15 business questions and one discussion

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William M. Pride Texas A&M University

Robert J. Hughes Dallas County Community Colleges

Jack R. Kapoor College of DuPage

Foundations of Business

Australia • Brazil • Mexico • Singapore • United Kingdom • United States

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Printed in the United States of America Print Number: 01 Print Year: 2015

To Nancy, Allen, Carmen, Mike, Ashley, Charlie, J.R., and Gracie Pride

To the memory of my wife Peggy and to my mother Barbara Hughes

To my wife Theresa; my children Karen, Kathryn, and Dave; and in memory of my parents Ram and Sheela Kapoor

Part 1 the Environment of Business 2 Chapter 1 Exploring the World of Business and Economics 2 Chapter 2 Being Ethical and Socially Responsible 37 Chapter 3 Exploring Global Business 68

Part 2 Business Ownership and Entrepreneurship 104 Chapter 4 Choosing a Form of Business Ownership 104 Chapter 5 Small Business, Entrepreneurship, and Franchises 132

Part 3 Management and Organization 164 Chapter 6 Understanding the Management Process 164 Chapter 7 Creating a Flexible Organization 188 Chapter 8 Producing Quality Goods and Services 210

Part 4 Human resources 244 Chapter 9 Attracting and Retaining the Best Employees 244 Chapter 10 Motivating and Satisfying Employees and Teams 272

Part 5 Marketing 304 Chapter 11 Building Customer Relationships Through Effective Marketing 304 Chapter 12 Creating and Pricing Products That Satisfy Customers 329 Chapter 13 Distributing and Promoting Products 362

Part 6 Information, accounting, and Finance 400 Chapter 14 Exploring Social Media and e-Business 400 Chapter 15 Using Management and Accounting Information 433 Chapter 16 Mastering Financial Management 466

Glossary G-1 Name Index NI-1 Subject Index SI-1

The following appendixes appear on the companion site www.cengage.brain.com Appendix A: Understanding Personal Finances and Investments A-1 Appendix B: Careers in Business B-1 Appendix C: Enhancing Union–Management

Relations C-1 Appendix D: Risk Management and Insurance D-1 Appendix E: Business Law, Regulation,

and Taxation E-1

Brief Contents

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About the Author xii Acknowledgments xiii

PArT 1 The Environment of Business 2 Chapter 1: Exploring the World of Business and Economics 2

5 Inside Business: Visa’s Vast Global Payments Empire 3 Your Future in the Changing World of Business 4

Why Study Business? 5 • Special Note to Business Students 8 Personal App: Be the employee you’d like to hire! 7 Business: A Definition 10

The Organized Effort of Individuals 10 • Satisfying Needs 11 • Business Profit 12

Types of Economic Systems 12 Capitalism 14 • Capitalism in the United States 15 • Command Economies 17

Measuring Economic Performance 18 The Importance of Productivity in the Global Marketplace 18 • The Nation’s Gross Domestic Product 19 • Important Economic Indicators That Measure a Nation’s Economy 20

The Business Cycle 21 Career Success: Career Moves and the Business Cycle 22 Types of Competition 23

Perfect Competition 23 • Monopolistic Competition 25 • Oligopoly 26 • Monopoly 26

Entrepreneurial Success: Meet the Teenaged Founder of Fish Flops 26

American Business Today 27 Early Business Development 27 • Business Development in the 1900s 28 • A New Century: 2000 and Beyond 29 • The Current Business Environment 29 • The Challenges Ahead 31

Social Media: Government Agencies Go Social 30 Summary 32 Key Terms 34 Discussion Questions 34 Video Case: KlipTech Turns Recycled Paper into Products

and Profits 34 Building Skills for Career Success 35

Endnotes 36

Chapter 2: Being Ethical and Socially Responsible 37

5 Inside Business: Tesla Motors 38

Business Ethics Defined 39 Ethical Issues 39

Fairness and Honesty 39 • Organizational Relationships 40 • Conflict of Interest 40 • Communications 41

Factors Affecting Ethical Behavior 41 Individual Factors Affecting Ethics 42 • Social Factors Affecting Ethics 42 • Opportunity as a Factor Affecting Ethics 43

Encouraging Ethical Behavior 43 Government’s Role in Encouraging Ethics 43 • Trade Associations’ Role in Encouraging Ethics 44 • Individual Companies’ Role in Encouraging Ethics 44 • Social Responsibility 46

The Evolution of Social Responsibility in Business 47 Historical Evolution of Business Social Responsibility 47 • Two Views of Social Responsibility 49 • The Pros and Cons of Social Responsibility 49

Ethical Success or Failure Businesses Feel Pressure Over Conditions in Suppliers’ Factories 50

Public Responsibilities of Business 51 Consumerism 51 • Public Health 53

Personal App: Do you always know what you’re buying? 52 Social Media: The FTC Blogs and Tweets Too 53 Employment Practices 55

Affirmative Action Programs 56 • Training Programs for the Hard-Core Unemployed 57 • Programs to Reduce Sexual Harassment and Abusive Behavior 57

Environmental Concerns 58 Pollution 59 • Effects of Environmental Legislation 59 • Business Response to Environmental Concerns 60

Career Success: Aiming to Be a Chief Sustainability Officer? 59

Implementing a Program of Social Responsibility 62 Commitment of Top Executives 62 • Planning 62 • Appointment of a Director 62 • The Social Audit 62

Summary 63 Key Terms 64 Discussion Questions 64 Video Case: PortionPac Chemical Is People-Friendly,

Planet-Friendly 65 Building Skills for Career Success 65

Endnotes 66

Contents

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vi Contents

Chapter 3: Exploring Global Business 68

5 Inside Business: Walmart’s Global Business Strategy 69 The Basis for International Business 70

Absolute and Comparative Advantage 70 • Exporting and Importing 71

Methods of Entering International Business 73 Licensing 73 • Exporting 74 • Joint Ventures 76 • Totally Owned Facilities 77 • Strategic Alliances 77 • Trading Companies 77 • Countertrade 77 • Multinational Firms 78

Entrepreneurial Success: Advice from Global Entrepreneurs 75 Personal App 76 Restrictions to International Business 78

Types of Trade Restrictions 79 • Reasons for Trade Restrictions 81 • Reasons Against Trade Restrictions 82

The Extent of International Business 83 The Economic Outlook for Trade 83

International Trade Agreements 86 The General Agreement on Tariffs and Trade and the World Trade Organization 86 • International Economic Organizations Working to Foster Trade 88

Career Success: Aiming for an Overseas Job? 87 Sources of Export Assistance 90 Financing International Business 91

The Export-Import Bank of the United States 91 • Multilateral Development Banks 91 • The International Monetary Fund 93 • The Challenges Ahead 93

Social Media: The IMF Goes Social Around the World 93 Summary 94 Key Terms 95 Discussion Questions 95 Video Case: Keeping Brazil’s Economy Hot 95

Building Skills for Career Success 96 Running a Business: Part 1: Let’s Go Get a Graeter’s! 98 Building a Business Plan: Part 1 100

Endnotes 102

PArT 2 Business Ownership and Entrepreneurship 104

Chapter 4: Choosing a Form of Business Ownership 104

5 Inside Business: GoPro’s Global Growth Began by Bootstrapping 105

Sole Proprietorships 106 Advantages of Sole Proprietorships 107 • Disadvantages of Sole Proprietorships 108 • Beyond the Sole Proprietorship 109

Social Media: Small Business Resources 109 Partnerships 109

Types of Partners 110 • The Partnership Agreement 111 Advantages and Disadvantages of Partnerships 112

Advantages of Partnerships 112 • Disadvantages of Partnerships 113 • Beyond the Partnership 114

Corporations 114 Corporate Ownership 115 • Forming a Corporation 115 • Corporate Structure 118

Entrepreneurial Success: Should Your Company Be a Benefit Corporation? 116

Personal App: Are you a stockholder? 117 Advantages and Disadvantages of Corporations 119

Advantages of Corporations 119 • Disadvantages of Corporations 120

Special Types of Business Ownership 121 S Corporations 121 • Limited-Liability Companies 122 • Not-for-Profit Corporations 123

Joint Ventures and Syndicates 123 Joint Ventures 124 • Syndicates 124

Ethical Success or Failure Tough Decisions for Entrepreneurs in Tough Situations 124

Corporate Growth 125 Growth from Within 125 • Growth Through Mergers and Acquisitions 125 • Merger and Acquisition Trends for the Future 127

Summary 128 Key Terms 129 Discussion Questions 129 Video Case: Project Repat Gives Old T-Shirts New Life 130

Building Skills for Career Success 130 Endnotes 131

Chapter 5: Small Business, Entrepreneurship, and Franchises 132

5 Inside Business: Bark & Co. Provides for Pampered Pooches 133

Small Business: A Profile 133 The Small-Business Sector 134 • Industries That Attract Small Businesses 135

Social Media: Small Business Saturday 135 Personal App: Have you worked for a small

business? 136 The People in Small Businesses: The Entrepreneurs 136

Characteristics of Entrepreneurs 137 • Other Personal Factors 137 • Motivation 138 • Women as Small-Business Owners 138 • Teenagers as Small-Business Owners 139 • Why Some Entrepreneurs and Small Businesses Fail 139

Career Success: Plan Now for an Entrepreneurial Venture Later 138

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The Importance of Small Businesses in Our Economy 140 Providing Technical Innovation 141 • Providing Employment 142 • Providing Competition 142 • Filling Needs of Society and Other Businesses 142

The Pros and Cons of Smallness 143 Advantages of Small Business 143 • Disadvantages of Small Business 144 • The Importance of a Business Plan 144 • Components of a Business Plan 145

The Small Business Administration 146 SBA Management Assistance 146 • Help for Minority-Owned Small Businesses 148 • SBA Financial Assistance 149

Franchising 150 What Is Franchising? 150 • Types of Franchising 150

Entrepreneurial Success: Is a Franchise in Your Future? 152

The Growth of Franchising 152 Are Franchises Successful? 153 • Advantages of Franchising 153 • Disadvantages of Franchising 154 • Global Perspectives in Small Business 155

Summary 156 Key Terms 157 Discussion Questions 157 Video Case: From Two Men and a Truck to 220

Franchises and 1,400 Trucks 158 Building Skills for Career Success 158 Running a Business: Part 2: Graeter’s: A Fourth-Generation Family Business 160 Building a Business Plan: Part 2 162

Endnotes 162

PArT 3 Management and Organization 164

Chapter 6: Understanding the Management Process 164

5 Inside Business: Managing Walt Disney for a Second Century of Creativity and Success 165

What is Management? 165 Personal App: Are you already a manager? 166 Basic Management Functions 167

Planning 167 • Organizing the Enterprise 171 • Leading and Motivating 171 • Controlling Ongoing Activities 172

Kinds of Managers 173 Levels of Management 173 • Areas of Management Specialization 174

Key Skills of Successful Managers 175 Conceptual Skills 176 • Analytic Skills 176 • Interpersonal Skills 177 • Technical Skills 177 • Communication Skills 177

Career Success: Collaborate Your Way to Success 176 Leadership 177

Formal and Informal Leadership 177 • Styles of Leadership 178 • Which Leadership Style Is the Best? 179

Entrepreneurial Success: Elon Musk’s Far-Out Ideas Are Crazy like a Fox 178

Managerial Decision Making 179 Identifying the Problem or Opportunity 180 • Generating Alternatives 180 • Selecting an Alternative 180 • Implementing and Evaluating the Solution 181

