QUESTIONS (MARKETING PLANNING)

1. a) Define price elasticity of demand and explain why some products are price-elastic and other products are price-inelastic.

b) Outline the factors which may influence an organisation's pricing policy.

(Marks available: 10)

Answer

2. a) What is meant by a random sample.

b) A marketing manager's experience has been that between 10% and 20% of women purchase a new brand of cosmetics within one month of its introduction.

She wishes to estimate, by sampling, the percentage of women who will purchase a particular new Brand X, within one month of its introduction.

How large a random sample should be taken if she wants the estimate to be at 95% confidence level.

(Marks available: 10)

Answer

3. a) What is the product offered by a lottery firm such as Camelot?

b) How might a lottery firm optimise its marketing mix?

(Marks available: 20)

Answer

MARKETING PLANNING (REVISION SUMMARY)

Advertising

This is a method of promotion that a business has to pay for. It is carried out through a variety of mediums, such as television, newspapers, magazines, cinema or radio. Advertising is either informative (making the market aware of the product / service) or persuasive (trying to entice customers to buy the product / service).

Advertising elasticity

This measures the effect on the demand for a product, following a change in advertising expenditure. It is calculated by the formula :



If a large fall in advertising expenditure lead to just a small fall in quantity demanded, then the product would be advertising inelastic.

Advertising Standards Authority (ASA)

This is an organisation which monitors advertisements in print (i.e. magazines, newspapers, posters) in the UK and ensures that they are "fair, true, decent and legal".

Advertising strategy

This is the way that the business attempts to achieve its advertising objectives. The advertising strategy will usually state the necessary finance that must be available and the relevant media to be used.

Branding

This means creating a name and identity for a product which differentiates it from those of competitors.

Brand leader

This is the product (brand) which has the largest market share in a particular industry. It is often in the 'Maturity' stage of the product lifecycle and due to its brand loyalty, it can have a high retail price.

Brand loyalty

This is where customers are happy with their purchase of a particular product, and will return to purchase it again in the future.

Consumer durables

These are products which are purchased by households, and are likely to last for a considerable period of time (e.g. televisions, cars, ovens, video-recorders, etc).

Contribution per unit

This is selling price minus variable costs per unit. The remaining money contributes towards covering fixed costs.

Cost-plus pricing

This means arriving at the selling price for a product by adding a profit mark-up to the total costs per unit.

Direct mail

This refers to promotional material that is sent directly to certain homes and addresses, which are selected from a list of known customers (e.g. 'Britannia Music Club').

Direct marketing

This refers to promotional activities that involve the business making direct contact with potential customers (e.g. direct mail and door-to-door selling).

Distribution

This refers to the process of getting the products from the factory to the customers.

Distribution channels

These are the stages involved in getting the product from the factory to the customers (e.g. wholesalers and retail outlets).

Income elasticity

This measures the effect on the demand for a product, following a change in the income of customers. It is calculated by the formula :



If a large fall in income leads to a small fall in quantity demanded, then the product would be income inelastic.

Loss leader

This term refers to a product which has its retail price set at a level which is less than its costs of production. This strategy is often used by multi-product businesses, which hope that customers will buy their loss leader product, as well as a range of their other products which carry a significant profit margin.

Marketing

The business function which involves getting the right product to the right place, at the right price, using appropriate methods of promotion, and doing it profitably. It is often pre-empted by carrying out extensive market research, in order to discover the customers' needs and wants.

Marketing mix

This term refers to the four main marketing strategies through which a business will attempt to achieve its marketing objectives. These are often known as the '4 Ps' (product, price, promotion and place).

Market penetration

This is a pricing strategy for a new product, designed to undercut existing competitors and discourage potential new rivals from entering the market. The piece of the product is set at a low level in order to build up a large market share and a high degree of brand loyalty.

Packaging

This refers to the colour, shape and presentation of the product and its protective wrappings. This is an important element in the promotional mix that a business chooses, because packaging can create a Unique Selling Point (U.S.P) for a product.

Predatory pricing

This is a pricing strategy which involves a business setting a price for a product at such a low level that their competitors are either forced to leave the market or, more seriously, are forced out of business.

Price discrimination

This is a pricing strategy which involves a business charging different prices to different people for the same product or service. This strategy aims to maximise the sales revenue of the business, by charging a higher price to those groups of customers who have a low elasticity of demand, and charging a lower price to those groups who have a high elasticity of demand. For example, the train companies charge a high price early in the morning to commuters, and a lower price several hours later for other members of the public, for the same distance and journey from London to Birmingham.

Price elastic

This refers to a situation where a given percentage change in the price of a product results in a larger percentage change in the level of demand for it (e.g. luxury products such as cars, holidays, dishwashers, etc). These products are considered to be price sensitive, since even a small rise in price can result in a large fall in demand.

Price elasticity

This measures the effect on the demand for a product, following a change in its price. It is calculated by the formula :



If a large fall in the price of the product leads to a small fall in quantity demanded, then the product would be price inelastic. An answer of more than one indicates that the demand for the product is price elastic. An answer of between zero and one indicates that the demand for the product is price elastic.

Price inelastic

This refers to a situation where a given percentage change in the price of a product results in a smaller percentage change in the level of demand for it (e.g. necessity and habit-forming products, such as milk, newspapers, alcohol and tobacco).

Price leader

This is the term used to describe a product or brand which is a dominant force in the marketplace and it can set its price at any level it chooses. The price that is set by competitors will therefore be dictated by the price leader.

Price taker

This is the opposite to a price leader. It refers to the products of a business which are not market-leaders, and therefore they have to set their price based upon the level set by the dominant product in the market place.

Price war

This refers to a situation where two or more businesses lower their prices in an attempt to win sales and market share from each-other. Price wars are most likely to start in very competitive markets, where the growth potential is very high and consumer sales are very lucrative (e.g. the supermarket industry - Tesco and Asda). Consumers are the only group who really benefit from a price war in the short-term, since they pay lower prices. However, if the price war results in one or more of the competitors becoming unprofitable and being put out of business, then the consumer may be faced with less choice and higher prices than before the price war started.

Pricing methods

This refers to the different ways that a business can decide on the price(s) to charge for its product(s). The main pricing methods are :

- Mark-up pricing (adding a fixed percentage of profit to the direct production costs or total variable costs).

- Cost-plus pricing (adding a percentage of profit to the full cost per unit).

- Competitive pricing (setting prices based upon the existing businesses in the marketplace).

- Skimming (setting the price at a high level, to reflect the innovative nature of the product or to cover the high costs of production).

- Penetration (setting a low price level, to undercut the existing competitors and build up a large market share).

- Psychological pricing (this means setting the price for a product at a level based on the expectations of the consumer. For example, £9.99 instead of the £10 threshold, or £99 instead of the £100 threshold).

Product development

This is a strategy of bringing new products to the marketplace. It can either involve making slight improvements to existing products, or by developing and launching totally new products. The objectives of product development include to increase sales revenue, to increase market share, or to defend a brand leader by making it even better than the competitors' products.

Product differentiation

This is the perceived difference(s) that consumers believe exist between one product and its competitors. A product with a high degree of differentiation can be sold at a high price, therefore yielding a high profit-margin.

Sales promotion

This is a promotional strategy designed to boost the sales of a product in the short-term (using such tactics as a price discount, free products, competitions, discount coupons, etc).

Skimming

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

MARKETING PLANNING (ELASTICITY)

Elasticity

This is the responsiveness of demand for a product to changes in one of the factors that influence demand. In other words, it measures the change in demand following a change in another variable (such as the price of the product, peoples' incomes, or the advertising of the product).

Price Elasticity of Demand

This is the responsiveness of demand for a product to a change in the price of the product itself (i.e. when the price of the product changes, by how much does demand change?).

