BUSINESS ACTIVITY

What are needs and wants?

Businesses are formed to provide goods and service m vs that satisfy needs and wants. Human needs are
goods and services that are necessary for survival. Human needs are goods and services that people cannot
live without them. Basic human needs include water, food, shelter, clothes and basic health care.

Human wants are goods and services that people desire but they are not necessary for survival. Wants
make life comfortable and enjoyable but people can still survive without them. Human wants include
mobile phones, cars, pets, entertainment and holidays abroad.

What are the differences between needs and wants?

Needs Wants
1. Needs are basic necessities required for Wants are luxuries that only make life better but
survival. are not necessary for survival.
Needs are few and limited. Wants are endless and unlimited.
2.
3. Needs are easy and cheap to satisfy. Wants are expensive and very difficult to satisfy.

Why is understanding needs and wants important to a business?

Knowledge about needs and wants is important in that:
➢ Businesses are able to successfully satisfy them.
➢ Businesses are able to make a choice on products to produce when resources are scarce (limited).

What is scarcity and opportunity cost?

Needs and wants are satisfied by producing goods and services. The goods and services are produced from
the following factors of production.

Factor Explanation
1. Land Land refers to all natural resources found on earth together with space
required to set up factories for production take place.
2. Capital Capital refers to money, machinery, equipment and buildings required
for production to take place.
3. Labour Labour refers to the human effort involved when goods and services are
produced. People who produce goods and services are paid wages and
salaries.
4. Entrepreneurship Entrepreneurship refers to people who take the risk to start businesses.
(enterprise) These people are rewarded through profit earned from their businesses.

The above factors of production (resources) are not always available to meet all the needs and wants of
people. This leads to an economic problem. This economic problem is called scarcity.
Therefore, scarcity means that there are limited (fewer) resources to meet unlimited wants.
Thus, a choice must be made since resources used for one product cannot be used for another. The choice
made is called opportunity cost.
Opportunity cost refers to something forgone (sacrificed) for the next best choice.
 Illustration:
A business may be faced with two choices; (1) to buy a delivery vehicle or; (2) to
build a new office. Due to limited capital, only one choice must be made.
(a) Which choice should be made?
(b) What is the opportunity cost of that choice?

How can businesses use specialisation to satisfy needs and wants?

In-order to maximise on the use of limited factors of production, businesses can specialise.
Specialisation is where by an individual, business or country focuses only on producing goods or services
they can do best.
Examples:
Shell specialises on producing oil and gas. Japan focused on car manufacturing.

Why is specialisation important?

❖ Productivity increases as resources are only used for goods and services that the business is good at.
❖ The cost of producing goods decrease as there will be less wastage of scarce resources.
❖ Work is done faster as workers will not have to move between processes. They only focus on jobs that
they are good at.
❖ Training of employees and sharing of information becomes easy as workers become more experienced
in their jobs.
❖ Specialisation allows businesses to divide work into small manageable tasks. This is called division of
labour.

What are the disadvantages of specialisation?

❖ Specialisation may lead to over-dependence on one employee. Thus, the business may fail to have a
suitable employee to stand in for another employee who is absent.
❖ The business may also over-depend on one product or one market. This may make it difficult for the
business to sell its products to other markets.
❖ Specialisation can make it difficult for employees, businesses or countries to respond to changes in the
market.
❖ Workers may become bored by repeating the same task. This may end up reducing productivity.

Review Questions
(a) Define the following terms:
(i) human needs
(ii) human wants
(iii) scarcity
(iv) opportunity cost [8]
(b) Identify and explain two advantages and two disadvantages of specialisation. [4]

What is added value?

Every business activity is aimed at combining factors of production to make goods and provide services that
satisfy consumer needs and wants. To make more sales and profit, businesses should add value to their
products.
Added value is the difference between the selling price of a product and the cost of inputs such as raw
materials, labour and components.

Selling price
$1 800 Cost of inputs
Added value
$1 200
$600

How added value can be increased?

Businesses might increase added value by:
(i). reducing the cost of inputs such as labour and raw materials or;
(ii). finding ways of increasing the selling price of their products.

Added valued can be achieved through any of the following approaches:

Method Explanation

1. Increasing the selling price If the business has the opportunity to increase selling prices while
costs remain unchanged, it can do so. This means more revenue
(income) is earned, increasing added value.
2. Buying cheaper raw The business can look for cheaper suppliers who can provide the
materials same raw materials at a lower price.
3. Using cheaper labour If the business is able to employ workers at a lower wage rate, it can
do so. The worker employed should be able to maintain the same
quality of the product.
4. Branding Branding involves the business coming up with a unique name,
colour or packaging for its product. Branded products can be sold at
a higher price leading to added value.
5. Reducing waste Reducing waste means saving on cost of production. This means the
business produces the goods or services at a lower cost, increasing
added value.
6. Adding extra features to the The business can include extra features or services that customers
product. can pay for as they buy the product. This further increases the
selling price for the product.

Classification of businesses into sectors of industry

Businesses operating in a country can be in any one of the following sectors of industry:
1. Primary sectors
The primary sector is made up of businesses involved in extraction of resources from nature, growing crops
rearing animals and harvesting raw materials. Activities involved in the primary sector are: mining, fishing,
farming and harvesting crops and forests. Raw materials obtained from the primary sector are transferred
to the secondary sector.

2. Secondary sector
The secondary sector is made up of businesses involved in changing raw materials into finished goods.
Activities involved in the secondary sector are: manufacturing, processing, construction and assembly.

3. Tertiary sector
The tertiary sector is made up of businesses that provide services to individuals. These are called personal
services. Services are also provided to businesses. These are called commercial services. Activities involved
in the tertiary sector are: transport, banking, insurance, education, health care, catering, retailing, training
and communication.

Why countries want businesses to change from one sector to

another?
Countries may encourage businesses and investors to invest in the secondary and tertiary sectors because
of the following reasons:

(a) Changing from primary to secondary sector.

Businesses may shift from the primary sector to the secondary sector because of the following reasons:
• There is reduction of raw materials such that it is becoming expensive or difficult for businesses to
continue extracting raw materials. This is common in mining where it may become expensive or risky to
continue mining.
• Laws have changed in a country. New laws to protect the natural environment make it difficult for
businesses to continue extracting resources from nature.
• Cheaper raw materials have been found in another country leading to loss of market for the local
businesses.

(b) Changing from secondary to tertiary sector.

Businesses may shift from secondary to tertiary sector because of the following reasons:
▪ As the standard of living of people improves in developed countries, they focus prefer personal services
rather than physical products. People are more interested in entertainment, internet and online
shopping.
▪ Manufacturing businesses in developed countries are losing market to cheap products from developing
countries.
▪ Tertiary sectors employ more people that primary and secondary sectors. In secondary sectors, labour
is being substituted by robots and automation.

Review Questions
Jean owns a restaurant in the city centre. She provides meals including meat and vegetables. All ingredients
are imported from other countries. A village close to the city has farmers producing restaurant ingredients.
Jean’s friend, Pearl, has advised her to increase value added at her restaurant.
Required
(a) What is added value? [2]
(b) In which sector of the industry is Jean’s restaurant? Give a reason for your answer. [2]
(c) Identify and explain two ways in which Jean could increase added value as suggested by Pearl. [6]
What is a mixed economy?
Another way of classifying businesses in a country is by the way they are owned and controlled. A mixed
economy is a country that has both private sector businesses and public sector businesses.
The private sector involves businesses that are owned and controlled by individual and companies. The
public sector involves businesses that are owned and controlled by the government or government
agencies such as councils. Public sector businesses exist to provide services to citizens of a country while
private sector businesses are formed to earn profit for their owners.

Examples of businesses in each sector

Private sector Public sector

• Grocery shops ▪ Health services such as hospitals and clinics

• Restaurants ▪ Educational institution such as government schools
• Property developers ▪ Revenue collection department
• Construction companies ▪ Water and electricity suppliers

Having private sector businesses in a country helps in the following ways:

❖ They produce a variety of goods and services to meet consumer needs and wants in-order to make
more profit.
❖ Private businesses are quick to respond to changes in an economy than public sector businesses.
❖ Private sector businesses use efficient methods of production which enables more goods and services
to be produced using limited resources.
❖ They employ citizens, they by reducing unemployment in a country.
Public sector businesses are necessary in that:
❖ They provide services such as water, health care and education that are less profitable to private
businesses.
❖ They ensure that basic services are available to the less privileged members of society who cannot
afford to buy from private sector businesses.
❖ They also earn profit for the government there by increasing revenue collected by the government.

What is entrepreneurship?
An entrepreneur is a person who takes the risk to start and operate a business enterprise. An entrepreneur
brings together the other three factors, land, labour and capital, to produce goods and provide services.

What are the characteristics of successful entrepreneurs?

Characteristics Explanations

1. Risk taker An entrepreneur should have the courage to start a business enterprise
even if it may lead to loss of money invested.
2. Hard working Successful entrepreneurs work long hours including rest days in-order to
achieve their goals.
3. Creative A good entrepreneur is one who comes up with new ideas to create new
(innovative) product or to be ahead of competitors.
4. Self-confident The entrepreneurs should have trust in their ideas and be able to
convince others that the idea can work.
 5. Ambitious The entrepreneur should have a strong desire to succeed.

6. Optimistic The entrepreneur should always look forward to a better future even if
the business is making a loss.
7. Good A good entrepreneur is one who is able to share ideas with employees,
communicator customers and other investors.

Why entrepreneurs start their own businesses?

Entrepreneurs start their own businesses to achieve the following:
1. To be independent - having their own businesses will allow them to choose time to start and end work,
the salary they can pay themselves and their times to rest.
2. To use personal talent - entrepreneurs may possess special or unique talent or skill that they want to
use without being limited.
3. To earn more income - the income to be earned from having a private business may be more than
working for someone else.
4. To become well-known - if the business become successful, the entrepreneur may become well-known
(famous).
Review Questions
Kemo was bored with her job in a clothing factory. Her main passion was fashion and she had always been good
at selling clothes, since she helped her father at his market stall. She encouraged her parents and some friends to
invest in her idea of opening a shop selling good quality ladies clothes. Kemo would put her personal savings into
the business.
Required
(a) What is meant by entrepreneurship? [2]
(b) Give one difference between a private sector business and a public sector business. [2]
(c) Identify two benefits to Kemo of starting her own clothing shop. [2]
(d) Identify and explain two characteristics possessed by Kemo that enables her to start her own clothing shop.
[4]

What are the contents of a business plan?

A business plan is document that outline, names, owners, aims, objectives and ways of achieving the aims
and objectives of a business.
A business plan is done before the business starts operating. A simple business plan should contain the
following sections.

Section Details
1. Business details This shows names of owners, business address and a brief summary of
(Executive summary) the main activities of the business.
2. Aims and objectives Outlines the intentions and targets of the business.
3. Marketing plan Shows the product and the different ways it will be sold to customers.
4. Production plan It outlines how the product will be made and the resources required.
5. Finance plan It shows the source of finance for the business, the cash flow forecast
and the profit forecast.
Why new businesses may not plan?
(a) Lack of knowledge – entrepreneurs may lack the necessary knowledge to prepare business plans. This
demotivates them, hence, they will not prepare a business plan.
(b) Time consuming - the process of preparing a business plan is time consuming due to the amount of
detail required. As a result, new entrepreneurs just ignore it.
(c) May never use the plan - some businesses have no need for following laid down plans. As a result
having a business plan is not useful to them. They will never follow it.

How business plans assist entrepreneurs?

1. It act as a guideline- by following a business plan, an entrepreneur is able to turn a business idea into
a successful business.
2. It gives the entrepreneur a planning culture- the entrepreneur will have the ability to plan activities
before implementing them.
3. It is required when applying for loan- bank managers request for detailed business plans to assess if
the businesses will be able to pay back loan applied for. They look at the cash flow forecast to see if
the businesses will generate enough cash to pay back money lent including interest charges.
4. It helps to monitor performance of the business- as the business operate the entrepreneur is able to
compare the profit made to the forecasts made in the business plan. The entrepreneur will then take
action to get the business back on track.

How governments support business start-ups?

Governments in developing countries usually support business start-ups. This is done by:
(i) providing grants
-a grant is money given to a new entrepreneur to start a business. This money is given to assist the
entrepreneur to buy machinery and equipment required to start operating. The government may not
require the grant to be paid back. No interest is charged on a grant.
(ii) training entrepreneurs
-governments have departments that are responsible for training and assisting new entrepreneurs
about the start-up process. This may involve assisting entrepreneurs to prepare business plans.
(iii) removing obstacles in setting up new businesses
-the government can assist new entrepreneurs by simplifying the paper work required when
registering a new business. For example, the business may start operating before it is fully registered.
(iv) tax incentives
-new business may be given a chance to operate for a few years without paying tax. This allows the
business to save cash to pay employees, increase profit for owners and to expand.

Why governments support business start-ups?

Governments support business start-ups because of the following reasons:
1. To reduce unemployment
-new businesses create employment opportunities for citizens who are out of work.
2. To increase competition
-new businesses give consumers more choices. This may lead to goods and services being sold at
reduced prices as the number of businesses increase.
3. To boost economic growth
-as more businesses are formed, the value of goods and services produced in a country increases as
well. This leads to an increase in economic growth.
4. To increase social benefits
 -as more businesses are formed, the number of businesses participating in community development
increases leading to improved social life in a country.

Review Questions
Kemo was bored with her job in a clothing factory. Her main passion was fashion and she had always been good
at selling clothes, since she helped her father at his market stall. She encouraged her parents and some friends
to invest in her idea of opening a shop selling good quality ladies clothes. Kemo would put her personal savings
into the business. “I think I should draw up a business plan”, said Kemo to Pearl. “I don’t think you will need it,
your business will be too small to need a business plan”, replied Pearl.
Required
(a) What is a business plan? [2]
(b) Give two reasons why the government may assist new entrepreneurs such as Kemo.[2]
(c) Do you agree that a business plan is not useful to Kemo? Justify your answer. [6]

Which methods are used to measure the size of businesses?

Different people are interested in knowing the size of any business because of the following reasons:
➢ Lenders prefer to lend money to larger businesses because they are able to repay the loans.
➢ Investors are more interested in investing in large businesses because they are assured of good return
from their investment.
➢ Businesses may also want to see the strength of their competitors.
➢ The government want to assist small firms to grow and compete with large firms.
However, it is always difficult to find one best method that can be used to measure business sizes. The
following are some are methods that can be used.
(i) Number of employees
(ii) Capital employed
(iii) Value of output
(iv) Value of sales
(v) Market share

1. Number of employees
This method involves comparing the number of workers employed by each business. In this case, a large
business is the one that employs many employees.

Illustration
Name of business PetroChina Walmart
Activities involved Oil and gas producer Retailer
Employees 550 000 2.2 million
Value of assets (capital) $350 billion $200 billion
Annual sales $850 billion $850 billion
Value of output $640 billion $430 billion
Market share 20.9% 35.7%
In the above illustration, Walmart may be considered to be a large business when compared to PetroChina
because it employs 1.650 million more employees. Using number of employees to compare business sizes is
easy as it only involves counting employees for each business.
However, some businesses employ less people because they use machines and equipment which are
automated. This makes their output to be higher than businesses employing humans. Other businesses hire
employees on a part-time basis. These employees may not be included in the records of the business but
they would have contributed to production for that business.

2. Capital employed
Capital employed is money invested in a business to buy productive assets such as buildings, machinery and
equipment. This money comes from owners or it is borrowed from banks. A business with more capital has
a higher chance to produce more products and expand its activities. Thus, a business with higher capital
employed is considered to be a large business.
In the above illustration, PetroChina may be considered to be a large business because it has $150 billion
more assets than Walmart. Using capital employed is suitable when comparing businesses in different
industries.

However, some businesses may be labour intensive which means they may require more employees than
machines. Such businesses may still be large but they are considered small due to low capital employed.

3. Value of output
This method involves comparing businesses basing on value of their annual production. Thus, a business
that produces goods with more value in a year is considered to be a large business. In the above
illustration, PetroChina is considered to be a large business because it produces $210 billion more than
Walmart. Using value of output is suitable when comparing businesses in the same industry as the output
(goods being produced) will be the same.
However, not all goods produced by a business are sold. A business may produce more but fail to sell all
goods produced. This makes it to be a smaller business when value of sales is used. This method is not
suitable when comparing businesses producing different products like in the case of PetroChina and
Walmart above.

4. Value of sales
Value of sales compares businesses using annual sales income made by a business. It is often used to
compare businesses in the retail industry as the success of those businesses depends on selling more.
In the above illustration, both businesses have an annual sales value of $850 billion. They are considered to
be of the same size.
Value of sales is suitable when comparing businesses in the same industry and the same market.

However, the nature of products sold differs between businesses. One business may sell only one product
to reach the same sales value as a business with many branches and employing many people. This method
is only useful when comparing businesses in the same industry and same market.

5. Market share
Market share refers to the percentage of the total market that is controlled by a business. A business has
high market share when it can sell to many customers. In the above illustration, Walmart controls 35.7% of
the market while PetroChina controls 20.9% of the market. Thus, Walmart is considered to be a large
business basing on market dominance.
Comparing business sizes using market share is suitable for businesses selling similar products and
operating in the same market.
However, a lot of research and data collection is required for this method to be useful. Some businessesg
may not provide true sales figures for the market share to be calculated. It is not useful to compare
businesses basing on market share when they are not operating in the same market and selling similar
products like in the case of PetroChina and Walmart above.

Review Questions
1. The following table shows details for businesses in Country X.

VALUE OF OUTPUT CAPITAL EMPLOYED NUMBER OF TYPE OF BUSINESS

($) ($) EMPLOYEES
BUSINESS A $230 million $180 million 10 000 Retail supermarket
BUSINESS B $300 million $500 million 6 000 Bank
BUSINESS C $300 million $200 million 23 000 Government enterprise

The Finance Minister for Country X thinks that Business C is the largest business in Country X. Do you agree?
Justify your answer. [6]

What are business objectives?

A business objective is an aim, target or goal that a business wants to achieve.
A business can set objectives such as:
• To increase sales by $18 000 by end of 2020.
• To increase market share by 20% in 2021.

Why would businesses require objectives?

A business cannot exist without knowing its purpose. Business objectives are important in that:
(a) they provide direction or guidance towards achieving the goals of the business.
(b) they allow businesses to plan in advance and work towards those plans.
(c) they make workers to unite because they are working towards the same goal.
(d) the business is able to compare its achievement to the objectives set.

Which business objectives can businesses set?

1. Objectives of private sector businesses

Private sector businesses are owned and controlled by private individuals or companies. These businesses
have the following objectives:
➢ Survival
➢ Profitability
➢ Growth
➢ Market share

(a) Survival
Survival is the most important objective for new businesses. This is because the business is entering a
market with businesses already operating there. Competition will be very high. So, the business’ goal will be
to survive before making a profit. If a new business does not seek to survive, it may fail. Survival can be
achieved through lowering prices to attract customers, advertising and creating unique products that are
not currently offered by existing businesses. Survival is also important to large businesses when there is an
economic recession. Demand for goods and services will be low and unemployment is high.

(b) Profitability
Profit is the objective of every entrepreneur. Entrepreneurs set up businesses to earn profit. Profit is the
rewarded for their investment. A business makes profit if its sales revenue is greater than its costs. Profit is
important to a business because:
▪ it is a measure of business success.
▪ it is used to reward entrepreneurs for their investment.
▪ it can be used to expand the business.
▪ it attracts investors.
In-order to maximise profit, businesses should find ways to reduce costs such as buying from cheaper
suppliers.

(c) Growth
Growth means expanding the business. Business owners are interested in increasing the size of their
businesses to increase sales, market share and to fight competition. A large business has advantages such
as; ability to get loans from banks, gaining trade discounts when buying goods and producing more goods
at a lower cost. These are called economies of scale.
Growth involves; opening new branches, buying additional machinery and equipment, developing new
product and employing more employees.

(d) Market share

Market share refers to the percentage of the total market that is controlled by a business. This is achieved
by comparing the business’ sales to the sales of other businesses in the market. Increasing market share
helps a business to:
• become well-known.
• increases sales and profit.
• fight competition.
• control prices, suppliers and customers.

2. Objectives of public sector businesses

Businesses in the public sector are owned and controlled by the government. These businesses are formed
mainly to provide goods and social services to citizens of a country. They can have the following objectives:

(a) Social objective

Businesses formed by the government are mainly aimed at providing social services to communities. Those
services may include health care, education, water and transport. The businesses are also aimed at creating
employment to members of society. In most, developing countries, the government is the biggest
employer.

(b) Environmental objective

The government may establish businesses responsible for protecting the natural environment. This is
because the natural environment can attract tourist and it is also a source of raw materials for other
businesses.

(c) Financial objective

Governments can form businesses to generate income for the country. The money earned from these
businesses is then used to improve the welfare of the citizens of that country. Ethopian Airways is a very
successful business that is owned and controlled by the government of Ethopia.
3. Objectives of social enterprises
A social enterprise is a business formed by private individuals with the aim of solving social problems but
also making a profit. These businesses are not government businesses but the entrepreneurs who formed
them are mainly concerned with the following objectives:

(i) Social objective

Social enterprises aim to assist disadvantaged people in society by providing finance for self-help projects,
providing basic services such as water, accommodation and food. Social enterprises also create
employment for communities in which they are located.

(ii) Environmental objective

There are entrepreneurs who recognise that the natural environment is very important and should be
protected. They form businesses whose activities focus mainly on protecting the natural environment such
as water sources, wildlife and forests.

(iii) Financial objective

Businesses formed by social entrepreneurs earn profit that can be reinvested back into the business so that
the profits provide funds that can be used to improve society and protect the environment.

Review Questions
Waste Concern (WC) is a private sector business in country X. The business was formed to recycle waste. It
achieves its aims by collecting waste from households and factories and turning it into organic fertiliser that is
sold at cheaper prices to communities in country X. The Managing Director, Yan Yem, believes that besides
achieving its objectives, the business is also helping the government of country X to achieve its objectives.
Required
(a) What is a business objective? [2]
(b) Give two objectives of Waste Concern. [2]
(c) Do you agree with the Managing Director that Waste Concern is assisting the government to achieve its
objectives? Justify your answer. [6]

Why some owners may want their businesses to expand (grow)?

Entrepreneurs may want their businesses to grow in-order to achieve the following advantages:
(i) To increase market share
A large business can offer a wide range of goods and services to customers located in different part of the
country or around the world. This makes the business to attract more customers and increase sales. A large
market share will give the business control over customer and suppliers.

(ii) To gain from economies of scale

As the business grows large, it can benefit from buying goods, raw materials at reduced prices. This makes
its products to be cheaper to customers. Cheaper inputs means more added value and profit for the
owners.
(iii) To become well-known(status)
A large business is well-known by many people because it will be operating in different locations. It
becomes easy for the business to advertise its products and to control the market.

(iv) To spread risk

As the business grows, it stops to depend with one market or a few customers. If demand for its products is
low in one area, it gains from customers in another market. Spreading risk by selling different types of
product is called diversification.

Which are the different ways in which businesses can grow?

There are two ways in which businesses can grow or expand, namely: internal growth and external
growth.
1. Internal growth
Internal growth involves the business expanding its existing activities by opening new branches, employing
more workers, buying additional machinery and equipment or developing new products. Internal growth is
funded by using internal resources such as:
a. using profit earned by the business from previous years.
b. the owners introducing more capital into the business.

What are the advantages of internal growth?

❖ The owners keep control of the business because they are not joined by new owners. This gives them
to ability to continue to make decisions that favour them and also continue with their vision.
❖ The growth process is easier to manage as it is slow. Owners may only expand the business when they
feel they are ready to do so.
❖ It is usually cheaper to use internal funds to expand a business. The business will not have to pay
interest on the money used.

What are the disadvantages of internal growth?

❖ The process takes long due to lack of enough capital or profits to fund the growth process. This is
common with small businesses where owner may not have additional savings to use for expanding the
business.
❖ The owners may not have adequate knowledge to fund the growth process. This may put them at risk
of losing their investment if the expansion fails.

2. External growth
External growth involves a business expanding by taking over or merging with another business. The
process of taking over or merging with another business is called integration.
(i) To take over a business means to buy it completely and take full control of that business. This may
happen with or without an agreement with the original owners of that business.
(ii) To merge means to join two businesses into one business that operates under one name or a shared
name.

Illustration:
1. Takeover
Tiger
Tiger Airways
Airways Buys Fast become (now larger
than before)
Jet s
 2. Merger
Tiger Fast Tiger
Airways Airways
Join with Fast become (now larger
Jet s than before)

Which are the methods of external growth?

Mergers and takeovers are called integrations. These can be in the form of:
• Horizontal integration
• Vertical integration
The third form of external growth is called conglomerate.

Illustration:
Car Dealer shop
vertical

Car Car
horizontal
manufacturer manufacturer B
A
vertical

Car parts supplier

1. Horizontal integration
Horizontal integration is when two businesses producing similar goods or services merge or takeover each
other. Usually such businesses are competitors. In the above illustration, two car manufacturers join to
form one business.

What are the advantages of horizontal integration?

• Competition is reduced when businesses combine. This makes the resulting business to have more
control of customers and suppliers.
• The combined business will have more sales revenue and profit. This is because the market share will
grow since they are combining customers from two businesses.
• The two businesses are able to share information and skills leading to higher chances of satisfying
customers.

2. Vertical integration
Vertical integration is where by a business merge or takes over another business at a different level of
production. The other business taken over or merged with is usually a supplier or a customer to that
business. In the above illustration, a car manufacture takes over a car dealer (shop). This is called forward
vertical integration. The car dealer is a customer to the car manufacturer.
If the car manufacturer takes over a car parts supplier, it is called backward vertical integration.

What are the advantages of vertical integration (both forward and

backward)?
• The business is able to control supply of raw materials. In this case, the business will get raw materials
at cheaper prices ahead of competitors.
• The buying business is assured of regular supply of inputs even if they are in short supply. It will instruct
the supplier not to sell to competitors.
• The buying business will have more access and information to customers. Thus, the business will
provide products that have higher chances of satisfying customers.
• The profit of the buying business will increase since it is now enjoying profit from the supplier or the
customer.
• The buying business will have more control of the market as the retailer may be instructed to only sell
products from the parent company.

3. Conglomerate
Conglomerate involves the business merging or taking over businesses in completely different industries. In
the illustration above, the car manufacture may buy a cloth manufacturing business or a fishing company.
This is called diversification.

What are the advantages of conglomerate?

• There is increased market share. Conglomerates are very large businesses that are able to reach
customers in different parts of the world.
• Producing and selling a wide range of products allow conglomerates to spread risk. If demand is not
high in one sector, they rely on the other sectors.
• Companies in a conglomerate are able to share ideas and technology since they are coordinated by the
same parent company.
• The conglomerate enjoys economies of scale by buying inputs in bulk at reduced prices for all
companies and also advertising for all companies under the same brand name.
 Review Questions
1. Copy and complete the following table, putting a tick in the appropriate box.

Horizontal Vertical Conglomerate

integration integration
1. A bread maker takes over a cocoa
wheat farm.
2. A travel agent merges with an online
holiday company.
3. A clothing retailer takes over a clothing
manufacturer.
4 A bank buys a mobile phone company.

5. An aircraft producer takes over a real

estate company.

2. Rufas is a fruit jam producer. He buys the fruits from a nearby farm and sells his jam to a grocery shop
in the city centre. In the past five years, his jam business was doing well and it earned him enough
profit to save. Recently a new jam producer came into the city. The demand for his jam is declining.
Rufas wants to grow his business.
Required
Explain the one advantage and one disadvantage to Rufas of using each of the following methods to
grow his business.
(a) opening a new branch in the city centre.
(b) merging with the farm.
(c) taking over the new jam producer. [9]

What are the problems linked to business growth?

