenlocal council for the provision of local outweigh the benefits that theservices. businesses bring to the community.2. Businesses also have to adhere to a Disagreements between stakewide-ranging amount of legislation, holderswhich is aimed at protecting the Due to the demands placed onconsumers, the employees and the businesses by so many differentlocal environment from business stakeholders, it is no surprise thatactivity. there are often disagreements and3. Businesses will be affected by conflict between the different groups.different economic policies, (for Some of the more common areas ofexample, if interest rates are conflict are:increased, then this will discouragebusinesses from borrowing money Shareholders and management36 | P a g e
  • 37. Profit maximisation is often the over- complain about the late deliveries ofriding objective of shareholders - raw materials and components fromresulting in large dividend payments suppliers, and the dubious quality offor them. However, it is far more likely the parts once they have beenthat the managers of the business will inspected.aim to profit satisfy rather than profitmaximise (that is, they will aim to earn The community and the businessa satisfactory level of profits, and thenuse the remaining resources to pursue As outlined previously, the localother objectives such as diversification community can often suffer at theand growth). This conflict between hands of a large company through thethese two groups is often referred to negative externalities of pollution,as divorce of ownership (the noise, congestion and the building ofshareholders) and control (the new factories in areas of outstandingmanagement). beauty. However, if the business faces strong protests from residents andCustomers and the business from pressure groups concerned about its actions, then it may decide toCustomers are unlikely to remain relocate to another area, causingloyal and repeat purchase from the much unemployment and a fall inbusiness if the product that the have investment in the community it leavespurchased is of poor quality and/or is behind.poor value for money. More customersare prepared to complain about thequality of products and after-salesservice than ever before, and thebusiness must ensure that it has inplace a number of strategies designedto satisfy the disgruntled customer,reimburse any financial loss that theymay have incurred and persuade themto remain loyal to the business.Suppliers and the businessSuppliers are often quoted ascomplaining about the lack of promptpayments from businesses fordeliveries of raw materials, and if thisbecame a regular problem then thesuppliers may well refuse credit to thebusinesses or may even cease alldealings with them. On the other hand,many businesses have been known to37 | P a g e
  • 38. Market segmentation -targeting strategiesOnce a firm has successfully identifiedthe segments within a market, the nextstep is to target these segments withproducts that closely match the needsof the customers within that segment.There are a number of targetingstrategies, including:Niche/concentration marketing – The main benefit for the firm is that itthis is concerned with targeting one can produce on a large scale,particular, well-defined group of benefiting from low unit productioncustomers (a niche) within the overall costs via economies of scale. Thesemarket. lower costs can be passed on to the consumer in the form of lower pricesJordan’s, the cereal company, adopted because, although profit margins onthis approach by targeting groups of each item sold may be lower, highcustomers interested in organic sales volume should generate largeproducts at a time when this group of profits overall.consumers represented a relativelysmall proportion of the overall market. The main disadvantage of mass marketing is that, increasingly inNiche markets can be targeted today’s markets, consumers are lessprofitably by small firms who have interested in standardised productsrelatively small overheads and, and often prepared to pay premiumtherefore, do not need to achieve the prices for products that cater for theirvolume of sales required by larger specific needs.competitors.The main disadvantages of niche market segmentation - bases of segmentationmarkets are that the potential for salesgrowth and economies of scale may Geographicbe limited, and the survival of the firmmay be seriously affected if sales • Region of the countrybegin to decline. • Urban or ruralMass marketing – this is concerned Demographicwith selling a single product to thewhole market. This strategy is based • Age, sex, family sizeon the assumption that, in respect to • Income, occupation, educationthe product in question, customers’ • Religion, race, nationalityneeds are very similar if not identical. Psychographic38 | P a g e
  • 39. • Social class Customer circumstances change, for• Lifestyle type example they grow older, form• Personality type families, change jobs or get promoted, change their buying patterns. ByBehavioural marketing products that appeal to customers at different stages of their• Product usage - e.g. light, medium life ("life-cycle"), a business can retain,heavy users customers who might otherwise switch• Brand loyalty: none, medium, high to competing products and brands• Type of user (e.g. with meals, specialoccasions) Target marketing communicationswhy segment markets? Businesses need to deliver their marketing message to a relevantThere are several important reasons customer audience. If the targetwhy businesses should attempt to market is too broad, there is a strongsegment their markets carefully. These risk that (1) the key customers areare summarised below missed and (2) the cost of communicating to customers becomesBetter matching of customer needs too high / unprofitable. By segmenting markets, the target customer can beCustomer needs differ. Creating reached more often and at lower costseparate offers for each segmentmakes sense and provides customers Gain share of the market segmentwith a better solution Unless a business has a strong orEnhanced profits for business leading share of a market, it is unlikely to be maximising its profitability. MinorCustomers have different disposable brands suffer from lack of scaleincome. They are, therefore, different economies in production andin how sensitive they are to price. By marketing, pressures from distributorssegmenting markets, businesses can and limited space on the shelves.raise average prices and subsequently Through careful segmentation andenhance profits targeting, businesses can oftenBetter opportunities for growth achieve competitive production and marketing costs and become theMarket segmentation can build sales. preferred choice of customers andFor example, customers can be distributors. In other words,encouraged to "trade-up" after being segmentation offers the opportunity forintroduced to a particular product with smaller firms to compete with biggeran introductory, lower-priced product ones.Retain more customers39 | P a g e
  • 40. Opportunity costOpportunity cost is one of the most important and fundamentalconcepts in the whole of economics. Given that we have saidthat economics could be described as a science of choice, wehave to look at what sacrifices we make when we have to make a choice. That iswhat opportunity cost is all about.The definition of opportunity cost is: The cost expressed in terms of the nextbest alternative foregone or sacrificed Take the following example: I recently bought a new pair of shoes which cost me £40. The cost here is being expressed in terms of the amount of money you had to give up to acquire those shoes. Because we all have a common understanding of money as being notes and coins that we use toexchange for the things we want, we can pretty much understand this sentence.We have to remember that money is merely bits of paper ormetal that we use as a convenient and accepted method offacilitating exchange - getting what we want. Expressing cost interms of the amount of money we have to give up to get whatwe want is always helpful in giving us the true cost ofsomething. For that, we need to use opportunity cost.What statements like this fail to convey, however, is the true picture of what you aresacrificing by choosing to buy the shoes. It is more accurate to say something likethe price I paid for these shoes was £40. To get an idea of the true cost, we wouldreally need to know something of the sacrifice made in giving up that £40.£40 can buy a number of things - let us assume that it can also buy the following:When thinking about how to dispose of your money, you have to make choices andthese represent the choices at this moment in time. These choices representdifferent aspects of value. Each of the items might represent some value to you butthey may be different. It is important to remember that you might, in an ideal worldwhere there were no scarce resources, want all these things. 40