Diagram 1 represents a product which has an inelastic demand:


Diagram 2 represents a product which has an elastic demand:



Diagram 3 represents a product which has a perfectly inelastic demand:



Diagram 4 represents a product which has a perfectly elastic demand:



Both diagrams 3 and 4 are theoretical extremes and there are no realistic examples.

The formula for calculating price elasticity of demand:



Example 1. If the price of product A rises from £ 8 per unit to £ 10 per unit, and the quantity demanded falls from 100 units to 50 units, then the price elasticity of demand for product A is:

50% : 25% = 2

Example 2. If the price of product B falls from £ 10 per unit to £ 9 per unit, and the quantity demanded rises from 80 units to 84 units, then the price elasticity of demand for product B is:

5% : 10% = 0.5

An answer of zero indicates that demand for the product is perfectly inelastic (see diagram 3).
An answer of between zero and one indicates that demand for the product is inelastic (see diagram 1).
An answer of one indicates that the demand for the product is unitary elastic.
An answer of greater than one but less than infinity indicates that the demand for the product is elastic (see diagram 2).
An answer of infinity indicates that the demand for the product is perfectly elastic (see diagram 4).

Income Elasticity of Demand

This is the responsiveness of demand for a product to a change in peoples' incomes (i.e. if a person's income changes, by how much does his / her demand for the product change?).

If an increase in income leads to an increase in demand for the product, then the product is a normal product. If an increase in income leads to a fall in demand for the product, then the product is an inferior product, (e.g. supermarket own-branded products, where an increase in income will often lead to an individual buying less of an own-brand product, and more of an expensive brand).

The formula for calculating income elasticity of demand:



Example 1. If a person's income rises from £ 200 per week to £ 250 per week, and his demand for product C rises from 10 units to 14 units, then the income elasticity of demand for product C is:

+40% : +25% = 1.6

Example 2. If a person's income falls from £ 400 per week to £ 360 per week, and her demand for product D rises from 100 to 105 units, then the income elasticity of demand for product D is:

+5% : -10% = -0.5

A positive answer indicates that the product is a normal product. A high positive answer would suggest that the product is a luxury product.
A negative answer indicates that the product is an inferior product. The larger the negative value, the more inferior it is.
An answer of zero indicates that changes in income have no effect on the demand for the product (i.e. the product is completely income inelastic).

Advertising Elasticity of Demand

This is the responsiveness of demand for a product to a change in the advertising expenditure used to promote it (i.e. if a business spends more money on the advertising of a product, by how much does the demand for the product change?).

The formula for calculating advertising elasticity of demand:



Example 1. If a business increased its advertising expenditure on product E from £ 1 million per year to £ 1.2 million per year, and the demand for product E rises from 10 million units to 14 million units, then the advertising elasticity of demand for product E is:

+40% : +20% = +2

Example 2. If a business reduced its advertising expenditure on product F from £ 2 million per year to £ 1.8 million per year, and the demand for product F rises from 1 million units to 1.1 million units, then the advertising elasticity of demand for product F is:

+10% : -10% = -1

A positive answer indicates that the advertising campaign is effective, since either an increase in advertising expenditure leads to a rise in demand for the product, or a decrease in advertising expenditure leads to a fall in demand for the product.
A negative answer indicates that the advertising campaign is ineffective, since either an increase in advertising expenditure leads to a fall in demand for the product, or a decrease in advertising expenditure leads to a rise in demand for the product.

MARKETING PLANNING (MARKETING MIX)

Marketing Mix

PRODUCT

Products can generally be classified under two headings - consumer products and producer products...

Consumer products

Purchased and used by individuals / citizens for use within their homes and these products fall into 3 categories:

Convenience products. Fast-moving consumer goods (f.m.c.gs) sold in supermarkets, such as soap, chocolate, bread, toilet paper, etc. These often carry a low profit-margin.
Shopping products. These are durable products which are only purchased occasionally, such as dishwashers, televisions and furniture. They often carry a very high profit-margin.
Speciality products. These are very expensive items that consumers often spend a large amount of time deliberating over, due to the large investment requires to purchase the product. Examples include cars and houses. The profit-margins are, again, very high.

Producer products

Purchased by businesses and are either used in the production of other products, or in the running of the business. For example, raw materials (timber, steel), machinery, delivery vehicles, and components used to make larger products (e.g. tyres and headlights for vehicles).

A product line is the term used to describe a related group of products that a business produces (e.g. a business may produce televisions, and its product line may include portable televisions, 12-inch screen models, 18-inch screen models, televisions with a built-in video facility, etc). Product mix is the term used to describe the different collection of product lines that a business produces (eg the same business may also produce video recorders, camcorders and computers, as well as televisions).

Most businesses will wish to change their product portfolio over time. This can be the result of changing consumer tastes, replacing those products which have entered the 'decline' phase of the product life-cycle or to try to break into new markets or new segments within an existing product. There are generally considered to be a number of stages in the development of new products:

The generation of ideas. A number of issues need to be considered, such as will the new product meet the objectives of the business? Does the business have the spare capacity to produce the product? Will the new product contribute to the continued growth of the business? Will new personnel be required, or will the business have to re-train the existing staff?
Testing the new concept. Is there a sufficient market for the new product? This stage of the product development process will involve carrying out extensive primary market research to test consumers' reactions to the suggested product. Consumers may suggest slight alterations and modifications to the suggested product in order to make it more marketable and desirable.
Analysing the costs/revenues. What will be the costs of production? How many units will the business be able to produce? What will the selling price be set at ? What will be the profitability of the new product?
Developing a prototype. The design, materials, quality and safety of the product will now become paramount. A prototype of the product will be developed using the details that the market research indicated that consumers wanted. It is essential to ensure that this stage of the development process is detailed and extensive, since to make alterations and modifications at a later date will be extremely expensive and time-consuming.
Test marketing the new product. The business may often decide to test market the new product in a small geographic area, in order to test consumer response, before it launches the product nationally. If the consumer response is favourable, then the product is likely to be launched nationally. However, if the consumers indicate that some element of the marketing mix is ineffective (price, packaging, advertising, etc) then this is likely to be changed before the national launch of the product.
National launch. This is where the product enters the 'Introductory' stage of its product life-cycle. This is a very costly operation, since a national launch needs to be supported by extensive advertising and promotional campaigns.

It is inevitable that many new product ideas will not get to the market place, and many of those that do succeed in being launched will fail within a few months of their commercialisation. However, the businesses which seem to be most successful in bringing new products to the market place tend to meet a number of vital criteria:

they develop 2 to 3 times the number of new products as their competitors;
they get the product to the market place quickly;
they compete in many different markets;
they provide strong after-sales service.

PRICE

The price level that a business decides to sell its product(s) at will affect both the quantity of sales and the profit-margin received per unit. There are many considerations that a business will need to take into account before it decides upon a selling price for a new product, such as:

The objectives of the business if the main objective of the business is to maximise profit, then it is likely that the product will be priced at a high level.
The degree of competition in the industry the number of competitors in the industry will affect the price level that the business decides upon for its product(s).
The channels of distribution the more intermediaries that are used in getting the product from the factory to the consumer, then the higher the selling price is likely to be.
The business image if the image of the business is prestigious and up-market, then a higher price is likely to be charged for the product(s).

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

Cost-plus pricing. This is where the cost of producing each unit is calculated, and then a percentage profit is added to this unit cost to arrive at the selling price.

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

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

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

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

Prestige pricing. This strategy is used where the business has a prestigious, up-market image, and it wishes to reflect this through high prices for its products (e.g. Rolls Royce).

Demand-orientated pricing. This method of pricing involves setting the price of the product at a level based upon customers' perceptions of the quality and value of the product.