As businesses expand, the problems they face also increase. Some problems faced when businesses grow
are as follows:
(i) The business becomes difficult to control
As the business grows there are many employees and branches to manage. This cannot be done by the
owner alone. The owners may end up appointing managers and specialists to manage the business on their
behalf.
(ii) Communication problems
As the business expands, the link between owners and managers becomes long. Information takes time to
reach low level employees.
(iii) Increased costs
Expanding a business require financial resources. Some businesses over-expand leading to them incurring
huge costs and running short of capital to maintain the business.
(iv) Change of objectives
As the business grows, it will join with other businesses or more investors. These people come with their
own ideas which may not be the same as that of the original owner. This may lead to conflict in managing
the business.
(v) Increased competition
Large businesses may find it difficult to continually attract new customers because of new businesses that
are coming up with new products.
How might problems linked to business growth be overcome?
❖ Improve communication between managers and employees so that everyone in the business has the
correct information. Employees should have the opportunity to give feedback.
❖ Expand slowly linking the rate of expansion to the financial resources available. It is always advisable to
expand using profit generated by the business instead of borrowing loans.
❖ Changing management style to suit the size of the organisation may be useful. For instance, managers
can also be given the opportunity to make small decisions involving their branches and employees
under them.
❖ Be innovative. This involves developing new ideas and using technology to better understand
customers and satisfy them.

Why some businesses remain small?

Not all businesses grow or expand. Some businesses remain small for the following reasons:

1. The market is also small

Some businesses are located in areas that have low population. The demand for their products is relatively
low. For such businesses, they do not have the desire to expand their activities because they may not get
more customers to buy their products. This is common for small businesses such as grocery shops, cafés,
and car washers who provide services to small villages and towns.

2. Lack of capital to expand

Many business owners do not have the capacity to raise enough capital to open new branches or to buy
additional machinery and equipment to increase production. Banks may not be willing to offer them loans
because they are considered to be too risky. Such businesses will remain small unless they start to earn
enough profit that can be used for expansion.

3. Lack of management skills

The success of every business depends on the managements skills of the owners. Some entrepreneurs do
not have the necessary skills to manage large businesses. As a result, they prefer to continue as small
businesses.

4. The owners’ objectives

Some business owners may simply choose to stay small as long as the business is making enough profit for
them. Having a larger business may mean more responsibilities, paying more tax and losing control of the
business. Running a large business is time consuming and stressful. It means managing more people and
making and making more decisions.

Why some businesses fail?

Not all businesses formed by entrepreneurs succeed. Businesses fail because of the following reasons:
(a) Poor planning
New and small businesses often fail due to lack of proper planning for the future. The owners may start
operating without a clear vision and objectives. At the end, the business may lack a clear path to
survive.
(b) Poor management
Some owners and managers lack proper management skills necessary to grow the business. This
happens when the business expand too quickly than expected. The management may fail to react
positively to the changes in market trends, hence, they are left behind, leading to collapse of the
business.
(c) Lack of capital
 Adequate capital is required for every business to be successful. A business without enough capital may
fail to pay its suppliers, workers and to repay loans borrowed. This may lead to the business being
closed.
(d) High competition
New businesses suffer high competition from existing businesses. When a new business enters the
market, established businesses reduce prices to keep their customers. This forces the new business to
lower prices as well leading to losses.
(e) Over-expansion
Some businesses expand too quickly leading to problems in management and ownership. Rapid
expansion exposes the business to errors and competition. The business may end up spending more
money trying to survive.

Review Questions
Glass Warehouse (GW) is a glass manufacturing company that makes glassware products such as windows
and bottles. The company is owned by two partners Grace and Kai. Grace thinks that they can expand their
business to other cities in the country as it has managed save $400 000. Kai is afraid because he has read that
80% of business fails when trying to expand.
Required
(a) Give two reasons why some business owners may want their business to remain small. [2]
(b) Identify two reasons why new businesses might fail. [2]
(c) Do you agree with Grace that they should expand their business to other cities in the country. Justify
your answer. [6]

Which types of business organisation do we have?

Business organisations are divided into private sector businesses and public sector businesses. Private
sector businesses are owned and controlled by individuals and companies while public sector businesses
are owned and controlled by government. The following chart illustrates business organisations found in
both the private sector and the public sector.
 BUSINESS
ORGANISATIONS

PRIVATE SECTOR
PUBLIC SECTOR
BUSINESSES
BUSINESS

SOLE TRADER PARTNERSHIP COMPANIES JOINT FRANCHISES GOVERNMENT

VENTURES BUSINESSES

PRIVATE LIMITED PUBLIC LIMITED

COMPANIES COMPANIES

1. Sole trader
A sole trader is a business owned and controlled by one person. It is the most common type of business set
up by new entrepreneurs.
The following are the key features of a sole trader:
➢ It is owned and controlled by one person.
➢ The owner is both the employee and the manager.
➢ The owner has unlimited liability- the owner has legal responsibility to pay for the debts of the
business if the business fail to pay its debts.
➢ A sole trader is unincorporated – there is no separation between the owner and the business.

What are the advantages of operating a business as a sole trader?

• A sole trader is usually a small business that requires low capital to start it. Thus, people can use
• personal savings to start their own businesses.
• The business is easy to set up as no special paperwork is required. The business can start operating
before it is registered.
• Decision making is quick as only one person is involved. There is no need to consult anyone to reach a
decision.
• The owner enjoys all the profits alone without sharing with anyone.
• The business has higher chances of satisfying customers because the owner is in constant interaction
with the customers.
• Sole traders are independent. They can choose the time to open and close the business and the time to
take rest.

What are the disadvantages of operating a business as a sole trader?

• The owner is unable to raise enough capital required to expand the business. Banks are not willing to
lent money to sole traders. Thus, most sole traders remain small or fail in their first few years.
• The owner has unlimited liability. If the business fails to pays its debts, the owner may lose personal
possessions to pay for the debts of the business.
• The owner suffers all the risks and losses on the business alone.
• Decision making is usually poor. The owner has no one to share idea with before implementing them.
• There is no one to share the work load with. If the owner is sick or is not available, there will be no one
to manage the business.
• The business lacks continuity. If the owner dies, the business stops to operate.
2. Partnership
A partnership is business owned and controlled by two or more people who share ideas and risks. The
partnership business has the following features:
➢ The business has two or more owners called partners.
➢ Partners may sign an agreement called a Deed of Partnership. nb
➢ The partners raise capital together.
➢ The partners share management of the business.
➢ Profits and losses are shared between partners.
➢ The partners have unlimited liability - this means that the partners can lose their personal property to
creditors if the business fails to pay its debts.
➢ Each member can make a decision on behalf of the partnership.
➢ If one partner dies or withdraws, the business is dissolved.

What are the advantages of operating a business as a partnership?

▪ The business is easy to set up as no special paperwork is required. The business can start operating
before it is registered.
▪ Capital raised through a partnership is higher than being a sole trader.
▪ Partners share responsibilities for managing the business. If one partner is not available, the other
partner can make decisions on behalf of the absent partner.
▪ Risks and losses made by the business are shared between partners. This is different from a sole trader
where the one person bears all the losses alone.
▪ Decision making is improved as each partner brings in new ideas, skills and experiences necessary in
operating the business.

What are the disadvantages of operating a business as a

partnership?
▪ Partners have unlimited liability. If the business fails to pays its debts, the partners may lose personal
possessions to pay for the debts of the business.
▪ Conflicts may arise. Partners may have disagreements that may negatively affect the progress of the
business.
▪ If a partnership agreement is not signed, disagreements may arise on the duties to be performed by
each partner and also on sharing profits.
▪ Profit is shared between partners. Sharing profit reduces profit earned by each partner.
▪ Capital raised through a partnership is still lower than that of a company. This makes it difficult to raise
more capital as the partners may not have other assets to support application for a loan.

Review Questions
Keren is an accountant. She wants to set up her accounting consultancy company. Her research has shown
that she needs $12 000. She has managed to save $8 000. Her sister who is a teacher is willing to join her
as a partner but she will continue to teach at a local school. Keren has approached a city bank and the
branch manager has advised her to provide a business plan.
Required
(a) What is a sole trader? [2]
(b) Give two features of a partnership. [2]
(c) Identify and explain two advantages and two disadvantage of Keren forming a partnership with her
sister. [12]
3. Companies
A company is an incorporated business formed by shareholders and managed by a board of directors.
An incorporated business is one in which there is separation between the business and its owners. The
business is responsible for all its debts. The company can take legal actions against its owners and the
owners may also take legal action against their own company. Companies are divided into private limited
company and public limited company.

(i) Private limited company

A private limited company is a business in which the shareholders (owners) are not free to sell their shares
to other people unless if all shareholders agree. Private limited companies are owned and controlled by
family members and close friends. The following are the features of a private limited company:
➢ Owned by people called shareholders.
➢ Shareholders are not free to transfer (sell) their shares to other shareholders.
➢ The company is not allowed to issue share to the public.
➢ The shareholders have limited liability.
➢ The company has separate identity from its owners.
➢ The company is managed by a Board of Directors appointed by shareholders.

What are the advantages of operating a business as a private limited

company?
❖ The shareholders are able to raise more capital to operate their business. Each shareholder provides
capital by buying shares in the company.
❖ The shareholders are able to maintain control of their business because they are not allowed to
transfer their shares without the agreement of other shareholders. Thus, no one from outside can
become a shareholder.
❖ The shareholders have limited liability. This means that if the company fails to pay its debts, the
shareholders may not lose private assets to pay for the debts of the company. They only lose the
capital they have invested in the company.
❖ The company’s financial affairs remain secret. This is because the company is not required by law to
publish its financial statements for the public to see.
❖ The company has continuity. If one shareholder dies or resigns, the business will continue to operate
because it is regarded as a separate person.

What are the disadvantages of operating a business as a private

limited company?
❖ Less capital is raised than in a public limited company. A private limited has fewer shareholders than a
public limited company and it is not allowed to issue shares to the public.
❖ A private limited company is relatively expensive to set up than a sole trader and a partnership. There
are legal documents that should be prepared before the company is allowed to operate.
❖ The Board of Directors appointed to manage the business may put their own interest first ahead of
the interests of shareholder. Thus, the business may not achieve the objectives of the owners.

(ii) Public limited company

A public limited company is a business in which the shareholders are free to sell their shares to the public
on the stock exchange. Thus, anyone with money can become a shareholder in a public limited company.
Please note: A public limited company is not a government business. The following are the features of a
public limited company:
➢ Owned by many shareholders.
➢ Managed by a Board of Directors.
➢ It publishes financial statements for the public to view.
➢ Holds a meeting of shareholders every year called Annual General Meeting (AGM).
➢ Allowed to advertise and sell shares to the public.
➢ Shareholders receive dividends from the profit earned by the company.

What are the advantages of operating a business as a public limited

company?
❖ The shareholders are able to raise more capital to form the business. This is because any member of
the public with money can buy shares in the company and become a shareholder.
❖ They enjoy economies of scale because they buy in bulk and receive trade discounts from suppliers.
This makes their products to be cheap to customers.

❖ Public limited companies have high status. They are very large companies with branches in several
parts of the world that are well known. Every other business wants to associate with them.
❖ The shareholders have limited liability. This means that if the company fails to pay its debts, the
shareholders may not lose private assets to pay for the debts of the company. They only lose the
capital they have invested in the company.
❖ The company has continuity. If one shareholder dies or retires, the business will continue to operate
because it is regarded as a separate person.
❖ Public limited companies can easily get loans from banks because banks trust them. They are
considered to be less risky to lend them money.

What are the disadvantages of operating a business as a public

limited company?
❖ The legal formalities involved in starting a public company are complicated and time consuming. The
business cannot start operating before it gets approval from the registrar of companies.
❖ The financial affairs of the business are not kept secret. The company is required by law to publish its
financial statements for the public to see. This may give competitors an advantage.
❖ The process of selling shares to the public is expensive. This is because the board of directors hire
specialists to do that for them. This increases expenses of forming the business.
❖ The original shareholders may lose control of their business because some people with money may
buy more shares or buy them out of the business.
❖ The Board of Directors appointed to manage the business may put their own interests first ahead of
the interests of shareholders. Thus, the business may not achieve the objectives of the owners.

Review Questions
Kallis Engineering (KE) is a private limited company. It is a small engineering company responsible for
manufacturing and repairing of farm equipment. The directors of KE are planning to expand their business to
other parts of the country. A specialist has advised them to change their business into a public limited company.
Required
(a) What is limited liability? [2]
(b) Identify and explain two advantages of Kallis Engineering operating as a public limited company. [4]
(c) Do you agree that Kallis Engineering should change to a public limited company before it expands? Justify
your answer. [6]

4. Joint ventures
A joint venture is a business enterprise formed and controlled by two or more businesses that join for a
specific purpose. Businesses may form joint ventures for the following reasons:
• To develop a new product.
• To undertake a large construction project.
• To expand into a new market.
• To share knowledge and expertise.
The following are the features of a joint venture company:
➢ A new company is formed (the joint venture company).
➢ The two companies remain separate from each other.
➢ The joint venture is for specific period.
➢ The two businesses share profits and losses.
➢ A manger is appointed to oversee the joint venture.

Company A Company B
(China) (Africa)

Joint
Venture
Company

Construction of dam in Africa

What are the advantages of operating a business as a joint venture?

 Companies wishing to invest in other countries reduce the risk of failure. They share costs and
knowledge with businesses already operating in those countries.
 It allows companies to complete large projects that require a lot of capital. Such projects could not be
done by individual companies.
 A joint venture agreement will allow companies to share technology and expertise especially in cases
where one is located in a less developed country.
 A joint venture agreement allows companies or countries to continue working together even after the
joint venture has ended.

What are the disadvantages of operating a business as a joint

venture?
 The joint venture agreement may fail to achieve its objective due to disagreements on ownership and
profit sharing between the joint partners.
 Joint venture agreements are normally abandoned due to legal, cultural, social and environmental
problems. The two joint venture companies may not share the same cultural, environmental and legal
beliefs.
 Communication problems always arise. The business that has more control over management will
receive communication about the joint venture ahead of the other partner.

5. Franchises
A franchise is a business agreement in which one business sell its products under the name or identity of
another business. Thus, a franchise agreement involves three things namely; the franchisor, the franchisee
and the franchise.
The franchisor is the business with well-known brand name, logos, trading rights and products that
another business wants to use.
The franchisee is any other business that pays for the right to use the brand name, logo, product or
trading rights of another business.
The franchise is the agreement allowing one business to use the brand name, logo, products or trading
rights of another business.

The following are the features of a franchise:

There is an agreement to use another business’ name, logo, products or trading rights.
The franchisee pays a fee to use the trading rights of the franchisor.
Control of the trading rights remains wnith the franchisor.

What are the advantages of operating a business as a franchise to

the franchisee?
There are high chances of gaining market share since the business will be selling its product under a
well-known brand name which is also trusted by customers.
The business and its employees may receive training, new technology and expertise from the
franchisor. The business will continue to use these benefits even after the end of the franchise
agreement.
Banks are willing to lent money to a business operating using a recognised brand name because it is
considered to have low risk. This helps the franchisee to quickly raise money required to expand the
business.
Sometimes, the business gets products directly from the franchisor. This ensures that all products sold
to customers have the same quality, increasing chances of satisfying customers.

What are the disadvantages of operating a business as a franchise to

the franchisee?
Licence fees that are paid to the franchisor may be high, reducing the profit earned by the business.
Control of the franchise remains with the franchisor which makes all decisions. The business may lack
the independence to make decisions that suit their specific location.
The business only relies with suppliers recommended by the franchisor. The business is unable to find
other suppliers that are cheaper in order to maximise profit.
What are the advantages of operating a business as a franchise to
the franchisor?
The business becomes well-known. Operating a franchise is a quick and easy way of expanding the
business to other parts of the world.
Fees paid by the franchisee add to the revenue earned by the business there by increasing profit as
well.
Risk of failure is shared with the franchisee.
Expenses to hire management, employees and to rent shops are reduced as this is done by the
franchisee.
What are the disadvantages of operating a business as a franchise to
the franchisor?
Bad management of the franchise by one business could create bad reputation of the entire franchise
leading to loss of customers.
If the fees charged by the franchisor are low, the business may lose revenue since the franchisee keeps
most of the profits.
The franchisor bears the costs of supporting all the franchises and making sure they are operating
successfully, including advertising for them. This increases expenses to the franchisor and reduce profit.

Review Questions
Diamond is a car repair mechanic. He operates a successful workshop, Diamond Car, in a small town in
country X. The success of his workshop has motivated him to think of expanding his car repair business to
three major cities in the country. The expansion requires $120 000. Diamond is considering two options to
use for expanding.
Option 1: Diamond Car enters into a joint venture with another motor repair company from country Y, which
will bring new workshop equipment. Diamond will manage the new company formed. The joint venture
partner will get 60% of profit made.
Option 2: Diamond Car buys a franchise for Xtreme Cars, a leading car repair business in country Y. The
franchise will provide the full amount required by Diamond but he will pay 20% for every car repaired.
Required
(a) What is a joint venture? [2]
(b) Give two advantages to Xtreme Cars of selling their franchise to Diamond. [2]
(c) Which option do you think Diamond should choose? Justify your answer. [6]

What are stakeholders?

Stakeholders are any people, businesses or organisations that have a direct interest on the activities of a
business. Stakeholders are divided into internal and external stakeholders as follows:

Internal stakeholders External stakeholders

1. Owners (shareholders) 1. suppliers
2. Managers 2. banks
3. employees 3. customers
4. government
5. community (pressure groups)
6. trade unions

What are stakeholder objectives?

Internal stakeholders
Stakeholders Why are they important? What are their main objectives?
Owners or These are people who invested money They want the business to make profit.
shareholders to start and expand the business. Profit is the reward they get from their
They might lose their investment if the investment.
business fails. Profit also increases their wealth. They use profit
to expand the business.
Managers Managers are people who hold higher Managers are interest in the success of the
positions in the business. They make business because it gives them more power, more
important decisions that determine the status and they may earn higher salaries through
success or failure of the business. bonuses.
 Employees Employees are people who work for Employees want the business to succeed so that
business and in return they are they continue to be employed and receive their
rewarded with wages and salaries. salaries and wages. They also expect an increase
in salaries and wages and improved working
conditions.
External stakeholders
Suppliers These are people or businesses that sell Suppliers are more interested in selling to a
goods and provide services to the business that is able to pay them on time.
businesses. They may supply the goods Suppliers may refuse further credit if a business is
and services on credit to the business. failing to pay them.
Banks Banks lent money to the business. They Banks are more interested on the ability of a
check the business’ finances to see if the business to repay the loan plus interest. A
business is making enough cash to get a business that has a poor cash position may not
loan. get a loan from a bank.
Customers These are people or other businesses Customers are interested on good quality and
that buy goods and services from the reasonably priced products. Customers prefer to
business. If customers are not satisfied buy from businesses they trust and which protect
they leave for other businesses. their rights.

Governments The government, through its various Government departments are interested in:
departments departments, put in place laws that the profit made by a business so that they
affect the operation of every business. can levy tax on the business.
supporting new and small businesses so that
the economy may grow.
checking whether the business is following
laws relating to environmental, employment
and consumers protection.

Trade unions A trade union is an organisation formed Trade unions are more concerned with higher
by a group of workers who join together salaries and wages for employees and better
to fight for their rights. working conditions for their members.
Trade unions may organise labour action
that can disrupt productivity of the
business.
The The community is made up of different The community wants the activities of the
community people and organisations that benefit business to improve the living standards of the
from the business’ goods and services. community. They want businesses to employ
The community is also negatively affected people from their own communities and to
by the activities of the business such as produce goods and services without damaging
pollution, damage to the natural the environment or causing pollution.
environment and unemployment.
They may form pressure groups to
disrupt or stop productivity of the
business.

How might stakeholder objectives conflict?

There is always a conflict between the objectives of different stakeholder groups. For instance;
 Employees may demand an increase in wages and salaries because the business has made more profit
while owners want to use the profit to expand the business by opening new branches.
The managers may want to increase output so that they meet customer orders. This may increase
pollution for the surrounding communities.
Increasing wages may motivate employees to work harder and produce more but it will increase costs
and reduce profit for owners.
Customers may want products of high quality at cheaper prices. This may increase the cost of making
the goods reducing profit to owners.
Government departments may want businesses to comply with all laws as they produce goods and
services but doing so may increase costs to the business reducing profits for owners.

Review questions
TurnUp is a private limited company that makes bricks by recycling waste plastic. The company is located in a
small busy town. The main objective of TurnUp is to maximise profit by keeping wages and other costs low.
One of the community leaders has written to the government requesting that the company should be closed
as its ovens are ‘a hazard to the town’. The company employs 50 full time employees and over 200 recyclers
from the town.
Required
(a) What are stakeholders? [2]
(b) Identify and explain the interests of two stakeholders of TurnUp. [4]
(c) Do you agree with the community leader that the government should close TurnUp? Justify your
answer.
[6]

MOTIVATION OF EMPLOYEES
What is motivation?
Motivation is the desire or drive that makes employees work hard and produce more goods and services.
Employees are motivated by the following factors:
1. Money (salaries and wages)
People require money for them to pay for goods and services and to take care of their families. They work,
even more, if there is a promise of being paid higher wages and salaries. Some manufacturing businesses
pay their employees according to number of units produced in order to encourage them to produce more
goods.
2. Their work
Employees work more because they are enjoying the job they are doing. They have an internal feeling that
their job is interesting. They feel more satisfied by doing their work and achieving set targets. This is
common for sports personnel.
3. Recognition
Employees are more motivated if their effort is acknowledge by positive comments and awards of
achievement. They feel that they have something to contribute to the job and society. Employers may also
delegate important duties to employees who are performing better to further encourage them.
4. The working environment
The physical and social working environments are very important for employees. Employees should be able
to contribute their effort in an environment that is free of injury, pollution and other dangers. The working
environment should offer employees an opportunity to give their opinions without fear.
5. Job security
People are motivated if the job offers them an assurance of being employed for a long time. Employees
work harder if they are sure that their jobs are safe. A workplace where employees regularly lose their jobs
is demotivating to employees.

Why is motivation of employees important to a business?

Motivation of employees is likely to result in the following.
a. Increase in productivity
If workers are satisfied with their work, they feel loyal to the business. They are willing to put extra effort to
produce more goods and service to meet set target and even surpass them. This reduces the cost of
production as less time is spent doing the same job.
b. Reduced absenteeism
Employees who feel that their work is not interesting and less rewarding tend to take more leave days (off
days) than motivated employees. Increasing motivation means less absenteeism leading to more
production. Production will continue smoothly as there is no need for other employees to stand in for those
that are absent.
c. Reduced labour turnover
Motivated employees are more likely to stay longer in the business than demotivated employees. The
business will save on the costs of recruiting and training new employees. The process of recruiting and
training employees takes time and it reduces productivity leading to low customer satisfaction and low
profit.
d. They contribute more ideas
Motivated employees feel a sense of belonging to the business. They want their business to succeed and
hence they come up with better ideas of improving processes and satisfying customer needs and wants.
This will lead to more sales and profit.
e. Reduced wastage during production
If employees are motivated, they perform their work with care and interest. They produce better quality
products without wasting resources. Demotivated employees are not willing to do their work properly. As
such, they waste raw materials and other resources as a way of showing their dissatisfaction. This will add
more costs to the business and reduce profit.

f. Satisfied customers
Motivated employees are willing to work extra hard to ensure that customers’ needs and wants are
satisfied. This may include providing free advice to customers and making follow up on products sold to
them. At the end, when customers are satisfied, they come to buy again leading to more sales for the
business.

THEORIES OF MOTIVATION

Which Theories of Motivation explain motivation of employees?

There people who studied workplaces and came up with theories that explain motivation of employees.
These people and their ideas are listed below:
 The person Country & profession Name of the theory
1. Abraham Maslow US- Psychologist Maslow’s Hierarchy of Needs Theory
2. Fredrick Taylor US-Engineer Taylor’s Scientific Management Theory
3. Fredrick Herzberg US- Psychologist Herzberg’s Two Factor Theory

What does Maslow’s Hierarchy of Needs Theory say?

Maslow suggested that people, including workers, have needs that can be placed in a hierarchy as follows:

Maslow’s Hierarchy of needs.

Feeling of achievement, development
of an employee’s potential.

Self-
actualisation

Esteem needs:
promotions, recognition

Social needs (Love & Belonging): team work,

support, good working relations

Safety and Security needs: job security, good working

environment

Physiological needs: water, food, shelter, clothes, education, healthcare

How do we apply Maslow’s hierarchy of needs to the work place?

Maslow’s hierarchy How they are used at work places?

of needs
Physiological needs Pay employees reasonable salaries and wages so that they are able to
meet basic needs for themselves and their families.
The business can provide rented accommodation for employees so that
they do not lose their salaries to pay for accommodation.
The business can provide transport to ferry employees to and from
work. This ensures that employees remain with additional income to
provide for their families.

The business may provide meals at work or monthly food hampers so

that employees work with enough energy. Hungry employees do not put
extra effort in their work.
Employees should be allowed rest times so that they regenerate
themselves.

Safety and Security The business must ensure that employees are working in an
needs environment free from injury, pollution and death.
Employees must be provided with adequate protective clothing suitable
for their work.
 Employees should be afforded the opportunity to sign employment
contract so that they feel confident to perform their duties and have job
security.
The business can pay for medical insurance for its employees so that if
they are injured at work, they can be treated without paying for their
medical bills

Social needs The business should ensure that employees feel belonging to the
organisation by involving workers on issues that affect them.
Employees should be able to build friendships, build teams and share
ideas about their work.
The business can hold events that unite and encourage social
interactions such as ‘end of year parties’ and sporting events.

Esteem needs ❖ Employees should be valued and respected as their contribution is

essential to the success of the business.
❖ The business can recognise or reward hardworking employees by giving
certificates of recognition, promoting them, delegating them important
tasks and publishing them in the business’s magazine.
❖ Employees can receive positive comments from management, company
cars or company houses, medals and paid holidays.

Self- actualisation Self-actualisation means employees should have the opportunity to be

successful in the jobs they are performing. This may be achieved by:
• High performing employees may be given positions of responsibility in
which they work with minimum supervision.
• Skilled employees may be sent for further education to upgrade their
skills with the training fees paid for by the business.
• Long servicing employees and other senior managers may be afforded
the opportunity to be shareholder in the business.
• Talented employees may be given the opportunity to develop new
products for the business or to suggest important changes.

What are the limitations (disadvantages) of Maslow’s Hierarchy of

needs to the workplace?
1. Not all employees have needs that follow a hierarchy. Some employees are concerned with earning
their salaries and wages and nothing more. So the business cannot motivate them in the same way
with employees that aim to achieve self-actualisation.
2. Many employees reach retirement age before they are fully satisfied with their salaries. To these
employees, salaries or wages are the only motivating factors.
3. Maslow’s theory is difficult to apply in factories where the focus is mainly on producing more at low
wages.

Review Questions
CWB is a small business owned by Cherry. The business makes a range of pottery products that includes
plates, cups and display pets. The products are sold to overseas markets. It employs 30 employees. Most of
the work done in CWB involves human skill. Machines are only used when drying the products. The owner,
Cherry, is looking at ways of motivating employees in order to meet production targets.
Required
(a) What is motivation of employees? [2]
 (b) Identify two effects of a demotivated work force. [2]
(c) Using Maslow’s hierarchy of needs, identify and explain ways that could be used by Cherry to motivate
employees to achieve the following.
(i) Physiological needs.
(ii) Self-esteem.
(iii) Self-actualisation. [6]

What does Taylor’s Scientific Management Theory say?

Taylor studies the way factory workers were performing the tasks and he made the following
recommendations:
➢ Employees were motivated by money. He suggested that factory employees can be rewarded according
to number of units produced. This is called piece rate.
➢ Labour productivity will improve if each employee performs work that they are good at. This is called
specialisation.
➢ Jobs should be divided into small tasks that are easy to manage and movement between tasks should
be reduced.
➢ Workers that produce more should earn more. This reduces the cost of production.

What are the limitations (disadvantages) of Taylor’s theory at

workplace?
1. Making work to be repetitive leads to boredom. Employees are motivated if they do a variety of tasks.
2. Money is not the only factor that motivates people to work. Other people enjoy their work, hence, they
put more effort each time they are given tasks to do.
3. Taylor’s recommendations means that workers may not have enough time to rest and refresh. They
work overtime in order to earn more.
4. Taylor’s recommendations are not suitable in jobs that are difficult to measure output of each
employee. For example, it is difficult to pay office workers using piece rate.

What does Herzberg’s Two Factor Theory say?