Ethical Success or Failure: CVS Backs Words with Actions 181

Managing Total Quality 181 Summary 183 Key Terms 184 Discussion Questions 184 Video Case: Meet Heidi Ganahl, Top Dog at Camp Bow

Wow 185 Building Skills for Career Success 185

Endnotes 186

Chapter 7: Creating a Flexible Organization 188

5 Inside Business: Can Structural Changes Re-Ignite McDonald’s Growth? 189

What is an Organization? 189 Developing Organization Charts 190 • Major Considerations for Organizing a Business 192

Job Design 192 Job Specialization 192 • The Rationale for Specialization 192 • Alternatives to Job Specialization 192

Career Success: Flexible Work Space: Are You Ready to Sit Next to the CEO? 193

Departmentalization 193 By Function 193 • By Product 194 • By Location 194 • By Customer 194 • Combinations of Bases 194

Delegation, Decentralization, and Centralization 195 Delegation of Authority 195 • Decentralization of Authority 196

The Span of Management 197 Wide and Narrow Spans of Management 197 • Organizational Height 198

Forms of Organizational Structure 198 The Line Structure 198 • The Line-and-Staff Structure 199 • The Matrix Structure 201 • The Network Structure 202

Personal App: Do you have a mentor? 199 Ethical Success or Failure: If We Get Ethics Right, Will

Compliance Follow? 200 Entrepreneurial Success: Entrepreneurs Set the Tone of

Corporate Culture 202 Corporate Culture 203 Committees and Task Forces 204 The Informal Organization and the Grapevine 205 Summary 206 Key Terms 207

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Discussion Questions 207 Video Case: Zappos Wants to Make Customers (and

Employees) Happy 207 Building Skills for Career Success 208

Endnotes 209

Chapter 8: Producing Quality Goods and Services 210

5 Inside Business: How Detroit Bikes Makes Bikes in Detroit 211

What is Production? 212 How American Manufacturers Compete in the Global Marketplace 212 • Careers in Operations Management 214

Social Media: Inside Boeing’s Factories 213 The Conversion Process 215

Manufacturing Using a Conversion Process 215

The Increasing Importance of Services 216 Planning Quality Services 216 • Evaluating the Quality of a Firm’s Services 217

Where do New Products and Services Come From? 218 Research and Development 218 • Product Extension and Refinement 218

Entrepreneurial Success: Have a New Product Idea? Think Quirky 219

How do Managers Plan Production? 220 Design Planning 220 • Site Selection and Facilities Planning 222 • Operational Planning 224

Career Success: How Would You Plan for Peak Holiday Deliveries? 225

Operations Control 226 Purchasing 226 • Inventory Control 227 • Scheduling 228 • Quality Control 228 • Production Planning: A Summary 231

Personal App: Nobody likes complaints! 229 Improving Productivity with Technology 232

Productivity Trends 232 • Improving Productivity Growth 233 • The Impact of Automation, Robotics, and Computers on Productivity 233 • Sustainability and Technological Displacement 235

Summary 236 Key Terms 237 Discussion Questions 237 Video Case: Chobani Gives the World a Taste for Greek

Yogurt 238 Building Skills for Career Success 239 Running a Business: Part 3: Graeter’s Grows Through Good Management, Organization, and Quality 240 Building a Business Plan: Part 3 242

Endnotes 242

PArT 4 Human resources 244

Chapter 9: Attracting and Retaining the Best Employees 244

5 Inside Business: Netflix Stands Ready to Change 245 Human Resources Management: An Overview 245

HRM Activities 246 • Responsibility for HRM 247 Personal App: How many skills do you have? 246 Human Resources Planning 247

Forecasting Human Resources Demand 247 • Forecasting Human Resources Supply 248 • Matching Supply with Demand 249

Entrepreneurial Success: Hiring Your First Employee: Key Questions to Consider 248

Cultural Diversity in Human Resources 250 Job Analysis 251 Recruiting, Selection, and Orientation 252

Recruiting 252 • Selection 254 • Orientation 256 Social Media: Recruiting Via Social Media 253 Compensation and Benefits 256

Compensation Decisions 256 • Comparable Worth 257 • Types of Compensation 258 • Employee Benefits 259

Career Success: What Are the Job Perks at Apple? 260 Training and Development 260

Analysis of Training Needs 261 • Training and Development Methods 261 • Evaluation of Training and Development 262

Performance Appraisal 262 Common Evaluation Techniques 262 • Performance Feedback 264

The Legal Environment of HRM 265 National Labor Relations Act and Labor–Management Relations Act 265 • Fair Labor Standards Act 265 • Equal Pay Act 266 • Civil Rights Acts 266 • Age Discrimination in Employment Act 266 • Occupational Safety and Health Act 266 • Employee Retirement Income Security Act 267 • Affirmative Action 267 • Americans with Disabilities Act 267

Summary 268 Key Terms 269 Discussion Questions 269 Video Case: The Container Store Hires Great Employees

to Sell Empty Boxes 269 Building Skills for Career Success 270

Endnotes 271

Chapter 10: Motivating and Satisfying Employees and Teams 272

5 Inside Business: What Makes a “Best Company to Work For”? 273

What is Motivation? 273 Historical Perspectives on Motivation 274

Scientific Management 274 • The Hawthorne Studies 275 • Maslow’s Hierarchy of Needs 276 • Herzberg’s Motivation– Hygiene Theory 277 • Theory X and Theory Y 279 • Theory Z 280 • Reinforcement Theory 281

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Contemporary Views on Motivation 281 Equity Theory 281 • Expectancy Theory 282 • Goal-Setting Theory 283

Key Motivation Techniques 284 Management by Objectives 284 • Job Enrichment 285 • Behavior Modification 286 • Flextime 286 • Part-Time Work and Job Sharing 287 • Telecommuting 288 • Employee Empowerment 289 • Employee Ownership 289

Career Success: Is Flextime for You? 287 Personal App: Can you work from home? 288 Entrepreneurial Success: A Time to Micromanage 290 Teams and Teamwork 290

What Is a Team? 291 • Types of Teams 291 • Developing and Using Effective Teams 292 • Roles Within a Team 293 •

Team Cohesiveness 293 • Team Conflict and How to Resolve It 294 • Benefits and Limitations of Teams 294

Ethical Success or Failure: When Teamwork Doesn’t Work 293 Summary 295 Key Terms 296 Discussion Questions 296 Video Case: Putting the Focus on People at the Fruit

Guys 297 Building Skills for Career Success 297 Running a Business: Part 4: At Graeter’s, Tenure Is “a Proud Number” 299 Building a Business Plan: Part 4 301

Endnotes 301

PArT 5 Marketing 304

Chapter 11: Building Customer Relationships Through Effective Marketing 304

5 Inside Business: Starbucks: What’s Not to Love 305 Managing Customer Relationships 305 Utility: The Value Added by Marketing 307 The Marketing Concept 308

Evolution of the Marketing Concept 308 • Implementing the Marketing Concept 309

Markets and their Classification 310 Developing Marketing Strategies 310

Target Market Selection and Evaluation 310 • Creating a Marketing Mix 313

Entrepreneurial Success: Small Businesses Create Big Buzz 315

Marketing Strategy and the Marketing Environment 316 Social Media: Warby Parker: Social Media Star 316 Developing a Marketing Plan 317 Personal App: Do you have a personal marketing plan? 318 Market Measurement and Sales Forecasting 318 Marketing Information 318

Marketing Information Systems 318 • Marketing Research 319 • Using Technology to Gather and Analyze Marketing Information 319

Types of Buying Behavior 321 Consumer Buying Behavior 321 • Business Buying Behavior 323

Ethical Success or Failure: Should E-Cigarettes Be Marketed to Young People? 322

Summary 324 Key Terms 325 Discussion Questions 325 Video Case: Raleigh Wheels Out Steel Bicycle Marketing 326

Building Skills for Career Success 327 Endnotes 327

Chapter 12: Creating and Pricing Products That Satisfy Customers 329

5 Inside Business: GoldieBlox Gets the Gold for Capitalizing on Free Marketing Opportunities 330

Classification of Products 331 Consumer Product Classifications 331 • Business Product Classifications 332

The Product Life-Cycle 332 Stages of the Product Life-Cycle 333 • Using the Product Life-Cycle 335

Personal App: Do you have one of these? 334 Product Line and Product Mix 335 Managing the Product Mix 336

Managing Existing Products 336 • Deleting Products 337 • Developing New Products 338 • Why Do Products Fail? 340

Entrepreneurial Success: BucketFeet: A Gift of Hand- Decorated Sneakers Creates a $1 Million Business 339

Branding, Packaging, and Labeling 340 What Is a Brand? 341 • Types of Brands 341 • Benefits of Branding 341 • Choosing and Protecting a Brand 343 • Branding Strategies 344 • Brand Extensions 344 • Packaging 344 • Labeling 346

Social Media: Going Boldly Where No Cookie Has Gone Before 342

Pricing Products 346 The Meaning and Use of Price 346 • Price and Non-Price Competition 347 • Buyers’ Perceptions of Price 347

Ethical Success or Failure: What is the Real Price…? 348 Pricing Objectives 348

Survival 348 • Profit Maximization 348 • Target Return on Investment 349 • Market-Share Goals 349 • Status-Quo Pricing 349

Pricing Methods 349 Cost-Based Pricing 349 • Demand-Based Pricing 351 • Competition-Based Pricing 351

Contents ix

Pricing Strategies 351 New-Product Pricing 352 • Differential Pricing 352 • Psychological Pricing 353 • Product-Line Pricing 354 • Promotional Pricing 355

Pricing Business Products 355 Geographic Pricing 355 • Transfer Pricing 356 • Discounting 356

Summary 357 Key Terms 358 Discussion Questions 359 Video Case: Mi Ola Strives for a Marketing Splash 359

Building Skills for Career Success 360 Endnotes 361

Chapter 13: Distributing and Promoting Products 362

5 Inside Business: Under Armour Gaining in the Race against Nike 363

Distribution Channels and Market Coverage 364 Commonly Used Distribution Channels 364 • Level of Market Coverage 365

Partnering Through Supply-Chain Management 366 Marketing Intermediaries: Wholesalers 367

Wholesalers Provide Services to Retailers and Manufacturers 367 • Types of Wholesalers 367

Marketing Intermediaries: Retailers 368 Types of Retail Stores 369 • Types of Nonstore Selling 371 • Types of Shopping Centers 373

Entrepreneurial Success: Mobile Goes Retro: Food Trucks and More 370

Physical Distribution 374

Inventory Management 374 • Order Processing 375 • Warehousing 375 • Materials Handling 376 • Transportation 376

What is Integrated Marketing Communications? 377 The Promotion Mix: An Overview 378 Advertising 379

Types of Advertising by Purpose 379 • Major Steps in Developing an Advertising Campaign 380 • Advertising Agencies 382 • Social and Legal Considerations in Advertising 382

Personal Selling 383 Kinds of Salespersons 383 • The Personal-Selling Process 384 • Major Sales Management Tasks 385

Sales Promotion 385 Sales Promotion Objectives 385 • Sales Promotion Methods 386 • Selection of Sales Promotion Methods 386

Personal App: Do sales promotion tools affect your buying decision? 386

Ethical Success or Failure: On-Campus Branding: What’s Your Experience? 388

Public Relations 389 Types of Public-Relations Tools 389 • Uses of Public Relations 390

Social Media: UPS and FedEx Are Social Media Savvy 389 Summary 391 Key Terms 392 Discussion Questions 393 Video Case: Honest Tea Plus Coca-Cola Equals National