  • 41. TRADE OFFSIn business there are many occasions whenone factor has to be traded off against another.An entrepreneur might get huge help at thestart from friends, yet realise that these samefriends lack the professionalism to help thebusiness grow. The needs of the business may have to be traded off against the friendships. Othertrade-offs may include – giving up a good job and prospects to be your own boss,giving up the most enjoyable things for profit etc.1.3.1 Researching demand for the business idea: 143-149 may 2009 q5 Market research: jan 2009 q6 Methods-primary/secondary sample paper q7 Quantitative/qualitative problems.1.3.2 Is there a market for the business idea? 152-155 Sample paper q3 Market size & share, May 2010 q 3 growth, May 2010 q 10 mass marketing niche, segmentation.1.3.3 Positioning the business idea. 7-10 May 2009 q8 Competition, May 2009 q11 market mapping, Jan 2009 q3 competitive advantage, Sample paper q9b adding value. May 2010 q6 differentiation1.3.4 Product Trial 166 Jan 2009 q9a Testing, expense, methods, benefits, Sample paper q1 disadvantages. May 2010 q71.3.5 Opportunity Costs 48-50 Jan 2009 9e Trade-Offs Sample paper 9e Choice – factors, stakeholders.41 | P a g e
  • 42. Past paper questions42 | P a g e
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  • 44. Soft drink projectDesign a “new” soft drink to bereadily available from December2012.Your Project should include An advert Marketing Mix:Identify price, product, place andpromotional aspects Questionnaire/Interviews/Surveys – to determine through market research, the current fashion/tastes of the soft drinks markets. Segmentation – whose is your market/customers? Which groups would buy your product? Market Mapping – who are the competitors and what are the strengths and weaknesses. Product trial – How are people going to try it? Additional information – market size, recent trends etc Added value – how do you convince people to pay a price for it when they know it only costs x amount to produce.When complete you will havecompleted a business plan! 44
  • 45. Section 4: There are several methods that a government can use to reduce the Economic considerationsThe Economic EnvironmentEconomics is concerned with theprocess of satisfying the needs andwants of the population, by using thelimited resources of the economy(land, labour, capital and enterprise,otherwise known as the factors ofproduction) in the most efficient way.There are generally considered to befour main objectives of an economy: amount of unemployment in an economy: 1. A low level of unemployment 2. A low level of inflation Policies to increase demand: such as reducing taxation or reducing 3. A high level of economic interest rates. growth 4. A good foreign trading Retraining incentives offered to the position unemployed.Unemployment is defined as the Helping new businesses to set-up,number of people in the workforce in a and offering incentives to existingcountry who are looking for a job, but businesses to relocate to areas of highcannot find one. unemployment.The two major measures of Inflation is defined as a general andunemployment are the claimant sustained rise in the average prices ofcount (where people must declare goods and services within an economythat they are out of work, capable of over a period of time. It is calculatedworking, available to work and actively by reference to the Retail Price Indexseeking work) and the International (R.P.I), which is a weighted index,Labour Force count (where people designed to indicate any changes inmust be out of work, have been the average price level in the UK.looking for work in the past 4 weeksand must be available to start work in Inflation can be very damaging to anthe next 2 weeks). economy because it leads to the reduced purchasing power of theUnemployment can be very damaging pound, uncertainty about the future, ato an economy because it can lead to fall in investment and savings, andfalling output, high government increasing costs for businesses.spending, and falling aggregatedemand.45 | P a g e
  • 46. and businesses, minus the income earned by foreigners investing in the UK). Economic growth is likely to lead to an increase in the amount of investment in the economy, as well as an increase in the number of new businesses starting up, leading to increases in output, expenditure and income. In order to improve the G.D.P. or the G.N.P. per capita (i.e. in order to achieve a faster rate of economicThere are several methods that a growth), then the government mustgovernment can use to reduce the ensure that the workforce israte of inflation in an economy: adequately educated and trained toIncreasing interest rates to discourage perform their jobs effectively,high levels of customer spending. significant amounts of investment in new machinery and productionReducing the amount of credit techniques are undertaken, and(borrowing) that is available to natural resources must be used tocustomers. their optimum efficiency.Incomes policies, where pay increases Balance of payments. This is aare limited, so to deter high levels of record of a countrys financialcosts and expenditure. transactions with the rest of the world over a given period of time (normallyEconomic growth. This term refers to 12 months).a real growth (i.e. accounting for theeffects of inflation) in the income per The current account of the balance ofcapita (or income per head) of the payments measures both visible tradepopulation over a given period of time. (that is, the imports and exports of tangible goods such as furniture andIt is normally measured by reference to cars) and invisible trade (that is, theGross Domestic Product (G.D.P) imports and exports of intangibleand Gross National Product (G.N.P). services, such as banking, shipping,Gross Domestic Product is the total and insurance). The capital account ofvalue of a countrys output over a the balance of payments measuresperiod of time (usually 12 months). any flows of capital between the UK and other countries (purchase ofGross National Product is calculated shares and other forms of investment).by adding G.D.P. to the net incomefrom abroad (i.e. the income earned on The exchange rate is the externaloverseas investments by UK citizens price of a countrys currency,46 | P a g e
  • 47. expressed in terms of another foreign goods and services cheaper tocurrency. import.For example, £1 = 1.5 euros A fixed exchange rate system involves the value of the currencyA free-floating exchange rate system being fixed against other currenciesinvolves the value of the currency and not being allowed to fluctuate inbeing allowed to float (fluctuate) response to the demand and supplyaccording to the supply and demand for it. This involves governmentfor the currency. intervention on a regular basis, buyingA demand for sterling is created when the currency when its value isthe UK exports goods and services threatening to fall, and selling the(foreigners must pay for these goods currency when its value is threateningand services using sterling, which they to rise.purchase in exchange for their own Under this system, the governmentcurrencies). can devalue the currency if it feels thatA supply of sterling is generated when its value is too high against foreignthe UK imports goods and services currencies, making their goods and(i.e. the UK must pay for these imports services uncompetitive. Thisusing the foreign currency of the devaluation of the currency boosts thecountry concerned). These foreign international competitiveness of thecurrencies are purchased in exchange countrys exports, by making themfor sterling on the world currency cheaper for other countries tomarket. purchase.An increase in the value of the pound Alternatively, the government canis known as an appreciation, and a revalue the currency if it feels that itsfall in the value of the pound is known value is too low against foreignas depreciation.. A strong pound currencies, making the level ofmakes goods and services produced demand too high for their goods andin the UK more expensive for services and leading to inflation.foreigners to purchase, but makes47 | P a g e