Herzberg studied the work of accountants and engineers. He proposed that:
Workers have two sets of needs that should be satisfied at work. He named these factors; hygiene
factors and motivators.
Hygiene factors are necessary for people to work but do not make people work harder. Hygiene factors
do not motivate people but it is necessary to satisfy them first because people may not work if hygiene
factors are not met.
Motivators were factors that encourage people to work harder. If motivators are satisfied, they will
increase employees’ productivity.
The following table shows both hygiene factors and motivators:
Hygiene factors Motivators
wages and salaries ❖ Personal achievement
Working conditions ❖ Opportunities for promotion
Relationships with managers ❖ Interesting work
Job security ❖ Trust and delegation of responsibility
Job status ❖ Recognition at work
Other rewards ❖ Personal development

How do we apply Herzberg’s Theory to the work place?

Businesses should quickly satisfy hygiene factors as these do not lead to increased productivity. Employees
expect to be rewarded with good wages and salaries, to work in a good working environment and to have
job security for them to work. However, even if these factors are satisfied, there is still no motivation to
work harder.
Businesses should focus more on satisfying motivators. These factors, if satisfied, will make employees to
work harder. Thus, businesses should recognise effort of hardworking employees by delegating them
responsibilities and promoting them. Employees can be sent for training to improve their skills and be given
more varied work.

What are the limitations (disadvantages) of Herzberg’s theory at

workplace?
1. The study focused mostly on office employees. Employees who work in factories are more concerned
with increase in wages as suggested by Taylor.
2. There are fewer motivators to satisfy all production employees. They cannot all be promoted as the
opportunities for promotion are few.

Review Questions
CWB is a small business owned by Cherry. The business makes a range of pottery products that includes
plates, cups and display pets. The products are sold to overseas markets. It employs 30 employees. Most of
the work done in CWB involves human skill. Machines are only used when drying the products. The owner,
Cherry, is looking at ways of motivating employees in order to meet production targets.
Required
(a) What are ‘hygiene factors’? [2]
(b) Give two proposals made by Herzberg in his theory. [2]
(c) Using Taylor’s theory, identify and explain two ways that could be used by Cherry to motivate
employees to meet production targets. [6]

Which methods of motivating employees can businesses use?

Employees are motivated using a combination of both financial and non-financial rewards:

1. What are financial rewards?

Financial rewards are any payments of money made by the business to its employees in exchange for their
effort at work. The following are some financial rewards that businesses use to pay their employees:

(a) Salaries
Salaries are normally paid to office employees and public sector employees such as teachers and nurses. A
salary is a fixed monthly payment. The salary is not linked to the effort of the employee. It is mostly based
on time (month). A salary is not based on units produced. It is an agreement between the employee and
the employer. Salaries are not normally motivating for employees to work harder. Employees who earn
salaries are motivated if they are promised bonuses or promotions.

(b) Wages
Wages are financial rewards for employees who are paid according to units produced or time worked.
Wages are paid daily or weekly. They are classified into piece rate and time rate.
(i) Piece rate
Piece rate are wages paid based on number of units produced. The basic rule is that an employee who
produces more units will also earn more wages. Paying employees using piece rate has the following
advantages:
▪ The business is able to reward employees who are putting more effort to their work as their work can
be measured easily.
▪ The business is able to meet orders from its customers as employees produce more goods in order to
earn more money.

However, piece rate has the following disadvantages:

▪ Employees may ignore quality and concentrate on producing more items. This may lead to poor quality
goods passing to customers leading to bad reputation of the business.
▪ Employees may overwork themselves in order to earn more money. This may lead to injuries, fatigue
and poor work.
▪ If there are machines breakdown, power cuts and other stoppages, the business may not pay the
employees because they are not producing. As a result, they become demotivated.
(ii) Time rate
When using time rate, employees are paid wages according to the number of hours worked. Paying
employing according to time rate has the following advantages to the business:
• Absenteeism is reduced. Employees report for work in order for them to get paid.
• It is easy to calculate wages at the end of each week as only a record of the attendance of each
employee is required.
• It is used in businesses where it is difficult to calculate the output of each employee.
• Quality products may be produced as employees take their time to do the work.
However, paying employees using time rate has the following disadvantages:
• Employees may just report for work without being productive, knowing that they will still get paid.
• The business may fail to meet customer orders as the employees are more concerned with hours
worked instead of quantity produced.
• The business should have a very good record keeping system so that employees do not cheat on the
hours worked.
(c) Bonuses
A bonus is an additional amount paid to employees for reaching an agreed target. Employees who earn
salaries are paid bonuses at the end of the year while employees who earn wages may be paid bonuses at
regular basis. A bonus is usually based on the performance of all employees.

(d) Commission
A commission is paid in addition to a wage or salary for sales staff. Thus, an employee who sells more
goods and services will also earn more money. This motivates them to find more customers. However,
paying a commission to employees may be stressful to them in times when the products are not in
demand.

(e) Performance based pay

This involves paying employees according to their level of performance. Performance based pay takes any
form such as awarding bonuses, commission and other incentives. Usually, employees are assessed at
regular intervals to see if they are meeting targets. Employees who meet or exceed set targets will earn
more money.

(f) Profit sharing

This involves employees receiving a small percentage of the profits made by the business they work for in
addition to their salaries and wages. This encourages employees to always work towards the overall
profitability of the business.

(g) Share ownerships

In limited companies, employees may be offered an opportunity to become shareholders. The company set
aside shares that are given to employees so that they become part owners of the company they are
working for. This encourages employees to work hard knowing that they are also working for their own
company.
2. What are non-financial rewards?
Non-financial rewards are other ways of motivating employees without paying them money. Non-financial
rewards may be divided into fringe benefits and other job related methods.
(a) Fringe benefits
Fringe benefits are additional non-monetary incentives awarded to employees on top of their salaries and
wages. The business may find it cheaper to offer employees fringe benefits as a way of motivating them
instead of increasing their salaries and wages.

The following is a list of fringe benefits that can be offered to employees:

Fringe benefits
o Providing accommodation. o Free or discounts on products produced by
o Providing transport to and from work for low the business.
level employees. o Retirement pension paid by the business.
o Company car and company house for senior o Free membership to a sport or social club.
managers. o Paid school fees for employee children.
o Paid health care insurance. o Free holiday abroad.
o Meals at work (breakfast and lunch).

(b) Other job related methods

Motivation of employees may be achieved through job satisfaction. The employees are motivated by
performing their job. Job satisfaction may be achieved in the following ways:

(i) Job rotation

Job rotation involves employees performing tasks for a short period before swapping with others. Thus, in a
normal working day, an employee can perform two or more different tasks. Job rotation had the following
advantages:
It makes work to be more varied and interesting to employees.
Employees can stand in for each other as each employee will have knowledge and experience of
various tasks in the business.
Employees become aware of the effect of their work to the work of others.
However, job rotation may have the following disadvantages:
Some employees may be better on one task that others. Such employees may not do well in other
tasks.
The process of swapping tasks may lead to production stoppages leading to loss of production time.
This involves training all employees on all tasks involved in the business.

(ii) Job enlargement

Job enlargement involves extra tasks or more varied activities to the job of an employee for the employee.
The added tasks or activities should be closely related to the skill and experience of the employee. Job
enlargement has the following advantages:
Motivation is improved as the employees have a variety of tasks to perform while doing the same job.
There is no need to move between processes saving production time.
The employees acquire additional skills that are related to the job.
However, job enlargement may have the following disadvantages:
If the added tasks are just more of the same job, the employee may feel overworked.
The added tasks may not be done properly if the employee feels that they are a burden to his duties.

(iii) Job enrichment

Job enrichment involves adding more responsibilities and challenges by adding tasks that require more
skills. Job enrichment allows employees to achieve personal growth by taking more challenging work. The
following are the advantages of job enrichment:
❖ It reduces boredom as the work is more challenging for the employee.
❖ It develops the employee’s skills and experience.

❖ Employees have chances of being promoted to a higher position.

❖ There is less supervision of employees as they have been trained for the new responsibilities.
However, job enrichment may have the following disadvantages:
❖ Employees might need additional training for the new responsibilities. This increase costs to the
business.
❖ Employees might demand a salary increment because of the new responsibilities.
❖ Some employees may find it difficult to cope with the new challenges.

(iv) Teamworking
Teamworking involves giving groups of employees responsibility for certain tasks which they do with little
or no supervision. Each team has the opportunity to decide its objectives and design ways of achieving
those objectives. This method is used most in production. Teamworking has the following advantages:
➢ Less supervision is needed as each team has the opportunity to set its targets and achieve them.
➢ It encourages planning and organisation on the part of employees.
➢ Employees become more involved in problem solving and decision making.
➢ Employees are more motivated as they have more control of their work.
However teamworking can have the following disadvantages:
➢ Employees may need training for them to be able to take responsibility of their work. This may add
costs to the business.
➢ Working in teams may create conflicts among workers if they do not share the same vision. This may
have reduces productivity.
➢ Employees might demand a salary increase if they realise that their responsibilities have increased.

Review Questions:
Metal King is public limited company that mine iron and process it into iron sheets that are sold to other
manufacturing companies. The company employees 1 300 employees. The Human Resources Manager is
concerned as many employees are leaving the company. ‘I don’t understand why motivation is poor. We
time rate and offer bonuses’.
Required
(a) What is meant by bonus? [2]
(b) Give two fringe benefits that Metal King can use to motivate its employees. [2]
(c) Explain one advantage and one disadvantage of each of the following methods of motivating employees
for Metal King.
(i) Job rotation
(ii) Job enrichment
(iii) Teamworking. [9]

ORGANISATION AND MANAGEMENT

What is an organisational structure?

An organisational structure refers to the different levels of management and responsibilities within an
organisation. Organisational structures are often shown in the form of a chart as follows.
 Organisational structure 1: Tall organisational structure

Manging Director

Marketing Production Finance

Manager Manager Manager
Chain of
command
Sales Market Qualaity
Persons Researchers Factory Supervisor Controller Bookkeeper

Factory Staff

Organisational structure 2: Flat organisational structure

Managing Director

Area Manager 1 Area Manager 2 Area Manager 3 Finance Director

Branch Manager 1 Branch Manager 2

span of control

The organisational structure shows the following:

❖ The chain of command- this refers to the different levels within the organisational structure that allows
instructions to be passed from senior management to lower level employees. In the above
organisational structure, the chain of command has three levels from the Managing Director to Branch
Managers.

❖ The span of control – this refers to the number of sub-ordinates working directly under one manager.
In the above organisational structure, there are two branch managers directly under Area Manager 2.

❖ Delegation of tasks - it shows subordinates that can be given authority by management to perform
important tasks.
What is a tall organisational structure?
Tall organisational structures have a long chain of command because there are many levels of
management.
Tall organisational structures have the following challenges:
Communication problems as information take longer to reach lower level management and employees.
There is a possibility that the information may get distorted before it reaches employees. Thus,
instructions may not be carried out as intended by senior management.
Senior managers have less control of lower level employees. Employees only interact with their
immediate managers. They only listen to instructions from their managers than from senior managers.

Employees are less motivated as their feedback is less valued. Due to the many levels of management,
issues raised by employees are not given value because it passes through many levels before it reaches
senior managers.
The business has high costs as there are many managers in the structure who are paid high salaries.
However, with a tall organisational structure;
Managers have fewer subordinates to supervise and therefore, managers are able to interact with their
subordinates.
Managers and employees are able to specialise because they have fewer responsibilities.

What is a flat organisational structure?

Flat organisational structures have a short chain of command and a wide span of control. One manger is
responsible for many sub-ordinates.
A flat organisational structure has the following challenges:
Managers have many subordinates to supervise leading to more delegation of work.
More mistakes are likely to be made by subordinates as the manager may not supervise all of them.

However, a flat organisational structure has the following benefits:

The business saves on salary costs as there are fewer managers that are paid high salaries.
Senior managers are able to get quick feedback from employees and attend issues raised by the
employee. This increases motivation.
Managers may delegate authority to employees increasing motivation of subordinates as employees
feel trusted.

Why an organisational structure is important to a business?

➢ It shows links and relationships between various departments in the business.
➢ It gives everyone in the organisation as sense of belonging as everyone is able to see their roles and
responsibilities in the organisation.
➢ Employees are able to identify the communication channel they should follow when raising issues to
senior management.
➢ Employees are able to see the manager they are accountable to in case orders are issued by people
without authority.

Review Questions
LFC owns a chain of ten sports clubs across country K. Each club has a similar structure. The Directors of LFC
believes that a good organisational structure is important for the success of the club. The directors propose
the following structure for each club.

Managing Directors

Fitness supervisor Office secretary

 Fitness trainers
Required
(a) Explain the following terms;
(i) Chain of command
(ii) Span of control [4]
(b) Identify the span of control of the fitness supervisor and the managing directors. [2]
(c) Do you think this organisational structure proposed by the directors will help the business to succeed?
Justify your answer. [6]

What are the roles and responsibilities of management?

Management involves a set of functions that help the organisation to make best use of its resources. These
functions include the following:

Which management What is involved?

function?
1. Planning Planning involves setting objectives and targets and designing ways
of achieving them. Planning is done before activities are done.
Planning gives the organisation a sense of direction and something to
work for.

2. Organising Organising involves delegating tasks to employees who will perform

them. Managers provide resources that are required by employees
for them to perform their work well. Managers use the
organisational chart to show positions, responsibilities and authority
of different people in the organisation.
3. Coordinating Coordinating involves bringing together the different departments in
the organisation so that they work towards the same goal.
Coordinating involves good communication of plans, supervising
employees and giving direction to subordinates.
4. Controlling Controlling involves measuring performance of everyone in the
organisation to make sure that the objectives are being achieved.
Usually the work of employees is compared to set standards.
5. Commanding Commanding involves giving clear instructions and guidelines to
employees so that they are aware of their tasks and responsibilities.
Commanding involves communication, guiding and motivating
employees to encourage them to work towards organisational
objectives.

What is Delegation?
Delegation means giving subordinates the authority to perform important tasks and make decisions.
The subordinates are given authority but the responsibility remains with management. That is, any decision
made by the subordinate that may have negative effect on the organisation will still be the responsibility of
management who delegated the authority. They cannot blame the subordinate.

Why is delegation important to management?

❖ Delegation allow managers to focus and spend more time on important issues such as decision making
and planning instead of performing tasks that can be done well by subordinates.
❖ As the organisation grow large, it is difficult for managers to perform all important tasks. It becomes
important for them to delegate authority to subordinates to perform management tasks.
❖ It is a way of motivating employees as they have the opportunity to perform more challenging tasks.
❖ It gives management the opportunity to monitor performance of employees who are shortlisted for
promotion.
❖ The employees may have better experience and skill in the task to be performed, so it will be good for
the manager to delegate authority to the subordinates to perform that task.

Why is delegation important to employees?

Employees get the opportunity to perform more challenging tasks. This is motivating for them.
Employees are able to learn new skills that are necessary for their future growth and development.
Delegation is an informal way of training employees for future senior positions in the organisation.
Employees will then have confidence to apply for senior positions when they arise.

Why management may not delegate authority to subordinates?

Managers fear to lose control and decision making. They feel that by delegating important tasks to
subordinates, they may not be able to monitor how work is done.
The subordinates may not have the required skills and experience to carry out those tasks and make
good decisions. They may fail to do the work as the manager expects.
Some managers are not good at explaining to subordinates the tasks and decisions they should make
and as such, they prefer to do important tasks by themselves.
Mangers may lack trust of subordinates, especially, in cases where there is a poor relationship between
the manager and subordinates.

LEADERSHIP STYLES

What is leadership?
Leadership is the ability of a manager to guide employees to achieve business objectives. Managers use
different leadership styles to achieve the goals of the organisation they are leading.

What are leadership styles?

Leadership styles are the various ways used by managers to guide their employees towards achieving
business objectives. There are three common leadership styles namely: autocratic, democratic and laissez-
faire.

1. Autocratic leadership
Autocratic leadership is where leader is the only one with authority and power to make decisions without
consulting subordinates. An autocratic leader relies on specific rules and instructions to control all
processes within the workplace. Everything rests with the leader and employees follow instructions without
questioning them. That means all creative decisions originate from the leader.

What are the advantages of Autocratic Leadership style?

(a) It allows for fast decisions to be made.
Since one person is in charge of all decisions made, there is no need to consult other workers in the
organisation. The idea brought up by the manager, becomes the final decision for everyone. This improves
the speed of decisions made.

(b) It improves overall communication.

Autocratic leaders are able to pass information quickly throughout the organization. This is possible
because there are fewer levels of management in their organisations. Information is usually given as a
command and there is no need to discuss it.

(c) It improves productivity.

Autocratic leaders are able to increase productivity in manufacturing businesses because they give orders
and instructions and expect them to be followed. Workers have fewer opportunities to try new things or to
make errors. They focus on achieving the targets set by the manager.

(d) It is good for handling crisis situations.

Autocratic leaders are able to handle a crisis situation easily because they are the ones who are in charge of
decision making. There is no need to consult subordinates. The leader will just issue commands or
instructions on the action that subordinates should take. This makes it suitable to be used in military and
government departments.

What are the disadvantages of Autocratic Leadership style?

(a) It creates a lack of trust.
Autocratic leaders believe that subordinates must be forced to do their work by using clear rules and
instructions. This type of leadership may create a lot of mistrust between the manager and employees
which may reduce productivity as workers only do their work when the manager is present.

(b) It is de-motivating to employees.

Autocratic leaders are in charge of everything and employees feel neglected. The manager makes all
decisions and takes all the praise. Employees do not have the opportunity to come up with ideas that help
to improve their work.

(c) It creates a system of over-dependence.

Workers are forced to depend on the manager for instructions and decisions. Nothing gets done if the
leader is not present. If they face problems in the work they are doing, they stop work and wait for the
leader, leading to reduced productivity.

2. Democratic leadership
Democratic leadership is where by the manager encourage subordinates to participate in decision making.
Democratic leaders are willing to accept ideas from subordinates. It creates a form of shared leadership
where each team member is invited to share their ideas, knowledge and experience.

What are the advantages of Democratic Leadership style?

(a) It is motivating to employees.
Consulting employees on important decisions makes them to feel important. This creates job satisfaction
for employees as they will work towards the ideas they helped to contribute there by increasing
productivity.
(b) It builds better trust between the manager and employees.
Employees who work with managers who use democratic methods tend to form closer relationships with
their managers. The employees feel being together with the manager, hence, everyone works harder to
make sure they produce a good result for the manager.

(c) It helps to solve complex problems.

Using democratic leadership styles, the manager get more ideas to solve complex problems from
employees. This reduces chances of making mistakes by the manager.

(d) It improves knowledge and skills of employees.

Democratic managers allow their subordinates to contribute their experience and knowledge to any given
situation in the organisation. By discussing ideas together, lower level employees are able to learn from
other employees.

What are the disadvantages of Democratic Leadership style?

(a) It takes time to make a decision.
The process of consulting employees may not be suitable where a quick decision is to be made. Thus, it
requires a very good manager to be able to make a better decision in the shortest possible time.

(b) It is demotivating if it is not handled properly.

Some leaders may choose the opinions of one person over the rest of the workers. When that occurs, the
other employees may feel like their ideas are not being valued. Over time, this may become demotivating
leading to a reduction in productivity.

(c) It can cause managers to leave important decision to employees.

Democratic leaders can also stop making important decisions and leave subordinates to make the
decisions. Employees may end up making poor decisions that negatively affect the whole organisation.

3. Laissez-faire leadership
The Laissez-Faire management style is one that is based on delegation. It involves the manager delegating
decision making to subordinates. Employees are free to make important decisions that affect the business
or productivity.

What are the advantages of Laissez Faire leadership style?

(a) It is more satisfying to individual employees.
Employees are able to decide on the work to perform and the methods to use to perform that work. This
makes employees to complete the tasks in their own time. Employees feel satisfied by the ability to use
their own skill and creativity to improve productivity and to meet target.

(b) It allows employees to test their own leadership skills.

A laissez faire manager may feel that there are experienced, capable and disciplined employees who can
perform tasks on their own. Such employees may be delegated authority to perform their work
independent from the manager’s supervision.

(c) It encourages employees to come up with new ideas.

Laissez Faire leadership can be used to encourage employees to be innovative. Each employee is offered an
opportunity to come up with their own way of solving problems. This leads to a variety of solutions to
solving the same problem.

(d) It creates more time for the leader to focus on important matters
Since most of the decision making process has been delegated to lower level employees, the manager has
enough time to make the most important decisions of the organisation.

What are the disadvantages of Laissez-Faire leadership style?

1. It reduces the importance of the manager.
There is little guidance offered to employees by the manager. The role of the manger may be seen to be
less important since employees can make important decisions for themselves.
2. It may become demotivating if it is overdone.
Managers who prefer to use the laissez faire management style are often viewed as being uninterested in
employee performance. Usually, employees expect to be supervised and praised for their performance. If
this is not done, employees become demotivated.
3. It is not suitable in emergency situations
Employees under laissez faire leadership may disregard important instructions passed by the manager. This
is because they are used to do work as they prefer. In cases of emergency it can be dangerous to use laissez
faire leadership as employees may disregard important instructions given by the leader.

Review Questions
Sasha owns a business which produces furniture. She employs 150 workers in the Production department, 15
in the Administration department and 2 security personnel. She uses a laissez-faire approach as she believed
her employees were responsible for their work. Productivity is low and she has delegated the Factory
supervisor to investigate.
Required
(a) What is delegation? [2]
(b) Give two disadvantages to Sasha for delegating work to the factory supervisor. [2]
(c) Explain one advantage and one disadvantage to Sasha of using laissez faire leadership style. [4]
(d) Do you think Sasha should change her leadership style to autocratic style? Justify your answer. [6]

RECRUITMENT AND SELECTION

What is recruitment and selection of employees?

Recruitment is a process of identifying the existence of a job vacancy and attracting suitable candidates to
fill up the vacancy. Thus, recruitment involves:
▪ identifying the existence of a job vacancy.
▪ identifying duties and responsibilities to be performed.
▪ identifying the qualifications and experience of the person required.
▪ advertising the job to attract suitable candidates.

Selection involves choosing the suitable candidate to fill up the job vacancy.
Selection involves:
• receiving curriculum vitae from various applicants.
• short-listing candidates for interviews.
• interviewing candidates.
• choosing a suitable candidate.

The recruitment process can be summarised by use of a diagram below.

 1. Vacancy arises
A job becomes vacant because someone has left the job or its a new position created.

2. Job description
Job description gives the duties, roles and responsiblities of the required person. It also show the
supervisor of that person.

3. Job (person) specification

Job specification outlines the qualifications, experience and personal qualities that the candidate
should possess. This is also known as person specification.

4. Advertising the vacancy

Advertising involves making people aware of the existence of a vacancy. Advertising can be done
internally or externally.

5. Receiving applications
The business will receive letters of application and curriculum vitae from various candidates.

6. Short-listing candidates
A short list of suitable candidates is made and invited for an interview.

7. Interviewing candidates
Interviews involves oral and written questions for candidates to prove themselves. Candidates are
tested on various skills required for the job.

8. Selecting a suitable candidate

This involves choosing the most suitable candidate to fill the vacancy. A letter is sent or a phone call
is made to inform the candidate about the job.

What are the differences between internal and external recruitment?

Internal recruitment involves filling a job vacancy using existing employees. The vacancy is advertised
within the organisation using newsletters, notice boards and word of mouth.
External recruitment involves filling a job vacancy using a person who is not currently working for the
organisation. The vacancy is advertised using local newspapers, national newspapers, recruitment agencies
and the company websites.

What are the advantages of internal recruitment?

➢ It saves time and costs since there is no need to advertise in expensive newspapers. Adverts can be
posted on the notice boards or employees may be informed by word of mouth.
➢ It is highly motivating to employees when they see their counterparts being promoted. It means the
organisation value its employees.
➢ The person recruited is already known by management, reducing chances of making mistakes when
recruiting.
➢ The person already knows the organisation, hence, there is little orientation required. Work can start
immediately.
What are the disadvantages of internal recruitment?
➢ No new ideas and experience is brought in by the person recruited. The person only knows the way
things are done in the organisation and will continue with that.
➢ It may create jealousy between competing employees in the business.
➢ The person recruited may not be respected by fellow colleagues since they are used to interacting with
them.
➢ It creates another vacancy that may need to be filled again.

What are the advantages of external recruitment?

It helps in bringing new ideas and skills that may not be available internally. This is because the new
employee may have worked for other organisations with different ways of doing the same job that can
be beneficial to the organisation.
The new person recruited has higher chances of being respected by the current employees because
they do not know the background of that person.
The organisation has a wider choice to recruit from as applications come from a wide range of
candidates.

What are the disadvantages of external recruitment?

It is expensive as the vacancy will have to be advertised in external media which is expensive. This
increases the expenses of the business.
It is time consuming as the vacancy will have to be advertised, wait for response and then interview
candidates. Some candidates offered the job may not accept the offer, leading to the process being
repeated.
The candidate selected may have to be trained first before work starts. This slows productivity.

What are part-time employees?

Part-time employees are people who are hired to work less than the normal number of working hours per
week. They work less number of hours than full-time employees. When employees work part-time, there
are advantages and disadvantages to both the employer and employee.

What are the advantages of employing part-time employees?

They become loyal to the business – part-time employees are more likely to develop loyalty to the
employer because they want to continue to be hired when work is available.
They are flexible –that is, they are only hired when the business has extra work that cannot be
completed by full- time employees. When work is not available, the business is not required to pay
them.

They save wage costs – part-time employees are paid wages that are lower than full time employees
because they work fewer hours than full time employees.
They provide more skills and experiences – part-time employees may have worked for various
organisations. They bring the experience gained from those organisations to improve productivity.

What are the disadvantages of employing part-time employees?

Part-time employees may not be available when required- some part-time employees may be holding
more than one job making them to be less committed to the business.
They may be less skilled- part-time workers may not have skills that are necessary to make them more
productive for the business.
They may miss important information- it is difficult to communicate with part-time employees if they
are not at work. They cannot attend meetings or get updates.
They can lack coordination with full-time employees - full-time employees may not cooperate with
them as they see them as their rivals.
What are the advantages of working as a part-time employee?
❖ Some part-time employees may have more than one job, earning more income than working full-time
on one job.
❖ Part-time employment offers people the ability to earn money while pursuing other interest such as
education.
❖ It gives individuals the opportunity to gain experience before being employed full-time.

What are the disadvantages of working as a part-time employee?

❖ If people work as part-time employees they are less likely to be trained as this add more costs to the
employer.
❖ They may not be hired on full-time basis because it will be cheaper for the business to continue hiring
them as part-time employees.
❖ Part-time employees are not entitled to fringe benefits such as medical insurance, pension and other
non-financial benefits provided to full-time employees.

Review Questions
Slash Active is health restaurant in a large city. The restaurant employs 6 full time employees and 2 part-
time employees recruited from the local communities as follows:
Tasks Number of full –time Number of part-time
employees employees
Preparing food and cooking 2 1
Making hot drinks 1 0
Serving tables 2 1
Cashier 1 0
The owner, Kausk, uses democratic style of leadership. He pays all members of staff the same wage of $8.00
per hour. The normal week has 35 hours and part time employees work 12 hours per week.
Required
(a) What is recruitment? [2]
(b) Identify two stages in the recruitment and selection of employees. [2]
(c) Give two differences between job description and job specification [2]
(d) Identify and explain two advantages to Splash active of employing part-time employees. [6]

TRAINING OF EMPLOYEES

Why employees are trained?

Employees are trained because of the following reasons:

1. There is introduction of new machinery and equipment.

When a company buys new machinery and equipment, there is need to train employees to make them
aware of the functions and performance of the new machines and equipment so that they operate them
correctly. Training employees before using new machines reduces damage to the machines and injuries to
employees.

2. When new process are introduced.

When the business introduces new processes of making products are introduced, it is necessary to train
employees so that they become efficient and produce goods without too many mistakes and errors.

3. To upgrade the skills of employees.

Some employees may have been hired without the necessary skills for the job they are doing. By training
them, the company is able to upgrade their skill so that they meet the level of productivity required in their
job.

4. To reduce the need to supervise employees.

Trained employees are fully aware of their duties and responsibilities. They can perform their work with
little or no supervision. Thus, the company can save on the cost of hiring supervisors.

What are the benefits of training to employees?

Training is beneficial to employees in that:
➢ Employees gain the required skills without paying for the training process.
➢ Employees may not leave their work to seek training in other places. They continue to work while being
trained.
➢ After being trained, employees are assured of continued employment. An employer cannot train
employees only to dismiss them.
➢ Employees get training that is directly related to the job they are currently doing.

Which are the types of training offered to employees?