Distribution 393 Building Skills for Career Success 394 Running a Business: Part 5: Graeter’s is “Synonymous with Ice Cream” 396 Building a Business Plan: Part 5 398

Endnotes 398

PArT 6 Information, Accounting, and Finance 400

Chapter 14: Exploring Social Media and e-Business 400

5 Inside Business: Taco Bell’s Recipe for Social Media Success 401

Why is Social Media Important? 402 What Is Social Media and How Popular Is It? 402 • Why Businesses Use Social Media 402

Ethical Success or Failure: Should Social Media Disclose Experiments to Users? 404

Social Media Tools for Business Use 405 Business Use of Blogs 405 • Photos, Videos, and Podcasts 406 • Social Media Ratings 406 • Social Games 407

Achieving Business Objectives Through Social Media 407 Social Media Communities 408 • Crisis and Reputation Management 409 • Listening to Stakeholders 409 • Targeting Customers 410 • Social Media Marketing 410 • Generating New Product Ideas 412 • Recruiting Employees 413

Career Success: Do You Have a Future in Social Media? 409 Personal App: Make a Good Impression Using Social

Media 413 Developing a Social Media Plan 413

Steps to Build a Social Media Plan 413 • Measuring and Adapting a Social Media Plan 416 • The Cost of Maintaining a Social Media Plan 417

Defining e-Business 418 Organizing e-Business Resources 418 • Satisfying Needs Online 419 • Creating e-Business Profit 420

Entrepreneurial Success: Advice from Teenage App Entrepreneurs 419

Fundamental Models of e-Business 421 Business-to-Business (B2B) Model 421 • Business-to- Consumer (B2C) Model 422

The Future of the Internet, Social Media, and e-Business 423 Internet Growth Potential 423 • Ethical and Legal Concerns 424 • Future Challenges for Computer Technology, Social Media, and e-Business 425

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Summary 427 Key Terms 428 Discussion Questions 429 Video Case: Luke’s Lobster: Entrepreneurs Use Social

Networking to Claw Their Way Up the Food Chain 429 Building Skills for Career Success 430

Endnotes 431

Chapter 15: Using Management and Accounting Information 433

5 Inside Business: Amazon Web Services Delivers in the Cloud 434

How Can Information Reduce Risk When Making a Decision? 435 Information and Risk 435 • Information Rules 436 • The Difference Between Data and Information 436 • Knowledge Management 437

Social Media: The Small Business Administration Is Big on Social Media 437

What is a Management Information System? 438 A Firm’s Information Requirements 438 • Costs and Limits of the System 440

How Do Employees Use a Management Information System? 440 Step 1: Collecting Data 441 • Step 2: Storing Data 442 • Step 3: Updating Data 442 • Step 4: Processing Data 442 • Step 5: Presenting Information 443

Personal App: Better Knowledge = Better Decisions 442 Why Accounting Information Is Important 445 Entrepreneurial Success: Avoid These Top Three

Accounting Mistakes 445 Why Audited Financial Statements Are Important? 446 • Accounting Fraud, Ethical Behavior, and Reform 446 • Different Types of Accounting 447 • Careers in Accounting 448

The Accounting Equation and the Balance Sheet 449 The Accounting Equation 449 • The Balance Sheet 450 • Assets 451 • Liabilities and Owners’ Equity 452

The Income Statement 453 Revenues 454 • Cost of Goods Sold 454 • Operating Expenses 455 • Net Income 456

Ethical Success or Failure: Timing Counts in Tesco’s Accounting Scandal 456

The Statement of Cash Flows 456 Evaluating Financial Statements 458

Comparing Financial Data 458 • Financial Ratios 460 Summary 461 Key Terms 463 Discussion Questions 463 Video Case: Making the Numbers or Faking the

Numbers? 463 Building Skills for Career Success 464

Endnotes 465

Chapter 16: Mastering Financial Management 466

5 Inside Business: Alibaba and the $25 Billion IPO 467 Why Financial Management? 468

The Need for Financial Management 468 • Financial Reform After the Economic Crisis 469 • Careers in Finance 469

The Need for Financing 470 Short-Term Financing 470 • Long-Term Financing 471 • The Risk–Return Ratio 472

Planning—The Basis of Sound Financial Management 472 Developing the Financial Plan 472 • Monitoring and Evaluating Financial Performance 475

Entrepreneurial Success: Celebrity Investors Bring Cash and Star Power 474

Personal App: Do You Have a Financial Plan? 475 Financial Services Provided by Banks and Other

Financial Institutions 476 Traditional Banking Services for Business Clients 476 • Credit and Debit Card Transactions 477 • Electronic Banking Services 478 • International Banking Services 478

Sources of Short-Term Debt Financing 479 Sources of Unsecured Short-Term Financing 479 • Sources of Secured Short-Term Financing 481 • Factoring Accounts Receivable 482 • Cost Comparisons 482

Sources of Equity Financing 483 Selling Stock 483 • Retained Earnings 485 Venture Capital, Angel Investors, and Private Placements 486

Social Media: Tweet to Chuck 485 Ethical Success or Failure: Should Fans Be Able to Buy

Securities Linked to Athletes? 487 Sources of Long-Term Debt Financing 487

Long-Term Loans 488 • Corporate Bonds 489 • Cost Comparisons 490

Summary 491 Key Terms 492 Discussion Questions 493 Video Case: Moonworks Partners with Bank Rhode

Island to Finance Growth 493 Building Skills for Career Success 494 Running a Business: Part 6: Graeter’s Recipe for Growth: New Systems, Social Media, and Financing 495 Building a Business Plan: Part 6 497

Endnotes 498

Glossary G-1 Name Index NI-1 Subject Index SI-1

The following appendixes appear on the companion site www.cengage.brain.com Appendix A: Understanding Personal Finances and

Investments A-1 Appendix B: Careers in Business B-1 Appendix C: Enhancing Union–Management Relations C-1 Appendix D: Risk Management and Insurance D-1 Appendix E: Business Law, Regulation, and Taxation E-1

Contents xi

William M. Pride Texas A&M University William M. Pride is professor of marketing, Mays Business School at Texas A&M University. He received his PhD from Louisiana State University. He is the author of Cengage Learning’s Marketing, 15th edition, a market leader. Dr. Pride’s research interests are in advertising, promotion, and distribution channels. Dr. Pride’s research articles have appeared in major journals in the fields of advertising and marketing, such as Journal of Marketing, Journal of Marketing Research, Journal of the Academy of Marketing Science, and the Journal of Advertising. Dr. Pride is a member of the American Marketing Association, Academy of Marketing Science, Association of Collegiate Marketing Educators, Society for Marketing Advances, and the Marketing Management Association. Dr. Pride has taught principles of marketing and other marketing courses for more than 30 years at both the undergraduate and graduate levels.

Robert J. Hughes Richland College, Dallas County Community Colleges Robert J. Hughes (PhD, University of North Texas) specializes in business administration and college instruction. He has taught Introduction to Business for more than 35 years both on campus and online for Richland College— one of seven campuses that are part of the Dallas County Community College District. In addition to Business and Foundations of Business, published by Cengage Learning, he has authored college textbooks in personal finance and business mathematics; served as a content consultant for two popular national television series, It’s Strictly Business and Dollars & Sense: Personal Finance for the 21st Century; and is the lead author for a business math project utilizing computer-assisted instruction funded by the ALEKS Corporation. He is also active in many academic and professional organizations and has served as a consultant and investment advisor to individuals, businesses, and charitable organizations. Dr. Hughes is the recipient of three different Teaching in Excellence Awards at Richland College. According to Dr. Hughes, after 35 years of teaching Introduction to Business, the course is still exciting: “There’s nothing quite like the thrill of seeing students succeed, especially in a course like Introduction to Business, which provides the foundation for not only academic courses, but also life in the real world.”

Jack R. Kapoor College of DuPage Jack R. Kapoor (EdD, Northern Illinois University) has been a professor of business and economics in the Business and Technology Division at the College of DuPage, where he taught Introduction to Business, Marketing, Management, Economics, and Personal Finance for more than 44 years. Professor Kapoor is a recipient of the Business and Services Division’s Outstanding Professor Award. He previously taught at Illinois Institute of Technology’s Stuart School of Management, San Francisco State University’s School of World Business, and other colleges. He has also served as an Assistant National Bank Examiner for the U.S. Treasury Department and as an international trade consultant to Bolting Manufacturing Co., Ltd., Mumbai, India.

Dr. Kapoor is known internationally as a coauthor of several textbooks in Business and Personal Finance including Foundations of Business, 5th edition (Cengage Learning); has served as a content consultant for two popular national television series “The Business File: An Introduction to Business,” and “Dollars & Sense: Personal Finance for the 21st Century”; and developed two full-length audio courses in business and personal finance. He has been quoted in many national newspapers and magazines, including USA Today, U.S. News & World Report, the Chicago Sun-Times, Crain’s Small Business, the Chicago Tribune, and other publications.

Dr. Kapoor has traveled around the world and has studied business practices in capitalist, socialist, and communist countries.

About the Authors

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The quality of this book and its supplements program has been helped immensely by the insightful and rich comments of a special set of instructors. Their thoughtful and helpful comments had real impact in shaping the final product. In particular, we wish to thank:

Acknowledgments

John Adams, San Diego Mesa College

Ken Anglin, Minnesota State University, Mankato

Ellen A. Benowitz, Mercer County Community College

Michael Bento, Owens Community College

Patricia Bernson, County College of Morris

Laura Bulas, Central Community College, NE

Brennan Carr, Long Beach City College

Paul Coakley, The Community College of Baltimore County

Jean Condon, Mid-Plains Community College

Mary Cooke, Surry Community College

Dean Danielson, San Joaquin Delta College

John Donnellan, Holyoke Community College

Gary Donnelly, Casper College

Karen Edwards, Chemeketa Community College

Donna K. Fisher, Georgia Southern University

Charles R. Foley, Columbus State Community College

Mark Fox, Indiana University South Bend

Connie Golden, Lakeland Community College

Karen Gore, Ivy Tech Community College - Evansville

Carol Gottuso, Metropolitan Community College

John Guess, Delgado Community College

Frank Harber, Indian River State College

Linda Hefferin, Elgin Community College

Tom Hendricks, Oakland Community College

Eileen Kearney, Montgomery Community College

Anita Kelley, Harold Washington College

Mary Beth Klinger, College of Southern Maryland

Natasha Lindsey, University of North Alabama

Robert Lupton, Central Washington University

John Mago, Anoka Ramsey Community College

Rebecca J. Mahr, Western Illinois University

Pamela G. McElligott, St. Louis Community College Meramec

Myke McMullen, Long Beach City College

Carol Miller, Community College of Denver

Jadeip Motwani, Grand Valley State

Mark Nagel, Normandale Community College

Dyan Pease, Sacramento City College

Jeffrey D. Penley, Catawba Valley Community College

Angela J. Rabatin, Prince George’s Community College

Anthony Racka, Oakland Community College— Auburn Hills Campus

Dwight Riley, Richland College

Kim Rocha, Barton College

Carol Rowey, Community College of Rhode Island

Christy Shell, Houston Community College

Cindy Simerly, Lakeland Community College

Yolanda I. Smith, Northern Virginia Community College

Gail South, Montgomery College

Rieann Spence-Gale, Northern Virginia Comm. College—Alexandria Campus

Kurt Stanberry, University of Houston, Downtown

John Striebich, Monroe Community College

Keith Taylor, Lansing Community College

Tricia Troyer, Waubonsee Community College

Leo Trudel, University of Maine - Fort Kent

Randy Waterman, Richland College

Leslie Wiletzky, Pierce College - Ft. Steilacoom

Anne Williams, Gateway Community College

xiii

We also wish to acknowledge Colette Wolfson and Linda Hoffman of Ivy Tech Community College for their contributions to the Instructor’s Resource Manual. We thank the Dallas Center for Distance Learning Solutions for their Telecourse partnership and for providing the related student and instructor materials. Finally, we thank the following people for their professional and technical assistance: Marian Wood, Elisa Reyna, Carolyn Phillips, MacKenzie Staples, Gwyn Walters, Laurie Marshall, Clarissa Means, Theresa Kapoor, David Pierce, Kathryn Thumme, Karen Tucker, and Dave Kapoor.