  • 48. Exchange Rates recently. Anything that comes from abroad is now more expensive: parts, components, finished goods, stocks, oil, food. Almost all firms import something, and are therefore likely to face higher costs. UK customers may move away from imports and foreign holidays as they are relatively more expensive. - That leads to a wider benefit: the UKThe exchange rate is the price of a is now relatively cheaper to foreigners,currency. That’s often a very difficult providing UK firms with better exportconcept to get your head around, opportunities, as well as moreparticularly as ‘common sense’ is domestic demand.misinformed by “exchanging” or“swapping” currencies when you go Evaluation pointsabroad on holiday. But if you getsome Euros before heading off for - The impact of changing exchangeFrance, you aren’t swapping your £s rates will be different on differentfor €s. You’re buying them. businesses. Firms with big import bills will be hit hard. Other businesses thatSo the £ is quite literally on sale in the are seeking to expand exports mayforeign exchange market. The graph find demand increasing for theirabove points out the basic history you products or services. Firms that wereneed to understand. The £ broadly fell planning to ‘offshore’ some of theirin value (it ‘depreciated’) from the production might reconsider (check out1980s until the early 90s. Our the links below).currency then sharply appreciated in - The uncertainty of exchange ratethe mid 90s, where it stayed (with change is a big headache for firms,some fluctuations) before plunging and tends to undermine overseasagain in 2008. investments and makes UK firms think twice before embarking on anyWhat does this mean for UK overseas project.businesses? - Exchange rates might not make such a big difference if firms or their- In general, a lower value £ means customers are not price sensitive, ofthat imports are more expensive. course.That’s part of the reason why there’sbeen upward pressure on inflation48 | P a g e
  • 49. 1.4.1 Current Economic Climate: text may 2009 q6 may 2009 q12 Economic Growth, 46-50 jan 2009 q7 Exchange Rates, may 2010 q 13 Inflation unemployment49 | P a g e
  • 50. Section 5: Financing the new business ideaLegal Structure PartnershipSole Trader To overcome many of the A sole trader is a problems of a one-person sole trader, a partnership may be business, commonly formed. A partnership is an association found in trades of individuals and generally there will where only small be between 2 and 20 partners. amounts of finance are required to set Each partner is responsible for the up and where there debts of the partnership and thereforeare very few advantages to the you would need to choose yourexistence of larger organisations (e.g. partners carefully and draw up anhairdressing, newsagents, market agreement on the responsibilities andtraders). rights of each partner (known as a Deed of Partnership or The ArticlesSole traders often employ waged of Partnership). The most commonemployees, but they alone have to examples of a partnership are doctorsprovide all the finance (often savings surgeries, veterinarians, accountants,and bank loans) and bear all the risks solicitors and dentists.of the business venture. In return, theyhave full control of the business and As stated earlier, most partners in aenjoy all the profits. partnership face unlimited liability for their debts. The only exception is in aA sole trader faces unlimited liability Limited Partnership. This is where afor his/her debts and it is referred to as partnership may wish to raisean unincorporated business - this additional finance, but does not wish tomeans that there is no legal difference take on any new active partners.between the business and the owner. To overcome this problem, theExamples of Sole Traders partnership may take on as many Sleeping (or Silent) Partners as they wish - these people will provide finance for the business to use, but will not have any input into how the business is run. In other words, they have purely put the money into the business as an investment. These Sleeping Partners face limited liability for the debts of the partnership. A partnership, just like a sole trader, is an unincorporated business.50 | P a g e
  • 51. Private Limited Company the amount of capital to be raised from the sale of sharesThis is a type ofjoint-stock details concerning meetings withincompany (that is, it the businessis an incorporated the arrangements for auditing thebusiness - where accounts of the business.the business has aseparate legal When these are completed, theyidentity from the owners). Often are sent to the Registrar ofprivate limited companies are small, Companies, who will then issue thefamily run businesses which are business with a Certificate ofowned by shareholders. Incorporation which allows the business to trade as a Private LimitedEach shareholder in a private limited Company. The companys name mustcompany MUST be a part of the finish with the word Limited and itbusiness and under no circumstances must raise less than £50,000 of sharecan any shares be sold to members of capital.the general public. Each share entitlesthe owner to 1 vote at the companys It can be very difficult for a shareholderAnnual General Meeting (A.G.M.) and in a private limited company to sellalso to a share of the companys profit their shares, since a buyer must beat the end of the financial year (a found within the framework of thedividend). company. Each shareholder has Public Limited Company (P.L.C.) limited liability for the companys debts and can, This is the therefore, only lose the other, much value of their investment larger, type of in the company. A joint-stock company is run by a company and,Board of Directors (who are elected just like aby the shareholders) and this is private limitedheaded by a Chairman. company, a PLC is an incorporated business, is run by the Board ofBefore a company can be formed, a Directors on behalf of thenumber of legal documents must be shareholders and has an A.G.M. atcompleted - most important are the which shareholders vote on certain keyMemorandum of association and the issues relating to the company.Articles of Association. These coverdetails such as : The main difference between a PLC and a private limited company is that athe objectives of the business PLC can sell its shares on the Stockits headquarters and registered office Exchange to members of the general51 | P a g e
  • 52. public and can, therefore, raise vulnerable to investors and bankerssignificantly more finance than a perceptions about its progress andprivate limited company. success. Following on from this, a PLC is also at risk from a takeover from anIf a private limited company wishes to outside body, if they manage tobecome a PLC, then it must change its accumulate over 50% of the shares inMemorandum and Articles of the PLC.Association and re-submit them to theRegistrar of FranchisingCompanies. Franchising has led to a rapid growthIf the in the presence of many high-streetcompany is stores in the UK over the past 10 yearsconsidered to (e.g. McDonalds, Tie Rack, Perfecthave acted Pizza, and The Body Shop). Alegally and for business franchise involves thethe best interests of its shareholders, franchisor (the owner of the business)then it will be issued with a new selling a business format to aCertificate of Incorporation and also franchisee (the purchaser of thewith a Certificate of Trading, which will business name) in return for a fixedallow it to sell its shares on the Stock sum of money and a percentageExchange. The price of the shares will royalty on sales revenue.then fluctuate according to investorsperceptions of the PLC. The franchisee will be basedIt is often the case with a PLC that the locally and isowners of the company (shareholders) likely to bewill wish the PLC to make as much making hisprofit as possible, so that the initial businessshareholders will receive a very venture. Hehandsome dividend per share. buys theHowever, the Board of Directors and business format, which has been triedthe management will often wish to and tested in other areas, and it isdevote some of the PLC s resources therefore a far less risky venture thanto growth and diversification (such as setting up his own business.the introduction of new products) and The franchisee has a licence to tradethis will clash with the shareholders under the franchisors name and alsodesire for maximum profits. This is to use the logos, trademarks, etc. theknown as the divorce of ownership licence that the franchisee buys isand control. usually restricted to a specificThe PLC has to publish its annual geographical area and for a limitedaccounts (known as disclosure of period of time.accounts) and therefore is extremely52 | P a g e
  • 53. This process of selling the rights to use However, the royalty must be paid toa companys name, logo, etc. can the franchisor even if a loss is maderesult in the parent company and the franchisee can have strictexperiencing rapid expansion in a restrictions placed on their actions andcountry, with little of the investment promotions within the store, notthat would have been required had the leaving the franchisee much room forcompany bought the outlets itself. The initiative and flair.franchisee is provided with a ready-made product, financial andmanagement help and advice, lowerstart-up costs than for a business ofhis own, and help with the store layout. customers and many competitors. Lenders are put off by the risk that theSources of start-up may fail. If that happens, thefinance owners may be unable to repay borrowed money.Why businessneeds finance Some sources of finance are short term and must be paid back within aFinance refers year. Other sources of finance areto sources of money for a business. long term and can be paid back overFirms need finance to: many years.Start up a business, eg pay for Creditors and debtorspremises, new equipment andadvertising. A creditor is an individualRun the business, eg having enough or businesscash to pay staff wages and suppliers that has lenton time. funds to aExpand the business, eg having funds business andto pay for a new branch in a different is owed city money. A or debtor is an coun individual or business who has try. borrowed funds from a business and so owes it money. New busi There is a cost in borrowing funds. ness Money borrowed from creditors is paid es back over time, usually with anfind it difficult to raise finance because additional payment of interest. Interestthey usually have just a few53 | P a g e