There are three types of training offered to employees namely:
• Induction training
• On-the-job training
• Off-the-job training

1. Induction training.
Induction training is offered to a new employee who has just joined the company. Induction training
involves giving an introduction to the employee about the company activities, customs, procedures and
employees. New employees are usually taken through the various departments of the company and
provided with company policy manuals to read and familiarize themselves. Induction training takes few
hours to a week depending on the size and nature of the organisation.

What are the advantages of induction training?

▪ New employees feel loved. They are likely to stay longer in the organisation.
▪ It helps new employees to settle in the job quickly.
▪ New employees are less likely to make mistakes.
▪ Employees may not be taught wrong habits by existing employees.

What are the disadvantages of induction training?

▪ It is time consuming to train a new employee. Induction training is done by existing employees who
may have to leave their work to train new employees.
▪ An employee on induction training is paid while no work is being done. This increases expenses to the
business.
▪ It delays the employee from immediately starting work. Production will be low while the employee is
being trained.

2. On-the-job training
On the job-training involve employees learning while doing their work by observing more experienced
employees doing the same tasks. This training is normally offered to unskilled and semi-skilled employees.
What are the advantages of on-the-job training?
• Work can continue whilst new employees are being trained. This reduces delays in productivity.
• The training is directly related to the work that the new employee will be doing. This increase chances
of producing better quality work.
• Employees get the opportunity to interact and know each other while still doing their work.
• The training is less expensive as the trainer is just paid a normal salary.

What are the disadvantages of on-the-job training?

• The trainer will not be as productive as usual. More time and focus is spent trying to show the new
employee how work should be done instead of increasing output.
• If the trainer has bad habits about work, they can be passed to the new employees.
• Experienced employees may not be willing to properly train new employees as they fear to lose their
jobs in future.

3. Off-the-job training
Off-the-job training involves employees learning away from their work place. This may involve taking up a
course at a college or training institution.
What are the advantages of off-the-job training?
The employees are taught a wide of skills by more experienced trainers.
Employees are able to focus on the training without having to worry about productivity.
Employees learn new skills and technology that is not currently being used by the business. They will
transfer those skills to other employees when they re-join the organisation.
The employee has chances of being awarded a certificate that can be used in future.

What are the disadvantages of off-the-job training?

It is expensive. The business will have to employ a replacement employee while still paying the fees and
salary of the employee being trained.
There are higher chances that when employees gain more knowledge and experience they could leave
for better organisations.
The training is not specific to the organisation hence the contribution of the employee after training
may be limited.

Review Questions
Wheels of Africa a business that sells new and used trucks to various African countries. They also provide
garage services for truck repairs. The garages are operated by highly trained workforce. They have recently
expanded their operations by opening a new show room and a garage in Country Z. This requires them to
recruit 50 new employees. The new employees will need to be trained.
Required
(a) Explain the term “induction training.” [2]
(b) Identify two benefits to Wheels of Africa of having a highly skilled work force. [2]
(c) The Managing Director is considering using on-the job training for the new employees. Do you agree?
Justify your answer. [6]

What is workforce planning?

Every large business should do workforce planning. Workforce planning is the process of establishing the
skills and number of employees required by a business.
The skills and number of employees required by a business depends on sales targets, production levels,
business objectives and machines available. Workforce planning involves:
▪ finding out skills currently available in the business.
▪ checking employees that are likely to leave the organisation by retirement or resignation.
▪ consulting existing staff to check employees who are willing to voluntarily leave the company.
▪ preparing a recruitment plan showing the skills and number of employees that are to be hired.
Why should a business reduce its workforce?
Workforce planning is important when the business is planning to downsize its workforce. Downsizing
means reducing the number of employees. There are many reasons for reducing employees as follows.
❖ introduction of automation.
❖ falling demands of goods and services.
❖ closure of some of the business departments.
❖ relocation of the business to another area.
❖ the business has merged or taken over by another.

How to downsize the number of employees?

Employees can be reduced by retirement, resignation, dismissal or redundancy.
1. Retirement
Retirement refers to the period of life when one chooses to permanently leave employment because of old
age. The traditional retirement age in most countries is 60-65 years.
2. Resignation
Resignation is a voluntary way of leaving a job. This normally involves an employee writing a formal letter
of resignation to the employer indicating the intention to leave work.
3. Dismissal
Dismissal involves an employee being informed to leave work because of disciplinary issues. For example,
an employee may be dismissed for coming late to work.
4. Redundancy
Redundancy is where by employees lose their job because the employer no-longer require their services.
This may occur even if the employee was performing duties well. Redundancy may also occur when there is
no-longer enough work to be done by the available employees. The following factors may help to decide
which employees to make redundant:
➢ Some employees may volunteer to leave.
➢ Employees who joined the business later are laid off first. (last- in –first- out)
➢ Employees who are less skilled are laid off first.
➢ Employees who have disciplinary issues are laid off first.
➢ Departments may decide employees who must be kept and those that should be laid off.

Which legal controls over employment issues are available?

1. Employment contracts
When a business hires employees, they should be given the opportunity to sign an employment contract.
An employment contract is a document that specifies conditions of employment. This may include wages
or salaries to be paid, hours of work, rest days and fringe benefits. An employment contract is important
because it can be used as evidence when there is a disagreement between the employer and the
employee.

2. Legal controls over health and safety at workplaces

It is the duty of the employer to ensure that the work place is in a good health and safe working condition.
National governments pass laws to ensure that:

employees are protected from dangerous machinery and equipment.

employees should be provided with protective clothing suitable for their work.
employees must work in a clean environment free from disease and pollution.
employees should not work for longer hours without rest periods.

3. Laws against discrimination at workplaces

Discrimination means making a choice of one or more individuals against the others. When a business is
hiring employees, there shall be no discrimination between men and women, religion, cultures and people
with disabilities. This means that where a job exists, an employer shall give equal opportunities to all
qualified people without disadvantaging anyone on the basis of gender, physical ability and religion. Where
such people have the same qualifications, they should be treated equally in-terms of working conditions
and salary paid.
This means that the business should ensure that:
(a) job adverts should not discriminate.
(b) employees are hired on merit and not on any other socio-cultural advantage.
(c) the working environment carter for women and people with disabilities.

4. Legal protection against unfair dismissal

Employees must be protected from unfair dismissal from their employers. Dismissal happens when an
employee is told to leave employment due to a disciplinary issue. Employers should not have the
opportunity to dismiss employees when they like. In-order to protect employees from unfair dismissal the
following should be allowed:
▪ employees should have the opportunity to join a trade union of their choice.
▪ pregnant women should be allowed to take leave of maternity.
▪ employees should be given warning before dismissal.
▪ employees should not be paid a wage that is below minimum wage.
If there is a disagreement between the employee and the employer, they should refer their matter to a
labour tribunal which may help them to come to an agreement.

5. Legal control over minimum wages

Workers have a right to be paid for the work they have done. The wage rate should be agreed before work
is done. Wage protection also means that the employer may not deduct or reduce the wages of the
employee without the approval of the employee.

What are the advantages of the legal minimum wage?

• It guarantees low skilled employees a basic amount of money for their survival.
• It prevents employees from exploiting low skilled workers by paying them low wages. Low skilled
workers find it difficult to find employment.
• It encourages other people in society to seek employment making it possible to have a constant supply
of labour.
• It is motivating to lowly paid workers as the minimum wage is usually above they would get if the
minimum wage was not there.

What are the disadvantages of the legal minimum wage?

• It increases the business’ costs and reduces profit.
• Unemployment may rise as low skilled employees lose jobs as businesses try to cover minimum wages.
• Businesses may increase prices of products in order to cover minimum wages. This may lead to a
general rise in prices in a country. This is called inflation.
• Those workers earning above the minimum wage may demand higher wages in order to separate
themselves from employees earning a minimum wage.

What are roles of trade unions?

Employees are free to belong to a trade union of their choice. A trade union is a group of workers who join
together to protect their interests. A trade union performs the following functions:
negotiating with employers for better wages and salaries for its members.
defending employee rights and jobs.
providing legal advice and represent members when they face labour disputes.
encouraging employers to allow employees to participate in decision making concerning their work.
help governments to develop labour policies and employment laws.
Unions help to improve working conditions and health and safety in the workplace. This improves
employee motivation and reduce labour turnover.

Review Questions
Honey Moon is a luxury hotel. It has 45 rooms and it is located near six other hotels. Honey Moon has 20 full-
time employees and 40 part-time employees. Only full time employees are registered with the Catering
Employment Association. The owner, Honey Bee does not want part time employees to be members of any
employee association. When the hotel is busy, all employees work overtime. Part-time employees are paid
$4.50 per hour while full-time employees are paid $9.10 per hour. The catering industry minimum wage is $7.80
per hour. The Association wants it to be revised to $9.30 per hour.
Required
(a) What is a trade union? [2]
(b) Give two reasons why a legal minimum wage is important for Honey Moon employees? [2]
(c) Do you agree that the legal minimum wage should be increased? Justify your answer. [6]
COMMUNICATION IN BUSINESS

What is communication?
Communication is the exchange of information between two or more people.

SENDER

MESSAG
E
RECEIVER
FEEDBACK

Communication can be internal or external. Internal communication involves exchange of information

within the business. It involves exchange of information between management and employees. External
communication involves exchange of information between the business and external stakeholders such as
customers, suppliers and the general public. Communication should be effective.

What is effective communication?

Effective communication means that the information being sent is understood and acted upon by the
receiver in the way it was intended. Any communication that does not produce the intended action is not
effective communication.

How to achieve effective communication?

Effective communication can be achieved if:
• the message is sent using the correct medium of communication.
• the receiver understands the message.

• the message is sent and received by the correct person or people.

• the receiver gives feedback to the sender to confirm that they have received and understood the
message.
Thus, for effective communication to be achieved, the sender must carefully plan the message and the
medium to be used so that the intended receiver is able to understand the message and give feedback.

Why is effective communication important in a business organisation?

1. It reduces the risk of mistakes- if the employees understand the instructions being issued, they are
able to perform their tasks with little mistakes and complete them correctly.
2. It is motivating to employees- giving correct information to employees makes them feel important in a
business. This will improve their morale.
3. It enables faster decision making- receiving correct information on time will allow management to
make changes that are necessary to improve sales, react to competition or reduce losses.
4. It improves customer relations-keeping customers informed about progress of their orders or new
products that the business has added will help increase sales and customer loyalty as customer feel
valued.

What are the barriers to effective communication?

Communication barriers are factors that prevent effective communication. Barriers to communication are
found within the sender, the receiver, the message, the medium used and feedback.
Most common barriers to communication are as follows:
1. On the part of the sender
• The sender may communicate a wrong message to the receiver.
• The sender may not be the one responsible for sending the message. This makes the receiver to doubt
the importance of the message.

2. On the message
• The language used in the message may be difficult to understand for the receiver. The language used
may not be suitable type of business involved.
• The message may be too long to read or listen to. Thus, the receiver may end up missing important
parts of the message.

3. On the part of the receiver

➢ The receiver may not pay attention to the details in the message. This makes the receiver fail to
interpret the message and take the correct action.
➢ The receiver may not trust the sender and as such they will not consider the importance of the
message.

4. On the medium
❖ The message may be lost before it reaches the receiver due to the communication method used. For
example, poor network connection may make the sender and receiver fail to pass messages between
each other.
❖ The sender may use a wrong method to send the message. For example, posting a letter for an urgent
matter instead of calling.
❖ The channel may not provide the opportunity for feedback. Thus, the sender may not be able to check
if the receiver has received the message and acted upon it.

5. On the feedback
• There may be no feedback from the receiver.
• The feedback may take more time to be received.

How to overcome barriers to communication?

o The sender should make sure that the message being communicated is at the level of understanding of
the receiver.
o The sender must provide a clear channel for feedback. Feedback can be in any form, verbal, written or
just a silent action. Ask the recipients to give feedback.
o The sender should use the shortest possible method. A long medium will distort the message.
o There should be trust between the sender and the receiver for the message to be given the importance
it deserves.

Which methods of communication can be used for internal

communication?

Which What are the advantages? What are the disadvantages?

method?
1 Meetings Employees have the opportunity to Meetings are not suitable for a large
seek clarification on issues before they gathering.
act upon the message. Meeting are time consuming. It takes
time to reach a decision.
 There is immediate feedback through Some employees may fear to
interactions that happen in the participate in the presents of
meeting. management.
Meeting provide both visual and verbal Meetings delay productivity.
impact to emphasise important points.

2. E-mails • Messages are send directly to the • Employees may ignore the e-mails.
employees concerned. • E-mails require internet connection
• Other documents such as reports and which might not be available where
minutes of meetings may be attached the employees are located.
to the e-mail. • Not all employees may have e-mail
• They offer a permanent record for addresses for them to be reached.
future reference.

3. Social o Allows management to send messages o Social networking disturbs productive

networking to many employees at once. employees.
sites o Many people are interested on being o Not all employees may be logged to
(Watsapp, on these sites hence there are higher the social networking sites.
facebook chances of employees receiving the o Employees may disregard the
e.t.c) messages. importance of messages sent through
o The cost of sending the message on social network sites as they are less
social networks is low. formal.

4. Notice ▪ Notice boards offer visual impart to ▪ Employees may not visit the notice
boards message. board regularly to read the messages.
▪ Messages posted on the notice board ▪ If the notice board is overloaded,
offer a constant reminder to employees may not see a new
employees. message.
▪ Notice boards are suitable for other ▪ It is difficult for the sender to check if
methods such as memos, posters and all employees have seen the message
instructions. and understood it.

5. Internal ❖ They are suitable for updating ❖ They are not suitable for giving
reports and employees for events that have taken instructions that require urgent action.
company place. ❖ The language contained in these
magazines ❖ They offer a permanent record of documents may not be understood by
information communicated for future all employees.
reference. ❖ Reports may not allow for feedback. A
❖ They are suitable where detailed meeting to discuss the report is
information is requires such as cash required.
flow forecast, financial performance
and future vision of the business.

Which methods of communication can be used for external

communication?

Which What are the advantages? What are the disadvantages?

method?
1. Letters Letters are considered a very It takes time to send a message and
formal way of communicating and receive feedback through a letter.
it is acceptable by many
 businesses and government Letters may be ignored by the
departments. receiver.
Other documents such as invoices Letters lacks visual impact to
and quotations can be attached to emphasise the importance of the
the letter. message.
The letter gives a permanent
record for future reference.

2. Newspapers Newspapers offer a permanent A poor message in a newspaper

record for future reference. may damage the reputation of the
They are suitable when business.
advertising products or giving a It is expensive to send messages
press statement. through a newspaper.
Newspapers are read by many It is difficult to get feedback to be
people in a country so the sure that the message has been
message can quickly spread. read by the intended people.

3. Websites ✓ Websites offer visual, verbal and ✓ Websites are expensive to maintain
motion pictures which help to as a monthly fee is charged to keep
emphasise the message. the website active.
✓ While passing messages, websites ✓ People without internet connection
can also be used for advertising may not be able to access
products. information on the business
✓ Information on websites can website.
reach people in different parts of ✓ It is difficult for recipients to know
the world. that there is new information on
the business website.

4. Telephone A telephone call gives immediate Making calls to many people is

feedback as people talk to each expensive.
other. Calls are not always recorded,
It is suitable where immediate hence, it is difficult to maintain a
action is required from the permanent record of the
receiver. conversation.
Calling someone emphasises the Telephone calls are not suitable for
importance of the message being public information such as notifying
communicated. customers of opening and closing
hours.

5. Posters ➢ Posters are good for attracting ➢ Posters can be ignored by the
attention hence they can be used intended recipients making them to
together with notice boards. be less effective.
➢ Posters are an effective way of ➢ There is no way readers can seek
advertising products and giving clarification about information
instructions to the public within a displayed on a poster.
small community. ➢ It is difficult for the sender to get
➢ Posters provide a permanent feedback to ensure that people
reference. They can only be have read and understood the
removed if the communication information on the poster.
expires.
 Review Questions
FBC is a commercial bank. It has 50 branches and 800 employees across country X. The Managing Director, Mr
Chingwena, wants to improve internal communication by introducing new technology into its branches. He says,
“customers complain about slow service. Memos never reach me, documents are everywhere and many part-time
employees complain, they don’t know what is happening”.
Required
(a) What is internal communication? [2]
(b) Give two barriers to effective communication in FBC. [2]
(c) Identify and explain why improving internal communication is important for FBC. [4]
(d) Identify and explain two methods that can be used to communicate with customers to reduce complaints. [6]

MARKETING

What is the role of marketing?

Marketing is the process of identifying customer needs and wants and finding ways to satisfy them. Thus,
marketing performs the following functions.
a. Identifying customer needs-this involves finding customer interest and preferences.
b. Satisfying customer needs- this involves developing a product (good or service) to meet the
needs and wants of customers at the correct price.
c. Maintaining customer loyalty-finding different ways that will encourage customers to buy the
product many times.
d. Building customer relationships – this involves giving customers good experiences as they buy
the product. This may involve training customer on use of the product, free repairs and
seeking feedback from customers on the performance of the product.
e. Anticipating chances in consumer tastes – this involves identifying new trends and gaps in the
market and designing products that satisfy those new trends.

Why consumer spending patterns may change?

The market does not remain the same. Some markets such as the market for mobile phones change rapidly.
There are many factors that make consumer spending patterns to change. Some of them are:

Which factors? What causes the change?

1. Changes in incomes As disposable incomes rise, people will demand goods and services they
could not afford previously. If unemployment is rising in an economy,
people demand less goods and services. They focus on survival.
2. Technological New technology has makes it possible for businesses to develop products
changes that were previously not possible to make. Thus, people shift to new
products in order to improve their lives.
3. Changes in prices Price influence demand. As prices rise, customers demand few goods. They
focus more on basic items such as food. A lower price makes it possible for
customers to buy more.
4. Changes in style, Demand for other products depends on the development of new styles,
fashion and tastes. designs and tastes. This very common in the clothing industry.
5. Seasonal factors The demand for certain products depends on the time of the year. For
instance warm clothes are demanded in winter.
Why some markets have become more competitive?
More often, there are many businesses trying to sell to the same customers. This makes a market to be
highly competitive. Competition means two or more businesses produce or sell similar products to the
same customers. Markets become competitive because of the following factors:

(a) Globalisation
Globalisation means people and businesses have been exposed to international markets. This has allowed
more choices to be available for consumers even beyond national boundaries. People can buy products
they want from other countries.

(b) Availability of good communication networks

Mobile phones and internet have made it possible for businesses to sell goods anywhere in the world. This
has increased competition for local businesses and provided consumers with more choices. The internet
has also provided consumers with more information to understand products before they buy them.

(c) Availability of efficient transport links

Efficient transport links between towns and countries have allowed consumers to travel for shopping in
other area and transport their goods at low cost. This has encouraged many individuals to set up small
businesses to compete with large businesses.

(d) Rapid changes in consumer tastes and preferences

As the living standards of consumers increase, they seek high quality products. These can be obtained
abroad at affordable prices. New businesses have been set up to provide goods and services that were not
available some years ago.

(e) Change in government policies.

Governments may introduce policies that encourage more business to be formed in order to boost
economic growth. As more businesses are formed, competition for customers increases.

Is competition good for consumers?

Competition is health for every economy because of the following factors:

1. It increases choices available to consumers.

That is, consumers will not have to rely on one supplier for their needs. They will compare products before
they buy.

2. Competition reduces prices.

When many businesses offer the same goods to the same market, consumers will have the power to
bargain for lower prices. The seller is forced to reduce prices to attract more customers.

3. It encourages innovation.
Businesses are forced to look for better ways of satisfying consumers at cheaper prices.

4. It encourages businesses to provide more information to consumers.

As businesses try to encourage consumers to buy their products, they end up providing more information
about a product. This helps consumers to make informed decisions before they buy products.
5. It forces businesses to be socially and environmentally responsible.
Businesses are forced to research and develop products that do not harm the environment and
communities.

How can businesses respond to changing consumer spending patterns

and increased competition?
Competition is a battle for survival and market control. Businesses must adopt the following approaches to
remain competitive:

(a) Being innovative

This involves finding new ways of satisfying customers. Businesses can develop new products or provide
more services to maintain customer loyalty.

(b) Increasing market research

Market research gives the business better knowledge about customers. By gaining more information about
the market ahead of competitors, a business is able to provide goods and services that satisfy customers
ahead of its competitors.

(c) Branding
Branding helps to differentiate the business’ products from its competitors. This allows the business to
advertise and charge high prices for its products to earn more profit than competitors. Branding also help
the business to identify its market segment and increase market share.

(d) Using latest technology

Using latest technology ensures that the high quality products produced and offered to customers. Latest
technology allows the business to produce products at a low cost, making it possible to sell at low prices
than competitors.

(e) Finding new markets for existing products

Increasing competition may force a business to look for more markets. This can be done by opening
branches in other areas or upgrading the existing product so that it can appeal to a new market segment.
New market allows the business to spread risk and increase market share.

(f) Using cheaper sources of finance

If the business is able to find cheaper sources of capital, it can produce and sell goods at low prices than
competitors. This is important in a market where price competition is high. A business that is able to reduce
its costs has an advantage over its competitors.

Review Questions
Trainer Sport is a public limited company that makes athletics shoes for Olympic athletes. The Marketing Director
has been looking at some data for the past two years. The market share for TS has been dropping.

Data for 2018 Data for 2019

 Market Share (%)

Trainer
Sport
30% R-Sport
50%

CBD
20%
Required
(a) What is ‘customer loyalty’? [2]
(b) Outline two roles of marketing. [2]
(c) Give two reasons why the athletics shoe market has become competitive. [2]
(d) Identify and explain two ways that the Marketing Director could use to increase market share for their
product. [6]

What are mass marketing and niche marketing?

Mass marketing involves selling the same product to the whole market. In mass marketing, the product is
designed to appeal to customers with different preferences. Niche marketing involves selling a product to a
small specialised market. Niche markets are made up of customers who prefer specialised and exclusive
products such as sports cars, designer suits and exclusive holiday resorts.

Niche
market, 20%

Mass
market,
80%

What are the benefits of mass marketing?

➢ Mass marketing creates opportunities for business expansion. This is possible because the product is
designed to appeal to different customers.
➢ The business can benefit from marketing economies of scale. That is, selling to a larger market reduce
the cost of advertising and distributing the product.
➢ The business is likely to increase sales revenue and profit due to increased repeat purchases.
➢ The business can reduce the risk of losing customers by offering different variations of the same
product.

What are the limitations of mass marketing?

➢ Mass marketing increases competition for the business. By trying to appeal to the entire market, a
business will end up competing with every business on the market.
➢ The business produces and sells standardised products which may not fully satisfy all customers.
➢ Mass marketing is very expensive. It can lead to a business making losses.
What are the benefits of niche marketing?
Competition is low due to the small size and specialised nature of the product offered.
Advertising costs are lower because customers are more concerned with quality than availability.
Customers are willing to pay a higher price for the product. This increases the profit made by the
business.
Niche markets allow new businesses to concentrate on a small market that was not satisfied by large
firms in the market.

What are the limitations of niche marketing?

The risk of losing sales is high since the market is small and specialised. If a better competitor joins the
market the business can lose all its customers.
Success in the niche market can attract bigger businesses to join that market, increasing competition.
Often businesses in a niche market specialise in one product. If the product is no longer in demand, the
business may fail because its product cannot appeal to other market segments.
Opportunities for sales growth are limited since the product appeal to a small specialised market.

Why market segmentation is undertaken?

Market segmentation is the process of dividing the market into small sub-groups called segments.
Segmentation is done by grouping together customers with similar characteristics. The following chart
shows segments in a car market.

luxury cars
Car Market
sports cars
15%
10%

pick up trucks
25%

family cars
50%

From the different segments, a business will then chose the customers it wants to serve. This is called a
target market. So, a target market is a group of customers that a business chooses to offer its product.

What are the potential benefits of segmentation to business?

Segmenting a market will have the following benefits to a business:
 The business has a high chance of satisfying its customers thereby improving sales and profit.
 It reduces marketing costs- marketing effort such as advertising and distribution is directed toward a
specific market instead of the entire market.
 The business is able to develop new products to better satisfy the market identified. This reduces
competition.
 Gaps in the market can be easily identified. The business is able to identify needs that are not currently
met by existing products.
How markets can be segmented?
There are many factors that businesses may use to segment the market. The following table shows some of
them.
Which factors can What it involves?
be used to segment
the market?
1. Income As income rises, people prefer high quality products and services.
Thus, products are designed and priced differently for low income
and high income earners.
2. Age As people grow old, their tastes and preferences change. Young
people prefer to spend on fashionable clothes, games and
entertainment. Older people are more concerned with saving and
building wealth.
3. Gender Men and women have different preferences and buying habits.
Women buy more frequently than men. Women seek opinions of
friends before buying. Thus, business can design products that
appeal differently to men and women.
4. Geographical location The place where people are located is important. People in urban
areas have more income than people in rural areas. Customers in
warm areas demand less blankets than customers in cold
environments.
5. Lifestyle This involves segmenting the market basing on personality, style,
beliefs and social classes. Lifestyle attaches value to products.
Businesses can charge high prices on products that are seen as
having high status.

Review Questions
Wyne is a qualified teacher. He has been unemployed for two years after college. He wants to set up a home
tutoring business. There are three private schools in his suburb. His target market is school drop-outs who
want to complete their IGCSE. This will be a niche market to his business. He is hoping to maintain customer
loyalty.
Required
(a) What is niche market? [2]
(b) Identify two factors that can consider when segmenting the market. [2]
(c) Identify and explain two benefits to Wyne of targeting a niche market. [6]

MARKET RESEARCH
Market research is the process of finding information about customers and products they prefer.
Businesses cause use both primary and secondary researches to find data about from its customers.

What is primary research?

Primary research involves collecting data directly from the market. Primary research methods include observations,
interviews and science experiments.

What are the advantages of collecting data through primary

research?
Primary research provides more information that a researcher would not gather through secondary research
methods.
 Data collected through primary research is raw data. Thus, a business is able to make a better decision based on
that data.
Data collected through primary research is based on the specific needs of the business. This increases chances of
satisfying consumer needs and wants.

What are the disadvantages of collecting data through primary

research?
Primary research is time consuming both in collecting and analyzing data.
Primary research is costly to conduct as it involves hiring people and travelling to conduct the research. Most
businesses do primary research only when secondary research could not answer their questions.

Which are the methods of doing primary market research?

There are several methods of doing market research. The following table lists some of them:

Method of Explanation Advantages Disadvantages

research
This involves looking at an The results obtained give It takes time to collect data as
1 Observation activity many times and confidence as they reflect the observations should be done
recording it e.g cars passing actual activities happening on many times to give accurate
through a place. Observation the market. results.
is an example of field
research.
An interview involves asking Questions are planned in Takes time where many
2 Interview questions to the target advance. people are to be interviewed
market about the product or Recording of answers is easy. individually.
preferences.
A questionnaire is a written More data can be collected. A long questionnaire is boring
set of questions given to People can answer at their to answer.
3 Questionnaire number of people. A own time and return the Respondents may not answer
questionnaire is an example questionnaires. all questions.
of personal interview. Field staff is not required. Some questionnaires may not
It is less expensive. be returned.

What is secondary research?

Secondary research or desk research is a research method that involves using already existing data. It
involves gathering data from researches done by others. Secondary research is less expensive than primary
research, as it makes use of already existing data.

What are the advantages of collecting data through secondary

research?
Most information in secondary research is readily available. There are many sources from which
relevant data can be collected and used.
Secondary research is a less expensive. Data can be collected as employees perform their normal duties
at work.
The data collection process is less time-consuming as data required is easily available.
The data that is collected through secondary research, gives businesses an idea about the information
that a business can collect during primary research.

What are the disadvantages of collecting data through secondary

research?
Data collected through secondary research may not be according to the specific requirement of the
business. Information provided may be general to the economic environment but not specific to the
business and its products.
Although data is readily available, there is need to check credibility of the data before a decision is arrived
at, based on that data.
The data obtained may not be up to date. Not all secondary data resources offer the latest data.

Which sources of information for secondary research are available?

Method of Explanation Advantages Disadvantages

research
Data available One of the most Data is readily available on the However, businesses need to
1 on the popular ways of internet and can be downloaded at consider only authentic and
internet. collecting secondary the click of a button. trusted website to collect
data is using the This data is free of cost or one may information.
internet. have to pay a small amount to It may take time to identify a
download the data. website with information that the
Websites have a lot of information business requires.
that businesses can use to suit their
research needs.