Many talented professionals at Cengage Learning have contributed to the development of Foundations of Business, 5e. We are especially grateful to Erin Joyner, Jason Fremder, Heather Mooney, Kristen Hurd, Megan Fischer, Jamie Mack, Linda May, Megan Guiliani, and Jeff Tousignant. Their inspiration, patience, support, and friendship are invaluable.

W. M. P.

R. J. H.

J. R. K.

xiv Acknowledgments

Engaged with you. www.cengage.com

Source Code: 14M-AA0105

Tap into engagement MindTap empowers you to produce your best work—consistently.

MindTap is designed to help you master the material. Interactive videos, animations, and activities create a learning path designed by your instructor to guide you through the course and focus on what’s important.

Tap into more info at: www.cengage.com/mindtap

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MindTap helps you stay organized and efficient by giving you the study tools to master the material.

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with information that shows where you stand at all times—both individually and compared to the highest performers in class.

MindTap delivers real-world activities and assignments

that will help you in your academic life as well as your career.

Flashcards

readspeaker

progress app

MyNotes & highlights

selF QuizziNg & practice

Learning Objectives What you will be able to do once you complete

this chapter:

1-1 Discuss what you must do to be successful in the world of business. 1-2 Define business and identify potential risks and rewards. 1-3 Define economics and describe the two types of economic systems: capitalism

and command economy.

1-4 Identify the ways to measure economic performance.

1-5 Examine the different phases in the typical business cycle. 1-6 Outline the four types of competition.

1-7 Summarize the factors that affect the business environment and the challenges that American businesses will encounter in the future.

Exploring the World of Business and Economics

ChaptEr

1 Why Should You Care? Studying business will help you

to choose a career, become a

successful employee or manager,

start your own business, and

become a more informed consumer

and better investor.

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Chapter 1 Exploring the World of Business and Economics 3

Wow! What a challenging world we live in. Just for a moment, think about how you would answer the question below.

In the future, which of the following is the most serious problem facing Americans?

a. Government spending and the national debt. b. The high unemployment rate. c. A volatile stock market. d. Social unrest. e. An unstable economy and global business environment.

Unfortunately there is no one best answer because all of the above options are serious problems facing you, American businesses, and the nation. Ask almost anyone, and they will tell you that they are worried about at least one or more of the above problems. At the time of the publication of your text, there are signs of economic improvement. The unemployment rate has dropped, consumers are spending more money, gasoline and the price of crude oil have decreased, and the stock market has reached all-time highs. The fact is that people are more optimistic about their future and the future of our nation. And yet, remember that back in 2008 the nation was beginning one of the worst recession periods since the Great Depression in 1929. Simply put, the economic picture is brighter, but individuals, business leaders, and politicians, still worry about their future and the future of the nation.

Visa’s Vast Global payments Empire

Handling the burgeoning volume of payments made via credit cards, debit cards, and mobile devices is the backbone of visa’s vast payments empire. although cash remains popular in many parts of the world, the california-based company processes 96 bil- lion transactions every year for consumers and businesses in 200 countries.

visa’s roots go back to 1958, when it was founded as Bankamericard, the credit card division of Bank of america. During the 1970s, the division became independent and was renamed visa and became an umbrella for a series of payment-processing net- works owned by banks in different regions. In 2007, these far-flung networks were united under the visa name to form a single busi- ness that today is a publicly-traded corporation serving more than 14,000 banks and 2.3 billion cardholders worldwide. Its competition includes mastercard—the second-largest payment network on the planet—and non-credit payment alternatives such as PayPal and Bitcoin.

During peak purchasing periods—such as the yearend holiday shopping season—visa can process as many as 56,000 transac- tions per second. most of these in-store and online payments are

made by customers using plastic. However, in today’s fast-moving economy, a growing number of payments are digital-only, made by customers using smart phones or tablet computers. visa has been innovating to serve these customers by offering services such as visa checkout, a digital wallet that powers payments made by mobile devices, and is part of the network that enables apple Pay transactions via iPhones.

Looking ahead, visa sees a lot of opportunity to expand within countries where cash has traditionally been king. By partnering with mobile-network firms throughout asia, the company is setting the stage for a huge increase in digital payments made by customers on the go. visa is also distributing tiny devices that turn a small business owner’s smart phone into a mobile checkout terminal. so whether the small business is in Hanoi or Hartford, visa makes it easy to authorize and complete the purchase within seconds.1

Did You Know? Visa earns $12 billion in revenue every year and has its brand name on 2.3 billion credit and debit cards issued worldwide.

InsIde BusIness

4 Part 1 The Environment of Business

Regardless of the current state of the economy, keep in mind that our economy continues to adapt and change to meet the challenges of an ever-changing world and to provide opportunities for those who want to achieve success. Our economic system also provides an amazing amount of freedom that allows businesses like Visa—the company profiled in the Inside Business opening case for this chapter—to adapt to changing business environments. To meet increased demand for its payment services—credit cards, debit cards, and mobile payment systems—Visa and its employees were able to introduce new products and services, earn a profit, and sell stock to the general public.

Within certain limits, imposed mainly to ensure public safety, the owners of a business can produce any legal good or service they choose and attempt to sell it at the price they set. This system of business, in which individuals decide what to produce, how to produce it, and at what price to sell it, is called free enterprise. Our free-enterprise system ensures, for example, that Amazon.com can sell everything from televisions, toys, and tools to computers, cameras, and clothing. Our system gives Amazon’s owners and stockholders the right to make a profit from the company’s success. It gives Amazon’s management the right to compete with bookstore rival Barnes & Noble and electronics giant Sony. It also gives you—the consumer—the right to choose.

In this chapter, we look briefly at what business is and how it became that way. First, we discuss what you must do to be successful in the world of business and explore some important reasons for studying business. Next, we define business, noting how business organizations satisfy their customers’ needs and earn profits. Then we examine how capitalism and command economies answer four basic economic questions. Next, our focus shifts to how the nations of the world measure economic performance, the phases in a typical business cycle, and the four types of competitive situations. Then we look at the events that helped shape today’s business system, the current business environment, and the challenges that businesses face.

1-1 YOur Future in the Changing WOrLd OF Business The key word in this heading is changing. When faced with both economic problems and increasing competition not only from firms in the United States but also from international firms located in other parts of the world, employees and managers began to ask the question: What do we do now? Although this is a fair question, it is difficult to answer. Certainly, for a college student taking business courses or an employee just starting a career, the question is even more difficult to answer. Yet there are still opportunities out there for people who are willing to work hard, continue to learn, and possess the ability to adapt to change. Let’s begin this course with three basic concepts.

• What do you want? • Why do you want it? • Write it down!

During a segment on a national television talk show, Joe Dudley, one of the world’s most respected black business owners, gave the preceding advice to anyone who wanted to succeed in business. His advice can help you achieve success. What is so amazing about Dudley’s success is that he started a manufacturing business in his own kitchen, with his wife and children serving as the new firm’s only employees. He went on to develop his own line of hair-care and cosmetic products sold directly to cosmetologists, barbers, beauty schools, and consumers in the United States and 18 foreign countries. Today, Mr. Dudley has a multimillion-dollar empire—one of the most successful minority-owned companies in the nation. He is not only a successful business owner but also a winner of the Horatio Alger Award—an award given to outstanding individuals who have succeeded in the face of adversity.2

free enterprise the system of business in which individuals are free to decide what to produce, how to produce it, and at what price to sell it

Learning Objective

1-1Discuss what you must do to be successful in the world of business.

Chapter 1 Exploring the World of Business and Economics 5

Although many people would say that Joe Dudley was just lucky or happened to be in the right place at the right time, the truth is that he became a success because he had a dream and worked hard to turn his dream into a reality. He would be the first to tell you that you have the same opportunities that he had. According to Mr. Dudley, “Success is a journey, not just a destination.”3

Whether you want to obtain part-time employment to pay college and living expenses, begin your career as a full-time employee, or start a business, you must bring something to the table that makes you different from the next person. Employers and our economic system are more demanding than ever before. Ask yourself: What can I do that will make employers want to pay me a salary? What skills do I have that employers need? With these two questions in mind, we begin the next section with another basic question: Why study business?

1-1a Why Study Business? The potential benefits of higher education are enormous. To begin with, there are economic benefits. Over their lifetimes, college graduates on average earn much more than high school graduates. Although lifetime earnings are substantially higher for college graduates, so are annual income amounts (see Figure 1-1). In addition to higher income, you will find at least five compelling reasons for studying business.

For hElp in ChooSinG a CarEEr What do you want to do with the rest of your life? Like many people, you may find it a difficult question to answer. This business course will introduce you to a wide array of employment opportunities. In private enterprise, these range from small, local businesses owned by one individual to large companies such as American Express and Marriott International that are owned by thousands of stockholders. There are also employment opportunities with federal, state, county, and local governments and with charitable organizations such as the Red Cross and Save the Children. For help in deciding which career might be right for you, read Appendix B: Careers in Business, which appears on the text website.

In addition to career information in Appendix B, a number of additional websites provide information about career development. For more information, visit the following sites:

• Career Builder at www.careerbuilder.com • Career One Stop at www.careeronestop.org • Monster at www.monster.com

To click your career into high gear, you can also use online networking to advance your career. Websites like Facebook, Twitter, LinkedIn, and other social media sites can help you locate job openings and help prospective employers to

Figure 1-1 Who Makes The Most Money?

Education makes a difference. Dollar amounts represent the average annual salary for full-time workers.

High school graduate

Some college, no degree

Associate’s degree

Bachelor’s degree or more

$52,728

$64,071

$69,688

$112,448

source: “educational attainment of Householder—Households with Householder 25 Years old and over by median and mean Income,” the U.s. census Bureau at www.census.gov (accessed January 12, 2015).

6 Part 1 The Environment of Business

find you. To make the most of online networking, begin by identifying and joining sites where you can connect with potential employers, former classmates, and others who may have or may hear of job openings. Next, be sure your online profiles, photographs, and posts communicate your abilities and interests. Finally, be ready to respond quickly when you spot a job opening.

One thing to remember as you think about what your ideal career might be is that a person’s choice of a career ultimately is just a reflection of what he or she values and holds most important. What will give one individual personal satisfaction may not satisfy another. For example, one person may dream of a career as a corporate executive and becoming a millionaire before the age of 30. Another may choose a career that has more modest monetary rewards but that provides the opportunity to help others. What you choose to do with your life will be based on what you feel is most important. And you are a very important part of that decision.

to BE a SuCCESSFul EmployEE Deciding on the type of career you want is only the first step. To get a job in your chosen field and to be successful at it, you will have to develop a plan, or a road map, that ensures that you have the skills and knowledge the job requires. You will also be expected to have the ability to work well with many types of people in a culturally diverse workforce. Cultural (or workplace) diversity refers to the differences among people in a workforce owing to race, ethnicity, and gender.