  • 54. is the cost of borrowing and the reward remained after corporation tax hasfor lending. been paid to the Inland Revenue and after dividends have been distributedA business owners house could be to shareholders. It is a useful source ofused as collateral finance to fund new products, etc.Creditors often ask for security before The sale of fixed assets, such aslending funds. This means sole traders machinery, vehicles or even land andand partners may have to offer their buildings which are idle, can also be aown house as a guarantee that monies large source of cash to fund newwill be repaid. A company can offer projects.assets, eg offices as collateral. Making more effective use ofThe type of finance chosen depends working capital, such as chasingon the type of business. Start ups and debtors for prompt payment, selling offsmall firms are considered very high any available stocks and negotiatingrisk and find it difficult to raise external longer credit periods with suppliers allfinance. The only source of funds release cash for use within the migh business. t be the External finance is generated from own outside the business in a variety of ers ways: own savi Bank overdrafts allow the business to ngs, withdraw more money from the bankretained profits and borrowing from than it has in its account. It is afriends. Companies can issue extra flexible, short-term method ofshares to raise large amounts of borrowing extra cash. However,capital in a rights issue. interest is calculated on a daily basis and it can be recalled at very shortInternal and External Sources of notice.Capita The amount of finance requiredby a business will depend on a range Trade credit involves the businessof factors, including the age of the obtaining goods from anotherbusiness, the track-record and business, but not paying for them for aprofitability of the business, the period of time.industry that it is in and the state of the Factoring involves a business sellingeconomy. its debts to a factor company, who willInternal finance is generated from immediately give the business 80% ofwithin the business and is likely to the money owed to it by its customer.come from one of three sources: At a later date, having collected the debt from the customer, the factorRetained profit refers to profits made company will give the business thefrom previous years, which have remainder of the money less a fee.54 | P a g e
  • 55. Leasing is a common way to fund new fixed assets, as opposed to purchasing them outright. Thebusiness will sign a contract mortgages, will increase the gearingcommitting it to using some vehicles, level of a company.machinery, premises, etc. for a fixed Venture capital is a very risky type ofperiod of time (often 3-5 years) with a investment that entrepreneurs (calledmonthly payment made to the venture capitalists) will make in acompany who owns the assets. The small to medium sized business, whichbusiness leasing the assets cannot put they believe has massive growththese items on its balance sheet (since potential. These funds will clearly helpit never owns them). the business to grow and achieve itsLoans and mortgages are often used purchase new fixed assets Whichever source of finance is(machinery, vehicles and land and chosen, the business must ensure thatproperty). They require monthly it is adequate for the needs of therepayments to be made for a business (i.e. it is enough to pay forsignificant period of time (up to 25 the new product development, newyears for a mortgage) and the bank will buildings, etc.) and that it isalso want an item to be placed as appropriate (i.e. it will not leave thesecurity (collateral) to cater for the business with large monthly interestevent of the business defaulting on it repayments, when they are alreadyloan repayments. The danger is that burdened with high gearing).too many loans and mortgages willincrease the companys gearing to a The overall objective in raising financedangerously high level. for a company is to avoid exposing the business to excessive highDebentures are sold by companies to borrowings, but without unnecessarilyinvestors as a way of raising finance diluting the share capital. This willfor use within the company. They are ensure that the financial risk of thelong-term, marketable securities, company is kept at an optimal level.which will pay the holder a fixedamount of money every year until itsmaturity date - at which time the holderwill be able to sell the debenture backto the company for it market price.However, debentures, like loans and55 | P a g e
  • 56. Sources of Finance: Activity Case 3Task: A large plc is planning on moving a major part of its production facility toYou will be given a variety of different Cornwall. It has identified a site near abusiness scenarios. You must decide former chalk pit that is now not used.what type of finance the business in The estimated cost of the facility isquestion should go for and why. Of £4.5 million.course, there could be more than oneappropriate source of finance - you Case 4could decide on a combination butagain, ensure that you explain why you A local Do It Yourself (DIY) store hashave decided on this route. experienced problems with acquiring goods from its suppliers because it hasThe Cases: been an erratic payer of its bills with them. The reasons it has experiencedCase 1 these problems is that it has contracts to supply building materials to aA medium-sized engineering firm with number of local firms all of whom onlyan annual turnover of £2.5 million has pay the bills for their orders every 3decided to install a new piece of months.machinery to help improve itsproductivity. The equipment needs to Case 5be housed in a new building to beconstructed on the site. The forecast A rugby club iscost of the building is £150,000 and anticipating turningthe equipment £400,000. fully professional after the team secured promotion to the Zurich premiership. To take its place in the league, the league committee have insisted that it also improves facilities at the ground. It has been estimated that the cost of these two measures will be £550,000.Case 2An individual has been maderedundant after 20 years with a majororganisation and has received a lump Case 6sum redundancy payment of £70,000.The individual is planning to set up a A major UK plc is planning thebookmakers and has identified a takeover of a rival business. The movesuitable premises valued at £180,000 has been investigated by thenear to a major town centre shopping Competition Commission andprecinct. permission has been granted. The56 | P a g e
  • 57. current share price of the rival firm is into a software package that will260p and the firm has made an offer of provide a sophisticated database340p per share. The current market programme that will do all the thingscapitalisation of the target firm is £4.5 that the charity will require for the nextbillion. 10 years. The cost of the software package is £65,000.Case 7A small partnership business hasdeveloped a new piece of softwarethat would massively improve theefficiency of personnel managementprocesses at large sized businessorganisations of all kinds. The softwarehas massive potential but at present isnot commercially viable because oflack of funds. The partners arecontemplating their next move. Case 10 Following the construction of a new housing estate on the outskirts of a major city, a group of 10 ambitious young professionals has decided to try to exploit the type of resident moving into the area by setting up a gym andCase 8 health centre on earmarked land within the development. The building hasA small newsagent in a rural village been bought by the group for £800,000centre has decided to purchase a new but needs to be furnished and fittedfreezer cabinet and oven/roasting unit out for the purpose intended. The costto provide hot meals for village of the bar, restaurant and gym facilitiesworkers and for students at the is estimated at £95,000 but the othersecondary school which serves the major cost is the swimming pool, spasurrounding area which is located half and sauna area. This could be utiliseda mile from the village centre. The cost on a separate project to the fitnessof the units is £3,500. centre as the local council want to secure use for local school childrenCase 9 and elderly residents - this being part of the purchase arrangementsA large charity organisation has associated with the new housingfollowed a consultancy programme on development.streamlining its records. Theconsultants have suggested investing57 | P a g e
