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:
•
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.

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

•
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.

•
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.

•
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.

•
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:
•
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.

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

•
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.

•
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.

BUSINESS ORGANISATION (LEGAL STRUCTURE)

Legal Structure

Sole Trader

A sole trader is a one-person business, commonly found in trades where only small amounts of finance are required to set up and where there are very few advantages to the existence of larger organisations (e.g. hairdressing, newsagents, market traders).

Sole traders often employ waged employees, but they alone have to provide all the finance (often savings and bank loans) and bear all the risks of the business venture. In return, they have full control of the business and enjoy all the profits.

A sole trader faces unlimited liability for his/her debts and it is referred to as an unincorporated business - this means that there is no legal difference between the business and the owner.


Partnership

To overcome many of the problems of a sole trader, a partnership may be formed. A partnership is an association of individuals and generally there will be between 2 and 20 partners.

Each partner is responsible for the debts of the partnership and therefore you would need to choose your partners carefully and draw up an agreement on the responsibilities and rights of each partner (known as a Deed of Partnership or The Articles of Partnership). The most common examples of a partnership are doctor's surgeries, veterinarians, accountants, solicitors and dentists.

As stated earlier, most partners in a partnership face unlimited liability for their debts. The only exception is in a Limited Partnership. This is where a partnership may wish to raise additional finance, but does not wish to take on any new active partners.

To overcome this problem, the 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.


Private Limited Company

This is a type of joint-stock company (that is, it is an incorporated business - where the business has a separate legal identity from the owners). Often private limited companies are small, family run businesses which are owned by shareholders.

Each shareholder in a private limited company MUST be a part of the business and under no circumstances can any shares be sold to members of the general public. Each share entitles the owner to 1 vote at the company's Annual General Meeting (A.G.M.) and also to a share of the company's profit at the end of the financial year (a dividend).

Each shareholder has limited liability for the company's debts and can, therefore, only lose the value of their investment in the company. A company is run by a Board of Directors (who are elected by the shareholders) and this is headed by a Chairman.

Before a company can be formed, a number of legal documents must be completed - most important are the Memorandum of association and the Articles of Association. These cover details such as :
•the objectives of the business
•its headquarters and registered office
•the amount of capital to be raised from the sale of shares
•details concerning meetings within the business
•the arrangements for auditing the accounts of the business.

When these are completed, they are sent to the Registrar of Companies, who will then issue the business with a Certificate of Incorporation which allows the business to trade as a Private Limited Company. The company's name must finish with the word Limited and it must raise less than £50,000 of share capital.

It can be very difficult for a shareholder in a private limited company to sell their shares, since a buyer must be found within the framework of the company.


Public Limited Company (P.L.C.)

This is the other, much larger, type of joint-stock company and, just like a private limited company, a PLC is an incorporated business, is run by the Board of Directors on behalf of the shareholders and has an A.G.M. at which shareholders vote on certain key issues relating to the company.

The main difference between a PLC and a private limited company is that a PLC can sell its shares on the Stock Exchange to members of the general public and can, therefore, raise significantly more finance than a private limited company.

If a private limited company wishes to become a PLC, then it must change its Memorandum and Articles of Association and re-submit them to the Registrar of Companies.

If the company is considered to have acted legally and for the best interests of its shareholders, then it will be issued with a new Certificate of Incorporation and also with a Certificate of Trading, which will allow it to sell its shares on the Stock Exchange. The price of the shares will then fluctuate according to investors' perceptions of the PLC.

It is often the case with a PLC that the owners of the company (shareholders) will wish the PLC to make as much profit as possible, so that the shareholders will receive a very handsome dividend per share.

However, the Board of Directors and the management will often wish to devote some of the PLC' s resources to growth and diversification (such as the introduction of new products) and this will clash with the shareholders' desire for maximum profits. This is known as the divorce of ownership and control.

The PLC has to publish its annual accounts (known as disclosure of accounts) and therefore is extremely vulnerable to investors' and bankers' perceptions about its progress and success. Following on from this, a PLC is also at risk from a takeover from an outside body, if they manage to accumulate over 50% of the shares in the PLC.


Public Sector Organisations

The public sector refers to all the businesses and organisations which are accountable to central or local government. They are funded directly by the government and they tend to supply public services rather than produce products for a profit.

The public sector provides 3 types of good / service.
•A public good is one which would not be provided by private sector businesses because it would not be profitable to do so (such as the emergency services and the armed services).
•A merit good is one which the government feel that everyone should have, whether or not they could afford them in the private sector (such as education and healthcare).
•Essential services (such as street lighting, refuse collection, street cleaning, parks, libraries, swimming pools, etc.).

A public corporation is the term used to describe a nationalised industry which is providing a good or a service to the general public. Until the successive Conservative governments of Thatcher and Major (1979-1997), there were many public corporations in the UK providing a huge range of services to consumers. However, the Conservatives sold many of these public corporations to the private sector - this process is known as privatisation.

Central government pays for the public goods and merit goods through taxation (e.g. Income Tax), whereas local governments pay for the services they provide through Council Tax (formerly Community Charge and, before that, through Rates).


Franchising

Franchising has led to a rapid growth in the presence of many high-street stores in the UK over the past 10 years (e.g. McDonalds, Tie Rack, Perfect Pizza, and The Body Shop). A business franchise involves the franchisor (the owner of the business) selling a business format to a franchisee (the purchaser of the business name) in return for a fixed sum of money and a percentage royalty on sales revenue.