This course, your instructor, and all of the resources available at your college or university can help you to acquire the skills and knowledge you will need for a successful career. But do not underestimate your part in making your dream a reality. In addition to the job-related skills and knowledge you’ll need to be successful in a specific career, employers will also look for the following characteristics when hiring a new employee or promoting an existing employee:

• Honesty and integrity • Willingness to work hard • Dependability • Time management skills

Cultural (or workplace) diversity differences among people in a workforce owing to race, ethnicity, and gender

What do you want to do with the rest of your life? While some people know exactly what they want to do in life, many people have trouble choosing a career. Often it helps to begin a career search by asking “What do I value?” or “What’s really important to me?” Ultimately, what you choose to do with your life is based on what you feel is most important. And you may be the most important part of the decision.

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Chapter 1 Exploring the World of Business and Economics 7

• Self-confidence • Motivation • Willingness to learn • Communication skills • Professionalism

Employers will also be interested in any work experience you may have had in cooperative work/school programs, during summer vacations, or in part-time jobs during the school year. In addition to job skills and knowledge, experience—even part- time work experience—can make a difference when it is time to apply for the job you really want.

to improVE your manaGEmEnt SkillS Many employees want to become managers because managers often receive higher salaries and can earn promotions within an organization. Although management obviously can be a rewarding career, what is not so obvious is the amount of time and hard work needed to achieve the higher salaries and promotions. For starters, employers expect more from managers and supervisors than ever before. Typically, the heavy workload requires that managers work long hours, and most do not get paid overtime. They also face increased problems created by an unstable economy, increased global competition, the quest for improved quality, and the need for efficient use of the firm’s resources.

To be an effective manager, managers must be able to perform four basic management functions: planning, organizing, leading and motivating, and controlling. All four topics are discussed in Chapter 6, Understanding the Management Process. To successfully perform these management functions, managers must also possess four very important skills.

• Interpersonal skills—The ability to deal effectively with individual employees, other managers within the firm, and people outside the firm.

• Analytic skills—The ability to identify problems correctly, generate reasonable alternatives, and select the “best” alternatives to solve problems.

• Technical skills—The skill required to accomplish a specific kind of work being done in an organization. Although managers may not actually perform the technical tasks, they should be able to train employees and answer technical questions.

• Conceptual skills—The ability to think in abstract terms in order to see the “big picture.” Conceptual skills help managers understand how the various parts of an organization or an idea can fit together.

In addition to the four skills just described, a successful manager will need many of the same characteristics that an employee needs to be successful.

to Start your oWn BuSinESS Some people prefer to work for themselves, and they open their own businesses. To be successful, business owners must possess

Be the employee you’d like to hire!

Think about what you’d look for if you were making hiring decisions, and strive to become that kind of employee. What characteristics, skills, and knowledge would make you an outstanding employee? Whether you expect to work for a big corporation, small business, government agency, or nonprofit group, understanding the basics of business will add to your attractiveness as an employee.

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8 Part 1 The Environment of Business

many of the same characteristics that successful employees and managers have, and they must be willing to work hard and put in long hours.

It also helps if your small business can provide a product or service that customers want. For example, Nick D’Aloisio, who lives in England, created his first app when he was 12. A few apps later he hit upon a new idea that propelled him into the major leagues of the app business world. This new app was based on a simple need: A way to summarize the information contained on a web page without having to read the entire page. To solve this problem and meet the needs of potential customers, D’Aloisio developed an algorithm that summarizes the key points in a few words. The app was called Summly and was sold on Apple’s App website. Eventually, Yahoo! became interested in Summly and Nick D’Aloisio. The search engine purchased the app and asked D’Aloisio to develop a related product called Yahoo! News Digest which debuted in 2014. Was he just lucky? No, the secret of his success was that he met the needs of customers who were willing to buy the app.4

Unfortunately, many business firms fail: Approximately 70 percent of small businesses fail within the first ten years. Typical reasons for business failures include undercapitalization (not enough money), poor business location, poor customer service, unqualified or untrained employees, fraud, lack of a proper business plan, and failure to seek outside professional help. The material in Chapter 5, Small Business, Entrepreneurship, and Franchises, and selected topics and examples throughout this text will help you to decide whether you want to open your own business. The material in this course will also help you to overcome many of these problems.

to BEComE a BEttEr inFormEd ConSumEr and inVEStor The world of business surrounds us. You cannot buy a home, a new Ford Fusion Hybrid from the local Ford dealer, a pair of jeans at Gap Inc., or a hot dog from a street vendor without entering into a business transaction. Because you no doubt will engage in business transactions almost every day of your life, one very good reason for studying business is to become a more fully informed consumer.

Many people also rely on a basic understanding of business to help them to invest for the future. According to Julie Stav, Hispanic stockbroker-turned-author/ radio personality, “Take $25, add to it drive plus determination and then watch it multiply into an empire.”5 The author of Get Your Share and other personal finance help books believes that it is important to learn the basics about the economy and business, stocks, mutual funds, and other alternatives before investing your money. She also believes that it is never too early to start investing. Although this is an obvious conclusion, just dreaming of being rich does not make it happen. In fact, like many facets of life, it takes planning and determination to establish the type of investment program that will help you to accomplish your financial goals.

1-1b Special note to Business Students It is important to begin reading this text with one thing in mind: This business course does not have to be difficult. We have done everything possible to eliminate the problems that you encounter in a typical class. All of the features in each chapter have been evaluated and recommended by instructors with years of teaching experience. In addition, business students—just like you—were asked to critique each chapter component. Based on this feedback, the text includes the following features:

• Learning objectives appear at the beginning of each chapter. • Inside Business is a chapter-opening case that highlights how successful, real-

world companies do business on a day-to-day basis. • Margin notes are used throughout a chapter to reinforce both learning objectives

and key terms. • Boxed features in each chapter highlight how both employees and entrepreneurs

can be ethical and successful. Topics discussed in the boxed features include career success, entrepreneurial success, ethics, and social media.

Chapter 1 Exploring the World of Business and Economics 9

• A Personal App in each chapter provides special student-centered examples and explanations that help you immediately grasp and retain the material.

• Concept Checks at the end of each major section within a chapter help you test your understanding of the major issues just discussed.

• End-of-chapter materials provide a chapter summary, a list of key terms, discussion questions, and a video case about a successful, real-world company.

• The last section of every chapter is entitled Building Skills for Career Success and includes exercises devoted to enhancing your social media skills, building team skills, and researching different careers.

• End-of-part materials provide a continuing video case about Graeter’s Ice Cream, a company that operates a chain of retail outlets in the Cincinnati, Ohio, area and sells to Kroger Stores and other retailers throughout the country. Also, at the end of each major part is an exercise designed to help you to develop the components that are included in a typical business plan.

In addition to the text, a number of student supplements will help you to explore the world of business. We are especially proud of the website that accompanies this edition. There, you will find online study aids, such as interactive Test Yourself quizzes, key terms and definitions, student PowerPoint slides, crossword puzzles, and links to the videos for each chapter. If you want to take a look at the Internet support materials available for this edition of Foundations of Business,

1. Go to www.cengagebrain.com. 2. At the CengageBrain.com home page, enter the ISBN for your book (located

on the back cover of your book) in the search box at the top of the page. This will take you to the textbook website where companion resources can be found.

As authors, we want you to be successful. We know that your time is valuable and that your schedule is crowded with many different activities. We also appreciate the fact that textbooks are expensive. Therefore, we want you to use this text and get the most out of your investment. To help you get off to a good start, a number of suggestions for developing effective study skills and using this text are provided in Table 1-1.

1. Prepare before you go to class Early preparation is the key to success in many of life’s activities. Certainly, early preparation for this course can help you to participate in class, ask questions, and improve your performance on examinations.

2. Read the chapter Although it may seem like an obvious suggestion, many students never take the time to really read the material. Find a quiet space where there are no distractions, and invest enough time to become a “content expert.”

3. Underline or highlight important concepts

Make this text yours. Do not be afraid to write on the pages of your text or highlight important material. When it is time to review for exams, it is much easier to review material if you have identified important concepts.

4. Take notes While reading, take the time to jot down important points and summarize concepts in your own words. Also, take notes in class.

5. Apply the concepts Learning is always easier if you can apply the content to your real-life situation. Think about how you could use the material either now or in the future.

6. Practice critical thinking

Test the material in the text. Do the concepts make sense? To build critical-thinking skills, answer the discussion questions and the questions that accompany the cases at the end of each chapter. Also, many of the exercises in the Building Skills for Career Success feature at the end of each chapter require critical thinking.

7. Prepare for the examinations Allow enough time to review the material before the examinations. Check out the concept check questions at the end of each major section in the chapter and the summary at the end of the chapter. Then use the resources on the text website.

taBLe 1-1 Seven Ways to Use This Text and Its Resources

10 Part 1 The Environment of Business

Because a text should always be evaluated by the students and professors who use it, we would welcome and sincerely appreciate your comments and suggestions. Please feel free to contact us by using one of the following e-mail addresses:

Bill Pride: [email protected] Bob Hughes: [email protected] Jack Kapoor: [email protected]

1-2 Business: a deFinitiOn Business is the organized effort of individuals to produce and sell, for a profit, the goods and services that satisfy society’s needs. The general term business refers to all such efforts within a society (as in “American business”). However, a business is a particular organization, such as Kraft Foods, Inc., or Cracker Barrel Old Country Stores. To be successful, a business must perform three activities. It must be organized, it must satisfy needs, and it must earn a profit.

1-2a the organized Effort of individuals For a business to be organized, it must combine four kinds of resources: material, human, financial, and informational. Material resources include the raw materials used in manufacturing processes as well as buildings and machinery. For example, Mrs. Fields Cookies needs flour, sugar, butter, eggs, and other raw materials to produce the food products it sells worldwide. In addition, this Colorado-based company needs human, financial, and informational resources. Human resources are the people who furnish their labor to the business in return for wages. The financial resource is the money required to pay employees, purchase materials, and generally keep the business operating. Information is the resource that tells the managers of the business how effectively the other three resources are being combined and used (see Figure 1-2).

Today, businesses are usually organized as one of three specific types. Service businesses produce services, such as haircuts, legal advice, or tax preparation. H&R Block provides tax preparation, retail banking, and software and digital products to both businesses and consumers in the United States, Canada, and Australia. Manufacturing businesses process various materials into tangible goods, such as delivery trucks, towels, or computers. Intel, for example, produces computer chips that, in turn, are sold to companies that manufacture computers. Finally, some firms called marketing intermediaries buy products from manufacturers and then resell them. Sony Corporation is a manufacturer that produces stereo equipment, televisions, and other electronic products. These products may be sold to a marketing intermediary—often referred to as a retailer—such as Best Buy or Walmart, which then resells the manufactured goods to consumers in their retail stores.

Learning Objective

1-2 Define business and identify potential risks and rewards.

business the organized effort of individuals to produce and sell, for a profit, the goods and services that satisfy society’s needs

Concept Check ✓✓ What reasons would you give if you were advising someone to study business?

✓✓ What factors affect a person’s choice of careers?

✓✓ once you have a job, what steps can you take to be successful?

Figure 1-2 Combining Resources

A business must combine all four resources effectively to be successful.