  • 58. 1.5.1 Sources of finance: 101-104 jan 2009 q5 Need for finance jan 2009 q9b Internal/external sample paper q6 Appropriateness 29-33 sample paper q9d Finance & time may 2010 q 11 Legal structures of business LiabilityPast paper questions 58
  • 59. Section 6 (timber, steel), machinery, delivery vehicles, and components used to Measuring the potential make larger products (e.g. tyres and success of a business idea headlights for vehicles).Product A product line is the term used to describe a related group of productsProducts can generally be classified that a business produces (e.g. aunder two headings - consumer business may produce televisions, andproducts and producer products... its product line may include portable televisions, 12-inch screen models, 18-Consumer products inch screen models, televisions with aPurchased and used by individuals / built-in video facility, etc). Product mixcitizens for use within their homes and is the term used to describe thethese products fall into 3 categories: different collection of product lines that a business produces (eg the sameConvenience products. Fast-moving business may also produce videoconsumer goods ( sold in recorders, camcorders and computers,supermarkets, such as soap, as well as televisions).chocolate, bread, toilet paper, etc.These often carry a low profit-margin. Most businesses will wish to change their product portfolio over time. ThisShopping products. These are can be the result of changingdurable products which are only consumer tastes, replacing thosepurchased occasionally, such as products which have entered thedishwashers, televisions and furniture. decline phase of the product life-cycleThey often carry a very high profit- or to try to break into new markets ormargin. new segments within an existing product. There are generallySpeciality products. These are very considered to be a number ofexpensive items that consumers often stages in the development of newspend a large amount of time products:deliberating over, due to the largeinvestment requires to purchase the The generation of ideas. A number ofproduct. Examples include cars and issues need to be considered, such ashouses. The profit-margins are, again, will the new product meet thevery high. objectives of the business? Does the business have the spare capacity toProducer products produce the product? Will the new product contribute to the continuedPurchased by businesses and are growth of the business? Will neweither used in the production of other personnel be required, or will theproducts, or in the running of the business have to re-train the existingbusiness. For example, raw materials staff? 59
  • 60. Testing the response is favourable, then the new concept. Is product is likely to be launched there a sufficient nationally. However, if the consumers market for the indicate that some element of the new product? marketing mix is ineffective (price, This stage of the packaging, advertising, etc) then this is product likely to be changed before the development national launch of the product. process will involve carrying National launch. This is where theout extensive primary market research product enters the Introductory stageto test consumers reactions to the of its product life-cycle. This is a verysuggested product. Consumers may costly operation, since a nationalsuggest slight alterations and launch needs to be supported bymodifications to the suggested product extensive advertising and promotionalin order to make it more marketable campaigns.and desirable. It is inevitable that many new productAnalysing the costs/revenues. What ideas will not get to the market place,will be the costs of production? How and many of those that do succeed inmany units will the business be able to being launched will fail within a fewproduce? What will the selling price be months of their commercialisation.set at ? What will be the profitability of However, the businesses which seemthe new product? to be most successful in bringing new products to the market place tend toDeveloping a prototype. The design, meet a number of vital criteria:materials, quality and safety of theproduct will now become paramount. A they develop 2 to 3 times the numberprototype of the product will be of new products as their competitors;developed using the details that the they get the product to the marketmarket research indicated that place quickly;consumers wanted. It is essential toensure that this stage of the they compete in many differentdevelopment process is detailed and markets;extensive, since to make alterations they provide strong after-sales service.and modifications at a later date will beextremely expensive and time- Priceconsuming. The price level that a business decidesTest marketing the new product. to sell its product(s) at will affect bothThe business may often decide to test the quantity of sales and the profit-market the new product in a small margin received per unit. There aregeographic area, in order to test many considerations that a businessconsumer response, before it launches will need to take into account before itthe product nationally. If the consumer60 | P a g e
  • 61. decides upon a selling price for a new know with some certainty what theproduct, such as: gross profit margin of each sale will be.The objectives of the business if the Here is an example of cost-plusmain objective of the business is to pricing, where a business wishes tomaximise profit, then it is likely that the ensure that it makes an additional £50product will be priced at a high level. of profit on top of the unit cost of production.The degree of competition in theindustry the number of competitors in Unit cost: £100the industry will affect the price level Mark-up: 50%that the business decides upon for its Selling price: £150product(s). How high should the mark-upThe channels of distribution the percentage be? That largely dependsmore intermediaries that are used in on the normal competitive practice in agetting the product from the factory to market and also whether the resultingthe consumer, then the higher the price is acceptable to customers.selling price is likely to be. For example, in the UK a standardThe business image if the image of retail mark-up is 2.4 times the cost thethe business is prestigious and up- retailer pays to its supplier (normally amarket, then a higher price is likely to wholesaler). So, if the wholesale costbe charged for the product(s). of a product is £10 per unit, the retailer will look to sell it for 2.4x £10 = £24.There are many methods and This is equal to a total mark-up of £14strategies that a business can use in (i.e. the selling price of £24 less theorder to arrive at a selling price for its bought cost of £10).products: The main advantage of cost-basedCost-plus pricing. Cost-based pricing pricing is that selling prices areinvolves setting a price by adding a relatively easy to calculate. If thefixed amount or percentage to the cost mark-up percentage is appliedof making or buying the product. In consistently across product ranges,some ways this is quite an old- then the business can also predictfashioned and somewhat discredited more reliably what the overall profitpricing strategy, although it is still margin will be.widely used. After all, customers arenot too bothered what it cost to make The main disadvantage is that cost-the product – they are interested in plus pricing may lead to products thatwhat value the product provides them. are priced un-competitively. Another potential issue is that firms mayThe most common method of cost- experience changes in their productionbased pricing is cost-plus (or “mark- costs which are not then reflected inup”) pricing. It is widely used in the selling prices offered, leading toretailing, where the retailer wants to lower profit margins.61 | P a g e