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

PROMOTION

Promotion refers to the tactics that a business uses to make consumers aware of their product(s) and to entice them to purchase the products, creating sales revenue for the business. Promotion can often be referred to as either:

'above the line' - promotional activity refers to extensive promotional campaigns on national media, such as television and newspaper advertisements.
Or,

'below the line' - promotional activities include more short-term tactics such as personal selling, sales promotions, packaging, branding and direct mail.

Most businesses will use a combination of 'above-' and 'below the line' tactics in order to create the desired impact on consumers.

Advertising

Advertising is the most expensive of all the promotional activities undertaken by businesses. It can be carried out on television, at the cinema, on the radio, on posters, in newspapers, in magazines, and on the internet. Advertising can allow the business to easily reach a vast audience, to have a great impact on consumers and to reinforce other types of promotion that it is carrying out (e.g. competitions). Advertisements can generally fall into two categories:

informative advertisements - informative advertisements attempt to purely let the consumer know the availability of the product, its function and purpose and to inform the consumers about the characteristics of the product (e.g. Government information films).
persuasive advertisements - persuasive advertisements attempt to get the consumers to purchase the product, by emphasising certain aspects of the marketing mix (e.g. the taste, style and moving images). Another category of advertising is 'corporate advertising', where the business advertises its name and image, rather than any of its product range.

There are several criteria that must be met in order for an advertisement to be considered 'effective':

Firstly, it must reach the desired target audience (i.e. those consumers who are most likely to purchase the product- this can be discovered through market research).
Secondly, the advertisements must be attractive and appealing to the target audience (this can be done through using certain images, pictures, words and personalities).
Thirdly, the advertisements must create far more money through sales revenue than the business spends on the advertising campaign.

There are two bodies established by the government which monitor advertisements in the UK. The Advertising Standards Authority (A.S.A) monitors any advertisements in newspapers, magazines and posters, and ensures that they are true, decent, fair and legal'. Any complaints by consumers can lead to the advertisement being investigated and possibly banned from publication. The Independent Television Commission (I.T.C) monitors any advertisements on the radio, on television and at the cinema. Again, it has the powers to investigate any complaints about certain advertisements and ban the business from advertising in the future.

Branding and packaging

Branding and packaging are another common way of differentiating the product from rival products in the market place. Businesses will try to stress the distinctiveness of their products and therefore create a certain image for their products in the eyes of the consumers.

A brand is simply a name for the product, often reflecting the character of the product, and businesses will try to build up brand loyalty (that is where consumers are happy with their purchase of a particular product, and will return to purchase it again in the future). A strong brand can enable it to be sold at a high price, resulting in a high profit-margin for the product. It can also provide a strong basis for the business to launch new products, using the reputation of its existing products to break into the market.

Packaging is also important because it is another way that the consumers can distinguish between different products (eg through the colours, size, shape and logos used on the packaging). Packaging also offers protection for the product during transportation and can contain competitions and prizes to further promote the sales of the product.

Loss Leaders

Supermarkets often sell a few of their own brands of products at a loss- these are called 'loss leaders'. The purpose behind these loss-making products is that they attract many consumers into the stores, who will consequently purchase a selection of profit-making products as well as the loss leader.

Personal selling

Personal selling can take the form of door-to-door selling, trade fairs, and exhibitions. These allow an opportunity for the salesman to show how the products actually work, to see the consumers' reactions to the product, and to allow the consumers to discuss the performance of the product with an employee from the business. This is otherwise known as direct marketing, since the business deals directly with the consumers, rather than through an intermediary such as a retail outlet.

Direct mail

Direct mail (sometimes referred to as 'junk mail') involves posting promotional literature directly to consumers' homes, which are selected from a list of known customers (e.g. 'Britannia Music Club'). It is more of a personalised way of promoting the business, but it often fails to produce a large enough sales revenue to justify its use. Telephone selling can be used as a slightly cheaper method of direct contact with potential consumers (e.g. double-glazing, insurance etc).

Sales promotions

Sales promotions are a short-term method of boosting sales volume and sales revenue, using such tactics as a price discount, free products, competitions, and discount coupons. They are often used to complement national advertising campaigns and can also include product endorsements by sports stars or television personalities, and may offer easy payment terms for the consumers. These have become a very popular way of boosting sales over recent years (e.g. Walkers Crisps 'Cubix' cards, McDonalds 'Who Wants To Be A Millionaire' scratchcards, etc).

PLACE

This refers to:

firstly to the stores and the retail outlets where consumers can purchase the products of the business,
secondly to the channels of distribution that the business uses to get its products from the factory to these outlets.

The channels of distribution refer to the intermediaries that a business chooses to use to transport its product and make it available to consumers (e.g. wholesalers, distribution companies and retail outlets).

Often, a manufacturer will sell its output in a large quantity to a wholesaler, who pays a low price per unit (this is known as 'bulk purchasing'). The wholesaler then breaks this large quantity into smaller batches, and sells each batch to a retailer after adding on a profit margin (this is known as 'breaking bulk').

The retailer then sells each batch of products to the consumer, after adding on a profit margin. The more intermediaries that exist in the distribution of a product from a factory to the consumer, then the higher the final price of the product, since each intermediary will add on a profit margin in return for offering their services.

In order for the distribution channel for a product to be efficient, then the following criteria must be met:

It must be able to make products available to consumers quickly and cheaply.
Some products, such as perishable and fragile products (fruit, glass products) need to have minimum handling and travelling time, in order to minimise the risk of damage to the products.
Large and dispersed markets will require many intermediaries -these must be chosen carefully to ensure the swift transportation and availability of the products to the consumers.
Heavy and bulky goods will often need a direct channel of distribution from the factory to the retail outlets.

The trend over recent years has been for businesses to eliminate many of the intermediaries in the distribution channel, and for the product(s) to be sold directly from the factory to the retail outlets, or even directly to the consumers themselves. This reduces the final price of the product that the consumer has to pay, and it also speeds up the delivery and distribution process.

Retailing is a fast-changing sector of the economy and there have been many developments in this sector over the last decade, including the development of out-of-town shopping centres, the widespread use of Electronic Point Of Sale (E.P.O.S) systems, longer opening hours to fit in with busier lifestyles, and an increasing demand from consumers for many products to be sold in one outlet.

These developments are enabling the larger businesses to dominate markets and hold a significant percentage of the overall market share. These retail outlets can, therefore, exercise more power than ever before when buying stock from factories and warehouses -enabling them to dictate the prices that they will pay for their supplies. The factory providing them with their stock and supplies will have little alternative than providing the supplies at a low price, since they cannot afford to lose such a large and important client.

MARKETING PLANNING (MARKETING BUDGET)

Marketing Budget


The marketing budget is a plan for the forthcoming year for the marketing department, outlining what it hopes to achieve in terms of sales volume, sales revenue, expenditure and profit. It will often outline the month-by-month targets for the department and show the departmental personnel the objectives that they need to achieve over the next 12 months.

The marketing department must ensure that it sets a budget based on the overall objectives of the business, as well as taking into account any expected changes in the external environment (e.g. if there is expected to be an economic downturn, then this needs to be translated into the sales and revenue targets for the next 12 months).

There are several ways that a business may set its marketing budget:

Based on the amount of finance available. The amount of money and finance that is available for the whole business will clearly affect the amount of planned expenditure within each department. The biggest source of expenditure within the marketing department is often the promotional campaigns.
Based on previous years' budgets. Some businesses will set the forthcoming year's marketing budget based on last year's figures, including a small percentage change in each category.
Based on the budgets of competitors. In very competitive industries (such as supermarkets) the amount spent on advertising and other promotional campaigns may be in relation to that spent by your main rivals.
Based on the sales levels from previous years. It may be the case that a business will use a set percentage of last year's sales revenue figure for its budgetary expenditure figure for the forthcoming year.
Based on the expected size of the product portfolio this year. If a business is planning to expand its product portfolio this forthcoming year, then the marketing expenditure budget will probably need to be set at a significantly higher level to reflect the extra money spent on the launch and advertising of the new products.