Human resources

Informational resources

BUSINESS

Material resources

Financial resources

Chapter 1 Exploring the World of Business and Economics 11

While most people think of retailers as the “store around the corner,” today many consumers prefer to shop online. To take advantage of the opportunities to sell goods and services online, there are retailers that exist only on the Internet and more traditional business firms that sell goods and services in both their brick-and-mortar stores and online. For example, Zappos, a highly successful Internet retailer, only sells merchandise online. Macy’s, on the other hand, sells merchandise in both its stores and online. According to market research, the number of people shopping online and using e-business to shop for goods and services continues to grow each year. For our purposes, e-business can be defined as the organized effort of individuals to produce and sell for a profit, the goods and services that satisfy society’s needs through the facilities available on the Internet. e-Business—a topic we will continue to explore throughout this text—has become an accepted method of conducting business and a way for businesses to increase sales and profits and reduce expenses.

1-2b Satisfying needs The ultimate objective of every firm must be to satisfy the needs of its customers. People generally do not buy goods and services simply to own them; they buy goods and services to satisfy particular needs. Some of us may feel that the need for transportation is best satisfied by an air-conditioned BMW with navigation system, stereo system, heated and cooled seats, automatic transmission, power windows, and remote-control side mirrors. Others may believe that a Chevrolet Sonic with a stick shift will do just fine. Both products are available to those who want them, along with a wide variety of other products that satisfy the need for transportation.

When firms lose sight of their customers’ needs, they are likely to find the going rough. However, when businesses understand their customers’ needs and work to satisfy those needs, they are usually successful. Back in 1962, Sam Walton opened his first discount store in Rogers, Arkansas. Although the original store was quite different from the Walmart Superstores you see today, the basic ideas of providing customer service and offering goods that satisfied needs at low prices are part of the reason why this firm has grown to become the largest retailer in the world.

e-business the organized effort of individuals to produce and sell for a profit, the goods and services that satisfy society’s needs through the facilities available on the Internet.

Some companies just do it right! Starbucks, a company that was started in 1971, has established a history of meeting the needs of its customers. Over the years, the company has grown to be the largest coffeehouse in the world with 20,000 stores in 65 countries. Perhaps the reason for its success is its mission to inspire and nurture the human spirit—one person, one cup, and one neighborhood at a time.

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Concept Check ✓✓ Describe the four resources that must be combined to organize and operate a business.

✓✓ What is the difference between a manufacturing business, a service business, and a marketing intermediary?

✓✓ explain the relationship among profit, business risk, and the satisfaction of customers’ needs.

1-2c Business profit A business receives money (sales revenue) from its customers in exchange for goods or services. It must also pay out money to cover the expenses involved in doing business. If the firm’s sales revenues are greater than its expenses, it has earned a profit. More specifically, as shown in Figure 1-3, profit is what remains after all business expenses have been deducted from sales revenue.

A negative profit, which results when a firm’s expenses are greater than its sales revenue, is called a loss. A business cannot continue to operate at a loss for an indefinite period of time. Management and employees must find some way to increase sales revenues and reduce expenses to return to profitability. If some specific actions are not taken to eliminate losses, a firm may be forced to close its doors or file for bankruptcy protection. Although many people—especially stockholders and business owners—believe that profit is literally the bottom line or most important goal for a business, many stakeholders may be just as concerned about a firm’s social responsibility record. The term stakeholders is used to describe all the different people or groups of people who are affected by an organization’s policies, decisions, and activities. Many corporations, for example, are careful to point out their efforts to sustain the planet, participate in the green ecological movement, and help people to live better lives in an annual social responsibility report. In its latest social responsibility report, General Mills describes how it contributes $153 million each year to a wide variety of causes, including support for programs that feed the hungry and nonprofit organizations, schools, and communities in the United States and around the globe.6

The profit earned by a business becomes the property of its owners. Thus, in one sense, profit is the reward business owners receive for producing goods and services that customers want. Profit is also the payment that business owners receive for assuming the considerable risks of business ownership. One of these is the risk of not being paid. Everyone else—employees, suppliers, and lenders—must be paid before the owners.

A second risk that owners undertake is the risk of losing whatever they have invested into the business. A business that cannot earn a profit is very likely to fail, in which case the owners lose whatever money, effort, and time they have invested.

To satisfy society’s needs and make a profit, a business must operate within the parameters of a nation’s economic system. In the next section, we define economics and describe two different types of economic systems.

1-3 tYPes OF eCOnOmiC sYstems Economics is the study of how wealth is created and distributed. By wealth, we mean “anything of value,” including the goods and services produced and sold by business. How wealth is distributed simply means “who gets what.” Experts often use econom- ics to explain the choices we make and how these choices change as we cope with

profit what remains after all business expenses have been deducted from sales revenue

stakeholders all the different people or groups of people who are affected by an organization’s policies, decisions, and activities

Learning Objective

1-3Define economics and describe the two types of economic systems: capitalism and command economy.

economics the study of how wealth is created and distributed

Figure 1-3 The Relationship Between Sales Revenue and Profit

Profit is what remains after all business expenses have been deducted from sales revenue.

Expenses

Sales revenue

Pro�t

Chapter 1 Exploring the World of Business and Economics 13

the demands of everyday life. In simple terms, indi- viduals, businesses, governments, and society must make decisions that reflect what is important to each group at a particular time. For example, suppose you want to take a weekend trip to some exotic vacation spot, and you also want to begin an investment pro- gram. Because of your financial resources, though, you cannot do both, so you must decide what is most important. Business firms, governments, and to some extent society face the same types of decisions. Each group must deal with scarcity when making impor- tant decisions. In this case, scarcity means “lack of resources”—money, time, natural resources, and so on—that are needed to satisfy a want or need.

Today, experts often study economic problems from two different perspectives: microeconomics and macroeconomics. Microeconomics is the study of the decisions made by individuals and businesses. Microeconomics, for example, examines how the prices of homes affect the number of homes individu- als will buy. On the other hand, macroeconomics is the study of the national economy and the global economy. Macroeconomics examines the economic effect of national income, unemployment, inflation, taxes, government spending, interest rates, and similar factors on a nation and society.

The decisions that individuals, business firms, government, and society make, and the way in which people deal with the creation and distribution of wealth determine the kind of economic system, or economy, that a nation has.

Over the years, the economic systems of the world have differed in essentially two ways: (1) the ownership of the factors of production and (2) how they answer four basic economic questions that direct a nation’s economic activity.

Factors of production are the resources used to produce goods and services. There are four such factors:

• Land and natural resources—elements that can be used in the production process to make appliances, automobiles, and other products. Typical examples include crude oil, forests, minerals, land, water, and even air.

• Labor—the time and effort that we use to produce goods and services. It includes human resources such as managers and employees.

• Capital—the money, facilities, equipment, and machines used in the operation of organizations. Although most people think of capital as just money, it can also be the manufacturing equipment in a Pepperidge Farm production facility or a computer used in the corporate offices of McDonald’s.

• Entrepreneurship—the activity that organizes land and natural resources, labor, and capital. It is the willingness to take risks and the knowledge and ability to use the other factors of production efficiently. An entrepreneur is a person who risks his or her time, effort, and money to start and operate a business.

A nation’s economic system significantly affects all the economic activities of individuals, businesses, government, and society within a country. This far-reaching impact becomes more apparent when we consider that a country’s economic system determines how the factors of production are used to meet the needs of society. Today, two different economic systems exist: capitalism and command economies. The way

microeconomics the study of the decisions made by individuals and businesses

macroeconomics the study of the national economy and the global economy

economy the way in which people deal with the creation and distribution of wealth

factors of production resources used to produce goods and services

entrepreneur a person who risks time, effort, and money to start and operate a business

What does it take to be a successful entrepreneur? Although some people think the life of an entrepreneur is easy, think again. To be successful, entrepreneurs—often referred to as risk takers—must work hard and put in long hours. And they must have an idea for a product or service that has the potential to be successful. Then they must be able to create a plan to turn the idea into a successful product or service.

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each system answers the four basic economic questions listed here determines a nation’s economy.

1. What goods and services—and how much of each—will be produced? 2. How will these goods and services be produced? 3. For whom will these goods and services be produced? 4. Who owns and who controls the major factors of production?

1-3a Capitalism Capitalism is an economic system in which individuals own and operate the majority of businesses that provide goods and services. Capitalism stems from the theories of the Scottish economist Adam Smith. In his book Wealth of Nations, published in 1776, Smith argued that a society’s interests are best served when the individuals within that society are allowed to pursue their own self-interest. According to Smith, when individuals act to improve their own fortunes, they indirectly promote the good of their community and the people in that community. Smith went on to call this concept the “invisible hand.” The invisible hand is a term created by Adam Smith to describe how an individual’s own personal gain benefits others and a nation’s economy. For example, the only way a small-business owner who produces shoes can increase personal wealth is to sell shoes to customers. To become even more prosperous, the small-business owner must hire workers to produce even more shoes. According to the invisible hand, people in the small-business owner’s community not only would have shoes but also would have jobs working for the shoemaker. Thus, the success of people in the community and, to some extent, the nation’s economy are tied indirectly to the success of the small-business owner.

Adam Smith’s capitalism is based on the following fundamental issues—also see Figure 1-4.

1. The creation of wealth is the concern of private individuals, not the government. 2. Individuals must own private property and the resources used to create wealth. 3. Economic freedom ensures the existence of competitive markets that allow both

sellers and buyers to enter and leave the market as they choose.

capitalism an economic system in which individuals own and operate the majority of businesses that provide goods and services

invisible hand a term created by Adam Smith to describe how an individual’s personal gain benefits others and a nation’s economy

New energy from an old source: The wind. To protect the environment and our natural resources as well as to reduce our dependence on oil, many utility companies are developing alternative energy sources such as wind power. Although the price of oil and gasoline has dropped and the production of oil and gas has increased, once developed, wind- energy may actually be cheaper than using oil in the future.

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Chapter 1 Exploring the World of Business and Economics 15

4. The role of government should be limited to providing defense against foreign enemies, ensuring internal order, and furnishing public works and education.

One factor that Smith felt was extremely important was the role of government. He believed that government should act only as rule maker and umpire. The French term laissez-faire describes Smith’s capitalistic system and implies that there should be no government interference in the economy. Loosely translated, this term means “let them do” (as they see fit).

Adam Smith’s laissez-faire capitalism is also based on the concept of a market economy. A market economy (sometimes referred to as a free-market economy) is an economic system in which businesses and individuals decide what to produce and buy, and the market determines prices and quantities sold. In today’s competitive world, a business like Ford Motor Company must decide what type of automobiles it will sell, how the automobiles will be produced, and for whom the automobiles will be produced. You, the consumer, must decide if you will buy a Ford product or an automobile manufactured by another company. Prices are determined by the interaction of consumers and businesses in the marketplace.

1-3b Capitalism in the united States Our economic system is rooted in the laissez-faire capitalism of Adam Smith. However, our real-world economy is not as laissez-faire as Smith would have liked because government participates as more than umpire and rule maker. Our economy is, in fact, a mixed economy, one that exhibits elements of both capitalism and socialism.

market economy an economic system in which businesses and individuals decide what to produce and buy, and the market determines quantities sold and prices

mixed economy an economy that exhibits elements of both capitalism and socialism

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Figure 1-4 Basic Assumptions of Adam Smith’s Laissez-Faire Capitalism

Laissez-Faire Capitalism

Right to economic freedom and freedom to compete

Right to own private property and resources

Right to create wealth

Right to limited government intervention

16 Part 1 The Environment of Business

In a mixed economy, the four basic economic questions discussed at the beginning of this section (what, how, for whom, and who) are answered through the interaction of households, businesses, and governments. The interactions among these three groups are shown in Figure 1-5.

houSEholdS Households, made up of individuals, are the consumers of goods and services as well as owners of some of the factors of production. As resource owners, people should be free to determine how their resources are used and also to enjoy the income, profits, and other benefits derived from ownership of their resources. For example, members of households provide businesses with labor, capital, and other resources. In return, businesses pay wages, rent, and dividends and interest, which households receive as income.