The franchisee will be based locally and is likely to be making his initial business venture. He buys the business format, which has been tried and tested in other areas, and it is therefore a far less risky venture than setting up his own business.

The franchisee has a licence to trade under the franchisor's name and also to use the logos, trademarks, etc. the licence that the franchisee buys is usually restricted to a specific geographical area and for a limited period of time.

This process of selling the rights to use a company's name, logo, etc. can result in the parent company experiencing rapid expansion in a country, with little of the investment that would have been required had the company bought the outlets itself. The franchisee is provided with a ready-made product, financial and management help and advice, lower start-up costs than for a business of his own, and help with the store layout.

However, the royalty must be paid to the franchisor even if a loss is made and the franchisee can have strict restrictions placed on their actions and promotions within the store, not leaving the franchisee much room for initiative and flair.

BUSINESS ORGANISATION (STARTING A SMALL FIRM)

Starting a Small Firm

Identifying an Opportunity

It is vital for the success of a business that it manages to identify an unsatisfied consumer need in a market and then produce a product, or provide a service, which meets the consumers' needs. The new product / service can be protected against competition by the use of copyrights and patents. These protect the owner / inventor from having their products, ideas, etc. copied and reproduced by other people without their permission.

Some of the most common reasons for starting up a new business include the need for independence; to achieve your personal ambitions; being bored with your current job; links with your hobbies and interests; redundancy from your previous job.

Many businesses which have started in the UK over the past 25 years have failed within the first 3 years of trading. To reduce the probability of failure, it is vital that businesses carry out market research in order to establish if a profitable gap exists in a market and to see if their business is in a strong enough position to fill this gap.

In order to make a success of the new business venture, the entrepreneur must be hardworking, ambitious, firm, decisive, organised, a good negotiator and must be able to recognise an opportunity when it arises.


The Business Plan

Once an entrepreneur has recognised an opportunity, he/she must draw up a business plan. This is a document which outlines the marketing, production and financial plans for the proposed business. It is used to try and persuade investors (banks, etc.) to lend money to the entrepreneur to fund his/her new business.

The main sections of a business plan include:

- the aims and objectives of the business

- details of the new product or service being offered

- an outline of the existing market details (i.e. size of the market, number of existing competitors)

- how and where the product will be produced

- the proposed number of employees

- a cashflow forecast, a projected profit and loss account and balance sheet for the end of the first year's trading

- details of the finance required and the forecasted rate of return on this.


Patents and Copyrights

An entrepreneur can use patents and copyrights to protect a new product, process, invention or information against copying and reproduction by other people without the entrepreneur's permission.

A patent gives an entrepreneur or a business the legal right to be the sole owner or user of a particular production process or of a new product. The Copyright, Designs and Patents Act (1988) gives this right for a 20 year period following registration.

In order for the patent to be approved, then the Patent Office has to be supplied with the original drawings and designs of the new product, and the inventor must state that the ideas and features of the product are his own work and have not been copied from other products. Patents are often sold to larger businesses in order to provide a large injection of capital, which can help the small business to grow and expand its product range.

A copyright is the legal right of the creators of certain kinds of material (books, films, sound recordings) in order to control the copying and duplicating of the owner's original work. The law on copyright is governed by The Copyright, Designs and Patents Act (1988). People using copyright material without permission risk legal action.


Problems of Start-ups

Most new businesses will face a number of problems when they are starting up and if these problems are not tackled immediately, then they may lead to the insolvency and failure of the new venture. Below are listed some of the major problems faced by a new company:

Raising finance and meeting the repayments

Raising finance and meeting the repayments is often cited as the major reason for the failure of many new business ventures. It can often be difficult for a budding entrepreneur to persuade banks and other financial institutions to lend money to a new business, and often they will only lend the money at a high rate of interest. These repayments can cripple the business and eventually lead to its insolvency.

As well as the repayments, the bank will insist that some security (or collateral) is provided by the business, so that if the business defaults on the loan repayments, then the bank will take ownership of an asset of the business which will cover the amount of the outstanding loan.

Having a positive cashflow

Leading on from this previous point, having a positive cashflow is vital for the survival of the business. Liquidity is the financial term given to express the ability of a business to raise cash at short notice. Any new business must have sufficient cash available to meet its short-term needs (such as paying employees, paying suppliers, rent, utility bills, etc.).

Many businesses have a lot of cash tied up in stocks, which are often difficult to sell and therefore the business may find it difficult to raise cash quickly. Further to this, if the business gives its customers credit (i.e. buy now, but pay us at a later date) then this will simply add to any cash flow problems that the business is facing.

Paperwork and legal requirements

All businesses face a variety of paperwork and legal requirements, and if any of these are overlooked or completed inaccurately, then this could lead to the failure of a new business. Taxation and insurance payments are vital for the smooth running and survival of new businesses. Any oversight on these payments could land the entrepreneur with a large tax bill or, perhaps worse, property and stock which will not be insured against fire, theft, etc.

Enticing consumers to try the new product

Enticing consumers to try the new product / service can also be a major problem for any new business, especially if there are already a handful of established businesses which dominate the market. Ensuring that consumers try your product and then buy it again at a later date (consumer loyalty) can often only be done through extensive (and costly) advertising and promotional campaigns.