Any differences between the budgeted figures and the actual outcomes are known as a variance.

Positive (i.e. favourable) variances occur where the actual amount of money flowing into the business is more than the budgeted figure, or where the actual amount of money flowing out of the business is less than the budgeted figure.

Negative (i.e. unfavourable) variances occur where the actual amount of money flowing into the business is less than the budgeted figure, or where the actual amount of money flowing out of the business is more than the budgeted figure.

QUESTIONS (MARKETING)

1. a) Why do well established companies, such as Coca Cola and McDonalds advertise?

b) Briefly outline a media mix which might be suitable as part of the promotion policy for a school or college

(Marks available: 10)

Answer


2. a) Why do marketing managers use the official socio-economic classification of the population i.e. A,B,C1,C2,D and E.

(5 marks)

b) Two new socio-economic groupings have been identified which make up 15 per cent of UK households. They are defined as:

'Silkies are single ladies on high income defined as £25,000 a year or more with kids up to 15 years old. They are classically time-poor, money rich, and have an expensive lifestyle with childcare and associated costs.
Slinkies are also on high income. There are no kids. Slinkies are clever, ambitious and status conscious.'

(Source: Financial Times)

How might such new groupings affect marketing strategy?

(5 marks)

(Marks available: 10)

Answer

MARKETING (REVISION SUMMARY)

Revision Summary


Asset-led marketing

This bases the marketing strategy of a business on its existing strengths, rather than on what the customer wants (e.g. Nestle developing a mousse-style dessert, based on its successful Smarties brand).

Base year

This refers to index number data, and it relates to the year that is chosen for comparison with other years (it has an index number of 100).

Confidence level.

This is a measurement of the degree of certainty to be attached to a conclusion which is drawn from a sample finding. The most common type is a 95% confidence level (i.e. the sample findings will be correct for 19 times out of every 20 attempts).

Correlation.

This measures the relationship that exists between two or more variables. A positive (or direct) correlation is said to exist where one variable increases along with the other, and vice versa (e.g. as disposable income per head rises, then so too does expenditure on food products). A negative (or indirect) correlation is said to exist where one variable declines as the other rises, and vice versa (e.g. as the price of new cars falls, demand for new cars will tend to rise).

Extension strategy

This is an attempt by a business to lengthen the product life-cycle for a particular brand. It is likely to be used at either the maturity or early decline stages of the life-cycle. Types of extension strategy include:

redesigning the product
adding an extra feature
changing the price
changing the packaging and advertising

Extrapolation

This means calculating and analysing recent trends, and assuming that these trends will continue into the future. They can then be used to predict, to a reasonable level of accuracy, how a particular variable (such as sales) will change in the future.

Index number

This is a statistical measure which is designed to make changes in a set of data (such as sales figures) easier to manage and interpret. It involves giving one item of data a value of 100 (the base period), and adjusting the other items of data in proportion to it.

Innovation

This means the commercial exploitation of an invention (i.e. altering an invention, so that it appeals to consumers and meets their needs).

Market orientation

This is a strategy that involves researching consumers' needs, and then developing new products and processes based around these needs. The main alternative is production orientation, where the business develops products based on its production capability and ignores consumers' needs.

Market penetration

This is a pricing strategy for a new product. The product is launched onto the market at a low price in order to build up a strong customer following. This low price aims to steal market share from existing competitors and it deters new competitors from entering the industry.

Market research

This is the process of gathering data on the habits, lifestyle and attitudes of actual and potential customers, with a view to developing products to meet their needs.

Market segmentation

This involves breaking the market down using various criteria, in order to identify distinct groups of customers. The main ways in which a market can be segmented are :

Demographically (such as occupation or age)
Psychographically (by peoples' attitudes and tastes)
Geographically (by region)

Market share

This measures the percentage of all the sales within a particular market that are held by one product or by one company.

Market size

This is the total sales of all the businesses in a particular industry.

Marketing mix

This is often known as "The 4 Ps" (product, price, promotion and place) and it is the term given to the main variables with which a firm carries out its marketing strategy and meets customers' needs.

Marketing model

This is a framework for making marketing decisions in a scientific manner. It is derived from F W Taylor's method of decision-making. The model has five stages.

Stage 1 - Set the marketing objective
Stage 2 - Gather the data that will be needed to help make the decision
Stage 3 - Form hypotheses
Stage 4 - Test the hypotheses
Stage 5 - Control and review the whole process

Marketing plan

This outlines the marketing objectives and strategy of a business. The plan is normally developed in three stages :

carrying out a marketing audit
setting clear objectives for the next year
developing a strategy for achieving the objectives

Marketing strategy

This is a medium- to long-term plan for meeting marketing objectives. A marketing strategy is implemented through the marketing mix (product, price, promotion and place).

Moving average

This is a method of identifying the trend that exists within a series of data. It calculates an average figure for every few items of data - therefore eliminating any fluctuations which may exist, in order to show the underlying trend.

Niche marketing

This is a business strategy that involves identifying consumers' needs and providing products to meet these needs in small, lucrative market segments. It is the opposite strategy to mass marketing.

Primary data

This is first-hand information that is specifically related to a firm's needs.

Primary research

This involves gathering first-hand data that is specifically concerned with a firm's products, customers or markets. It is gathered through questionnaires, observation or experimentation (e.g. test markets).

Product life cycle

This theory states that all products follow a number of stages during their commercialisation (introduction, growth, maturity, saturation and decline). Each product will pass through these stages at different speeds.

Product portfolio

This refers to the range of products produced by a business. This portfolio should range over a variety of markets and a variety of stages in the product life cycle. One way of analysing the product portfolio of a business is through the Boston Matrix.

Qualitative research

This is detailed research into the motivations behind consumers' attitudes and behaviour. It is carried out through interviews and discussion groups.

Quantitative research

This means carrying out research into consumers' buying habits, trying to investigate such issues as a product's consumer profile, likely levels of sale at different price levels, and predicted sales of new products.

Quota sample

This involves segmenting the population and interviewing a given number of people in each segment, according to their demographic characteristics

Random sample

This involves giving every person in the population an equal chance of being interviewed to find out their tastes, shopping habits, etc.

Retail prices index (RPI)

This shows changes in the price of the average person's shopping basket. The RPI is the main measurement of inflation in the UK and is calculated through a weighted average of each month's price changes.

Sample

This is a group of people who are chosen to take part in a market research campaign. Their views and opinions are assumed to be representative of the population as a whole.

Secondary data

This is market research information which is collected from second-hand sources (e.g. reference books, company reports, or government statistics).

Stratified sample

This is a method of sampling that interviews people from a specific subgroup of the population, rather than from the population as a whole. This method of sampling would be chosen buy a business if the buyers of its products fell into a certain age-group or geographic area, rather than being spread across the whole population.

Test market

This is the launch of a new product within a small geographic area (rather than nationally), in order to measure its potential sales and profitability. This reduces the risk and the costs associated with a national failure.

Value added

This is the difference between the cost of the raw materials / inputs and the price that customers are prepared to pay for the final product (i.e. value added = selling price - bought-in goods and services).

MARKETING (MARKETING STRATEGY)

Marketing Strategy

Niche Marketing

This involves a business selling its product(s) in small, often lucrative, segments of a market. It is the opposite strategy to mass marketing. Many small businesses can identify unsatisfied consumer needs in a particular segment within a large industry, and they can develop products to meet these needs.

This allows the small businesses to exist in industries that are dominated by large businesses (e.g. Classic FM in the radio broadcasting industry, SAGA in the holiday industry). However, if larger rivals appear within the niche market, the smaller businesses will often find it difficult to compete effectively with these well-resourced businesses.