As consumers, household members use their income to purchase the goods and services produced by business. Today, almost 70 percent of our nation’s total production consists of consumer products—goods and services purchased by individuals for personal consumption.7 This means that consumers, as a group, are the biggest customers of American business.

BuSinESSES Like households, businesses are engaged in two different exchanges. They exchange money for natural resources, labor, and capital and use these resources to produce goods and services. Then they exchange their goods and services for sales revenue. This sales revenue, in turn, is exchanged for additional resources, which are used to produce and sell more goods and services.

consumer products goods and services purchased by individuals for personal consumption

Figure 1-5 The Circular Flow in Our Mixed Economy

Our economic system is guided by the interaction of buyers and sellers, with the role of government being taken into account.

BusinessesGovernments Service

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Service

Resource markets

Households

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Wages Rent

Interest

Sa les

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Chapter 1 Exploring the World of Business and Economics 17

Along the way, of course, business owners would like to remove something from the circular flow in the form of profits. When business profits are distributed to business owners, these profits become household income. (Business owners are, after all, members of households.) Household members try to retain some income as savings. But are profits and savings really removed from the flow? Usually not! When the economy is running smoothly, households are willing to invest their savings in businesses. They can do so directly by buying stocks issued by businesses, by purchasing shares in mutual funds that purchase stocks in businesses, or by lending money to businesses. They can also invest indirectly by placing their savings in bank accounts. Banks and other financial institutions then invest these savings as part of their normal business operations. Thus, business profits, too, are retained in the business system, and the circular flow in Figure 1-5 is complete. How, then, does government fit in?

GoVErnmEntS The numerous government services are important but they (1) would either not be produced by private business firms or (2) would be produced only for those who could afford them. Typical services include national defense, police, fire protection, education, and construction of roads and highways. To pay for all these services, governments collect a variety of taxes from households (such as personal income taxes and sales taxes) and from businesses (corporate income taxes).

Figure 1-5 shows this exchange of taxes for government services. It also shows government spending of tax dollars for resources and products required to provide these services.

Actually, with government included, our circular flow looks more like a combination of several flows. In reality, it is. The important point is that together the various flows make up a single unit—a complete economic system that effectively provides answers to the basic economic questions. Simply put, the system works.

1-3c Command Economies A command economy is an economic system in which the government decides what goods and services will be produced, how they will be produced, for whom available goods and services will be produced, and who owns and controls the major factors of production. Today, two types of economic systems—socialism and communism— serve as examples of command economies.

SoCialiSm In a socialist economy, the key industries are owned and controlled by the government. Such industries usually include transportation, utilities, communications, banking, and industries producing important materials such as steel. Land, buildings, and raw materials may also be the property of the state in a socialist economy. Depending on the country, private ownership of smaller businesses is permitted to varying degrees. Usually, people may choose their own occupations, although many work in state-owned industries.

What to produce and how to produce it are determined in accordance with national goals, which are based on projected needs and the availability of resources. The distribution of goods and services—who gets what—is also controlled by the state to the extent that it controls taxes, rents, and wages. Among the professed aims of socialist countries are the equitable distribution of income, the elimination of poverty, and the distribution of social services (such as medical care) to all who

command economy an economic system in which the government decides what goods and services will be produced, how they will be produced, for whom available goods and services will be produced, and who owns and controls the major factors of production

Can a small business compete with Walmart? That’s a tough question to answer. Today, Walmart is recognized as the largest retailer in the world and a tough competitor—especially for small businesses in small towns. The mega retailer’s policy of low prices has enabled it to build an empire of nearly 11,000 stores in 28 countries that serve more than 245 million household members each week.

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need them. The disadvantages of socialism include increased taxation and loss of incentive and motivation for both individuals and business owners.

Today, many of the nations that have been labeled as socialist nations traditionally, including France, Sweden, and India, are transitioning to a free-market economy. Currently, many countries that were once thought of as communist countries are now often referred to as socialist countries. Examples of former communist countries often referred to as socialists (or even capitalists) include most of the nations that were formerly part of the Union of Soviet Socialist Republics, China, and Vietnam.

CommuniSm If Adam Smith was the father of capitalism, Karl Marx was the father of communism. In his writings during the mid-1800s, Marx advocated a classless society whose citizens together owned all economic resources. All workers would then contribute to this communist society according to their ability and would receive benefits according to their need.

Since the breakup of the Soviet Union and economic reforms in China and most of the Eastern European countries, the best remaining examples of communism are North Korea and Cuba. Today, these so-called communist economies seem to practice a strictly controlled kind of socialism. The basic four economic questions are answered through centralized government plans. Emphasis is placed on the production of goods and services the government needs rather than on the needs of consumers, so there are frequent shortages of consumer goods.

1-4 measuring eCOnOmiC PerFOrmanCe Consider for just a moment the following questions: • Is the gross domestic product for the United States increasing or decreasing? • Why is the unemployment rate important? • Are U.S. workers as productive as workers in other countries?

The information needed to answer these questions is easily obtainable from many sources. More important, the answers to these and other questions can be used to gauge the economic health of the nation.

1-4a the importance of productivity in the Global marketplace One way to measure a nation’s economic performance is to assess its productivity. While there are other definitions of productivity, for our purposes, productivity is the average level of output per worker per hour. An increase in productivity results in economic growth because a larger number of goods and services are produced by a given labor force. To see how productivity affects you and the economy, consider the following three questions:

Question: How does productivity growth affect the economy?

Answer: Because of increased productivity, it now takes fewer workers to produce more goods and services. As a result, employers have reduced costs, earned more profits, and sold their products or services for less. Finally, productivity growth helps American business to compete more effectively with other nations in a global, competitive world.

Question: How does a nation improve productivity?

Answer: Reducing costs and enabling employees to work more efficiently are at the core of all attempts to improve productivity. Methods that can be used to increase productivity are discussed in detail in Chapter 8, Producing Quality Goods and Services.

Learning Objective

1-4Identify the ways to measure economic performance.

productivity the average level of output per worker per hour

Concept Check ✓✓ What are the four basic economic questions? How are they answered in a capitalist economy?

✓✓ Describe the four basic assumptions required for a laissez-faire capitalist economy.

✓✓ Why is the american economy called a mixed economy?

✓✓ How does capitalism differ from socialism and communism?

Chapter 1 Exploring the World of Business and Economics 19

Question: Is productivity growth always good?

Answer: Fewer workers producing more goods and services can lead to lower salary expenses for employers and higher unemployment rates for workers. In this case, increased productivity is good for employers but not good for unemployed workers seeking jobs in a very competitive work environment.

1-4b the nation’s Gross domestic product In addition to productivity, a measure called gross domestic product can be used to measure the economic well-being of a nation. Gross domestic product (GDP) is the total dollar value of all goods and services produced by all people within the boundaries of a country during a one-year period. For example, the values of automobiles produced by employees in an American-owned General Motors plant and a Japanese-owned Toyota plant in the United States are both included in the GDP for the United States. The U.S. GDP was $17.6 trillion in 2014.8 (Note: At the time of publication, 2014 was the last year for which statistics were available.)

The GDP figure facilitates comparisons between the United States and other countries because it is the standard used in international guidelines for economic accounting. It is also possible to compare the GDP for one nation over several different time periods. This comparison allows observers to determine the extent to which a nation is experiencing economic growth. For example, government economic experts project the U.S. GDP will grow to $24.1 trillion by the year 2022.9

To make accurate comparisons of the GDP for different years, we must adjust the dollar amounts for inflation. Inflation is a general rise in the level of prices. (The opposite of inflation is deflation.) Deflation is a general decrease in the level of prices. By using inflation-adjusted figures, we are able to measure the real GDP for a nation. In effect, it is now possible to compare the goods and services produced by a nation in constant dollars—dollars that will purchase the same amount of goods and services. Figure 1-6 depicts the GDP of the United States in current dollars

gross domestic product (GDP) the total dollar value of all goods and services produced by all people within the boundaries of a country during a one-year period

deflation a general decrease in the level of prices

inflation a general rise in the level of prices

It takes employee communication and teamwork to improve a company’s productivity. One of the best and fastest ways to improve a company’s productivity is to encourage employees to talk to each other and work in teams. While other methods can be used, the advantage of employees talking and working together is that it is an inexpensive way to improve quality, reduce costs, increase profits, and improve productivity.

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20 Part 1 The Environment of Business

and the real GDP in inflation-adjusted dollars. Note that between 1990 and 2014, America’s real GDP grew from almost $9 trillion to $16.2 trillion.10

1-4c important Economic indicators that measure a nation’s Economy In addition to productivity, GDP, and real GDP, other economic measures exist that can be used to evaluate a nation’s economy. One very important statistic is the unemployment rate. The unemployment rate is the percentage of a nation’s labor force unemployed at any time. Although the unemployment rate for the United States is typically about 4 to 6 percent, it peaked during the recent economic crisis. At the time of publication, the unemployment rate is just under 6 percent. This is an especially important statistic—especially if you are unemployed.

The consumer price index (CPI) is a monthly index that measures the changes in prices of a fixed basket of goods purchased by a typical consumer in an urban area. Goods listed in the CPI include food and beverages, transportation, housing, clothing, medical care, recreation, education, communication, and other goods and services. Economists often use the CPI to determine the effect of inflation on not only the nation’s economy but also individual consumers. Another index is the producer price index. The producer price index (PPI) measures prices that producers receive for their finished goods. Because changes in the PPI reflect price increases or decreases at the wholesale level, the PPI is an accurate predictor of both changes in the CPI and prices that consumers will pay for many everyday necessities in the future.

Some additional economic measures are described in Table 1-2. Like the measures for GDP, real GDP, unemployment rate, and price indexes, these measures can be used to compare one economic statistic over different periods of time.

unemployment rate the percentage of a nation’s labor force unemployed at any time

consumer price index (CPI) a monthly index that measures the changes in prices of a fixed basket of goods purchased by a typical consumer in an urban area

producer price index (PPI) an index that measures prices that producers receive for their finished goods

Concept Check ✓✓ How does an increase in productivity affect business?

✓✓ Define gross domestic product. Why is this economic measure significant?

✓✓ How does inflation affect the prices you pay for goods and services?

✓✓ How is the producer price index related to the consumer price index?

Figure 1-6 GDP in Current Dollars and in Inflation-Adjusted Dollars

The change in GDP and real GDP for the United States from one year to another year can be used to measure economic growth.

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source: U.s. Bureau of economic analysis website at www.bea.gov (accessed December 16, 2014).

Chapter 1 Exploring the World of Business and Economics 21

1-5 the Business CYCLe All industrialized nations of the world seek economic growth, full employment, and price stability. However, a nation’s economy fluctuates rather than grows at a steady pace every year. In fact, if you were to graph the economic growth rate for a country like the United States, it would resemble a roller-coaster ride with peaks (high points) and troughs (low points). These fluctuations are generally referred to as the business cycle, that is, the recurrence of periods of growth and recession in a nation’s economic activity.

At the time of publication, many experts believed that the U.S. economy was showing signs of improvement. Key economic indicators including the gross domestic product, the stock market, and consumer spending have improved, and the cost of energy and the unemployment rate have decreased. And yet, the nation’s unemployment rate is still high and there are concerns about the size of the national debt—a topic described later in this section. There are also concerns about the long- term stability of the U.S. economy and economies of foreign nations around the globe and the political and social unrest throughout the world.