Government Data for secondary Data obtained from these agencies is There is a certain cost applicable
2 and non- research can also be authentic and trustworthy. to download or use data available
government collected from some These agencies provided up to date with these agencies.
agencies. government and non- information about countries and The data obtained may not be
government agencies their economic performance. specific to the business.
e.g tax office,
government statistics
office, the WTO.

Publications Local newspapers, These commercial information The data obtained may not be
and journals, magazines, sources provide first hand, up to specific to the business.
3 information radio and TV stations date information on economic Commercial agencies charge a
channels. are a great source to developments, products and new fee to provide relevant data to
obtain data for market researches. the business. This increases the
secondary research. Businesses can request to obtain cost of the research.
data that is relevant to their industry
or customers.

What is sampling during market research?

Market research is an expensive process and it is also time consuming. In order to reduce costs and time,
researchers use sampling.
A sample is a small group of people selected to represent the larger population during market research.
The sample should have the same characteristics as the population being researched. For instance, a
researcher cannot give all potential customers to complete a questionnaire or to try a new product. A small
group is selected to represent all potential customers.

Why is sampling important?

Sampling during market research assist researchers in the following ways:
It saves research costs - It is very expensive and impractical to issue questionnaires or to interview
everyone involved in the market research process.
It saves time- the research should be completed within a reasonable time so that the findings can be
used by the business. Trying to involve everyone in a research may take a long time.
 It makes analysis of data easier – having a sample reduces the amount of data that should be recorded
and analysed, reducing chances of error from researchers.

Which sampling methods are used during market research?

The following methods are normally used during sampling:

Method Explanation
1. Random Random sampling involves picking people without using any particular
sampling method (at random). Every person has an equal chance of being
selected for the research.
Random sampling is important because it reduces bias on the part of the
researcher.
2. Quota sampling This involves choosing people according to certain characteristics. For
example, the sample can be made up of people of the same age, gender
or income. This approach is necessary when the research is interested in
a specific group of people in the research. It means the researcher will
not waste time and money collecting data from people who are not
relevant for that research.

Which methods of data presentation can be used during a market

research?
Data collected through market research is raw data. This data should be processed for it to be useful to
users. After the data has been processed, it is presented to users using any of the following methods.

Methods of data presentation Advantages Disadvantages

1 Tables Tables are good for organising data Too much data on the table
A table shows data presented in before presenting using charts and becomes complex to understand.
rows and columns. graphs.
Tables are not exciting to study,
Tables allow users to compare multiple hence, users can ignore the data.
data as the rows and columns can be
extended.

2 Bar charts The main disadvantage is that it is

A bar chart shows data according to Offer a visual impact as users can difficult to determine fractions on
height of bars. The most frequent quickly notice data with the highest bar. a bar chart.
data has the tallest bar.
It is less complicated for users with Even though bar charts can show
limited knowledge in data analysis. trends, it is difficult to use them
to predict future trend like line
Comparison of data can be done by graphs are able to do.
placing bars side by side.
 3 Pie charts Pie charts have good visual impact as It is hard to compare two sets of
A pie chart shows data presented in the size of each sector shows size of data with each other.
sectors of a circle. The size of each each data presented.
sector represents the percentage of Too many sectors make the pie
the data presented. Pie charts can be coloured to make chart to be less effective.
them to be interesting to users.
A pie chart cannot show trends
Pie charts can be used with people so it is not useful for data that
limited knowledge of data presentation. show changes over time.

4 Line graphs It is useful in showing trend over a Line graphs are not visually
A line is drawn joining points plotted period of time. interesting like other graphs.
on a paper. Two or more lines can be plotted on the
same paper to help compare them. For
instance, a business can use line graphs
to show sales of each product over
time.
Line graphs can be useful in predicting
future trend and any missing
information.

Review Questions
Brown Delight produces chocolate bars that are sold to retail shops across country S. During the period 2016
to 2019, the business collected the following sales data for its three best-selling. The average sales figures and
market share for each chocolate are provided in the table below.
Sales and market share
Chocolate name Sales Market share
$’000 (%)
Nutcake 2 000 10%
Brown milk 5 000 60%
Brown diamond 3 000 30%
The data was part of primary research about consumer preference of Brown Delight’s chocolates.
Required
(a) What is primary research? [2]
(b) Give two advantages of using secondary research when conducting market research. [2]
(c) Using data in the table, use the following methods of data presentation:
(i) a bar chart for sales
(ii)a pie chart for market share [6]

THE MARKETING MIX

THE marketing mix refers to all activities involved in marketing a product. The activities are often called the
4 Ps of marketing namely:
❖ Product
❖ Price
❖ Place
❖ promotion

1. THE PRODUCT
What is a product?
Product refers to anything offered by business to satisfy consumer needs and wants. Products can be in the
form of goods or services. Goods are classified into consumer goods and capital goods.
Consumer goods are products used by consumers on a day to day basis. Consumer goods that are used for
a long period of time are known as durable goods such as cars, radios and furniture. Consumer goods that
are perishable (used up quickly) are known as non-durable goods. Examples include food, clothing, soaps
and cosmetics.
Capital goods are products that mainly used in the production of other goods. They include machines,
equipment and raw materials used in the production of other products.
Services refer to intangible products. Services are classified as personal services and commercial services.
Personal services are offered directly to consumers. They include health care, banking, education and
catering.
Commercial services are offered to businesses involved in producing goods or services. They include
banking, communication, transport, insurance, security, transport and marketing research.

What are benefits of developing a new product?

The following are some benefits derived from developing a new product:

❖ The business will have a Unique Selling Point (USP). That is, the business will have a product with
unique features that differentiate it from competitor products. Thus, customers are able to recognise
the new product.
❖ To stay ahead of completion. A business may not continue to offer the same product. At some point, it
must be creative and develop a new product to stay ahead of it.
❖ New or improved products have high chances of satisfying the needs and wants of consumers giving
the business a competitive advantage and an increased market share.
❖ New products allow the business to diversify its products. This means that a business will now have a
wide range of products to sell, reducing the risk of failure if demand falls, especially, where it sells only
one product.
❖ New products allow the business to expand into new markets that were not previously served by
existing products. This allows the business to extend its influence and increase market share.
❖ It maintains customer loyalty. There are customers who are willing to continue buying the business’
products for as long as the business continues to improve its products.
❖ New products may boost the sales of existing product if it becomes successful on the market.
Customers will begin to associate the success of the new product to all products in the business.

What are costs of developing a new product?

The following are the costs of developing a new product:
➢ Financial costs are incurred in market research. The process of collecting data, analysing and testing it
usually involve a lot of money that smaller businesses may not have. Some businesses sub-contract this
process to specialist researchers who charge a lot of money.

➢ Productive time is reduced. Before a product is fully put on the market, some designs and testing will
have to be carried out. The process is repeated several times before a final product is sold. This process
takes away productive time that can be used for improving sales of the existing products.
➢ Loss of sales of existing products. The new product may end up competing with existing products of the
same company. This may result in overall sales revenue declining as only the new one is demanded on
the market.
➢ Marketing costs may rise. Launching a new product requires active advertising for customers to aware
of its existence. This may reduce the potential profits to be earned from the new product.

Why is branding a product important?

Branding is the process of creating a unique image about a product in the minds of consumers.
• The product will have a brand name that will help to identify it and separate it from other products on
the market.
• A successful brand makes consumers to remember it when they go for shopping. This increases
company sales.
• A brand name can be emphasised during advertising by using other features such as the logo, designs,
packaging and brand image.
• A good brand enables the business to build and maintain brand loyalty. Consumers become associated
with that brand and they may want to continue buying the same brand in their life time.
• Branding enables businesses to enter global markets. Branded products are usually associated with
high status, hence, a high price can be charged for them.

Why is packaging a product important?

Packaging is the physical container or wrapping for a product. Packaging is important for the following
reasons:
1. To protect the product. Packaging gives protection to the product so that it does not get damaged
before it is used by consumers.
2. To allow handling and transporting. Some products are difficult to handle and transport when
they are a not packaged.
3. Provide information about the product. Information about use, performance and disposal of
products are normally printed on the packaging.
4. Branding. Packaging is used for promoting a product by including brand name, brand image, colours
and many other features associated with the brand.
5. Extending the product life cycle. A product reaching its decline stage can be extended by using
a new packaging without changing the contents of the product itself. This has an effect of customer
seeing it as a new product.

What are the challenges faced when packaging products?

1. Packages are costly.
They increase the cost of selling the product to customers. The price of the product may have to be
increased to cover for the additional cost of packaging it.
2. Packages are harmful to the environment.
After using the product, it may be difficult to dispose the packaging without damaging the environment.
3. Some products may require more than one form of packaging.
This makes the product to be heavy and expensive to transport, especially, in cases where the product is
sold in international markets.

Review Questions
Choc Home produces chocolate bars that are sold to supermarkets across country S. Its bestselling brand of
chocolate is ChocDelight. It is put in expensive wrappers of aluminium foil and packaged in small glittering
boxes and transported in large card board boxes. The sales of the ChocDelight are at their highest level. The
business has been fined by the Environmental Management Authority for causing littering.
 Required
(a) What is branding? [2]
(b) Give two advantages of branding a product. [2]
(c) Identify and explain two disadvantages to Choc Home of packaging a product. [6]

What is a Product Life Cycle (PLC)?

The product life cycle describes the various stages that a product passes through from its introduction until
the business stop selling it. The Product Life Cycle measures the sales of a product over time. The product
life cycle can be presented in the form of a graph as follows:

The Product Life Cycle

Sales 4.Maturity 5.Extension

2.Growth
4.Decline

1.Introduction

Time

Stage of What is involved? What are the pricing strategies

the PLC to use?
1 Introduction The product is put to the market. Sales are Price skimming can be used where by
or launch generally low due to lack of knowledge customers pay a very high price at
about the product. Lots of advertising to launch where competitors are few.
create awareness is required. Profit is very Penetration pricing can be used where
low or nil due to high costs of launch such as low prices are charged in-order to
advertising. attract customers.

2 Growth The business starts to enjoy economies of Promotional pricing is used where the
scale. Sales and profits are gradually rising. business lowers the price for short
Prices are being influenced by competitors. period in order to attract customers.
A lot of promotion is implemented. New Competitive pricing can also be used
businesses enter the market attracted by the in which the price is set at the same
success of the product. level as competitor prices.

3 Maturity At maturity, the product is well established. Prices are based on competitors. The
Sales are no longer rising significantly. business can use psychological pricing
The product is widely available. The business in which prices are set slightly below
concentrates on maintaining market share competitor prices.
and customer loyalty. There is product
modification and improvement.
Promotion is aimed at reminding customers
about the product.
 4 Decline The market becomes saturated. Sales are Prices are lowered to maintain
declining. Customers are now switching to customers.
competitor products. The business looks for Cost based pricing is also used to
cheaper production methods in-order to determine the break-even point.
maintain profits. Prices are lowered. Promotional pricing is used to boost
Decision on whether to maintain the product sales in the short-run while waiting to
or stop it will have to be made. make a decision.

Which product extension strategies can be used?

Marketing decisions at each stage of the product life cycle is based on the following factors:
➢ Marketing objectives.
➢ Changes in customer preferences.
➢ Reaction of competitors.
As the product reaches its decline stage, businesses try to find ways in which they can boost sales and the
profitable life of a product. The following approaches could be used:
▪ Selling the products to new markets that were not previously served by the business.
▪ Using a new advertising campaign that creates a new image for the product.
▪ Introducing new, improved versions of the product.
▪ Changing the packaging.
▪ Selling the product through additional channels of distribution such as online retailing and us of agents.
A successful product extension strategy starts well before the decline stage.

Review Questions
MHC makes a wide range of electrical products including cameras and phones. It operates in a competitive
market with many phone and camera producers. All its products are sold under the same brand name. The
Marketing Director has suggested that one model of its cameras, Fotoshoot, has reached its decline stage as
its sales are below normal. The Managing Director thinks that Footshoot can still sell.
Required
(a) What is the product life cycle? [2]
(b) Identify and explain one advantage and one disadvantage to MHC of developing a new product. [4]
(c) Explain two extension strategies that MHC could use to increase sales of Fotoshoot. Which extension
strategy would you recommend? Justify your answer. [6]

2. PRICE

Which pricing methods can a business use?

Price refers to the monetary value attached to a product. The pricing decision is mainly based on; cost of
production, competition and the level of demand on the market.
The following pricing methods are normally used:

1. Cost plus pricing

Cost based pricing is used when the objective is to recover cost of production. In this case, a business adds
a percentage profit to cost to arrive at the selling price.
The advantage of this pricing method is that it is easy to calculate selling prices and profit. Businesses are
able to lower prices during promotions without going below cost.
However, cost plus pricing does not consider the price at which customers are willing to buy the product.
Also, it does not take into account prices being charged by competitors for the same product.

2. Competitive pricing
Competitive pricing is used in a market where competition is very high. The market has many businesses
selling the same product to the same customers. Customers have many choices. The objective is to
discourage competitors from entering the market by setting prices at the same level as competitors or

slightly below them. This pricing method may result in price wars in markets that have large businesses that
are highly competitive. That is, any attempt to lower prices will cause competitors to lower their prices
much more leading to cycles of price fights. Competitive pricing may not be profitable to most businesses.

3. Penetration pricing
This involves entering a new market at a lower price to attract customers, including those customers from
competitors. This strategy is suitable for new businesses or when launching a new product. The business
can gradually increase prices as it gains market share.
However, penetration pricing may not be profitable enough for the business as it may fail to recover costs.
It may take too long for the business to become profitable.

4. Price skimming
Price skimming is when a very high price is set when launching a new product on the market. Price
skimming is used for products that are seen as of high quality. This strategy is suitable where a new product
has been produced and the objective is to recover research and development costs before competitors
start to produce it. Price skimming is successful if competition is low.
However, price skimming may lead to high prices that may not be afforded by many customers leading to
low sales revenue. Price skimming cannot be used for a long period as a strategy because competition will
rise and sales will drop.

5. Psychological pricing
Psychological pricing is based on the customers’ perception about the product. Marketers recognise that
customers link prices to product quality and value. A high price may suggest a high quality or high
performance product. Thus, high income earners may purchase the product as a status symbol.
Psychological pricing may also involve charging a price just below a whole number, ($0.99 instead of $1.00),
giving an impression that the product is cheap.
However, psychological pricing may lead to small loss in sales revenue due to the small reduction in price.
Competitors may use the same strategy making this pricing strategy less effective.

6. Promotional pricing
Promotional pricing involves charging a lower price for a product for short period of time. The objective is
to increase sales and market share by attracting new customers. Businesses may also use ‘buy one get one
for free’ strategy in which customers get two or more products after paying for one. This method is suitable
as a product extension strategy and also to increase sales of slow moving inventory.
However, profit is sacrificed in-order to boost sales. Competitors may also use the same strategy to retain
their customers. This promotional pricing is suitable for customers that look for bargains, usually, low
income earners.

7. Dynamic pricing
Dynamic pricing involves selling the same product to different groups of customers at different prices. It is
possible to charge the customers different prices because they have different preferences and they are also
price sensitive. For instance, passengers are charged different air fares in the same flight by classifying
different parts of the airplane.
Dynamic pricing has the following advantages:
increased sales revenue as prices can be adjusted according to demand.
increased market share as the business is able to satisfy different groups of customers using the same
product.
encourages demand by creating different social classes among customers.
What is price elasticity of demand?
Price elasticity measures the change in demand for a product when prices change. A product has a price
elastic demand if a small increase or decrease in price may lead to a very high change in demand.
Therefore, if the demand for a product is price elastic, it is not a good idea to raise the price. This is because
customers may quickly switch to competitor products.

What is price inelastic demand?

Demand is less responsive to increase or decrease in prices. A rise in prices has a small effect on the
quantities demanded. Thus, even if a business may lose a few customers, overall revenue will rise. A
reduction in prices is less likely to attract any new buyers. As such, this may lead to a drop in sales revenue.
Knowing about price elasticity will assist business to select a suitable pricing method for their products.

Review Questions
GPS produces a wide range of sports based computer games. It is in a competitive market. The Marketing
Manager has been looking at the information of two products.
Game C is in maturity stage of the product life cycle. It is sold in most sports shops. Demand is believed
to be price elastic.
Game D is about to be released. It has been very expensive to develop. It includes latest graphics.
Demand is expected to be high. It will be sold in a few exclusive sports shops.
Required
(a) Explain the term ‘price inelastic demand’? [2]
(b) Suggest two pricing strategies that can be used at maturity to boost sales of Game C. [2]
(c) Which pricing method could GPS use to launch Game D? Justify your answer. [6]

3. PLACE

What is place?
Place refers to the various methods of making the product available to consumers. If the product is not
available where consumers can buy it, they may give up looking for it. This may reduce the sales and profit
of the business. A business can use different distribution channels to make their products available to
consumers.
A distribution channel is a method or route by which a product is passed from the producer to the
consumer. There are four common distribution channels as follows:

Channel 1
Producer Consumer

The producer sells directly to the consumer. There is no intermediary in this channel. This is done through
the use of factory shops, sales agents and e-commerce.
Advantages
• This method is suitable for specialised goods such as machinery, cars and houses.
• The method is used for personal services since services depend on the good relationship between the
customer and the service provider.
• It is the quickest method to sell perishable goods such as fruits and vegetables. They can reach
customers whilst still fresh.
• The producer receives direct feedback from consumers.
• The producer enjoys increase sales revenue as there are fewer distribution costs involved in this
method.
Disadvantages
o Access to the market may be difficult where the producer is selling to an international market.
o The cost of transporting goods to individual customer may be higher than when goods are distributed
in bulk.
o The market may not be large enough to give the business enough sales revenue.

Channel 2
Producer Retailer Consumer

Goods are sold to customers through retail shops. Retailers act as intermediaries by buying from producers
and selling to consumers.
Advantages
• Sales volume increase as retailers buy in bulk.
• Retailers may advertise the products on behalf of the producer.
• The producer saves distribution costs such as transport and storage.
• Any losses from expired goods are bone by the retailer.
Disadvantages
o The producer may offer trade and cash discounts to the retailer which reduces the revenue earned.
o The producer may not get enough feedback from consumers.
o Large retailers may end up controlling the producer in order to monopolize the distribution of goods.

Channel 3
Producer Wholesale Retailer Consumer
rr
This channel involves two intermediaries: wholesaler and retailer.
Advantages
• The wholesaler breaks bulk. That is, the wholesaler buys goods in large quantities, repackage them and
sell the goods in small quantities to retailers. This saves the producer from processing too many small
orders.
• The wholesaler provides additional storage space for the producer. Wholesales have large warehouses
that can store large quantities of inventory.
• The producer saves costs in handling, transporting and storage of goods as these are functions
performed by wholesalers and retailers.
• The wholesaler is the one who suffers the risk of loss from damages and unsold inventory.
• The wholesaler can offer credit terms to retailers, helping the producer to sell goods much quicker.
Disadvantages
o The producer loses some profit as there are many intermediaries before goods reach customers. Any
attempt to increase prices may be resisted by wholesalers.
o The producer may not get enough feedback from consumers. Important information may be lost
between the retailer and wholesaler.
o Wholesalers demand huge trade discounts and credit terms. This may leave the producers facing
financial problems.
o This channel is not suitable for perishable products as they may reach consumer after they are expired.

Channel 4
Producer Agent Wholesale Retailer Consumer
rr
An agent is another intermediary that can be used by producers. Agents do not buy goods for resale but
they arrange sales on behalf of the producer. Agents receive a commission for their services.
Advantages
• Agents are suitable where the producer sells to international markets. In this case, the producer has
little knowledge about the local market it is serving.
• Agents perform marketing and distribution on behalf of the producer. This reduces the costs of
employing a marketing specialist.
• Agents may offer specialist services such as repairs and training on behalf of the producer. This further
increase customer satisfaction and increase sales.

Disadvantages
o The producer has less control in the way the product is distributed as the agent has more information
of the local market than the producer.
o The final price charged for the product will be higher due to the commission paid to the agent. This may
make the product to be more expensive for customers.

Review Questions
D & D manufactures sports balls and sportswear. The products are sold throughout the whole world
using agents in different countries. D & D thinks that they can increase market share if they sell through
other channels.
Required
(a) What is meant by direct distribution? [2]
(b) Identify and explain one advantage and one disadvantage of two other channels that D & D could
use for its sports products. [8]

4. PROMOTION

WHAT IS PROMOTION?
Promotion is a marketing strategy done to inform customers about the product, price and place to buy it.
Promotion aims at the following:
❖ informing customers about the product.
❖ reminding customers about the product.
❖ encouraging the customers to buy the product by showing the benefits of the product to them.
❖ increasing customer loyalty and brand awareness.
❖ increasing sales and market share.

Promotion involves two main activities namely advertising and sales promotion.

1. Advertising
Advertising is done to inform or persuade customer to buy the product.
Informative advertising provides factual information about the product such as instruction on use.
Persuasive advertising provides information aimed at influencing customers to try the product or switch
from competitor products. This may lead to increase in sales.

Where to advertise products?

Advertising can use both electronic and print media.

Method of Advantages Disadvantages

advertising
 Print media
1. Newspapers ➢ Local newspapers are relatively cheap ➢ Newspaper adverts are not attractive.
and are suitable for small businesses. They do not attract the same attention
➢ Local newspapers have a higher chance as electronic media.
of reaching the target market since they ➢ Too much detail may make customers
are distributed in the same locality. ignore the advert.
➢ Newspapers give a permanent record ➢ They should be coloured to attract
that customers can refer to in future. attention.
➢ National newspapers can reach a wide ➢ Customers may be distracted form
range of customers. seeing the advert by other things such
➢ More details such as instructions may be as news.
included.

2. Leaflets and ➢ They are suitable for small to medium ➢ Leaflets may be wasted as not
brochures. businesses. everyone who receives them will read.
➢ They can be physically distributed to ➢ Leaflets placed in letter boxes may just
individual customer in that area. be thrown away.
➢ Leaflets are generally cheap to produce
than advertising in newspapers.
3. Posters and ➢ They are usually large to attract ➢ Billboards are expensive to install.
billboards attention from a distant. ➢ If billboards and posters stay for too
➢ They are permanent. They continue to long, they will no-longer attract
emphasise the message. attention.
➢ They are suitable for local events hence ➢ They contain fewer details.
they can be placed in the area in which ➢ People are not able to seek clarity
the event is taking place. because they will be passing.

Electronic media

4. Television ➢ It combines both sound and moving ➢ Producing and broadcasting adverts on
pictures. This helps to reinforce the television is quite expensive.
message. ➢ The messages are too short, hence,
➢ Adverts can be targeted to different they may not give a complete message.
audiences depending on the ➢ Viewers may be annoyed by the advert
programmes on offer. especially when they are watching
➢ Adverts can be repeated many times to their favourite programmes.
reinforce the message.
5. Radio ➢ It is cheaper than a TV advert. ➢ Visual messages cannot be broadcast.
➢ The message can be heard by a wider ➢ Listeners may not pay attention to
audience, especially, in rural areas radio adverts. They may take that
where there are no TVs. opportunity to do other things such as
➢ Adverts can be aired according to discussing the previous programme.
programmes.
6. Internet ➢ A large amount of detail can be placed ➢ Customers may not view the website
on the company website. unless they are looking for that site.
➢ It is suitable for both local and ➢ Pop ups and other websites are seen as
international markets. a scam, hence, people may not take
➢ Pop ups can be used at different them seriously.
websites, increasing chances of users ➢ It is expensive to maintain a website
seeing the advert. due to monthly data charges paid to
the service provider.

2. Sales promotion
Sales promotions are incentives offered to the customers to encourage them to buy the product. Sales
promotions are aimed at increasing sales for short period of time. Sales promotion can be done as support
to adverting. The following are the different methods of sales promotion.

Method How it influences sales?

1. Price reductions This involves giving customers discounts or additional products (buy one get one free).
Customers may also be issued with coupons or reward cards so that on their next
purchases they may benefit from a discount.
Businesses may also reduce prices during certain times in the day, month or year (e.g
Black Fridays)
2. Competitions Businesses may include entry tickets to a competition on the packaging promising to
reward customers who buy in large quantities or many times.
3. Free samples Free samples of the product may be given to customer to try in the shop or at home
hoping that the customer will like the product and buy. This method is suitable where
a new product is being introduced or an existing product has been improved.

4. After-sales- Businesses can make a follow up on products sold to customers with the aim of
service assisting customer to use them or repairing them when they are not working properly.
This is suitable for capital goods and other specialist products. This approach gives
confidence to customers.
5. Point of sale Products are displayed close to the point where customers pay for them. This highlight
displays the product as it becomes more distinct. This may encourage impulse buying.
6. Loyalty cards Retails shops issue customers with cards that are used to earn points each time
customers make a purchase. After some time, customers are able to exchange their
points for certain goods in the shop.

Other methods of promoting a product.

Method How it influences sales?

1. Personal selling A sales person or agent is employed to influence sales by visiting customers and
explaining to them about the product features and performance. This is suitable for
financial products and most expensive goods.
2. Sponsorships The business can donate money to support a social event or a social club. During the
event, the business will have the opportunity to showcase its products by attracting
attention through things such as T-shirts, banners and hats.
3 Publicity This involves the business building its image by having positive stories published in
different media about the business and its products. The use of trade shows is also
under publicity.
4. Celebrity Well known people in society such as film actors, sports personnel may be used to
endorsements boost product image. People who like the celebrity may end up buying the product

What factors to consider when choosing a promotion method?

1. Marketing budget- the business should first check if it has enough money to pay for the promotional
method desired.
2. The objective of promoting the product- advertising is suitable for long period of time while sales
promotion is for a short time.
3. The type of product- specialist products may require personal selling while clothes may require sales
promotions.
4. Stage in the product life cycle- a product at introduction may require a lots of promotion while at
maturity, branding can be used.
Why is the marketing budget important in promoting a product?
The activities of marketing products cost time and money. Businesses prepare a plan in advance known as a
marketing budget. The marketing budget refers to money set aside by a business to promote its products.

The marketing budget outlines the following:

• Objectives of the marketing department.
• Marketing research costs.
• Salaries of marketing personnel.
• Advertising and selling costs.
Spending on marketing activities should be cost-effective. The business must compare the cost of
advertising to the expected increase in sales. The business should spend only minimum amount necessary
to achieve the intended objectives. If a business does not have a good budget, it may not reach certain
customers.

Review Questions
Able Bakery (AB) makes arrange of oven products including cakes and bread. The products are sold in a
variety of shops and supermarkets across country J. The Marketing Director wants to increase sales. She
cannot decide on the best method of promotion to use.
Required
Explain how each of the following three methods of promotion could help AB increase its sales.
• Free samples
• Display shops
• Discounts
Which method do you think AB should use? Justify your answer. [12]

How can technology assist in marketing a product?

New technology is now part of the marketing mix. Many businesses have found new opportunities in using
technology for marketing their goods and services. This requires frequent changes to the elements of the
marketing mix as follows:

Marketing item Explanation

Products Technology has created new needs and wants such as internet data subscription.
Many products now have a shorter product life cycle. Products are now being
manufactured using robots and 3D technology.
Place Direct selling become more common as people prefer to shop from the comfort of
their homes. International competition has increased due to online shops. Shops are
now ‘open’ for 24hrs 7days a week.
Price Businesses are able to use dynamic pricing in which they charge different prices to
same customers. Prices are now based on customer preferences and competitors.
Customers now enjoy price discounts due to the availability of multiple suppliers.
Promotion Website and pop ups are now replacing the traditional window shopping.
Customers now have more information about a product that before. Social
networking sites such as Facebook, Instagram, Youtube have become active market
places.

What is e-commerce?
E-commerce is the process of buying and selling goods through the internet. Businesses think much about
how to attract attention of consumers at their website and achieve a sale. E-commerce is done mainly
through websites and social networking sites.

What are the opportunities of e-commerce to businesses?

❖ Lower fixed costs- businesses no-longer rent physical buildings in order to display goods. They only pay
for monthly data charges and sell through online platforms.
❖ Increased market share- businesses are able to reach customers located in other countries without
having physical shops there.
❖ Reduced sales and marketing costs- instead of employing people to do personal selling, businesses cut
costs by using interactive platforms on their website to assist customers to buy.
What are the threats of e-commerce to businesses?
Increased global competition-customers have many choices to buy from and as such, they can choose
any supplier from any other country.
Cost of maintain websites may be high -business needs to keep their website operating to achieve
effective sells and to be trusted by customers.
Higher distribution costs - goods sold online become expensive to post or transport them to the
customers.
Limited feedback from customers- there is no face to face contact with customers which can provide
useful feedback.