It is also dangerous for a business to offer just one product within the market, since any larger rivals are likely to be more diversified and have a wider product portfolio. Theses larger businesses could, therefore, reduce their prices to such a low level that the small business cannot compete profitably.

Nevertheless, during periods of economic growth and higher consumer spending, then niche markets can offer a very lucrative opportunity to many small businesses to offer a personalised, high value-added service/product.

Product Life-Cycle

This shows the various stages that a product is expected to pass through and it also indicates the likely level of sales that can be expected at each stage.

The length of the lifecycle will vary from product to product and from industry to industry (e.g. Oxo Cubes, Levi Jeans and Kellogg's Cornflakes have lifecycles that have lasted for over 50 years, but various pop groups and childrens' toys have a lifecycle that can last less than 12 months). Generally, there are six stages to the lifecycle - development, introduction, growth, maturity, saturation and decline, as illustrated on the diagram below :


During the development stage, much time will be spent designing and testing the product concept. A prototype will often be test-marketed, in order to assess the potential sales and profitability of the new product. A decision will then be made whether or not to launch the product. The business will, therefore, incur many expenses during the development stage of the product lifecycle and the product will produce a large, negative cashflow.

It is estimated that only 1 in every 5 new products actually pass the development stage and reach the introductory stage of the lifecycle.

The introduction stage commences with the launch of the product onto the market. Sales are low and costs are still very high (especially advertising and distribution). The product is, therefore, unprofitable at this stage. The length of this stage will vary considerably according to the product. Some products will take a long time to reach the growth stage of the lifecycle (e.g. new novels) whereas others will head straight from introduction into growth in a matter of days (eg new pop-music album releases).

Once the business has made customers aware of the new product and it has managed to achieve a high level of repeat-purchasers, then the product will head into the growth stage of the lifecycle. This is where the product starts to become profitable. Advertising is still extensive. Competitors may launch similar products to cash-in on the successful new product.

The business will try to prolong the growth stage for as long as possible, but sooner or later it will reach the maturity stage of the lifecycle. The growth in sales will start to slow down and the product will nearly reach its maximum market share. There will be several competing products on the market.

The saturation stage of the lifecycle will occur where the sales of the product have reached their peak and the number of competing products will have grown significantly. It is during this stage of the lifecycle that the business may decide to use an extension strategy to prolong the lifecycle and boost sales, sales revenue and profits.

The final stage of the lifecycle is where the sales of the product go into decline. This is usually an inevitable result of changing customer tastes and fashions, new technology and the loss of market share to new products introduced by competitors.

Extension strategies

If a business believes that a product which has reached the saturation stage of the lifecycle can still produce a higher level of sales, then it may choose to implement one or more extension strategies to improve the product's ailing level of sales, such as :

changing the appearance and the packaging of the product;
trying to find new uses for the product;
trying to find new markets for the product;
trying to entice customers to use the product more frequently;
ltering the ingredients of the product.

The effects of an extension strategy on a product lifecycle can be represented in the diagram below:


The purpose of the extension strategy is to delay the decline stage of the lifecycle and produce extra sales and revenue for the business.

Boston Matrix

This is a method of analysing the product portfolio of a business (that is, the number and range of different products which a business produces at a particular point in time). This model was developed by a group of management consultants called the Boston Consulting Group, and it divides the products that are produced by a business into 4 categories, according to their market share and the level of market growth. The 4 categories are :

Problem Child

Sometimes referred to as Question Marks or Wild Cats). This is a product which has a low market share in a high growth industry. These products have often been launched quite recently and have not had the necessary time to establish themselves in the market. They will require a significant amount of money to be spent on their promotion in order to achieve a healthy market share. They are at the 'Introduction' stage of the product life-cycle.

Stars

These products have a high market share in a high growth market. They are very successful products which create a large amount of revenue for the business. They still require a large amount of money to be spent on their promotion, in order to keep ahead of the rival products in the marketplace. They are at the 'Growth' stage of the product life-cycle.

Cash Cows

These products have a very high market share in a stable market (i.e. market growth is low). These products are at the 'Maturity' and 'Saturation' stages of their product life-cycle and produce a very large amount of revenue for the business. This money is often used to promote the 'Problem Child' products and to develop new products.

Dogs

These products have a very low market share in a low growth market. They produce very little revenue for the business and are at the 'Decline' stage of the product life-cycle. The business has to decide whether to try and extend the life-cycle and boost sales revenue, or whether to delete the product from the portfolio.

These different categories can be represented in a Boston Matrix, as illustrated below:


As you can see from the above diagram, this business has five products in its portfolio. The size of each circle is proportional to the amount of revenue which each product generates. Some important points to note from the diagram :

Product 1 is a 'Dog' and is clearly in decline - the business would be advised to delete this product from its portfolio.

Product 2 is a 'Cash Cow' and produces large amounts of revenue to fund new product development as well as to fund 'Problem Child' products (such as Product 3).

Product 4 is a 'Star' and is generating a high level of sales, but is probably likely to face strong competition in the near-future. It will, therefore, require much money to be spent on its advertising and promotion, in order to protect its sales from rival brands.

Product 5 is another 'Dog', but it clearly still produces a reasonable level of sales revenue. The business may decide to use an extension strategy to prolong the life-cycle of the product and to boost its
sales level. Otherwise product 5 may well go into terminal decline like product 1.

Asset-Led Marketing

This refers to the situation where a business develops its strategy based upon its existing strengths and assets. This involves the business focussing on what it currently performs effectively, and then using this as the base for developing new products or breaking into new markets.

For example, many chocolate manufacturers (such as Cadbury, Nestle and Mars) have built on the tremendous success of their confectionery products to break into the ice-cream market (e.g. brands such as Crunchie, Starburst and Rolo have become high sales-volume ice-cream lines, as well as maintaining their high sales levels for the confectionery lines).

Niche marketing capitalises on the consumer loyalty that a business has, and helps it to develop new products and devise new marketing strategies.

Adding value

This refers to the amount of money which is added on to the raw material cost in order to arrive at the retail price for a product.

For example, the raw materials needed to manufacture a car might include steel, plastic, rubber, aluminium, glass, electronics, etc. These may total £6,000 for a particular car, which retails to customers for £19,000. The difference of £13,000 is added value.

It represents what the customer is actually prepared to pay for the final product. This £13,000 is not the profit that the manufacturer receives from selling the car, since part of it will be used to pay for wages and factory costs - so the profit will be less than the £13,000.

Some products have a very high added value figure (e.g. McDonalds 'Big Mac', Sunny Delight, and Manchester United football kits. The customer is prepared to pay a price which is several hundred percent higher than the cost of the raw materials. This could be due to the speed of service, the quality of the image / brand, the taste, the design, the advertising or the quality of the finished product.

Marketing Model

This is a framework for making marketing decisions in a scientific manner. It is derived from Frederick Taylor's method of decision-making. The model has five stages:

Stage 1 - Set the marketing objective (normally based on the company's objectives). For example, if the company's main objective is growth, then a marketing objective may be to increase the number of markets in which it sells its products.

Stage 2 - Gather the data that will be needed to help make the decision. This will involve the extensive use of market research to gather qualitative and quantitative data concerning the market size, the market growth, customers' perceptions of the company and its products, the competitors, etc.

Stage 3 - Form hypotheses, (theories and strategies about how best to achieve the objective). For example, a medium-sized UK manufacturer of shoes may start selling products in the lucrative North American market, or it may decide to concentrate on new segments of the UK market (e.g. sports-shoes).

Stage 4 - Test the hypotheses. Each hypothesis will be analysed to see its potential profitability and the likelihood of success. This will be carried out through further market research, possibly by test marketing a product in a small geographic area in order to assess its potential for success.