  • 62. Mark-up pricing. This is where the reflect thisbusiness adds a profit mark-up to the through highdirect cost for each unit in order to prices for itsarrive at the selling price. This profit products (e.g.mark-up will need to cover the fixed Rolls Royce).overheads and then contribute towardsprofit. Demand-orientated pricing. This method of pricing involves setting thePredatory (or destroyer) pricing. This price of the product at a level basedmethod of pricing involves a business upon customers perceptions of thesetting its prices at such a low level quality and value of the product.that other (often smaller) competitorscannot compete profitably, and as a Competition-orientated pricing. Thisresult they are forced out of the method of pricing ignores both theindustry. This leaves the larger costs of production and the level ofbusiness in a dominant position, and it customer demand. Instead it bases thecan then raise its prices to a much price level on the prices charged byhigher level in order to recoup any the competitors in the industry -eitherlosses that they incurred when their undercutting the competitors, chargingprices were low. a higher price, or charging the same price. Going rate pricing is the termSkimming pricing. This is a pricing used to describe a business chargingstrategy for a new product, designed to a similar price to competitors for acreate an up-market, expensive image similar setting the price at a very high level.It is a strategy often used for new, Psychological pricing is a pricinginnovative or high-tech. products, or tactic that is designed to appeal tothose which have high production customers who use emotional rathercosts which need recouping quickly. than rational responses to pricing messages.Penetration pricing. This is a pricingstrategy for a new product, designed to Sometimes prices are set at whatundercut existing competitors and seem to be unusual price points. Fordiscourage potential new rivals from example, why are DVD’s priced atentering the market. The price of the £12.99 or £14.99? The answer is theproduct is set at a low level in order to perceived price barriers that customersbuild up a large market share and a may have. They will buy something forhigh degree of brand loyalty. The price £9.99, but think that £10 is a little toomay be raised over time, as the much. So a price that is one penceproduct builds up a strong brand- lower can make the differenceloyalty. between closing the sale, or not!Prestige pricing. This strategy is used The aim of psychological pricing is towhere the business has a prestigious, make the customer believe the productup-market image, and it wishes to is cheaper than it really is. Pricing in62 | P a g e
  • 63. this way is intended to attractcustomers who are looking for “value”.For example, a new car might bepriced at £12,995 rather than at£13,000. A rational customer wouldknow that the price difference of £5 istiny for such a high value item as anew car. However, customers don’tnecessarily behave rationally. Somemay look at that price and “round itdown” to £12,000, making theperceived difference more significant!The main advantage of psychologicalpricing is that it allows a business toinfluence the way that customers viewa product without the need to actuallychange the product.63 | P a g e
  • 64. CostsVariable and Total CostsGenerally speaking, a business willincur two types of cost when itproduces goods and provides servicesto consumers:Fixed costs & Variable costs. When fixed costs are added to variable costs, then the total costs (TC) of theA fixed cost is one which is totally business can be calculated.independent of the level of output,and it would be incurred even when In other words, TFC + TVC = TC.output was zero. Examples include This helps the business to calculate itsrent, mortgage payments, managers total costs at any given level of output.salaries, and loan repayments. Theyare often referred to as overheads. Total costsTotal fixed costs (TFC) Note that TC starts at the same point as TFC.Variable costs are those which varydirectly with output (i.e. as the level Average costs (AC) are calculated byof output increases, then variable dividing total costs by the level ofcosts increase). Examples include raw output.materials, production wages, otherdirect production costs, and utility bills. In other words:Total variable costs (TVC) Average costs64 | P a g e
  • 65. It is clear to see that average costs willalso start to decline over time. Whenthis occurs in the long-run, then thebusiness is said to have achievedeconomies of scale.However, the business is likely toreach a level of output where averagecosts (the cost per unit) will start to riseagain. In these circumstances, thebusiness is said to be experiencingdiseconomies of scale.When average fixed costs are addedto average variable costs, then theaverage total costs (AC) of thebusiness can be calculated.In other words:AFC + AVC = ACThis helps the business to calculate itsaverage cost at any given level ofoutput.65 | P a g e
  • 66. Contribution Analysis towards fixed costs, then it is still worthwhile to produce it.Contribution is the term given to theamount of money that remains after all Total contributiondirect and variable costs have beendeducted from the sales revenue of Total contribution = Total salesthe business. revenue - Total direct and variable costs.It is called contribution because itrepresents the amount of money which For example, if a business has totalis available to contribute towards sales revenue of £ 4 million, and itscovering the fixed costs of the total variable and direct costs are £ 2.5business and, once these are covered, million, then the total contribution forit represents the amount of money the business is £ 1.5 million. Thiswhich will contribute towards the profit contribution will hopefully cover theof the business. In other words, fixed costs and then contributecontribution - fixed costs = profit. towards profit.Contribution can be analysed in twoways:Contribution per unit soldContribution per unit sold = Sales priceper unit - Variable costs per unit.For example, if a product has a sellingprice of £ 10, and its variable costs(labour, raw materials, etc) is £ 3 perunit, then it has a contribution of £ 7per unit.If a product is loss-making, but itnevertheless makes a contributiontowards covering the fixed costs of abusiness, then it would be unwise todelete the product from the productportfolio. This is because the totalprofit of the business will actuallydecrease if the contribution from theloss-making product is no longerreceived. Therefore it is vital that aloss-making product is not deletedsimply because it fails to produce aprofit - if it produces a contribution66 | P a g e
  • 67. Break-Even ChartsThis is a graph showing the totalrevenue and the total costs of abusiness at various levels of output. Itis a form of Management Accountingand it enables a manager to see theexpected profit or loss that a product In other words, the business will needwill face at different levels of output. to produce 200,000 units before it breaks-even.The break-even point is the point ona break-even chart where the total Any level of output below 200,000 willrevenue (T.R) of a business (or yield a loss.product) is equal to its total cost Any level of output above 200,000 will(T.C). yield a profit.It can also be calculated The profit is equal to total revenuemathematically by using the following minus total cost (or profit = TR -formula: TC). Total revenue (TR) is calculated by multiplying the selling price by theFor example: number of units sold.A business produces just one product, In this example, the selling price is £ 9which it sells for £ 9 per unit. The and the number of units sold isvariable cost of each unit is £ 4 and 500,000.the business faces fixed costs per year Therefore the total revenue (TR) is £ 9of £ 1 million. x 500,000 = £ 4.5 million.The business currently produces and The total cost (TC) is calculated bysells 500,000 units. adding together the total fixed costsWhat is the break-even level of (TFC) to the total variable costsoutput and what profit will the (TVC).business make if it sells all of its In this example, the fixed costs are £ 1output? million and the total variable costs areIn order to assist the drawing of the £ 4 x 500,000 units = £ 2 million.break-even chart, we can calculate the Therefore the total cost (TC) is £ 3break-even level of output and the million.amount of profit using simple formulae: The profit is, therefore, TR - TC, which gives us: £ 4.5 million - £ 3million = £ 1.5million.67 | P a g e
  • 68. We can now draw a break-even chart up from the 500,000 unit mark toand check the figures on the chart with where it hits the TC line. This is thenthe answers above. measured across to the y-axis (again using a red line) to give us total costsIn order to have an accurate break- of £ 3 million.even chart, three lines must beplotted: The vertical red- line from the 500,000 unit mark is then extended to where itTotal Fixed Costs (TFC), hits the TR line. Again, this is thenTotal Costs (TC) measured across to the y-axis to give us a total revenue of £ 4.5 million.Total Revenue (TR). Therefore, the profit is theThe x-axis is labelled as Output (in difference between TR and TC (i.e. £units). In this example, the axis will go 1.5 million).up to 500,000 units. Although break-even analysis is a veryThe y-axis is labelled as Costs, useful tool, it does have severalRevenue and Profit (in £ ). In this drawbacks:example, the axis will go up to £ 4.5million. It assumes that the TFC, the TC and the TR functions are linear. In reality, this is very unlikely. It assumes that the selling price is constant, in reality the selling price is likely to vary from customer to customer and region to region. It assumes that the business only produces one product. It assumes that the business can sell all of its output. In reality, very few businesses will be able to do this andAs you can see, the answers on the some will remain as unsold stock.chart correlate with the answerscalculated using the two formulae The data used to construct the break-above. The break-even point (shown even chart may well be out-of-date andas a red dot) is the point where the TC therefore inaccurate.and the TR lines cross. This is thenmeasured by dropping a vertical redline down to the x-axis, to give 200,000units.The profit at 500,000 units is thencalculated by taking a red vertical line68 | P a g e