What are the opportunities of e-commerce to customers?

➢ More choices- due to the rise in online shops, consumers are presented with unlimited choices.
➢ Low prices- consumers are able to search for the best price to buy a product. This has allowed them to
save income for other activities.
➢ Convenience in purchasing goods- customers can place orders at any time even during the night and
still get assistance.
➢ No need to hold cash- most online shop accept debit cards and bank transfers making it easier for
customers to pay without holding cash.

What are the threats of e-commerce to customers?

Increase in fraud and theft as customers suffer from hacking and false websites. As a result they lose
money to unidentified suppliers.
Products cannot be seen or tested before purchase thus making it difficult to return unwanted or
damaged products.
Many customers in developing world do not have reliable internet connection. Thus, transactions may
be disrupted in the process.

What is a marketing strategy?

A marketing strategy is a plan of action that a business takes to achieve its marketing objectives. A good
marketing strategy should be able to combine all the four elements of the marketing mix.

What are the marketing objectives that determine a business

strategy?
A business may have the following objectives in order to develop its marketing strategy:
• To increase sales of the existing product by selling to new markets.
• To reach other parts of the existing market.
• To increase sales by improving an existing product.
• To increase market share by targeting competitors.
• To increase market share through niche marketing.
• To maintaining market share where competition is increasing.

Failure to develop a good marketing strategy may lead to failure to achieve the desired objectives as:
➢ products which meet customer needs are priced very highly.
➢ products that meet the needs of consumers are not well known by potential customer.
➢ customers know about the product but they cannot find where to buy it.

How legal controls affect marketing strategy?

Countries put legal controls to protect consumers from misleading promotion, faulty, harmful and
dangerous goods. Consumers need protection from businesses that take advantage of consumers’ lack of
technical knowledge about products. Consumer protection laws are aimed at protecting consumers from
businesses that:
❖ Supply goods and services that are unsafe or unfit for their purpose.
❖ Supply goods that are below standard.
❖ Give false written or verbal information about a product e.g claiming that a pair of shoes is made of
leather when it is made of plastic.
❖ Carryout offensive or insulting advertisements.
❖ Sell underweight products.
❖ That sell products with hidden costs without explaining this to customers.

Why businesses do not adhere to laws?

➢ Business managers believe that following laws is costly. The business’ products may become more
expensive to customers making them to be less competitive.
➢ Business owners are more interested in profit than the welfare of consumers.

What are the effects to a business of violating legal controls?

o Production may have to be stopped leading to the need to redesign product to meet the required
standard.
o Countries may impose fines to business that violet law leading to high costs and low profit.
o The reputation of the business is damaged leading to reduced sales and business closures.
o Increased customer complaints that may lead to replacements or refunds to customers.

What opportunities are available when selling to international

markets?
A number of businesses prefer to sell their products in a number of countries. This is because of the
following opportunities:
1. Increased market share- markets in other countries are expanding rapidly due to rising population
and incomes. Businesses prefer to sell to countries that offer potential for growth and profitability.
2. To spread risks- businesses may not want to rely on one market for all its sales. If the home market
becomes saturated with competition, sales revenue may drop.
3. Reduced trade restrictions- many countries have removed trade restrictions that protected
domestic businesses. This has allowed foreign companies to enter such markets.
4. To extend product life cycles- products that are reaching their decline stages may be re-launched
in new markets abroad, improving sales.
5. Lower operating costs – some countries have lower costs of advertising, distribution and
production.

What are the challenges of entering international markets?

1. Lack of knowledge-the business may lack proper understanding of buying patterns of local
customers and their preferences.
2. Cultural differences- different countries have unique cultures that if the businesses fail to
understand them, it reduce chances of success. Some products have been rejected in certain countries
because they undermined the cultures of those countries.
3. Legal restrictions- countries have laws that sometimes make it impossible for foreign businesses to
operate freely. This makes foreign businesses to have a disadvantage when competing with local
companies.
4. Exchange rate risk- the differences between the value of the local currency and that from an
international country may cause a loss to a business selling abroad.

What should business do to overcome problems of entering foreign

markets?
1. Form joint ventures – the business can join with another business operating in the foreign country.
This has the potential to give the foreign business access to existing customers, information and
distribution channels. However, the businesses will have to share profit which is not always easy. They
may also differ in their objectives and cultures.
2. Use agents- agents have export knowledge about foreign markets. They can advertise, sell and
distribute products on behalf of the business. However, agents require payment in the form of
commission on each sale they make. They may also fail to give back money from sales to the business.
3. Enter into mergers or takeovers- the foreign business may merge with a supplier or customer
already operating in that country or takeover a competing business. This will allow it to have customers
already existing. There are trained local employees who have knowledge of the local market. Takeovers
may be resisted by both employees and laws of the country. Management and cultural differences may
reduce the success of the business.
4. Use franchising – this involve allowing businesses in the international market to sell products using
its licence, logos and brand name. This is a cheap way of achieving brand recognition. The business will
have less control over products being sold. Any substandard products sold under the brand name will
affect other shops.
 Review Questions
K Kosmetics manufactures make-up for women. The company sells its products across Europe but wants
to start selling to African countries. The Marketing Director says ‘there are a lot of opportunities in these
markets and also several problems. We are reaching saturation in Europe and we need new markets’.
Required
(a) What is meant by ‘reaching saturation in Europe’? [2]
(b) Suggest two methods that can be used by Kosmetics to overcome problems of entering new
markets. [2]
(c) Identify and explain two problems for K Kosmetics of entering new markets abroad. [6]

OPERATIONS MANAGEMENT

PRODUCTION OF GOODS AND SERVICES

What is production?
Production is the process of making goods and providing services to satisfy consumer needs and wants.
In manufacturing businesses, production involves adding value as raw materials are converted to finished
goods.

What is the difference between production and productivity?

Production involves converting inputs to outputs. The inputs are land, labour, capital and enterprise. These
are called economic resources or factors of production.
Productivity measures the efficiency of a business by comparing output to inputs. Thus, productive may
mean;
• using fewer inputs to produce same output or,
• using same inputs to produce greater output.
Thus, as the employees become more efficient, output per worker rise leading to a decrease in cost of
production.
How can businesses manage resources effectively to produce goods
and services efficiently?
The aim of every business is to combine factors of production in such a way that it produces the highest
output using few resources possible.
Productivity can be improved by:
❖ Improving the layout of processes and machines in-order to reduce time taken to perform tasks by
moving between processes.
❖ Improving labour efficiency by training employees so that they acquire better production technique.
❖ Introducing automation.
❖ Motivating employees because a motivated workforce is more likely to work harder to achieve
production targets.
❖ Improve quality control so that wastage of raw materials and finished products are reduced.
❖ Improve inventory management by using good quality materials that reduces waste and the need to
redo work.
❖ Rewarding workers for activities that improve efficiency such as saving on raw materials used.
❖ Improving the working environment by using better lighting, good ventilation and less pollution.
❖ Adopting lean production methods and efficient inventory management techniques.

What are the benefits of increasing efficiency in production?

Increasing efficiency and productivity helps the business to:
▪ increase output and revenue.
▪ reduce the cost of production making it possible for the business to charge low prices in times of high
competition.
▪ reduce workers needed for each process, leading to decrease in labour costs and improved profits.

Why do businesses hold inventories?

Inventories can take various forms including raw materials, semi-finished goods, finished goods and
components. Holding inventories may help the business in the following ways.

(a) To avoid loss of sales due to stock-outs.

If a business runs out of inventory, loyal customers may end up switching to other suppliers. It may become
difficult to regain such customers.
(b) To reduce costs of re-ordering materials.
Re-ordering costs may be in the form of transporting goods, preparing orders and the waiting time
between placing an order and receiving it. The costs are high for businesses that import goods.
(c) To reduce production delays
Stock out may lead to production stoppages. These stoppages may lead to the business failing to meet
customer order and create a bad reputation for the business.
(d) To enjoy purchasing economies of scale
If the business buy inventory in bulk, it may benefit from quantity discounts. This reduces the overall cost of
production and increase profitability.

What are the problems of holding inventories?

➢ There is an increase in inventory holding costs such as the need to build warehouses and pay security
guards to avoid theft.
➢ Inventory can rot or become out-dated while in the warehouses.
➢ Holding inventory will tie up cash that may be used for other purposes. This reduces the liquidity of the
business.
➢ Semi-finished goods may lose value while still waiting to be completed.

Review Questions
TXW makes car parts which are sold to international car manufacturers. The Production Manager has been
looking at productivity data. The data for 2015 and 2016 is shown in the table below. All employees work 40
hours per week.

Year Output per week (units) Number of employees per week

2015 23 000 200
2016 27 000 250
Required
(a) Explain the term ‘productivity’. [2]
(b) Give two factors that increase productivity. [2]
(c) Calculate output per employee for 2015 and 2016. [4]
(d) Identify and explain two reasons for the change in productivity between 2015 and 2016. [6]

LEAN PRODUCTION METHODS

What is lean production?

Lean production refers to techniques used by businesses to reduce waste in-order to increase efficiency
during production.
Lean production removes any activities that do not add value to the final goods produced. It also reduces
time it takes for product to be developed and made available to customers. This allows products to be
made faster and cheaper.
Under lean production the focus is on:
▪ making continuous improvement in production process.
▪ speeding processes by preventing employees from moving between processes.
▪ reducing waste.
▪ improving quality of work at all stages.

There are several types of waste that occur during the production process. Some of them are:

1. Over-production- this involves producing goods without finding customers for them. This may lead
to high storage costs and damage of goods stored in warehouses.
2. Transporting goods unnecessarily – goods are normally damaged during transportation to
warehouses.
3. Defects- faulty goods require goods to be repaired or redone before they are delivered to customers.

Which are the methods used under lean production?

1. Kaizen
Kaizen is a Japanese principle that means continuous improvement by eliminating waste. The
improvements come from ideas of employees instead of investing in new technology.
The belief is that workers have better knowledge of the production process. Small groups of workers
regularly meet to discuss problems and provide solutions.
Waste is reduced by changing layouts so that workers will not have unnecessary movements.
What are the advantages of using the Kaizen approach in production?
➢ Reduced wastage of raw materials.
➢ Good time management during production thereby saving on wage costs.
➢ Reduced space needed to produce goods.
➢ Fewer employees are required as jobs can be combined. This reduces wage costs and increase
profitability.
➢ Improved employee motivation through teamwork and greater involvement in decision making.

2. Just-in-time inventory control (just-in-time production)

Just-in-time is a stockless production approach in which materials and components are only supplied when
required. The business does not hold inventory. Production focuses more on eliminating the need to hold
inventory of raw materials, components and finished goods. JIT benefit the business in the following ways:
Costs of holding inventory are reduced. The business will not spend money on building warehouses and
providing security to safeguard inventory.
Storage space could be rented out to generate more revenue for the business.
Cash is freed for other purposes instead of being held in inventory, thereby, improving the liquidity of
the businesses.
Products are only made after a customer is identified. This ensures an increase in sales revenue.

3. Cell production (teamworking)

Cell production means that the production line is divided into separate self-contained cells each making an
identifiable part of the finished product.
This approach improves motivation of employees as they work towards completing an identifiable unit.
The employees feel more valued and belonging to the team in the cell.
Employees have the opportunity to improve their production process.

Which methods of production can businesses use?

1. Job production
Job production involves making a product according to the customer’s specifications. The customer places
an order with details of the preferences to be made on the product. The job is unique to the customer.
Examples products produced using job production include suits, wedding dresses, houses or jewellery.

What are the advantages of job production?

• There are higher chances of satisfying customers as the job is done according to the customers’
specifications.
• Businesses are able to charge a higher price as the product is unique. This increases revenue earned by
the business.
• Employees are more motivated to do work since there is variation of work done.
• Losses are minimised since products are made for customers already identified.

What are the disadvantages of job production?

• Skilled labour is required. This increases wage costs, thereby, reducing overall profit.
• Mistakes on production are costly as the work may have to be redone.
• Excess material, components and other tools bought for one job may not be suitable for use for
another job.
• There are many stoppages and production delays as employees shift production from one job to
another.

2. Batch production
This involves producing a limited number of identical products in a block or batch. Batches allow for
variation in products due to colour, size or quantities. Bread, cakes, shirts medicines can be produced in
batches.

What are the advantages of batch production?

It gives businesses flexibility to change production while still achieving economies of scale more than
job production.
A problem with one batch can be easily traced and corrected.
It is a good way of adding variety to the goods produced, giving customers a choice on identical items.
Workers’ tasks are more varied than in flow production. This reduces their boredom.

What are the disadvantages of batch production?

Resetting machines to produce a new batch may be time consuming and it delays production targets.
Careful planning is needed in shifting between batches. Poor planning may lead to batches being
mixed.
Having batches means more costs of holding stocks for both raw materials and finished goods.
Batch production is more costly than flow production due to the different raw materials required to
produce different batches.

3. Flow production
Flow production involves making large quantities of identical products using a continuous process. It is also
called mass production. Large numbers of identical units are produced on a production line. Examples of
products produced through flow production include drinks, cars and food.

What are the advantages of flow production?

❖ Goods are produced quickly and cheaply. The business enjoys economies of scale due to the high
number of units produced and quantity of raw materials purchased.
❖ Automated production lines reduce the wage costs.
❖ The business is able to charge lower prices and be able to compete due to lower cost of production.
❖ Repeated tasks involved make employees to specialise in their work improving efficiency.

What are the disadvantages of flow production?

❖ The cost of production equipment is usually high as the business always looks to achieve efficient
production methods.
❖ Workers may become bored by repeating the same work.
❖ Storage and inventory holding costs are high due to the bulk purchases of raw materials and storage for
finished products.
❖ Machine breakdowns may stop the whole production line.

Factor to consider when selecting a production method

1. The nature of the product
Products that are produced according to the customers’ requirements are produced as jobs. This is because
such products are unique and they are required to meet certain conditions for them to successfully satisfy
the customers. Flow production may be used where variation of products is not important.
2. The size of market
If the market is very large, mass production may be required to meet demand. Thus, flow production or
batch becomes suitable. The business may not undertake individual jobs.
3. The size of the business
Small businesses are usually labour intensive because they do not have enough capital to buy machines and
tools needed for flow production. Thus, they rely more on job production or batch production. Large
businesses can automate their processes and they can use flow production.

Review Questions
Carlos produces luxury leather hand bags for female celebrities around the world. Most of the work is done by
hand. Carlos has two skilled workers and 12 assistant employees. The demand for hand bags is rising due to the
coming fashion festival. In order to meet demand, Carlos is planning to use batch production using automated
robots.
Required
(a) What is batch production? [2]
(b) What is just in time inventory management? [2]
(c) Give two advantages of using job production in the production of hand bags. [2]
(d) Do you agree that Carlos could use automated robots to produce his product? Justify your answer. [6]

How technology has changed production methods?

Technological advancements have allowed businesses to improve production methods. Many production
processes are now being controlled by computers. Production has been improved by:
1. Computer aided design (CAD)
Computer aided design involves products that are designed and tested by computers before actual
production takes places. This reduces wastages during testing and retesting of products.
2. Automation
Automation involves robots and machines programmed to perform tasks continuously. This has reduced
human errors and fatigue in production.

What are the advantages of technology in production?

❖ Productivity increases as new technology improves efficiency. It now takes less time to perform the
same task as before.
❖ Technology has enabled businesses to produce products that meet changing consumer tastes. As such,
businesses are able to quickly adjust their production methods to meet changing consumer needs.
❖ Better quality products are produced due to better production methods and better quality control
provided by computerised systems. Products are tested by computers before they are put to mass
production.
❖ Businesses have saved on labour costs. Fewer people are employed as machines do most of the work.

What are the disadvantages of technology in production?

❖ It is expensive to invest in new computers and robots. Small businesses with less capital are not able to
enjoy economies of scale brought about by new technology.
❖ Employees may become demotivated by introduction of technology as this may result in them
becoming redundant. This may further reduce the productivity of labour.
❖ New technology may quickly become redundant in businesses where products are constantly changing.
Technology bought for current products may not be suitable in the production of the next product.
❖ There is need to hire specialist who can program and repair the machines. This increases costs of
production and reduce overall profitability.

COSTS, SCALE OF PRODUCTION AND BREAK-EVEN ANALYSIS

What are costs of production?

Businesses incur costs as they produce goods and provide services. These costs are classified into fixed
costs and variable costs.

(a) Fixed costs

Fixed costs are costs that do not change as the productivity increases or decreases. These costs are based
on time. Examples of fixed costs are rent of factory and salaries.

(b) Variable costs

Variable costs are costs that change when productivity increases or decreases. When output increases,
variable costs, also, rises. Examples of variable costs are wages and raw materials.

(c) Total costs

Total costs are costs made up of both variable and fixed costs.

(d) Average costs per unit (unit cost)

An average cost is the cost of producing one item.
Average costs per unit (unit cost) = Total costs
Number of units

Illustration
Big Ball Ltd produced the following cost data for May 2019:

Units 10 000 units 20 000 units

Fixed costs $15 000 $15 000
Variable costs $20 000 $40 000
Total costs $35 000 $55 000
Their product is sold at P5.00 per unit.
Required
(a) Calculate the average cost per unit at (i) 10000units and (ii) 20000 units.
(b) Draw a break-even chart for May 2019.
(c) Using the BEP chart in (b) above, determine the total cost of producing 17 500 units.

Method
Average costs per unit (unit cost) = Total costs
Number of units
(i) $35 000/10000 = $3.50 per unit
(ii) $55 000/ 20000= $2.75 per unit
(iii) graph paper required here.

What is the Break-even point?

The BEP is a point in which a business is neither making a profit nor a loss. At this point, total costs are
equal to total revenue.
Total revenue – Total costs = 0.
Any production or output above the BEP will result in profit and any output below the BEP will result in a
loss.
How to calculate the BEP?
The BEP can be calculated using an equation as follows:

BEP in units = Total Fixed costs

(selling price per unit – variable costs per unit)
= X units

Sales at BEP = Units at BEP × Selling Price per unit

Review Questions
AFC makes a wide range of animal feed. The Operations Manager produced the following data from the
previous month

Product A Product B
Fixed costs per month $60 000 $45 000
Variable costs per kilo $4 $3
Selling price per kilo $6 $6
Planned sales for next month (kilo) 80 000 30 000

Required
(a) Calculate the BEP output for the two products. [4]
(b) Calculate the profit to be made next month if AFC sells all the 30 000 units planned for product B. [4]
(c) Draw the break –even chart for AFC for product A. [6]

Why is breakeven analysis important to a business?

The breakeven analysis is a very important planning tool in production. It assists managers in the following
ways:
 It shows the expected level of profit at different levels of production (output).
 It shows the units that a business must sell for it to be safe from making losses. This is called margin of
safety.
 It helps in making short-run decisions such as whether to make or buy a product or whether to reduce
prices to increase sales.
 It also shows the effect of changes in prices and costs to the overall profitability of the business.

What are the limitations of the BEP?

➢ The BEP assumes that all units produced will be sold to cover costs. At times units produced may not be
sold as planned leading to building up of inventories. This further increases cost of production and
reduce profit.
➢ Fixed costs may not continue to remain constant. At some point as production continues to rise, fixed
cost may increase due to the need for additional factories, machines and supervisors.
➢ The BEP principle ignores other factors that affect revenue and costs such as advertising, competition
and trade discounts. These make costs and revenue not to behave in a straight line.

Why is cost information important to a business?

1. Cost information is important in pricing products. Selling prices should be set at a level that allows the
business to cover its costs in-order to make profit.
2. Businesses are able to make a decision on whether to stop production or not. If the cost of production
rises, a business may stop production in order to avoid further losses.
3. Deciding on the location of the factory. Businesses set up factories in areas where fixed costs such as
rent are low. This ensures that profit is maximised.

What are economies of scale?

Economies of scale are cost advantages enjoyed by a business when it produces more. As the scale of
production increases, average cost per unit decreases. The following are some economies of scale that a
business enjoys:
1. Purchasing economies
These are decrease in costs arising from buying raw materials and components in bulk. The businesses
get trade discounts from suppliers which reduce the cost of production. This allows businesses to
charge low prices and become more competitive.
2. Marketing economies
These are decrease in costs arising from selling and advertising goods in large quantities. Businesses are
able to create their own channels of distribution that are cheaper than using other businesses. For
multinational companies, advertising can be done by the head office for all branches across the globe.
3. Technical economies
These are benefits that arise due to employing highly skilled workers and buying automated machines.
Large businesses are able to buy machines which reduce wastages and decrease the cost of production
per unit. Small firms cannot afford buy machines that improve efficiency, hence, they do not benefit
from technical economies of scale.
4. Managerial economies
These are benefits that a business enjoys by employing specialist managers to oversee various
departments in the firm. Skilled managers help to increase efficiency and help to reduce costs.
5. Financial economies
These are benefits enjoyed by a business when raising capital to use for production. Large firms are
able to raise capital cheaply than small businesses because they are trusted by banks. A lower rate of
interest is charged to large businesses because they apply are less risky. This further reduces their
operating costs making their products to be competitive.
What are diseconomies of scale?
Diseconomies of scale are factors that lead to an increase in the average cost as the business grows large.
The business becomes less efficient and loses some cost advantages. Some diseconomies of scale are:
1. Poor communication
As the business becomes large, sending and receiving messages becomes difficult. Workers may receive
inaccurate information due to the many levels of hierarchy involved. It may take time to correct such
information and by the time action is taken, damage may have been done.
2. Slow decision making
There is no direct contact between senior management and lower level employees. Decisions regarding
workers may take time to be implemented. Management may also take time to obtain feedback from
lower level employees resulting in conflicts and loss of production time.
3. Demotivation of employees
Automation may lead to employees performing repetitive work. This becomes boring to employees as
their individual effort may not be recognised.

Review Questions
 Brown Cake is a large bakery that makes bread, biscuits and cakes using batch production. The Operations
Director says, ‘I have been told of that lean production techniques in the bakery would help to increase profit’.
Brown Cake has 45 employees who are always looking for ways to improve how things are done. The business
is also looking at ways of achieving economies of scale in its production.
Required
(a) What is meant by ‘lean production’? [2]
(b) Identify and explain two lean production methods that Brown Cake can implement to improve profit.
[4]
(c) Identify and explain two economies of scale that might benefit Brown Cake.[6]

ACHIEVING QUALITY IN PRODUCTION

What is quality?
Quality means producing a product that is suitable for its purpose. Improving quality of products ensures
that customers are satisfied and sales increase. Producing quality products reduces cost of production as
material used are also of high quality. They are not easily wasted away.

What are the benefits of producing quality products?

The following are the benefits of improving quality:
➢ Quality products create a good reputation for the business. Customers trust quality products as they
always satisfy their needs and wants.
➢ Quality products can be associated with successful branding. Advertising the brand becomes easy as
customers become loyal to the brand and share positive experiences about the product.
➢ Selling quality products increase sales revenue. Quality products are normally sold at a higher price
than competitor products. This ensures that the business earn additional revenue.
➢ The business is assured of long term profitability. Businesses which produce quality products always
look for ways to improve their products. In so doing, they ensure loyal and new customers continue to
buy from them.

What are the costs of failing to maintain quality products?

A business that fails to invest in quality or maintain quality products may suffer from the following:
Loss of market share to competitors as current and potential customers will resist buying the firm’s
products choosing competitor products.
The business will suffer bad reputation. Customers will spread negative information about the product
leading to bad reputation and loss of sales.
Increase in costs due to the need to redo or replace products returned by customers.
Increased advertising expenditure is done in-order to try and improve damaged brand image.
The value of the business as a whole may decrease as customers, investors and employees leave the
business.
What are the ways of achieving quality in production?
Quality is achieved by implementing any of the following techniques below.

METHODS OF ACHIEVING QUALITY

Total Quality Management

Quality assurance

Quality control

1. Quality control
Quality control is the process of checking for quality of goods and services at the end of the production
process. The idea is to stop faulty and defective products from being sold to consumers.

What are the advantages of quality control?

• It is less time consuming as the inspection process is done at the end of the production process.
• It tries to eliminate faults before they reach consumers. This ensures that negative publicity about the
product or the business is avoided.
• Less training of quality inspectors is required, saving costs of production.

What are the disadvantages of quality control?

• Inspection is done at regular intervals. Some faulty products can skip the inspection process and still
reach consumers.
• It is expensive in that faulty products are only identified after completion. It means the product may
have to be re-done or replaced after fully produced.
• Quality control does not identify the reason for faulty and defective products. The faults are only
discovered when the product is completed.

2. Quality assurance
This involves checking for quality at each stage of the production process. The aim of quality assurance is to
achieve quality at every stage of the production process from designing, purchasing materials, delivery to
customers and after sales services.

What are the advantages of quality assurance?

❖ Quality assurance makes sure that there is greater satisfaction to customers when goods are sold by
eliminating defects and errors.
❖ Costs of repeating the process or replacing the products are reduced thereby improving profitability.
❖ There are fewer customer complains.
❖ There is improved motivation of employees as they work to achieve set quality standards at their work
stations.

What are the disadvantages of quality assurance?

❖ It is expensive to train all employees to have skills to monitor quality.
❖ It depends on the ability of employees available to stick to the quality standards set. Some employees
may not fully inspect their processes, leading to products passing without fully inspected.
❖ Checking quality at every level may be time consuming and it requires a lot of workers to do that. This
may increase wage costs.

3. Total quality management(TQM)

Total quality management is an approach designed to achieve quality assurance. Total quality management
aims to achieve zero defects through continuous improvement. This approach was adopted after realising
that, even with quality assurance, some products could still reach customers with defects. Under TQM,
quality is maintained throughout the whole business. Every department in the business should work
towards eliminating faults and defects. This includes non-production departments such as finance,
administration and marketing.

What are the advantages of Total Quality Management?

❖ Quality becomes the overall focus of the whole business, thereby, increasing chances of satisfying
customers.
❖ TQM ensures that errors and defects are eliminated before products are delivered to customers.
❖ Customer complaints are reduced as products delivered to customers always meet the required
standard.
❖ TQM reduces costs of replacing products.

What are the Disadvantages of Total Quality Management?

❖ It is expensive to train and implement as periodic inspections of departments must be done to ensure
quality is achieved.
❖ It involves having employees with a quality management culture. Thus, training is required for all
employees.
❖ Employees may not focus on quality if they are paid according to number of units produced.

Review Questions
Kemo owns a successful restaurant in the city centre. He employs 8 chefs and 16 kitchen assistants. Customers
expect Kemo to provide quality service. Kemo believes that total quality is the best way to improve annual profit
of $30 000 and remain competitive. In the same city centre, there is a Café with a well-known brand.
Required
(a) What is ‘total quality management’? [2]
(b) Identify two difficulties that Kemo may face when introducing Total Quality Management at his
restaurant? [2]
(c) Explain how the following factors may help Kemo to achieve total quality.
(i) Employees working for Kemo.
(ii) Ingredients used in the restaurant [6]
LOCATION OF BUSINESSES

Which are factors to consider when choosing the location of a

manufacturing business?
The following table gives factors affecting location of manufacturing industries.

Factor Explanation
1 Availability of raw Businesses that deal with bulky or heavy raw material may locate closer to
materials sources of raw materials to reduce transport costs. This also applies to
businesses that use perishable raw materials which should be processed
quickly while they are still fresh.
2 Availability of labour Manufacturing businesses that are labour intensive locate their factories in
areas where wage costs are low or where there is high unemployment.
3 Availability of good Transport is important for both the supply of raw materials and the
transport networks distribution of goods to retailers. For businesses that supply fresh, perishable
products, they should have good access to transport to take those products to
the final consumer before they perish.
4 Close to market If finished goods are bulky or expensive to transport to the market, being
close to the market will help reduce transport costs.
5 Availability of energy Most manufacturing firms require energy and water to operate machines and
and water sources purify products. They need reliable sources of energy and water for
production to take place. Being close to sources of energy and water saves
production costs making products to be competitive on the market.
6. Government influence Some government offer subsidies and grant to businesses willing to set up
manufacturing businesses in certain areas. The government can allow such
businesses to operate for some years without paying tax.

What are the factors affecting the location of service sector

businesses?
The following table gives factors to consider when setting up a service business.