Stage 5 - Control and review the whole process. This involves implementing one of the hypotheses, via the marketing mix, and looking at its outcome (ie did it meet the objective? could it have been improved?). This will help the business to set future strategies and plans which will be achievable and realistic.

MARKETING (MARKET RESEARCH)

Market Research

Market research involves gathering and analysing data from the marketplace (i.e. from consumers and potential consumers) in order to provide goods and services that meet their needs.

Primary research

This is research designed to gather primary data, that is, information which is obtained specifically for the study in question. It can be gathered in three main ways - observation, questionnaires and experimentation.
Copyright S-cool

Observation involves watching people and monitoring and recording their behaviour (e.g. television viewing patterns, cameras which monitor traffic flows, retail audits which measure which brands of product consumers are purchasing).

Questionnaires are a means of direct contact with consumers and can take a variety of forms. Personal questionnaires (such as door-to-door interviewing), postal questionnaires, telephone questionnaires and group questionnaires (such as asking for the attitudes of a group of consumers towards a new product). Questionnaires can be a very expensive and time-consuming process and it can be very difficult to eliminate the element of bias in the way that they are carried out. It is important that every respondent must be asked the same questions in the same order, with no help or emphasis being placed on certain questions / responses.

Experimentation involves the introduction of a variety of marketing activities into the marketplace and then measuring the effect of each of these on consumers. For example, test marketing, where a new product is launched in a small, geographical area and then the response of consumers towards it will dictate whether or not the product is launched nationally.

Secondary research

This is the collection of secondary data, which has previously been collected by others and is not designed specifically for the study in question, but is nevertheless relevant. Secondary data is far cheaper and quicker to gather than primary data, but it can be out-of-date by the time that it is researched. The main sources of secondary data are reference books, government publications and company reports.

The primary and the secondary research will provide the business with much data relating to its markets and its consumers. This data can then be used to describe the current situation in the marketplace, to try to predict what will happen in the future in the marketplace, and to explain the trends that have occurred.

The business may also use the market research data to segment the market. This involves breaking the market down into distinct groups of consumers who have similar characteristics, so as to offer each group a product which best meets their needs. The main ways of segmenting a market are:

By consumer characteristics: this involves investigating their attitudes, hobbies, interests, and lifestyles.

By demographics: their age, sex, income, type of house, and socio-economic group.

By location: the region of the country, urban -v- rural, etc.

Effective segmentation of the market can lead to new opportunities being identified (i.e. gaps in the market for a product), sales potential for products being realised and increased market share, revenue and profitability.

Quantitative vs Qualitative research

Quantitative research

Quantitative research involves carrying out market research by taking a sample of the population and asking them pre-set questions via a questionnaire (normally 200+ respondents) in order to discover the likely levels of demand at different price levels, estimated sales of a new product, and the 'typical' purchaser of the company's products. The data is numerical and can be analysed graphically and statistically. There are several types of sample that can be used to gather quantitative data:

Random sampling - this gives each member of the public an equal chance of being used in the sample. The respondents are often chosen by computer from a telephone directory of from the Electoral Register.

Quota sampling - this method involves the consumers being grouped into segments which share certain characteristics (e.g. age or gender). The interviewers are then told to choose a certain number of respondents from each segment. However, the numbers of people interviewed in each segment are not usually representative of the population as a whole.

Cluster sampling - this normally involves the consumers being grouped into geographical groups (or 'clusters') and then a random sample being carried out within each location.

Stratified sampling - the consumers are grouped into segments again (or 'strata') based upon some previous knowledge of how the population is divided up. The number of people chosen to be interviewed from each 'strata' is proportional to the population as a whole.

Qualitative research

Qualitative research attempts to gain an insight into the motivations that drive a consumer to behave in a particular way. It is usually conducted through group discussions (often called focus groups) in order to discover the rationale behind consumers' purchases. The group discussion is often chaired by a psychologist in a relaxed manner, which should encourage the consumers to discuss their shopping habits and pre-conceptions concerning certain products and brands.

Forecasting

This involves attempting to estimate future outcomes (e.g. the level of sales). Forecasting can be done in a number of ways:

Extrapolation - this involves identifying the trend that existed in past data and then continuing this into the future. This is often done by using a software package to establish a line of best fit for past data, and then simply extending this line into the future.

The Delphi Technique - this involves using a panel of business and forecast 'experts' who discuss and agree long-range forecasting for important issues and events.

Market research - this can be used to try and establish the purchasing intentions of consumers.

Time Series analysis - this also attempts to predict future levels from past data. There are 4 main components of time-series data : the trend, cyclical fluctuations (due to the economic cycles of recessions and booms), seasonal fluctuations and random fluctuations.

Clearly, trying to predict and forecast what will happen in the future is not easy and many variables will change in both the short-term and in the long-term which will affect the accuracy of forecasts. It is always advisable for businesses to use a variety of forecasting techniques to arrive at suitable and acceptable figures for the future (e.g. costs, revenues, sales levels, profits, etc).

Statistical Analysis

There are a variety of techniques that a business can use to analyse the data that it collects through its market research methods.

The mean - this is the sum of the items divided by the number of items.

The median - this is the middle number in a set of data.

The mode - this is the number, or value, that occurs most frequently in a set of data.

The range - this is the difference between the highest value and the lowest value in a set of data.

The interquartile range - this considers the range within the central 50% of a set of data. It therefore ignores the top 25% and the bottom 25% and is less prone to distortion by extreme values.

The standard deviation - this is a measure of the deviation from the mean value in a set of data.

Confidence Interval - this is a measure of the likely accuracy of the results of a sample. With a 95% confidence interval, there is a 0.95 probability that the true average will be where the sample believes it will lie (in other words, the results of the sample will be correct 19 times out of 20).

Index numbers - this is a statistical measure which is designed to make changes in a set of data (such as sales figures) easier to manage and interpret. It involves giving one item of data a value of 100 (the base period), and adjusting the other items of data in proportion to it.

For example, if the sales for a particular business are £200,000 in year 1, £220,000 in year 2 and £270,000 in year 3, then index numbers can be used to help identify the trend within the data. The sales in year 1 will be given an index number of 100 (this is known as the base-year). Year 2 has £20,000 more sales than in year 1 - this is a 10% rise, so the index number in year 2 will be 110. Year 3 has £70,000 more sales than year 1 - this is a 35% rise, so the index number in year 3 will be 135.

Moving average - this is another way of identifying the trend in a set of data. It allows extreme values to be glossed over, so as to show the underlying pattern in a set of data. For example, consider the following data referring to sales over a 5 year period for a business :
Year 1 £100,000
Year 2 £120,000
Year 3 £ 65,000
Year 4 £132,000
Year 5 £146,000

The mean value of sales over this 5 year period is found by adding all 5 values together, and dividing the resulting answer by 5 (£563,000 / 5 = £112,600).

However, a 3-year moving average can give a more realistic indication of the changes in the trend over the 5 years. This is calculated by adding together the first three year's data, and dividing the resulting figure by 3 (£285,000 / 3 = £95,000).

This process is then repeated for the next 3-year period (i.e. years 2, 3 and 4). This gives a figure of £317,000 / 3 = £105,667.

The next 3-year period covers years 3, 4 and 5. This gives an answer of £343,000 / 3 = £114,333.

These figures show how the trend has moved within the data over the 5 year period.

QUESTIONS (BUSINESS ORGANISATION)

Questions

1.

a) What is meant by "tall" and "flat" organisational structures?

b) Why have many organisations moved away from tall to flat organisational structures?

(Marks available: 10)

Answer


2.

a) What services do banks offer to small businesses?

b) How might the purpose of a loan influence the period over which it is borrowed?

(Marks available: 10)

Answer


3. a) What is the difference between organic growth and growth through acquisition?

b) Is growth necessarily good for a firm?