  • 69. Profit and Loss Account period). Examples include wages, raw materials, and utility bills -often knownThe profit and loss account is a as revenue statement which representsthe revenue that the business has It must be remembered that expensesreceived over a given period of time, are not necessarily the same asand the corresponding expenses costs.which have been paid. For example, if a business purchasesIt also shows the profit that the a new fixed asset (such as a machine) then it will clearly incur the monetarybusiness has made over a period of cost of purchasing the machine (saytime (usually 12 months) and the uses £50,000).to which the profits have been put. However, this £50,000 will not beRevenue written-off as an expense, since theRevenue is the inflow of money to the benefits from the machine will last forbusiness in the course of the ordinary more than a single accounting periodactivities of the enterprise. (i.e. for more than 12 months). Instead of writing-off the total cost of theThere are a number of different machine, a portion of the £50,000 willsources of revenue; be written-off as an expense each year over the useful life of the machine -thiscash sales is known as a depreciation sales (i.e. where the business Format of the Profit and Losshas sold goods to customers, but has accountnot yet received the cash) The usual layout for a profit and loss accountinterest is as below:royalties £000£000dividends that the business receiveson its investments or Sales Revenue 1,000fees for hiring-out the resources of thebusiness to a third party. Cost of Sales:Revenue is recognised at either thereceipt of the cash OR at the point of Materials 300sale (if the goods are sold on credit).Expenses Direct labour 200Expenses are expired costs (i.e. costs Production overheads 100from which all benefits have beenextracted during an accounting69 | P a g e
  • 70. associated with the production, and (600) the production overheads. These are sometimes referred to as direct materials, direct labour and directGross profit 400 overheads).Less selling expenses 100 Sales revenue less C.o.G.S. is known as Gross profit.Less administrative expenses 120 However, we have not yet accounted for selling and administrative expenses (such as advertising costs, distribution (220) costs, salaries, utility bills, etc.). When these are deducted from theTrading [Operating] Profit 180 Gross Profit, the result is known as trading or operating profit. TheseAdd non-operating income (10) refer to the profit made from normal trading activities.Profit before interest and tax 190 The next adjustment is to add on any income from other activities, known as non-operating income (e.g. renting outLess interest expense (30) premises). The resulting figure is known as profit before interest andProfit before tax [Net Profit] 160 tax. We then deduct a figure for interestLess taxation (60) charges. The resulting figure is known as profit before tax or net profit.Profit after tax 100 The final part of the account is known as the appropriation account. ItLess dividends (20) provides information on the way in which the profit is dispersed.Retained Profit 80 Some is taken in corporation tax and goes to the Inland Revenue, some is drawn from the business asThe first line gives the Sales dividends to be distributed to theRevenue for the business from selling shareholders and the remainderits goods and services. is retained within the business for re- investment.From this, we deduct the "Cost ofgoods sold" (costs directly associatedwith the production of the goods andservices - such as the cost of the rawmaterials, the labour charges70 | P a g e
  • 71. Ratio Analysis - Introduction The business would want this margin to be as high as possible, since a highRatio analysis is an accounting tool, margin will leave more profit forwhich can be used to measure the covering the remaining expenses and,solvency, the profitability, and the if the business is a company, foroverall financial strength of a business, covering the dividend payments toby analysing its financial accounts shareholders.(specifically the balance sheet and theprofit and loss account). The net/operating profit marginAccounting ratios are very easy to This measures the net profit of thecalculate and they enable a business business as a proportion of the salesto highlight which areas of its finances revenue. It is calculated using theare weak and therefore require following formula:immediate attention.There are two main ratios that can beused to measure the profitability of abusiness: For example, if a business has gross profit of £1 million and sales revenue 1. The gross profit margin. of £6 million, then the net profit margin 2. The net/operating profit margin. would be:The gross profit marginThis measures the gross profit of thebusiness as a proportion of the sales This means that for every £1 of salesrevenue. It is calculated using the revenue, 16.7 pence remains after allfollowing formula: direct and indirect expenses have been deducted. This money then contributes towards covering the corporation tax that must be paid onFor example, if a business has gross profits to the Inland Revenue and, ifprofit of £4 million and sales revenue the business is a company, coveringof £6 million, then the gross profit the dividend payments tomargin would be: shareholders. Any profit which remains is kept in the business for re-investment and is called retained profit. Again, theThis means that for every £1 of sales business would want this margin to berevenue, £0.67 remains after all direct as high as possible, allowing bothexpenses have been deducted. This large dividend payments tomoney then contributes towards shareholders and a significant amountcovering the other expenses of the of profit to be retained for | P a g e
  • 72. 72 | P a g e
  • 73. Improving profit marginsMars bars shrink in sizeThe size of Mars and Snickerschocolate bars has been shrunk bymore than 7 per cent as the companytries to cut costs.A Mars bar "By slightly reducing portion sizes onWhile the best-selling treats have been Mars and Snickers we were able toreduced from 62.5g to 58g, their prices continue to responsibly meethave remained the same. consumer demands for healthier lifestyles whilst not increasing ourThe change happened in the second prices."half of last year and the downsizedversions are now on sale in the shops, Consumer Focus, the customer bodywhere a Mars bar still costs 37p and a set up by the Government, isSnickers is 41p. concerned that firms are attempting to fool consumers.Mars UK claimed the switch to smallersizes was designed to help tackle the "Shrinking the size of chocolate barsnations obesity crisis. should be part of a drive to combat obesity. However, shrinking size butHowever, the move was not advertised not price could damage consumersdespite claims it was for a public trust in the brands they love," said itshealth initiative. policy expert Lucy Yates.The reduced Mars contains just 19 Mars UKs sister operator in Australiafewer calories at 261, while the is shrinking the size of 90 productsSnickers has 23 fewer at 296. while keeping prices the same.Mars UK has now confirmed that the The change there has been handledchange was triggered by rising costs, very differently by being presented in aaccording to the Daily Mail. major advertising campaign as a public health measure."Like all food manufacturers, we haveseen continued cost increases over The tactic of cutting product sizes,the last few years," it said in a known as the Grocery Shrink Ray instatement. America, is a tactic being used by many British companies."We look to absorb the vast majority ofthese costs by being more efficient,but on occasion we have to considerincreasing prices.73 | P a g e