Factor Explanation
1. Availability of market Being close to customers is very important for service businesses as most
services are offered directly to users. However, the use of internet has made it
possible for service businesses to reach customers located in different parts of
the world.
2. Availability of labour Some services depend on the skills of labour available. Locating service
businesses in places where people with the necessary skills stays is important
to reduce the cost hiring and training unskilled workers.
 3. Access to Most services depend on transport and communication. These days,
communication businesses network through internet connection. For international businesses
networks to invest in a country, they require good transport and communication
networks.
4. Availability of Services depend on direct access. Businesses locate services in places where it
premises is easy for customers to receive the services. However, services may be
located away from busy areas because the rentals in cities and central areas
are very high. Services located in centralised areas are normally expensive due
to rentals involved.

How legal controls affect location of businesses?

The choice of location of a business may conflict with government objectives because of the following
reasons:
The business may be locating in an area where it may damage the physical environment such as
vegetation and wild animals.
The business’ activities in that location may cause pollution or it might be too close to residential areas.
The preferred location may be reserved for future expansion of other activities.

What should the government do to prevent businesses from locating

in illegal areas?
In order to prevent businesses from setting up in prohibited areas and encouraging them to locate in other
areas, governments develop laws. These laws are aimed at:
 Restricting businesses from operating in areas where they can damage the environment like nature
reserves.
 Restricting some businesses from locating in areas where their activities will conflict with activities
allowed in that area.
 Restricting certain buildings from being erected in an area where they are not suitable for. This is
intended to make buildings safe for use.

Review Questions
Kape Foods (KP) processes a wide range of frozen foods such as fish, meat and vegetables. Its products are sold
to various supermarkets around country Y. the company is planning to open two new branches. The Production
Manager has advised that finding the right location was important. The new branches will create 300 jobs each.
Required
(a) Identify two ways in which the government of country Y may influence the location of KP’s new branches.
[2]

(b) Explain why the following factors are important to KP when deciding the location of its new branches.
(i) competitors
(ii) water sources
(iii) road networks. [9]
FINANCIAL INFORMATION AND DECISIONS

Why do businesses need finance?

Businesses require finance for a variety of reasons as follows:

1. To start up a business
Businesses require money to start operating. This money is called start-up capital. The capital is required to
purchase assets such as motor vehicles, land and buildings. Money is also required to purchase goods that
are sold to customers or to buy raw materials for producing other goods.
2. To expand an existing business
An existing business may need money in-order to expand it. Expansion can be done by opening new
branches in other locations, increasing assets such as buildings and machinery or taking over other
businesses.
3. To provide working capital
Working capital is the money needed by a business to pay for day to day expenses. Such day to day
expenses may include wages, raw materials, rentals and electricity bills. A business may have all other
assets it needs to operate but if it fails to have enough working capital, it may fail to operate.

What are the main sources of finance?

Sources of finance may be internal or external. They may also be long term or short term as illustrated
below.

Short term Internal sources Long-term Internal sources

• Debt factoring ▪ Profit earned (Retained profit)
• Selling existing assets ▪ More capital from the owner
• Selling goods to reduce inventory
levels

Short term External sources Long-term External sources

➢ Bank overdraft ❖ Issue of shares
➢ Credit purchases ❖ Issue of debentures (long term loans)
➢ Micro-finance ❖ Leasing
❖ Hire purchase
❖ Joint venture/partnership/franchise

What are internal sources of finance?

Internal sources of finance are funds generated from within the business. Internal sources of finance can be
short term or long term.

Which are the short term internal sources of finance?

1. Debt factoring
Debt factoring involves selling debts owed to the business by credit customers to debt collection agent. The
agent pays cash for the debts at a discount. The agent then collects the debts.

What are the advantages of debt factoring?

❖ Debt factoring ensures that the business receives immediate cash that is required to improve liquidity
for the business.
❖ This also improves the cash position of the business as it has received cash that might not have been
paid by credit customers.
❖ The risk and cost of collecting debts is passed to the debt factoring company, saving the business from
further losses trying to collect the debts.

What are the disadvantages of debt factoring?

❖ The business losses part of the revenue from credit sales as the debts are sold to the debt factoring
company at a discount.

2. Selling existing non-current assets

This involves selling non-productive or idle assets in the business. For example, a business may be having an
extra delivery motor vehicle. It can be sold to provide cash for working capital purposes.

What are the advantages of selling existing non-current assets?

• Selling idle assets provide liquidity necessary to pay for day to day expenses and short term debts.
• The business is able to raise cash without incurring further debts since this method does not involve
borrowing money.
• The business will not lose the idle assets from depreciation. Depreciation is an expense which reduces
profit.
What are the disadvantages of selling existing non-current assets?
• Selling idle assets is a long process. There may not be a ready buyer for such assets as they involve a lot
of money. Even if the buyers are found, they may ask for instalments.
• Small businesses may not have excess assets to sell making it difficult to raise funds through this
method.

3. Selling inventory
This involves selling goods held for resale. Selling inventory is necessary when the aim is to increase
liquidity (cash available).
What are the advantages of selling inventory?
➢ Selling excess inventory reduces other costs such as inventory holding costs (storage and security
costs). This helps the business to raise money for other purposes such as opening new branches.
➢ Selling inventory is a quicker way of improving liquidity if there are ready buyers for that inventory.
➢ Selling inventory saves the cost of borrowing money. Banks are not willing to lent money to small
businesses.
What are the disadvantages of selling inventory?
➢ Sometimes inventory is difficult to sell, especially, where the demand for the goods being sold is price
elastic and there is high competition.
➢ The business may not raise the required capital as inventory only improve liquidity but not overall
capital of a business.
➢ Over-selling inventory may result in stock-outs and disappointment to loyal customers.

Which are the long term internal sources of finance?

1. Retained Profits
Businesses may not distribute all the profit earned to shareholders. Some profits are kept in the business
for future use.

What are the advantages of retained profits?

▪ Retained profits are interest free. The businesses do not pay interest as the profits already belong to
the businesses.
▪ There is no need to repay the money after using it. This will ensure that the business will continue to be
stable as long as it is making enough profit to finance its activities.

What are the disadvantages of retained profits?

▪ New businesses will not have profits hence this form of finance is not suitable for them.
▪ Many small businesses take too long to be profitable. Thus, it takes long for them to set aside enough
profit for future growth.
▪ Keeping some profits in the business means low dividends are paid to shareholders. Some shareholders
may not like it. They may end up selling their shares and leaving the business.

2. More capital from the owner

The owners may bring in more capital from their personal savings.

What are the advantages of capital from the owners?

❖ Once the capital has been introduced, it will continue to be used for a long time without the need to
repay it. This ensures long term financial stability for the business.
❖ There is no interest payment. Since this source of finance does not involve borrowing money, the
business will not have to pay any interest charges.
❖ Savings are usually quick to obtain than having to apply for a loan.
Disadvantages of capital from the owners
❖ The owners of small businesses may not have enough savings to raise the required capital.
❖ Using personal savings increases the risk of loss to owners. If the business fails, they will lose their
entire savings.

Review Questions
Amvita wants to start up a flower shop. The business requires $1 000 start-up capital. She has managed to
raise $800 from her previous job. She thinks that by selling her personal car for $500, she can raise the balance.
Required
(a) What is ‘start-up capital’? [2]
(b) Why is start-up capital important for Amvita? [2]
(c) Give two internal sources of finance that a business could use other than sells of assets and capital from
the owner. [2]
 (d) Identify and explain one advantage and one disadvantage to Amvita of selling her personal motor
vehicle to raise the balance of the start-up capital. [4]

What are external sources of finance?

External sources of finance are funds raised from individuals and organisations outside the business.
External sources of finance are generally expensive and difficult to find. External sources are also divided
into short term and long term sources.

Which are the short term external sources of finance?

1. Trade credits
This involves buying goods on credit. The business buy goods and pay for them later.
What are the advantages of trade credits?
o Buying goods on credit allow the business to have cash in the business that can be used for other day to
day operations.
o Most trade credits are interest free. The supplier can only charge interest when the business exceeds
the due date.
o Goods bought on credit can pay for themselves. That is the business may sell the goods before it pays
for them.
What are the disadvantages of trade credits?
o The supplier may refuse to give future trade credit in cases where the business has previously failed to
pay for the goods. Trade credit depends on the trust between the business and its suppliers.
o The business may lose the opportunity to buy goods at cheaper prices as it loses on cash discounts.

2. Bank overdraft
A bank overdraft is an arrangement between the business and its bank in which the business is allowed to
overdraw its bank account. The business spent more cash than its bank balance.
What are the advantages of bank overdrafts?
• The business can still write cheques to its suppliers even though it does not have enough money in its
bank account.
• If a bank overdraft is used properly, it allows the business to pay other short term debts.
What are the disadvantages of bank overdrafts?
• Interest is paid daily on the amount overdrawn. The interest charged on overdraft is usually higher than
on a loan. This further increases the cost of financing a business.
• A business cannot rely entirely on a overdraft for its operations. The availability of overdraft depends
entirely on the trust between the business and its bank.

3. Micro-finance
Micro finance refers to small loans that are provided to less privileged people or small entrepreneurs to
finance their businesses. The loans are provided because:
(i) Commercial banks are not willing to lent money to small businesses.
(ii) Small loans are less profitable to banks.
(iii) Less privileged people lack assets that can be used as collateral for them to get loans from banks.

What are the advantages of Micro-finance?

• Low income earners are able to obtain finance without providing collateral security. This ensures that
less privileged members of society are able to start their own businesses.
• The micro-finance is relatively cheaper as the interest charged is low.
• The process of applying for the loan is easier that when applying from banks due to less paper work
involved.
What are the disadvantages of Micro-finance?
• There are too many people who apply for micro-finance. The success of obtaining this form of finance
depends on the funds available and a good business plan.
• The loan obtained is small so it cannot meet all the requirements of the business. Thus, the business
takes longer to expand.

Which are the long term external sources of finance?

1. Issue of shares
A limited company can issue new shares to existing and new shareholders to raise capital.
What are the advantages of issuing shares?
❖ Shares are a permanent source of finance to a business. The business is assured of long term expansion
as the capital will not be paid back.
❖ Since issuing shares is raising capital from the owners, no interest is paid for it. This reduces the
expenses of the business.
❖ Issuing new shares improves the liquidity of the business. This is because cash is injected into the
business when investors buy shares.
❖ More capital is raised since a large number of investors are free to buy shares from the stock exchange.
What are the disadvantages of issuing shares?
❖ The original shareholders may lose control of the business as new shareholders become owners as well.
This may affect the objectives of the original owners.
❖ The shareholders expect to receive dividends from their investment. If dividends are not paid they may
end up withdrawing their investment leaving the business with less capital again.

2. Issues of debentures
A debenture is a long term loan to a limited company. This loan is raised by issuing debentures to various
individuals and businesses willing to lend money to the business.
What are the advantages of debentures?
• Debentures are long term sources of finance that can be used for a long period without the need to
repay them. This ensures that the business grows and become profitable before the debentures are
repaid.
• No collateral security is required. Companies are not required to pledge their assets in order to raise
debentures.
• The original owners of the business will maintain control of their business because debenture holders
do not vote to make decisions.
• Debentures can be redeemed if the business no-longer require them. Cancelling debentures reduces
interest payments.
What are the disadvantages of debentures?
• Since debentures are a loan, the company will have to pay interest to the debenture holders, whether
the business makes a profit or not. This will reduce the profit available to shareholders.
• Paying interest and repaying the loan reduces the liquidity of the business. The business may end up
having less cash to pay for day to day expenses.
• Repaying the debentures may deplete the capital of the business. This may create more capital
problems for the business if the debentures are not replaced by another source of capital.
3. Leasing
Leasing involves a business using an asset by renting it. The business pays monthly instalments for using the
asset.
What are the advantages of leasing?
➢ The business has an option to buy the leased asset in future when profit and cash becomes available.
➢ The business is able to use up to date expensive machinery and equipment that the business may not
be able to buy.
➢ The business will reduce liquidity problems since it will not use a lot of cash to pay for the asset.
➢ Care and maintenance of the asset is done by the leasing company. This means that the business will
save costs from operating the leased asset.
What are the disadvantages of leasing?
➢ The total value of monthly lease payments is higher than buying the asset. This makes leasing to be an
expensive source finance.
➢ At the end of the lease agreement, the leased asset may be returned to its owner, leaving the company
without an asset to use.
➢ The leased asset does not belong to the business. Therefore, it cannot be used as collateral when
borrowing other loans.

4. Hire purchase
Hire purchase is a method of buying an asset on credit in which the buyer pays a deposit and make monthly
instalments.
What are the advantages of hire purchase?
o Unlike leasing, under hire purchase, the asset is owned by the business even before it is fully paid for.
o Hire purchase agreements are spread over a long period of time. This ensures that businesses do not
have liquidity problems as they pay the monthly instalments.
o The business has the opportunity to earn revenue and cash while still paying for the asset.

What are the disadvantages of hire purchase?

o Buying an asset using hire purchase is expensive than using cash. The hire purchase price includes the
price paid for the asset and interest charges.
o If the business fail to pay monthly instalments, the asset may be repossessed (taken back) by the seller
leaving the business with no asset to use.

5. Joint ventures and partnerships

This involves two or more businesses joining together.
What are the advantages of joint ventures and partnerships?
❖ More capital is raise as the two businesses will bring in their own share of capital.
❖ No interest charges are paid from money contributed by each business. This reduces the expenses of
the business and increase profitability.
❖ The businesses contribute permanent capital to the business. This ensures long term survival of the
business.
What are the disadvantages of joint ventures and partnerships?
❖ The original owners of the business will lose control in decision making. They will lose their ability to
make decisions independently as they will have to discuss with the other partners.
❖ Disagreement may arise concerning management of the business and sharing of profit. This may lead to
the collapse of the business.
❖ Profits will have to be shared between the partners, thereby, reducing profit available to the original
owners of the business.

What are the factors to consider when choosing a source of finance?

The type and amount of finance that is available will depend on several factors. These factors will help
make the firm decide how much it needs or can borrow. These are as follows:
1. Risk and gearing
Raising finance by borrowing loans and leasing means the business will increase the amount of debt in the
business. This means that the business will be having more debt than capital. A high level of debts is called
gearing. If the business fails to pay back its debts, it may lose its assets to creditors.
2. Period involved
Short term finance is obtained through trade credits, bank overdrafts, loans and selling idle assets.
Permanent finance is obtained through issue of shares, debentures, leasing and partnerships.
3. Cost of finance
It is always good for businesses to raise a cheaper source of finance. Lenders require businesses to pay
interest on loans. This increases the cost of financing a business. Capital from owners such as issue of
shares and personal savings are cheaper sources of finance.
4. The type of business
A sole trader will be limited to the capital the owner can put into the business plus any money that can be
borrowed from relatives and friends. A limited company will be able to raise more capital by issuing shares.
5. The stage of development of the business
A new business will find it much harder to raise finance than an established firm. As the business develops
it is easier to persuade outsiders to invest in the business. It is also easier to obtain loans as the firm has
assets to offer as security.
6. The state of the economy
When the economy is booming, business confidence will be high. It will be easy to raise finance both from
borrowing and from investors.
When the economy is not performing well, investors are not willing to lent money to businesses. If they
lent money, they will charge high interest rates making loans to be very expensive for businesses.
7. Amount involved
If the amount of finance required is high, a business may take a loan or decide to issue new shares. For
small amounts, a business may choose to apply for a bank overdraft, sell assets or buy on credit.

Review questions
Lara is a sole trader. She has successful small taxi business. Lara wants to expand by offering an airport taxi
service to and from the city centre. Lara needs to buy an eight-seater vehicle to carry people and their luggage. It
will cost $9000. She has fewer savings as she has invested everything into the business. Her current overdraft is
$1500. She thinks she has three options to raise the required finance.
Required
Consider the following three options that Lara might use to raise the required finance. Recommend the option
that Lara could use. Justify your answer.
• Bank overdraft
• Leasing an eight seater vehicle
• Partnership with her uncle. [12]

CASH FLOW FORECASTS

What is cash?
Cash refer to notes, coins and bank balances that a business can use to pay for goods and services. Cash is a
liquid asset. That is, it can be used to pay for short term debts such as paying suppliers of goods and
services or to reverse a bank overdraft.

Why is cash important to a business?

1. It is used to pay for day to day expenses

The business requires cash to pay for day to day services such as water, electricity and fuel. Lack of cash
may lead to the business failing to access these services. This may lead to production stoppages.
2. It is used to buy inventory
Cash is important when buying goods for resale. Some suppliers demand cash payment before they release
raw materials. In that case, a business with cash will have preference than a business with liquidity
problems.
3. It is used to settle short-term debts
The business may owe other businesses for goods and services. Those businesses require to be paid in
future. This requires liquidity in the form of cash. A business that pays its suppliers early may receive a cash
discount.
4. It is used to repay loans
Every business should have enough cash to repay the loans or bank overdraft. Failure to repay loans may
attract interest charges leading to more liquidity problems for the business.

What is a cash flow forecast?

A cash flow forecast is a future estimate of the business’ cash inflows and outflows. A cash flow forecast
can be prepared monthly or yearly. It shows the expected cash inflows, the expected cash outflows and the
bank balance at the end of the month.
Cash inflow includes any money received by the business. It can be in the form of sales of goods, sales of
non-current assets, loans borrowed and cash injected by the owner.
Cash outflow includes any money paid by the business. This may include interest payments, loan
repayments, payment for expenses, cash withdrawn by owner for personal use and purchases of assets.

Why a cash flow forecast is important to a business?

1. It is required by banks when applying for a loan
Banks provide loans to businesses. For them to do so, they request businesses to provide cash flow
forecasts. The cash flow forecast helps bank managers to determine the amount to lend to the business
and also to assess the ability of the business to repay the loan.

2. It helps the business to control cash spending

A cash flow forecast shows a plan of cash to be collected by a business and ways to spent it. Holding too
much cash means capital is not being put to good use. Thus, a business may plan the time to pay its
suppliers in cash so as to take advantage of cash discounts.
3. It is necessary when planning to start a business
When starting a business, it is important for the owners to prepare a cash flow forecast so as to estimate
cash needed in the first few months of operation. Many small businesses fail at start-up because they lack a
plan of cash needed to pay for day to day expenses.
4. It helps to prevent insolvency.
Insolvency means the inability of a business to repay its loans due to cash shortage. By having a cash flow
forecast, a business is able arrange better ways of paying its debts.

How to prepare a cash flow forecast?

 Gear Ltd
Cash flow forecast for the year ended …
Month 1 Month 2 Month 3
Cash inflows:
Cash from sales of goods xx xx xx
Cash received from services xx xx xx
Loans xx
Capital introduced xx
Total cash inflow (a) XX XX XX
Less: Cash outflows:
Expenses xx xx xx
Loan interest xx
Loan repaid xx
Purchase of assets xx
Total outflows (b) (XX) (XX) (XX)
: .Net cash flow (a-b) XX XX XX
Add: Opening balance XX XX XX
Closing balance XX XX XX

What are the main causes of cash flow problems in a business?

Cash flow problems arise because of the following factors:

1. Holding too much inventory

Buying too many raw materials and finished goods tie up cash. Inventory is difficult to convert to cash. At
times there is no ready buyer for the inventory. The inventory may, also, be converted to cash at a lower
value than it was bought.

2. Expanding too quickly

Expanding too quickly means the business is opening new branches, increasing production and employing
more workers. This creates more costs for the business that require cash.

3. Buying expensive non-current assets

Non-current assets require large sums of money to buy them. Buying machinery, equipment and motor
vehicles uses up cash reserves. A business with low cash reserves is encouraged to buy assets on credit or
to use leased assets.

4. Withdrawing cash for personal use

Cash taken buy owners for private use leave the business with low cash reserves. Owners should be
discouraged from withdrawing cash for private use.

5. Repayments of debts
A business with a high level of debt faces cash flow problems as they repay the debts plus interest.

What is working capital?

Working capital is money required to pay for day expenses. A business that maintains positive working
capital will be in a good liquidity position because it will have enough cash and other liquid assets to pay its
short term debts as they fall due. Liquid assets are those assets that can be converted to cash easily.
Examples of liquid assets are inventory and trade receivables. Cash is the most liquid asset. Working capital
is calculated as; current assets minus current liabilities.

Working capital = current assets – current liabilities

What happens when a business does not have enough working capital?
❖ The business will fail to pay for day to day expenses such as rent and wages.
❖ The business may fail to buy goods for resale to its customers.
❖ The business may fail to pay its short term debts on time leading to interest charges.
❖ The business may fail to take advantage of cash discounts offered by suppliers.
❖ The business may not enjoy economies of scale as it cannot buy in bulk.

How can cash flow and working capital problems be overcome?

Which method of How it works? What are the limitations of that method?
overcoming cash flow
problems?
1. Increasing bank loans Loans improve the cash available Paying interest on loan reduces profit available to
for working capital purposes. owners.
The loan will have to be repaid at a future date, creating
more cash flow problems.
2. Delaying payments to Cash is kept in the business for The business may lose the opportunity to buy on credit
suppliers other purposes. in future.
The business may lose cash discounts and trust from
suppliers.
3. Make credit customers pay Cash will increase in the short term. It is expensive to collect debts as debtors may have to be
early allowed cash discount for them to pay early.

4. Cash sales Cash is always received after each Customers may switch to businesses that offer credit.
sale. Some products are difficult to sell for cash.
5. Delay buying non-current Not buying non-current assets The long term efficiency of the business may be reduced
assets reduce cash outflows. since assets are needed to generate revenue for the
business.
6. Introduce more cash The cash available will increase for The owners may not have additional cash to inject into
a long time as more cash is brought the business.
in by owners.

Review Questions
Star Cruise makes luxury boats. The Managing Director is always worried about cash flow. She says, ‘I pay all
suppliers after 30 days. My customers take 3 months to pay. Look at my cash flow? I need to do something ’.
Month 1 Month 2 Month 3
$’000 $’000 $’000
Cash inflows 20 80 40
Cash outflows 30 40 30
Net cash flow (10) 40 Y
Opening balance (20) (30) 10
Closing balance (30) X Z
Required
(a) What is a ‘cash flow forecast’ [2]
(b) Calculate the figures X , Y and Z. [4]
(c) Identify and explain two ways the Managing Director of Star Cruise can improve cash flow in Month 1. [4]

THE INCOME STATEMENT

What is an income statement?

The main objective of every business is profitability. The income statement is used to determine profit and
loss made by the business. Profit is the difference between revenue earned and expenses incurred by the
business in that period.
What is the difference between profit and cash?
1. Profit is not the same as cash. Profit is the reward for taking a risk to form a business. Profit is the
excess of revenue to costs while cash is money available for spending.
2. A business can make a profit but without cash. This is possible where the business sells mostly on
credit. The business will show profit made from those sales but the customers have not paid for the
goods so cash will not be available.
3. A business can have cash without making profit because the business may sell some non-current assets
or borrow money to improve liquidity. This increases the cash available but the business may be
making a loss because its expenses may be high.

How to prepare an income statement?

An income statement is a document that shows the calculation of profit or loss made by a business during
the year.
Income statement for the year ended 31 December …
$’000
Revenue (sales) 6 000
Less: Cost of sales (4 000)
Gross Profit 2 000
Less: Expenses (1200)
Net Profit 800
Definition of terms
➢ Revenue refers to all income from sales of goods or provision of services.
➢ Costs of sales refer to money paid to buy goods for resale.
➢ Gross profit is the difference between revenue and cost of sales.
➢ Expenses refer to all money paid for services used by the business such as rent, wages and salaries and
electricity.
➢ Net profit is the difference between gross profit and expenses. If gross profit is less than expenses, it
becomes a net loss.

Review Questions
Tickers make watches and clocks. The following is Tickers’ income statement for the year ended
31 December 2019.

Revenue X
Cost of sales 180 000
Gross profit 120 000
Expenses Y
Profit 30 000
Required
(a) Calculate X and Y [2]
(b) Tickers has made a profit of $30 000 and thinks that the business can be more profitable. Identify
and explain two ways of improving profitability of the business. [4]
(c) Even after making a profit of $30 000, Tickers had $4 000 bank overdraft in its bank account. Identify
and explain two reasons for this. [4]

How to improve the profit of a business?

(a) Increase selling prices
By increasing selling prices, the business is able to increase revenue earned. This is suitable for products
that have price inelastic demand. However, increasing prices may lead to customers switching to
competitor products.
(b) Reduce cost of sales
The cost of sales can be reduced by buying in bulk to obtain trade discounts or switching to cheaper
suppliers. However, suppliers may not be willing to reduce prices where there other buyers for their goods.
If the business finds a cheaper supplier, they may end up buying poor quality goods that may lead to bad
reputation of the business.
(c) Reduce operating expenses
Operating expenses are day to day expenses of the business. A business that is able to control its operating
expenses has higher chances of increasing net profit. However, fixed costs such as rent, salaries and
depreciation of assets are always difficult to control. These expenses must be paid for whether the business
makes a profit or not.

Review Questions
Paul has a take-away shop. He provides the following details for June 2019.

Selling price per meal $6 per unit

Cost of sales $3 per unit
Expenses per month $ 2 400
June sales 1 200 units
Required
(a) For the month of June 2019, calculate
(i) Revenue
(ii) Cost of sales
(iii) Profit [6]
(b) Differentiate between profit and cash. [4]

THE STATEMENT OF FINANCIAL POSITION

What is a statement of financial position?

The statement of financial position shows the assets, liabilities and capital of a business at particular date.
Thus, the statement of financial position gives the net worth of business at that date.

How to prepare a statement of financial position?

Statement of financial position as at 31 December ….

$ $
Non-current assets 1 400
Current assets 2 300
Less: Current liabilities 1 300 1 000
Net assets 2 400

Shareholders’ equity (Owners’ Equity) 1 800

Add: Non-current liabilities 600
Capital employed 2 400

Definition of terms
1. Non-current assets are items owned by the business for a period of more than one year. Examples
of non-current assets are; motor vehicles, equipment and property.
2. Current assets are items owned by the business for a period of less than one year. Examples of
current assets are; inventory (stock), trade receivables (credit customers) and cash.
3. Inventory refers to goods held for resale, raw materials held for production and goods still in the
process of production.
4. Current liabilities are debts that should be paid with one year. Examples of current liabilities are
credit suppliers of goods and bank overdrafts.
5. Shareholders’ equity is the capital invested in the business by the owners plus any profit earned.
For limited companies, shareholders’ equity is made up of share capital plus reserves.
6. Non-current liabilities are long term debts of a business. Non-current liabilities are made up of
long term loans.
7. Capital employed refers to the long term capital of a business used by the business to earn revenue.
Capital employed is made up of shareholders’ equity plus non-current liabilities.

Capital employed = shareholders’ equity + non-current liabilities.

Capital employed is also equal to Net Assets.

Review Questions
Buckle Up is a successful transport company. It plans to expand its business by offering more services to
its customers. The Finance Director provided the following statements of financial positions:

Before expansion After expansion

($’000) ($’000)
Non-current assets 75 90
Current assets 30 Y
Current liabilities 20 35
Shareholders’ equity X 80
Non-current liabilities 20 30

Required
(a) What are ‘non-current assets’? [2]
(b) Calculate X and Y. [4]
(c) Using the financial information provided by the Finance Manager, do you agree that Buckle Up
should expand its services? Justify your answer. [6]

ANALYSIS OF FINANCIAL INFORMATION

What is analysis of financial information?

After preparing financial statements an analysis can be done to see whether the business is:
performing better that the previous years
performing better than other businesses in the same industry.
Analysis is done using ratios. These ratios are divided into profitability and liquidity ratios.

1. Profitability ratios
Profitability ratios show the ability of a business to increase profit made by the business. Profit is important
it is the reward to investors.

(a) Gross profit margin

Gross profit margin is gross profit as a percentage of revenue.

Gross profit margin = gross profit × 100%

revenue

Gross profit is the profit earned by a business after paying for cost of sales.
Gross profit is increased by:
▪ Increasing selling prices.
▪ Buying from cheaper suppliers
▪ Negotiating for trade discounts from suppliers.

(b) Net profit margin

Net profit margin is net profit as a percentage of revenue.

Net profit margin = net profit × 100%

revenue

Net profit is increased by:

▪ Increasing selling prices.
▪ Buying from cheaper suppliers
▪ Negotiating for trade and cash discounts from suppliers.
▪ Reducing operating expenses.

(c) Return on capital employed (ROCE)

Return on capital employed measures the efficiency of a business in using capital to earn profit for its
owners. It measures profit earned for each dollar invested. ROCE is expressed as a percentage.