(Marks available: 20)

Answer

BUSINESS ORGANISATION (REVISION SUMMARY)

External financing

This means obtaining sources of finance from outside the firm. This can be done in one of three ways: debt (such as loans), share capital, or grants from the Government.

External constraint

This is a factor outside the control of the business, which directly affects the business. The main types of external constraint include consumer tastes, competitors' actions, economic circumstances, legal constraints, social attitudes and pressure group activity.

Flotation

This is the term given to the initial launch of a company on to the stock market, by offering its shares to the general public.

Franchise

This is a business which is based upon the name, products, trademarks, logos, etc. of an existing, successful business. To obtain a franchise involves the payment of an initial fee plus the ongoing payment of a royalty based on sales revenue.

Franchisee

This is a person or company who has bought a franchise (i.e. the rights to use the name, products, trademarks, logos, etc. of another company (the franchisor).

Franchisor

This is the successful business which will sell the rights to its business name, products, etc. to suitable franchisees. This can be a far cheaper and easier way to expand the company than the alternative of opening more branches itself.

Horizontal integration

This occurs where a firm takes over or merges with another firm at the same stage of production (i.e. the two firms were in direct competition with each-other).

Internal constraint

This is a factor that restricts the business from achieving its objectives, but it is within the control of the business. The main internal constraints are finance, marketing, people and production.

Internal financing

This is the generation of cash from within the company's resources/accounts. This can be obtained from retained profits, working capital and the sale of fixed assets.

Lease

This is a way of securing and using property for a restricted period of time. When the lease runs out, the ownership of the property returns to the freeholder (the owner).

Leasing

This is a method of securing and using fixed assets (other than property) without the need for the initial cash outlays needed to purchase the asset.

Limited liability

This is the idea that the owners of a company (shareholders) are only responsible for the amount of money that they have invested into the company, rather than their personal assets. Thus if a firm becomes insolvent, the maximum that creditors can receive is the shareholders' initial investment. The word 'Ltd' or 'PLC' appear after the company's name to inform creditors that the business has limited liability.

Management buy-in

This occurs when managers from outside a company buy up the shares and take control of the company. This strategy is pursued if the managers believe that they can run the firm more efficiently than the current management.

Management buy-out (MBO)

This occurs when the managers of a business buy out the shareholders, and therefore own and control the business. The management believe that they can improve the profitability and efficiency of the business.

Merger

This is an agreement between the managements and shareholders of two companies to bring both firms together under a common board of directors. It is also referred to as amalgamation or integration.

Multinational

This is a business organisation which has its headquarters in one country, but has manufacturing plants in many other countries.

Ordinary share

These are purchased in order to have part ownership in either a Private Limited Company or in a Public Limited Company (PLC). At the end of each financial year ordinary shareholders receive a dividend per share that they own, but only after debenture holders, preference shareholders, long-term debt holders and the government (through taxes) have been paid. They are, therefore, often said to have the 'last claim' on the profits of the company. Similarly, if the company becomes insolvent and goes into liquidation, ordinary shareholders are the last group of people to receive any return, after all other debts have been paid.

Partnership

This is a business organisation where two or more people trade together under the Partnership Act of 1890. Most partners in a partnership will have unlimited liability, which means each partner is liable for the debts of the other partners. Common examples of partnerships include solicitors, doctors, veterinarians and accountants. Forming a partnership allows more capital to be used in the business than is the case with a sole trader, and the pressures and responsibilities involved in running the business are spread over several individuals.

Preference share

This is a share paying a fixed dividend, which is considerably less risky than an ordinary share. If the company becomes insolvent and goes into liquidation, then preference shareholders would be repaid in full before ordinary shareholders. This is also true of dividends, which are paid to preference shareholders before ordinary shareholders receive theirs. Preference shares therefore carry less risk than ordinary shares, but they also carry no voting rights or rights to a share of the company's profitability.

Primary sector

This is that part of the economy consisting of agriculture, fishing and the extractive industries such as oil exploration and mining.

Private limited company

This is a small to medium-sized business that is usually run by a small number of people (shareholders) and in many cases it is a family run business. The shareholders can determine their own objectives without the emphasis on short-term profits, that are so common among public limited companies.

Private sector

This is that part of the economy which is owned and controlled by private individuals and shareholders and is, therefore, out of the government's direct control. The remainder of the economy is called the public sector.

Public corporation

This is another name for a nationalised industry that is an enterprise owned by the government / state, which offers a product or service for sale.

Public sector

This is that part of the economy which is directly owned and / or controlled by the government / state. The public sector includes public corporations (nationalised industries), public services (such as the National Health Service) and local services (such as swimming pools, street cleaning, libraries, etc.).

Public limited company (PLC)

This is a company with limited liability that has over £50,000 of share capital and a very large number of shareholders. PLCs are the only type of company allowed to be quoted on the Stock Exchange. These companies have to disclose their annual accounts, are open to take-over bids.

Prospectus

This is a document which companies have to produce when they go public (ie when they wish to float on the Stock Exchange). It gives details about the company's activities and anticipated future profits. It has to conform to the Companies Act 1985 and be handed to the Registrar of Companies.

Sale and leaseback

This is a contract to raise cash by selling the freehold to a piece of property and then buying it back on a long-term lease. This ensures that the firm can stay in its premises and therefore can carry on trading as if nothing has happened. The money released through this process enables the firm to improve its liquidity position, although its owns less fixed assets than before.

Secondary sector.

This is that part of the economy involved in the making and manufacturing of goods. Over the past twenty years, the UK has seen a large decline in the number of people employed in the secondary sector of the economy, due to firstly a fall in demand for the output and secondly due to the replacement of workers by machines (mechanisation).

Sole trader

This is an individual who owns and controls his / her own business. Common examples of sole traders include corner shops, newsagents and market traders. They have unlimited liability for their debts and often have little available finance for expansion. They often employ waged workers, yet keep all the profit (after tax) for themselves.

Stock Exchange

This is a market for securities (the collective name for stocks and shares). The London Stock Exchange is one of the biggest in the world after Tokyo and New York. Its main functions are to enable firms or governments to raise capital and to provide a market in second-hand shares and government stocks.

Take-over

This involves purchasing over 50 per cent of the share capital of a company and then being able to exert full control over it. This process is also known as acquisition or integration.

Take-over bid

This is an attempt by a company to buy a controlling interest (i.e. over 50% of the ordinary shares) in another company. This is done by offering the target firm's shareholders a significantly higher price for their shares than the prevailing market price.

Tertiary sector

This is that part of the economy concerned with providing goods and services to customers. It is the largest sector in terms of employment in the UK, accounting for over two-thirds of the workforce.

Unlimited liability

This refers to the fact that the owners of certain business organisations (sole traders and partnerships) are not limited to the extent of their debts. They will have to sell off their own assets and use their own personal wealth, if necessary, to meet the debts of their business. If the business debts are greater than their own personal wealth, then the business may be forced into bankruptcy.

Vertical integration

This occurs when two firms join together (through a merger or a take-over) that operate in the same industry, but at different stages in the production chain. Backward vertical integration means buying out a supplier (e.g. a car manufacturer buying a components supplier). Forward vertical integration means buying out a customer (e.g. the car manufacturer buying up a chain of car showrooms).

BUSINESS ORGANISATION (THE GROWTH OF BUSINESS)

The Growth of Business


Internal -v- External Growth

There are two main ways in which a business can grow - internal growth and external growth.

Internal growth

(Often referred to as organic growth) refers to a situation where a business increases its size through investing in its existing product range, or by developing new products. This will normally be financed through the use of retained profits (from previous trading years), bank loans or, if the business is a PLC, through the issue of shares. This is a slower and safer method of expansion than external growth.