  • 74. There are a number of ways a firm can What are the effects of each of theseimprove its profit margins: on the profit and loss account? 1. Reduce the number of special What could be the consequences? offers. 2. Buy cheaper raw materials 3. Stock a wider range of products 4. Increase prices 5. Reduce wastage 6. Stock more seasonal items.1.6.1 Sales volume & revenue: 72-73 may 2009 q9 Goods/services Sales volume Total revenue Pricing: demand-based cost-based competition-based 184-188 May 2010 q12 psychological.1.6.2 Business Costs: 73-75 Fixed costs Variable costs Total costs1.6.3 Profit & contribution 82 Sample paper q5 Calculating profit Contribution: selling price – variable costs1.6.4 Break-even revenue level. 82-87 Sample paper q4 Jan 2009 q9c Break-even analysis May 2010 q8 Break-even point Actions Chart/formula Margin of safety Limitations of break-even1.6.5 Profit & Loss account 377-382 May 2009 q10 Calculating profit & loss Gross Profit Cost of Sales Expenses Net/Operating Profit1.6.6 Measurement of profit 394-404 May 2009 q4 Use of P & L account Sample paper q2 Ratio analysis: Gross Profit Margin Net Profit Margin Improving Profit Margins Limitations of ratio analysis74 | P a g e
  • 75. Past paper questions75 | P a g e
  • 76. Section 7: Putting a business planning idea into practice is a majorOnce an entrepreneur has recognised cause ofan opportunity, he/she must draw up a businesbusiness plan. This is a document s failure.which outlines the marketing, Businesproduction and financial plans for the ses areproposed business. It is used to try more likely to succeed if their strategyand persuade investors (banks, etc.) to is carefully plannedlend money to the entrepreneur to fundhis/her new business. There is an alternative. A business plan is a report by a new or existingThe main sections of a business business that contains all of itsplan include: research findings and explains why the- the aims and objectives of the firm hopes to succeed. A businessbusiness plan includes the results of market research and competitor analysis.- details of the new product or service Analysis is when a businessbeing offered interprets information.- an outline of the existing market Drawing up a business plan forcesdetails (i.e. size of the market, number owners to think about their aims, theof existing competitors) competition they will face, their financial needs and their likely profits.- how and where the product will be Business plans help to reduce risk andproduced reassure stakeholders, such as banks.- the proposed number of employees- a cashflow forecast, a projectedprofit and loss account and balancesheet for the end of the first yearstrading- details of the finance required andthe forecasted rate of return on this.Most small businesses have verylimited resources. Research is costlyand can seem like a poor use of time.Some entrepreneurs ignore planningand analysis and instead rely on theirgut instinct. They launch products theybelieve customers want andcompetitors cannot match. Poor 76
  • 77. Cash Flow Forecast 1. Overtrading -where the business attempts to expandCash Flows too rapidly, without a sufficient financial base.Cash is the most liquid of all the assetsof a business -it represents the bank 2. Having too much moneybalance and the cash that the invested in has available on thepremises (otherwise known as petty 3. Allowing too much credit tocash). their customers.Cash flow refers to the difference 4. Unexpected changes inbetween the cash flowing into the demand for their (e.g. through sales revenue) 5. Overborrowing -thereforeand the cash flowing out of the having large monthly loanbusiness (e.g. bills and wages). repayments, which have to beCash flow problems met.Having a positive cash flow is vital for There are many actions that athe survival of a business, since business can take when it iswithout the ability to pay workers and experiencing a liquidity crisis:suppliers then the business will soon 1. Offering price discounts tohave to cease trading. boost sales and salesThis potential problem is compounded the fact that businesses often have 2. Selling off fixed pay many expenses several weeksor even months before any cash 3. A sale and lease backactually flows into the business. arrangement.For example, wages and salaries will 4. Chasing debtors for thehave to be paid to employees, monies owed to the business.suppliers will have to be paid for anyraw materials, and the rent or 5. Selling off payments will have to be Whatever action is decided upon, thepaid before the products can be business must ensure that it ismanufactured and sold to customers. implemented quickly and that a carefulFurther to this point, if the products are eye is kept on the liquidity (cash flow)sold on credit to customers, then the position in the future.time delay between the cash outflows Cashflow statementand the cash inflows will be evenlonger. A cash flow statement is a Financial Accounting document, which showsThe major causes of cash flow the cash inflows and the cash outflowscrises for a business are:77 | P a g e
  • 78. for a business over the past 12 Example:months. Total Jan Feb Mar AprIt indicates those months in which the £business suffered a cash flow crisis(where cash outflows were greater Sales 2850 900 850 750 350than cash inflows) and it will also revenuehighlight those months in which the Otherbusiness was cash-rich (i.e. more cash 650 200 200 100 150 revenueinflows than cash outflows). Total cashIt allows a business to prepare a cash 3500 1100 1050 850 500 inflowsflow forecast for the forthcoming year,by basing the estimated cash inflows Total cashand outflows on the results from the 3400 700 950 1200 550 outflowsprevious year. NetCashflow forecast monthly 100 400 100 (350) (50)A cash flow forecast is a cash flowManagement Accounting document, Bankwhich outlines the forecasted future 300 600 700 350 300 balancecash inflows (from sales) and theoutflows (raw materials, wages, etc)per month for a business over anaccounting period. The business forecasts that in January it will experience cash inflows of £1,100 and cash outflows of £700, leaving a positive net monthly cash flow of £400. This is added to the £200 bank balance which existed at the end of December, to give a forecasted bank balance at the end of January of £600. In February, the forecasted cash inflows are only £100 more than the forecasted outflows, leaving a bank balance of £700. However, in the months of March and April, the business is forecast to experience negative net monthly cash flows (i.e. its cash outflows are78 | P a g e
  • 79. forecast to be greater than its cashinflows).This gradually reduces the bankbalance to just £300 by the end ofApril.It is important for a business toproduce a cash flow forecast, so that itcan prepare for those months in whichit is forecast to experience a cash flowcrisis (i.e. the business needs toarrange extra borrowing or overdraftfacilities to provide extra cash).Alternatively, in the months where thebusiness is forecast to be cash-rich, itcan use this money profitablyelsewhere within the business ( product development).1.7.1 Creation of a business plan may 2009 q 7 What is a business plan? 21-25 may 2010 q 5 Contents 79-86 may 2011 q12 Cash flow management79 | P a g e
  • 80. Past Paper questions 80
  • 81. Revision a word cloud that identifies the keywords from Unit 1!The clouds give greater prominence to words that appear morefrequently in the source text. You can tweak your clouds with differentfonts, layouts, and color schemes. The images you create with Wordleare yours to use however you like. You can print them out, or savethem to the Wordle gallery to share with your friends.81 | P a g e
  • 82. RevisionCreate a power-point presentation that answers one of the following tasks:Entrepreneur a) Identify an entrepreneur, what does he/she do, why, and how?Examples: Steve Jobs, Mark Zuckerberg, Anita Roddick, Giorgio Armani. Whatwere their motives?Supply and Demand b) Draw and label a supply and demand curve showing their interaction. Explain what happened if one of the main factors (determinants) changes. Eg price of substitutes.Market research c) Identify 3 other methods of market research. What are the advantages and disadvantages of these methods? Find suitable examples of poor market research eg Coca-Cola DasaniMarket Niche d) Identify 2 companies that have a Market Niche. What does this mean and what are the specific segments they have identified?Product Positioning e) Think of a small café/restaurant you have visited in Valencia. How have they positioned themselves? Who are the competition? Why are they different (competitive advantage) and which methods to they use toa dd value? Eg How to they persuade us to pay 1,50 for a coca cola that costs 50c in the supermarket?Product Trial f) Identify a product Trial that has taken place that you are familiar with. How did they test market? What were the advantages and disadvantages? Was it/Is it successful?Stakeholders g) Identify a small business you are familiar with. Who are the stakeholder groups involved. How are they involved? How could they be affected by the current economic recession?82 | P a g e