ROCE = net profit × 100%

capital employed (net assets)

The best approach is to increase profit using the same capital or to earn the same profit using less capital.
All factors that increase gross profit and net profit, also, increases return on capital employed.

Illustration
Tickers make watches and clocks. The following is Tickers’ income statement for the year
ended 31 December 2019.
Revenue 300 000
Cost of sales 180 000
Gross profit 120 000
Expenses 90 000
Profit 30 000
The capital employed at 31 December was $850 000.
Required
Calculate;
(a) gross profit margin.
(b) net profit margin
(c) return on capital employed (ROCE)
 Review Questions
Zee Foods produces mealie -meal and flour. The raw materials are obtained from local farmers. The
Finance Manager provides the following income statements for 2018 and 2019.

2018 2019
$’000 $’000
Revenue 300 450
Cost of sales 180 300
Gross profit 120 150
Expenses 80 60
Net profit 40 90
Capital employed amounted to $1 400 000.
Required
(a) Calculate the following ratios:
(i) Gross profit margin
(ii) Net profit margin
(iii) Return on capital employed (ROCE), for each year. [6]
(b) Identify and explain two reasons for the changes in the ratios calculated in (a) above. [6]

2. Liquidity ratios
Liquidity measures the ability of a business to pay its short term debts using cash. Liquid assets are cash and
other assets that can be converted into cash easily. A low ratio for liquidity shows cash flow problems. A
too high ratio shows that the business is not efficient in using cash resources.

(a) Current ratio

The current ratio shows the ability of a business to pay its current liabilities (short term debts) using its
current assets.
Current ratio = current assets
current liabilities

(b) Acid test ratio

The acid test ratio shows the ability of a business to pay current liabilities with other current assets,
excludes inventory. This is because inventory is difficult to sell quickly to obtain cash. By excluding
inventory, a business will get a realistic view of its ability to cover current liabilities.

Acid test ratio = current assets- inventory

current liabilities

Illustration
MT Wholesale sells agriculture inputs. Their summarised statement of financial position is given below.
2018 2019
Inventories 20 000 30 000
Trade receivables 50 000 40 000
Cash 60 000 50 000
Total current assets 130 000 120 000

Trade payables 80 000 70 000

Bank overdraft 20 000 10 000
Total current liabilities 100 000 80 000
Required
For each year, calculate the following:
(a) Working capital
(b) Current ratio
 (c) Acid test ratio [6]
Explain the liquidity situation between 2018 and 2019. [6]

Who are the users of accounting information?

Financial information generated from bookkeeping and accounting process is used by a number of people
and organizations to make decisions. The following are some of the users of financial information of a
business.
1. Internal users
(a). Management.
Management use information for planning and future decision making. They also want to know if the
business is making a profit or not. Managers may earn bonuses if the business performs well.
(b). Employees
Employees are interested in profit made by the business. Employees demand higher wages when the
business makes high profits. They also want to see if they will continue to be employed. A business making
loss is likely to lay-off some employees.
(c ). Owners/ investors /shareholders
Owners/ Shareholders are investors in the business. They are interested in the profit made by the business,
since profit is the reward they get from their investment. By earning profit, their wealth will increase.
Investors finance businesses that have the potential to increase their wealth.

2. External users
(d). Banks
Banks provide loans to businesses. Banks want to see if the business will be able to pay back the loan. They
are more interested in the liquidity position of a business.
(e ). Creditors/ Suppliers
Creditors are people or organisations that supplied goods and services to the business on credit. They want
to see if the business will be able to pay for the goods in the near future. Businesses that are able to pay
creditors often get better credit terms such as cash discounts and longer credit periods.
(f). Government agencies
Companies are required by government to pay tax on profit made. Tax authorities check the profit made
by a business so that they can calculate tax to be paid by the business. Other government departments
check the business’ compliance to environmental and safety laws by assessing money spend on these
issues.
(g). Customers
Customers want to buy from businesses that will continue to exist for a long time. Customers want to see
if the business will continue to supply them goods in future.

Practice Questions
Buckle Up and Slik Ride are two businesses in the tertiary sector. Their statements of financial position are
given below.

Buckle Up Slik Ride

($’000) ($’000)
Non-current assets 75 90
Current assets 30 65
Current liabilities 20 45
Shareholders’ equity 65 80
Non-current liabilities 20 30
The closing inventory for Buckle Up was $8 000 while the closing inventory for Slik Ride was $33 000.
Required
(a) What is liquidity? [2]
(b) Explain why the customers of Buckle Up are interested in the above financial information. [2]
(c) For each business, calculate;
 (i) current ratio
(ii) acid test ratio [4]
(d) Identify and explain two ways in which the owner of Buckle Up can improve liquidity of the business.
[6]

EXTERNAL INFLUENCES ON BUSINESS ACTIVITY

What are government economic objectives?

Governments may influence business activities in order to achieve certain economic objectives. The
economic objectives that governments seek to achieve include the following:

1. Increasing economic growth

Economic growth is seen when the Gross Domestic Product (GDP) of a country increases. GDP
measures the value of goods and services produced in a country in one year. An increase in economic
growth is seen from a rise in the value of goods and services being produced in a country. As GDP
increases, people enjoy a higher standard of living.

2. Reducing unemployment
Unemployment refers to people who are able and willing to work but could not find suitable jobs.
Unemployment means fewer people have money to spend on goods and services. Demand for goods
and services decreases and economic growth is slow. The government may have to spend more money
in providing social services and social security payments to support unemployed families.
Reducing unemployment means more people are working and earning regular incomes. As
employment increases, demand for goods and services rises. Businesses are created to produce more
goods and services leading to economic growth and higher standards of living of people in a country.
Government spending on social services is reduced saving the money for further expansion of the
economy.

3. Reducing inflation
Inflation refers to a general increase in the price levels of goods and services in a country over time. An
increase in prices by one business in a country is not inflation. As inflation rises, people will not be able
to buy the same goods as they bought in the previous year. For those who are working, the value of
their salaries and wages decline.
When there is inflation, business costs increase as a result of rising prices of goods and services and
demand for higher wages from employees.
If the government is able to lower inflation, businesses are able to produce goods and services that are
affordable to both local and export markets. Consumers will continue to demand more goods and
services leading to a rise in GDP.

4. A favourable or positive balance of payment (BOP)

Balance of payment (BOP) is the difference between the value of exports and imports in a country.
Every country desires that its exports exceed imports so that it has a positive balance of payment. A
positive or favourable balance of payment means a country is earning more foreign currency from its
international trade. Foreign currency is important in that:
The local currency will not lose value against currencies of other countries.
The government will not have to borrow foreign currency from international banks to import goods
from other countries.
Businesses in a country are able to import raw materials and machines from other countries at a
cheaper cost.

What are the main stages of a business cycle?

A business cycle refers to an increase or decrease in the economic activity of a country over time. The
increase or decrease is measured using the Gross Domestic Product (GDP) of that country. The business
cycle has four main stages namely; growth, boom, recession and slump. These stages can be illustrated by
means of an economic growth curve.

GDP($)

Recovery/growth
boom

recession

growth
slump

Years

Economic What is it? What are the economic activities involved?

event
1. Growth Growth is a stage of the At Growth;
business cycle when the GDP is rising.
GDP is steadily rising. Unemployment is falling.
There is a general increase in economic activity.
The country is enjoying a higher standard of
living.
Businesses are enjoying rising sales revenue
and profits.
Levels of output rise and demand for goods
increase.
Costs of production slightly rise as business buy
assets to meet demand.
2. Boom Boom is a stage of the At Boom;
business cycle when GDP is at its highest.
economic activity is rapidly There is high spending on goods and services.
rising. Demand is very high.
Consumer confidence is high as people have
enough incomes to spend.
Employment is at its peak (very few people are
unemployed)
High demand leads to prices rising as
businesses try to meet demand.
Firms compete to employ skilled labour leading
to higher wage costs.
Employees continue to demand high wages
leading to inflation.
3. Recession A recession is a stage of the At Recession;
business cycle in which ❖ GDP is falling.
 there is a gradual decline of ❖ Demand for goods and services fall as they
economic activity. become too expensive for consumers due to
rising prices.
❖ Sales decline due to fall in demand.
❖ Businesses reduce production.
❖ Employees are made redundant due to low
production.
❖ Incomes fall as businesses employ less
expensive labour.
❖ Some businesses close due to rising fixed costs.

4. Slump A slump is a stage of the At Slump;

business cycle in which GDP  Sales and profits are very low and some
has fallen and economic businesses are making losses.
activity is at its lowest.  Unemployment is at its peak and there wage
A slump can also be cuts for those still employed.
described as a prolonged  Fixed costs are very high and businesses are
recession. operating to break-even point.
 Many people experience poor living standards.
 Government spending increases in order to
provide basic services and to stimulate the
economy to grow again.
5. Recovery Recovery is a stage of the At Recovery;
business cycle in which GDP is slowly rising.
there is confidence in the Business confidence recovers.
economy after a slump and New investors enter the market.
economic activity and GDP is Sales and profits begin to rise again.
slowly rising. Businesses employ more people to increase
output to meet rising demand.

Review Questions
Country G is enjoying an economic boom. Economic data for the past two years has shown that GDP has
increased from 4% to 11%. The Small to Medium Enterprises (SME) department of country G has registered
an increase of 30% new start-ups. The Foreign Affairs department has recorded a rise of 35% in foreign
business registration. DZL is a private limited company in country G that produces and sells electrical gadgets
to both local and international markets. The components used by DZL are imported from other countries
abroad.
Required
(a) What is an economic boom? [2]
(b) Give two characteristics of an economy with high inflation. [2]
(c) Give two economic objective of the government of country G. [2]
(d) Identify and explain two benefits of the economic boom to DZL. [6]

What are government economic policies?

In order to influence business activity and achieve its economic objectives, the government uses economic
policies. These policies are divided into two namely fiscal and monetary policies.
Fiscal policies influence business activity by increasing or decreasing taxes and government spending.
Monetary policies influence business activity by increasing or decreasing interest rates.

1. Fiscal policy
(a) How the government influence business activity using taxes?
The government can encourage economic growth by reducing taxes for individuals and businesses. Lower
taxes for individuals mean they have more disposable income to spend on goods and services.
Lower taxes for businesses mean they buy raw materials and machines at cheaper prices. This leads to a
reduction in the cost of production. Businesses are able to charge low prices. Goods and services becomes
affordable to consumers hence they demand more goods and services leading to low unemployment and a
rise in the general standard of living for the whole country.
Low tax, also, means that businesses have more profits that can be used to expand their businesses by
opening more branches or extending their factories, employing more people.

The government may also use import tariffs and quotas. An import tariff is a tax charged on goods
imported from another country. An import tariff is aimed at reducing imports so that people buy products
produced locally. Import tariffs make imported products to be more expensive than local products. Thus,
consumers will buy locally made products leading to a rise in the GDP of a country.
An import quota is a limit on the quantity of goods that can be imported into a country. Quotas are mainly
used by the government to protect certain domestic industries from foreign competition.

(b) How the government influence business activity using government

spending?
The government can also boost the economy by increasing government spending. To increase government
spending, it means the government uses part of its reserves to buy goods and services from local
businesses. Government spending is normally achieved by the government providing contracts to local
businesses to construct roads, dams and hospitals, hiring more workers and increasing social grants. More
government spending means demand for goods and services will increase, leading to an increase in output
from businesses. As businesses produce more to meet government orders, they employ more people
leading to less unemployment.

2. Monetary policy
How the government influence business activity using interest rates?
An interest rate is the cost of borrowing money. The government, through the central bank, is the one that
determine the interest rates charged by lenders to people and businesses.
A reduction in interest rates means the cost of borrowing is lower. It becomes cheaper for businesses and
individuals to borrow money to use for expanding their businesses or starting new businesses. Low interest
rates means that businesses have low expenses, hence, they can produce goods and services cheaply
making them affordable to consumers.
However,
Low interest rates in a country may discourage people from saving their incomes to build wealth.
People who save money gain from interest earned from their savings.
At the same time, foreign businesses are not willing to invest or deposit their money in a country with
low interest rates because their reward will be very low.

Review Questions
Country G is enjoying an economic boom. Economic data for the past two years has shown that GDP has
increased from 4% to 11%. The Small to Medium Enterprises (SME) department of country G has registered
an increase of 30% new start-ups. The Foreign Affairs department has recorded a rise of 35% in foreign
business registration. DZL is a private limited company in country G that produces and sells electrical gadgets
to both local and international markets. The components used by DZL are imported from other countries
abroad.
Required
(a) What is an import tariff? [2]
(b) Give two reasons why the government of country G can implement import quotas. [2]
(c) Identify and explain two ways in which a business like DZL, producing luxury electrical gadgets, could be
affected by a rise in taxes in country G. [4]
(d) Identify and explain two ways in which an increase in interest rates by the government of country G
could affect DZL. [6]
ENVIRONMENTAL AND ETHICAL ISSUES

How business activities impact on the environment?

Businesses are involved in providing goods and services to satisfy consumer needs and wants. In doing so,
they end up having a negative impact on the natural environment. The following impacts have been noted:
1. Pollution
Pollution takes various forms such as water pollution, air pollution and poor waste disposal. In all forms of
pollution, business activities make it difficult for humans and animals to enjoy a clean natural environment.
For example, the use of non-bio degradable plastic has been a huge concern as it has polluted land and
seas.
2. Global warming
Business activities have significantly contributed to a gradual rise in global temperatures and melting of
glaciers, drying of underground water sources and persistent droughts. Main business activities that have
contributed to global warming are burning fossil fuels and cutting down trees.

What is good ethical behaviour?

Good ethical behaviour means that businesses do the right things when producing goods and services
without the need for laws to control them. In some instances, ethical issues may conflict with business
objectives. In that case, the business should make a decision in the best interest of all stakeholders. The
following are some ethical issues that businesses should consider:
 Businesses should not bribe government officers in order to gain contracts or have access to
confidential information.
 Businesses should not employ children as workers.
 Businesses should not use raw materials that have been obtained through destruction of the natural
environment.
 Advertisements should not be misleading.
 Businesses should put true information on the labels for their products. They should not put labels that
falsify weight and ingredients of their products.

What are externalities?

Externalities are positive or negative activities of a business that are likely to have a benefit or cost society.
They are divided into:
▪ Positive externalities.
▪ Negative externalities.

1. Positive externalities
Positive externalities are social benefits that come as a result of business activities. These are gains that
society enjoys as a result of the business activities. The following are some external benefits:
➢ Local communities are employed when businesses produce goods and services.
➢ Consumers will have a variety of goods and services near them.
➢ Businesses may develop infrastructure such as road, dams, malls and school that can be used by
communities to improve their lives.
➢ The government may charge tax and collect more revenue that can be used to improve social services.
➢ Small businesses may provide services to bigger businesses.

2. Negative externalities
Negative externalities are sometimes called social costs. These activities lead to suffering of communities.
Examples of external costs are:
➢ Waste products that cause pollution.
➢ Land destruction when mining.
➢ Deforestation.
➢ Global warming.
Other people and the government may incur additional costs in order to reverse negative externalities.

What should be done to reduce the impact of business activities on

the environment?

1. Develop government laws

Governments can pass laws that make certain business activities illegal. This can be achieved by:
Making it illegal for businesses to set up businesses in environmentally protected areas such as
wetlands and game reserves.
Making it illegal for businesses to dump industrial waste near residential areas, rivers and seas.
Making it illegal to make packaging materials that cannot be recycled or that are non-bio-degradable.
Governments can impose heavy financial penalties to businesses that pollute the environment.
Governments can give incentives to businesses that are implementing measures to protect the
environment. For example, companies that import machines to reduce pollution should not be charged
import tariffs.
However, the reason why governments may not implement these laws is that they end up making products
to be more expensive to produce. The cost is then passed to consumers, making the products expensive.

2. Use community pressure groups

Pressure groups are increasingly becoming powerful as a means of monitoring business activities.
A pressure group is made up of people who seek to protect the environment and their community by
influencing the behaviour of the government or businesses involved. They achieve this by:
❖ Calling for consumer boycotts of products produced under environmentally unfriendly conditions.
❖ Negative publicity of businesses that are destroying the natural environment.
❖ Protesting at the premises of businesses involved in environmental destruction.
❖ Lobbying the government to punish business that are destroying the environment and causing suffering
of communities.
How should businesses contribute to sustainable development?
Sustainable development means using the available resources wisely so that they can continue to be
available when required in future. Business activities have produced products that are toxic to the
environment. The clearing of trees has led to unclean breathing air and bare land leading to soil erosion.
Businesses can contribute to sustainable use of resources by:
1. Recycling
By reusing water and other packaging materials, businesses can save trees and other resources for future
use. Recycling reduce land pollution by reducing waste disposal.
2. Reducing
This involves avoiding the use of any material or equipment that has a negative impact on the natural
environment. For instance, businesses may not repack in plastic bags, products that are already packaged
in plastic.
3. Replacing
The business can develop systems that replace resources being extracted from the natural environment.
For example, a furniture manufacturing company can replant trees in the same area it is extracting timber.
4. Using environmentally friendly production methods
For instance, businesses may replace plastic bottles for drinks with other bio degradable materials or
reusable containers.
5. Using renewable energy
There are various sources of renewable and clean energy that can be used to power industries and
households instead of using coal or oil. Businesses may consider using wind, solar and hydro energy that
emit less pollution to the environment.
What business opportunities are available to businesses when trying
to achieve sustainable development?
Businesses working towards achieving sustainable development may benefit from the following
opportunities:
They can import machines and tools free of import tariffs as an incentive to encourage them to invest
in clean methods of producing goods.
They are assured continued supply of natural resources as they will always be available in future.
They open up new opportunities to create products they have not produced previously.
They may reduce cost of production as they concentrate on production methods that use clean energy.

Review Questions
Red Tigers is a popular football club. It has top quality players as it scout players from local sports
academies. Each week, about 60 000 people visit their stadium to watch its matches. The stadium is located
in a small town 10 km from the city centre. The local community pressure group, Ever Concern, has
expressed concern on negative externalities arising from the activities of the football club. He noted that
besides other issues, very young children were included in top matches. The club president has promised to
look into the concerns raised by the community.
Required
(a) What are externalities? [2]
(b) Give two negative externalities arising from the activities of the football club. [2]
(c) Identify and explain two measures that the club president could use to create positive externalities for
the community. [6]

BUSINESS AND INTERNATIONAL ECONOMY

What is Globalisation?
Globalisation is the free movement of goods and services, labour, capital and technology all over the world.
Globalisation has been facilitated by:
The rise in free trade agreements in which countries agree to import and export goods without
restrictions in the form of tariffs and quotas. Consumers can purchase goods and services from other
countries with little import controls.
Improved and cheaper travel links and communication between all parts of the world have made it
much easier for free movement of people from one part of the globe to the other. This makes it easier
for customers to compare costs involved before they buy since the information is available on the
internet.
The increase in industrialised countries such as China, India and Brazil has made it possible for goods to
be affordable and accessible globally.

What are tariffs and quotas?

Governments may seek to protect local producers from foreign goods by imposing tariffs and quotas.
An import tariff is a tax imposed on goods imported into a country. This tax is aimed at making imported
goods more expensive than locally produced goods. Consumers are then forced to buy locally made
products.
An import quota is a limit on the quantity of goods imported into a country.

Why tariffs and quotas are important.

▪ Import tariffs and quotas reduce competition to domestic producers, allowing starting businesses to
develop with less competition.
▪ Unemployment is reduced as local jobs are protected from technology that may make them redundant.
▪ They prevent international businesses from dumping cheaper goods in domestic markets. Dumping also
lead to increase in pollution in the domestic market.
What are the opportunities of globalisation?

1. Increased demand for goods and services.

Businesses in developed countries are able to access markets in less developed countries thereby
increasing demand and sales revenue.
2. Internet opportunities
The internet has become a perfect opportunity to advertise goods and services for people in different parts
of the world. Thus, people can buy products from the comfort of their homes.
3. Increased opportunities to expand businesses
Businesses may open branches in other countries by forming joint ventures and partnerships with local
businesses. Both countries benefit from a partnership formed between a local and an international
company to produce goods, especially in less economically developed countries.
4. Increasing economies of scale
Large companies enjoy production and marketing economies of scale that come as a result of mass
production and centralised advertising. For example, an advertisement posted on the internet at the head
office is likely to be accessed globally and have the same impact wherever the product is sold.
5. Increasing employment opportunities.
Global trade has caused an increase in demand for labour in other countries. As such, businesses with high
demand for employees have managed to advertise and recruit workers from other countries.
6. Increased choices to consumers
Consumers can access products from different parts of the world. This has led companies to be efficient in
producing goods and services so as to be competitive globally.

What are the threats of globalisation?

1. New technology may increase unemployment in less developed countries.
International companies investing in less developed countries may bring technology that will make labour
redundant, increasing unemployment and other social costs in those countries.
2. Increase in foreign competition
The removal of protectionism will lead to loss of market to international companies for small and medium
industries in less developed countries. The international companies have the advantage of producing goods
and services at low cost.
3. The dumping effect
International companies involved in mass production of goods have created a dumping effect in less
developed countries by selling low quality products at very low prices. These products may end up
contributing more waste than the benefits of using them.
4. Exploitation of raw materials
International companies have resorted to obtaining cheaper raw materials from less developed countries.
The extraction of raw materials has left communities suffering from negative externalities such as pollution.
Review Questions
Blue Eye Technology is a public limited company in country D. It manufactures computer hardware and
software. The company plans to expand its activities to less developed countries and take advantage of
globalisation. It has found a market in country Y for some computers that were not sold in the past five years.
Blue Eye will form a joint venture with a local company in country Y.
Required
(a) What is globalisation? [2]
(b) Identify and explain two advantages of globalisation to Blue Eye Technology. [4]
(c) Do you think the investment by Blue Eye Technology will benefit country Y? Justify your answer. [6]

What are multinational companies (MNCs)?

Multinational companies are businesses that have branches or operations in more than one country. An
example of multinational companies is Unilever which is a British-Dutch company which has branches in
many different countries around the world.

What are the benefits of a business operating as a multinational

company?
1. Cheap raw materials
Multinational companies enjoy cheaper raw materials from countries they are operating in. For instance,
multinational companies involved in mining are able to extract cheaper minerals like gold and platinum
from lowly developed countries and send them to their head offices for processing.
2. Cheap labour
International markets provide cheap labour. For example, sports companies like Nike produce their
sportswear in China because China has low wages than USA.
3. Access to markets.
Having branches in many countries means that multinational companies are able to access global markets
and increase demand for their goods and services.
4. Reduce barriers to trade
Some countries have tariffs and quotas that make it difficult for foreign goods and services to be sold in
their local market. Multinational companies solve this problem by setting up factories in those countries
and produce the same goods and services.
5. To spread risk
Having branches in many different countries will ensure that if domestic demand is falling, the company will
still have other markets to sell their products.
6. To enjoy marketing economies of scale.
By spreading their activities to different markets, the companies are able to produce goods close to
consumers. This reduces the cost of transporting the goods to reach markets making them affordable to
local consumers. The multinational companies use one centralised adverting for all their branches.

What are the benefits to a country of having a multinational company

investing?

Benefits Explanations
1. Infrastructure development. Multinational develop other structures such as roads, clinics
and water points that will benefit society.
2. Employment opportunities As they set up factories and shops to produce and distribute
goods and services, locals will have the opportunity to be
employed.
3. Increased choices for Multinational companies bring new products that were not
consumers previously available in the local market. This gives consumers
the opportunity to buy a variety of products.
4. Increase in economic growth Having companies from other countries means an increase in
investment as these companies bring in capital to a country.
This increases the economic activities of a country, increasing
its GDP.

What are the disadvantages to a country of having multinational

companies investing?

(a) Competition for small business

Multinational companies may bring products that are being produced by local businesses. Since
multinational companies enjoy economies of scale, they can lower prices and attract customers away from
local businesses, forcing them to close down. The multinational company may end up becoming a
monopoly.
(b) Repatriation of profits to their countries
Multinational companies send back profits earned to their home countries. This leaves the host country
less developed because the profits will develop other countries instead of the host country.
(c) Exploitation of natural resources
Multinational companies may locate in a particular country in order to obtain cheaper raw materials. The
extraction of raw materials will leave the host country under-developed and suffering from environmental
issues.
(d) Exploitation of labour
Multinational companies aim to produce goods at low cost to maximise profit. In doing so, they look for
countries with cheap labour where they can pay low wages. This will result in local people being exploited.
(e) Increase in pollution
Multinational companies produce goods in large quantities. The processes involved may not be
environmentally friendly. For instance, energy generated to power industries may result in air pollution as
coal may be used. Also, packaging used to wrap products causes land pollution.

Review Questions
Net Care is a multinational company that produces and sell cosmetics and health care products such as toothpaste
and shampoos. It has several branches in other countries. It plans to open a new branch in country C. Unemployment
in country C is very high but market research has shown that Net Care will obtain cheaper raw materials in country C
reducing the cost of production. There are several small producers of cosmetics and health care products in country
C. The new factory will employ 400 workers at a wage rate of $8 per hour. The trade minister in country C thinks this
is too low. The Managing Director of Net Care says, “Everyone can benefit”.
Required
(a) What is the difference between an import quota and an import tariff? [2]
(b) Identify and explain two advantages to Net Care of opening a new branch in country C. [6]
(c) Do you think the trade minister should allow Net Care to open a new branch in country C? Justify your answer.
[6]

What is an exchange rate and why is it important?

An exchange rate is the value of a country’s currency when compared to the currency of another country.
Exchange rates affect the prices of imports and exports. This will further affect sales, costs and profit.
A currency may appreciate or depreciate in value.

1. Currency appreciation
Currency appreciation is a rise in the value of a country’s currency when compared to another currency.
That is, the currency of a country is now worth more than the currency of another country. It can now buy
more of the other currency than before. A currency may appreciate because of the following reasons:
➢ The country exports more than it imports.
➢ The country has a favourable balance of payment. Thus, customers outside the country must sell more
of their currency to buy products from the country.
➢ The interest rates in the country are relatively high to attract foreign savings.
➢ Inflation is lower than in other countries.

Why is the appreciation of a currency important to a country?

Positives
Businesses using imported raw materials buy cheaper from other countries reducing the cost of
production making products to be affordable to local consumers.
 Business confidence rises. Investors are willing to invest in a country where their money gains value.
Foreign companies and individuals deposit money in local banks further increasing capital available to
fund business activity.
Inflation is kept low. Consumers can enjoy the same prices over a long period of time.
Businesses can afford to buy machinery and equipment from foreign markets at cheaper prices.
Negatives;
Exports become very expensive. Foreign customers will find it expensive to buy goods produced in the
country because they will have to sell more of their currency in order for them to buy. Thus, a business
that relies only on exports will suffer reduced sales revenue and competition from international
businesses.

2. Currency depreciation
Currency depreciation is the fall in the value of a country’s currency when compared to another country’s
currency.
Currency depreciation means that the country’s currency is now worth less than another country’s
currency. It can now buy less of another country’s currency than before. This is caused by:
❖ The country imports more than it exports.
❖ Interest rates have fallen relative to other countries and as such depositors have moved their savings to
other countries.
❖ Inflation has risen than in other countries.

Why is the depreciation of a currency important to a country?

Positives
Exports become cheaper. The price of goods and services sold to foreign markets becomes lower and
more competitive. Customers in foreign markets will sell less of their currency to buy goods and
services from the country.
Negatives
Imports become expensive. Local businesses buy raw materials from other countries at a higher price.
They will have to raise more of the domestic currency for them to buy. This increases the cost of
production and prices of goods produced. Local customers may not afford to buy goods produced
leading to a fall in demand.
Investors will move away their savings to other countries, leaving the country with less capital to
expand the economy.
Inflation rises as businesses increase prices in order to recover costs on imported goods.

Summary:
Currency appreciation is good for importers and bad for exporters while currency depreciation is
good for exporters and bad for importers.

Review Questions
Denzel owns a successful candy manufacturing business in country X. The sugar used to manufacture the
candies is imported from country S. In the past year, the currency of country X has fallen by 10% against
that of country S. Denzel is worried about the movement of the exchange rate.
Required
(a) What is meant by exchange rate? [2]
(b) Give two effects to Denzel of a drop of 10% in the exchange rate. [2]
(c) Identify and explain two benefits to Denzel of an appreciation in the currency of country X. [6]