External growth

Involves much greater sums of money and takes place through the use of mergers and takeovers (often known as growth through amalgamation, or simply integration).
Regardless of the method of growth, there are several reasons why firms wish to grow:
•To achieve economies of scale and see the average cost of production decline.
•To achieve a greater market share.
•To satisfy the ego of the businessman.
•To achieve security through becoming more diversified.
•To survive in an increasingly competitive market.


Mergers and Take-Overs

A merger occurs where two firms combine, with the consent of both groups of shareholders and Directors.

A takeover (also known as an acquisition) refers to a situation where over 50% of the shares in another company have been purchased - therefore giving the predator full control of the newly acquired company. Both mergers and takeovers are referred to as growth through amalgamation, or simply as integration.

There are several different classifications of integration:
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Horizontal. This occurs when two firms in the same industry join together who produce the same product and are at the same stage of the production process (e.g. the Nestle takeover of Rowntree). The new, larger business is likely to be more powerful, have a larger market share, and achieve higher sales revenue and profits. However, the new business may become complacent and inefficient and find that it suffers from diseconomies of scale and / or falling profits.

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Vertical. This occurs when two firms combine who are in the same industry, but at a different stage of the production process.

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Forward vertical integration. Occurs where a company merges with, or takes-over, another company which is closer to the retail stage (i.e. nearer to the consumer). An example of this would be a car manufacturer taking-over a range of car showrooms. Forward Vertical integration is often the result of a desire to secure an adequate number of market outlets and to raise their standard.

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Backward vertical integration. Occurs where a company merges with, or takes-over, another company which is closer to the source of the raw material (e.g. a car manufacturer taking-over a supplier of car components). Backward Vertical integration is often the result of a company being able to exercise much greater control over the quantity and quality of it supplies, as well as securing its supplies at a lower cost.

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Conglomerate. This occurs where two firms merge which are in different industries and produce different goods - in other words, it is pure diversification. The major advantage to the new, larger firm is that it has diversified its product range and spread its risks.

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Lateral. This occurs where two firms combine which are similar in some way, but are not in the same industry (e.g. Cadbury-Schweppes). Here, both companies produced products which were sold to similar market segments (confectionery and soft drinks). Often, the firms can benefit from the management and marketing techniques employed by the other.


The underlying motive for most mergers and takeovers is to achieve synergy. This is often called the "2+2=5 Effect", since the end result will hopefully be more than what the two firms put in to the venture.

If it is believed that a proposed merger or takeover is likely to act against the public interest, then it may be referred to the Competition Comission for investigation. In general, any merger or takeover which will result in a market share of 25% or more will be investigated by the Competition Comission.

This body does not have the power to take legal action against the company, but instead it can recommend to the Office of Fair Trading (O.F.T.) that some action needs to be taken against the recently merged companies.


Internal and External Sources of Capital

The amount of finance required by a business will depend on a range of factors, including the age of the business, the track-record and profitability of the business, the industry that it is in and the state of the economy.

Internal finance is generated from within the business and is likely to come from one of three sources:
1.
Retained profit refers to profits made from previous years, which have remained after corporation tax has been paid to the Inland Revenue and after dividends have been distributed to shareholders. It is a useful source of finance to fund new products, etc.

2.
The sale of fixed assets, such as machinery, vehicles or even land and buildings which are idle, can also be a large source of cash to fund new projects.

3.
Making more effective use of working capital, such as chasing debtors for prompt payment, selling off any available stocks and negotiating longer credit periods with suppliers all release cash for use within the business.


External finance is generated from outside the business in a variety of ways:
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Bank overdrafts allow the business to withdraw more money from the bank than it has in its account. It is a flexible, short-term method of borrowing extra cash. However, interest is calculated on a daily basis and it can be recalled at very short notice.

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Trade credit involves the business obtaining goods from another business, but not paying for them for a period of time.

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Factoring involves a business selling its debts to a factor company, who will immediately give the business 80% of the money owed to it by its customer. At a later date, having collected the debt from the customer, the factor company will give the business the remainder of the money less a fee.

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Leasing is a common way to fund new fixed assets, as opposed to purchasing them outright. The business will sign a contract committing it to using some vehicles, machinery, premises, etc. for a fixed period of time (often 3-5 years) with a monthly payment made to the company who owns the assets. The business leasing the assets cannot put these items on its balance sheet (since it never owns them).

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Loans and mortgages are often used to purchase new fixed assets (machinery, vehicles and land and property). They require monthly repayments to be made for a significant period of time (up to 25 years for a mortgage) and the bank will also want an item to be placed as security (collateral) to cater for the event of the business defaulting on it loan repayments. The danger is that too many loans and mortgages will increase the company's gearing to a dangerously high level.

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Debentures are sold by companies to investors as a way of raising finance for use within the company. They are long-term, marketable securities, which will pay the holder a fixed amount of money every year until its maturity date - at which time the holder will be able to sell the debenture back to the company for it market price. However, debentures, like loans and mortgages, will increase the gearing level of a company.

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Venture capital is a very risky type of investment that entrepreneurs (called venture capitalists) will make in a small to medium sized business, which they believe has massive growth potential. These funds will clearly help the business to grow and achieve its potential.


Whichever source of finance is chosen, the business must ensure that it is adequate for the needs of the business (i.e. it is enough to pay for the new product development, new buildings, etc.) and that it is appropriate (i.e. it will not leave the business with large monthly interest repayments, when they are already burdened with high gearing).


Problems of Growth

Rapid and unexpected growth can lead to a host of problems for businesses. Probably the most common problem is the effect that the growth has on the company's finances - specifically upon the liquidity and gearing of the company.

Extra expenses and increased long-term liabilities (such as loans and mortgages) may reduce the liquidity and increase the gearing levels of the company and leave it dangerously close to insolvency.

It may simply be the case that the managers cannot cope with the extra responsibilities and workloads that they are faced with - this could lead to a rapidly expanding workforce, with the problems of recruitment, training and lengthy communication channels that this will inevitably lead to.

It is also possible that the company may become inefficient and it may experience diseconomies of scale (rising average costs). This could lead to a significant fall in profits, which in turn could persuade shareholders to sell their shares - this would result in a falling share price.

A major problem that a PLC can experience as it grows is the divorce of ownership and control. This refers to the fact that the owners of a PLC (shareholders) are usually interested in maximising the company's profits and, therefore, their own dividend payments. However, the control of the company is in the hands of the management and the Directors. They too want the company to be profitable, but would also like some of the company's resources and money to be invested into new products and new markets.

This, clearly, reduces the short-term profits of the company and, therefore, also reduces the dividend payments to shareholders.


Management Buy-Outs and Management Buy-Ins

Management Buy-Outs

Management Buy-Outs involve the management team buying an equity stake in the company that they work for (i.e. they become the owners, or part-owners, of the company). Each member of the management team will be expected to invest much of his own money into the venture, but the majority of the finance required to buy the company will come from financial institutions and from venture capitalists.

One of the most common examples of Management Buy-Outs is when the management team of a company that is facing receivership decides to buy-out the company, rather than let it be acquired by an outside organisation.

The management team, when deciding whether to buy-out the company, should make an assessment of the business in terms of its cashflow, profitability, product range, assets and the different markets in which it operates. If the company looks as if it has potential, then the management team may well take the risk and buy-out the company.

The managers often make a success of such a venture because they are more in touch with the workings of the company and with the markets in which they operate. The managers are often a highly motivated group of people and they realise that the success or failure of the company rests with their activities. An example of a Management Buy-Out that was a tremendous success was Denby Pottery, and one that failed was M.F.I.

Management Buy-Ins

Management Buy-Ins exist where the management team of an outside company buy enough shares in another company to control it. The managers buy the shares because they believe that they can run the company more efficiently and profitably than the existing management team. A Management Buy-In is likely to be financed predominantly through borrowed funds, which will cause the gearing ratio to be high.