The changes that result from either economic growth or economic downturn affect the amount of products and services that consumers are willing to purchase and, as a result, the amount of products and services produced by business firms. Generally, the business cycle consists of four phases: the peak (sometimes called prosperity), recession, the trough, and recovery (sometimes called expansion).

During the peak period (prosperity), the economy is at its highest point and unemployment is low. Total income is relatively high. As long as the economic outlook remains prosperous, consumers are willing to buy products and services. In fact, businesses often expand and offer new products and services during the peak period to take advantage of consumers’ increased buying power.

Generally, economists define a recession as two or more consecutive three- month periods of decline in a country’s GDP. Because unemployment rises during a recession, total buying power declines. The pessimism that accompanies a recession often stifles both consumer and business spending. As buying power decreases, consumers tend to become more value conscious and reluctant to purchase frivolous or nonessential items. And companies and government at all levels often postpone or go slow on major projects during a recession. In response to a recession, many businesses focus on producing the products and services that provide the most value to their customers.

Economists define a depression as a severe recession that lasts longer than a typical recession and has a larger decline in business activity when compared to a

Learning Objective

1-5Examine the different phases in the typical business cycle.

business cycle the recurrence of periods of growth and recession in a nation’s economic activity

recession two or more consecutive three-month periods of decline in a country’s GDP

depression a severe recession that lasts longer than a typical recession and has a larger decline in business activity when compared to a recession

taBLe 1-2 Common Measures Used to Evaluate a Nation’s Economic Health

Economic Measure Description

1. Balance of trade The total value of a nation’s exports minus the total value of its imports over a specific period of time.

2. Consumer confidence index

A measure of how optimistic or pessimistic consumers are about the nation’s economy. This measure is usually reported on a monthly basis.

3. Corporate profits The total amount of profits made by corporations over selected time periods.

4. Inflation rate An economic statistic that tracks the increase in prices of goods and services over a period of time. This measure is usually reported monthly and calculated on an annual basis.

5. National income The total income earned by various segments of the population, including employees, self-employed individuals, corporations, and other types of income.

6. New housing starts The total number of new homes started during a specific time period.

7. Prime interest rate The lowest interest rate that banks charge their most credit-worthy customers.

22 Part 1 The Environment of Business

recession. A depression is characterized by extremely high unemployment rates, low wages, reduced purchasing power, lack of confidence in the economy, lower stock values, and a general decrease in business activity.

The third phase of the business cycle is the trough. The trough of a recession or depression is the turning point when a nation’s production and employment bottom out and reach their lowest levels. To offset the effects of recession and depression, the federal government uses both monetary and fiscal policies. Monetary policies are the Federal Reserve’s decisions that determine the size of the supply of money in the nation and the level of interest rates. Through fiscal policy, the government can influence the amount of savings and expenditures by altering the tax structure and changing the levels of government spending. For example, during the economic crisis that began in 2008, both the Federal Reserve’s monetary policies (lower interest rates) and the government’s fiscal policies (increased spending) were used to stimulate the economy.

One of the concerns about the government’s recent stimulus programs is the national debt. Although the federal government collects approximately $3 trillion in annual revenues, the government usually spends more than it receives, resulting in a federal deficit. For example, the government had a federal deficit for each year between 2002 and 2014. The total of all federal deficits is called the national debt. Today, the U.S. national debt is $18 trillion or approximately $56,000 for every man, woman, and child in the United States.11

Since World War II, the average business cycle has lasted 69 months, or a little less than six years, from one peak period to the next peak period. During the same time period, the average length of recovery (often referred to as expansion) has been 58 months while the average recession has been 11 months.12 Recovery (or expansion) is the movement of the economy from the trough, when a nation’s production and employment bottom out and reach their lowest levels, to the next peak in a business cycle. Some experts believe that effective use of monetary

monetary policies Federal Reserve’s decisions that determine the size of the supply of money in the nation and the level of interest rates

fiscal policy government influence on the amount of savings and expenditures; accomplished by altering the tax structure and by changing the levels of government spending

federal deficit a shortfall created when the federal government spends more in a fiscal year than it receives

national debt the total of all federal deficits

Career moves and the Business Cycle

Whether you’re at the start of your career or you have entry-level experience and are looking ahead to your next position, keep the business cycle in mind as you plan future career moves. Jobs are more plentiful during the prosperity phase of the business cycle because businesses are booming and they need more employees to keep up with higher demand for goods and services. When employers must compete for talented employees at the peak of the business cycle, they offer higher salaries and more generous benefit packages.

During a recession, however, employers postpone hiring new employees to reduce salary costs in order to cope with stagnant or lower consumer and business spending. Job searches generally take longer, and job applicants face more competition from new graduates, unemployed people, and mid-career employees. Salaries tend to rise slowly during a

recession because employers aren’t competing against each other to hire the best employees.

If your job search takes place during a period of prosperity, you’ll have more choices of industry and employer—and if your skills and experience closely fit an employer’s needs, you’ll be in a stronger position to negotiate compensation. During a recession, experts advise thinking about a lateral move (either with your current employer or at the same level with a new employer) to build your skills, increase your knowledge, and add to your experience. The point is to prepare yourself for a higher-level, higher-paying job by the time the recession is over.

sources: Based on information in Dionissi aliprantis, anne chen, and chris vecchio, “Job search Before and after the great recession,” Federal Reserve Bank of Cleveland, august 12, 2014, www.clevelandfed.org; anna Zernone, “Is a Lateral career move right for You?” Times-Union (Albany, NY), February 21, 2014, www.timesunion.com; nick Inglis, “How to map Your career Path,” U.S. News and World Report, January 23, 2014, http://money.usnews.com.

Career Success

Chapter 1 Exploring the World of Business and Economics 23

and fiscal policies can speed up recovery and reduce the amount of time the economy is in recession. During the recovery stage of a business cycle, high unemployment rates decline, income increases, and both the ability and the willingness to buy rise.

1-6 tYPes OF COmPetitiOn Our capitalist system ensures that individuals and businesses make the decisions about what to produce, how to produce it, and what price to charge for the prod- uct. Mattel, Inc., for example, can introduce new versions of its famous Barbie doll, license the Barbie name, change the doll’s price and method of distribution, and attempt to produce and market Barbie in other countries or over the Internet at www.mattel.com. Our system also allows customers the right to choose between Mattel’s products and those produced by competitors.

As a consumer, you get to choose which products or services you want to buy. Competition like that between Mattel and other toy manufacturers is a necessary and extremely important by-product of capitalism. Business competition is essentially a rivalry among businesses for sales to potential customers. In a capitalistic economy, competition also ensures that a firm will survive only if it serves its customers well by providing products and services that meet needs. Economists recognize four different degrees of competition ranging from ideal, complete competition to no competition at all. These are perfect competition, monopolistic competition, oligopoly, and monopoly. For a quick overview of the different types of competition, including numbers of firms and examples for each type, look at Table 1-3.

1-6a perfect Competition Perfect (or pure) competition is the market situation in which there are many buyers and sellers of a product, and no single buyer or seller is powerful enough to affect the price of that product. As pointed out in Table 1-3, real-world examples of perfect competition are corn, wheat, peanuts, and many agricultural products. For perfect competition to exist, there are five very important concepts.

• We are discussing the market for a single product, such as bushels of wheat. • There are no restrictions on firms entering the industry. • All sellers offer essentially the same product for sale. • All buyers and sellers know everything there is to know about the market

(including, in our example, the prices that all sellers are asking for their wheat).

• The overall market is not affected by the actions of any one buyer or seller.

competition rivalry among businesses for sales to potential customers

perfect (or pure) competition the market situation in which there are many buyers and sellers of a product, and no single buyer or seller is powerful enough to affect the price of that product

Concept Check ✓✓ What are the four phases in the typical business cycle?

✓✓ at the time you are studying the material in this chapter, which phase of the business cycle do you think the U.s. economy is in? Justify your answer.

✓✓ How can the government use monetary policy and fiscal policy to reduce the effects of an economic crisis?

Learning Objective

1-6Outline the four types of competition.

taBLe 1-3 Four Different Types of Competition

The number of firms determines the degree of competition within an industry.

Type of Competition Number of Business Firms or Suppliers Real-World Examples

1. Perfect Many Corn, wheat, peanuts, many agricultural products

2. Monopolistic Many Clothing, shoes

3. Oligopoly Few Automobiles, cereals

4. Monopoly One Software protected by copyright, many local public utilities

24 Part 1 The Environment of Business

When perfect competition exists, every seller should ask the same price that every other seller is asking. Why? Because if one seller wanted 50 cents more for his products than all the others, that seller would not be able to sell a single product. Buyers could—and would—do better by purchasing the same products from the competition. On the other hand, a firm willing to sell below the going price would sell all its products quickly. However, that seller would lose sales revenue (and profit) because buyers are actually willing to pay more.

In perfect competition, then, sellers—and buyers as well—must accept the going price. The price of each product is determined by the actions of all buyers and all sellers together through the forces of supply and demand.

thE BaSiCS oF Supply and dEmand The supply of a particular product is the quantity of the product that producers are willing to sell at each of various prices. Producers are rational people, so we would expect them to offer more of a product for sale at higher prices and to offer less of the product at lower prices, as illustrated by the supply curve in Figure 1-7.

The demand for a particular product is the quantity that buyers are willing to purchase at each of various prices. Buyers, too, are usually rational, so we would expect them—as a group—to buy more of a product when its price is low and to buy less of the product when its price is high, as depicted by the demand curve in Figure 1-7.

thE EquiliBrium, or markEt, priCE There is always one certain price at which the demand for a product is exactly equal to the quantity of that product produced. Suppose that producers are willing to supply two million bushels of wheat at a price of $8 per bushel and that buyers are willing to purchase two million bushels at a price of $8 per bushel. In other words, supply and demand are in balance, or in equilibrium, at the price of $8. Economists call this price the market price. The market price of any product is the price at which the quantity demanded is exactly equal to the quantity supplied.

supply the quantity of a product that producers are willing to sell at each of various prices

demand the quantity of a product that buyers are willing to purchase at each of various prices

market price the price at which the quantity demanded is exactly equal to the quantity supplied

What company uses the slogan “More Saving, More Doing?” For a clue look at the orange store fixtures in this photo. That’s right—the answer is Home Depot. Although it has competition from Lowes, a smaller home improvement store, and local lumber yards and hardware stores, Home Depot is the largest home improvement store in the world with stores in all 50 states, the District of Columbia, Puerto Rico, U.S. Virgin Islands, 10 Canadian provinces, and Mexico.

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Chapter 1 Exploring the World of Business and Economics 25

In theory and in the real world, market prices are affected by anything that affects supply and demand. The demand for wheat, for example, might change if researchers suddenly discovered that it offered a previously unknown health benefit. Then buyers would demand more wheat at every price. Or the supply of wheat might change if new technology permitted the production of greater quantities of wheat from the same amount of acreage. Other changes that can affect competitive prices are shifts in buyer tastes, the development of new products, fluctuations in income owing to inflation or recession, or even changes in the weather that affect the production of wheat.

Perfect competition is quite rare in today’s world. Many real markets, however, are examples of monopolistic competition.

1-6b monopolistic Competition Monopolistic competition is a market situation in which there are many buyers along with a relatively large number of sellers. Real-world examples of products sold in a monopolistically competitive market include clothing, shoes, soaps, furniture, and many consumer items. The various products available in this type of competitive market are very similar in nature, and they are all intended to satisfy the same need. However, each seller attempts to make its product different from the others by providing unique product features, an attention-getting brand name, unique packaging, or services such as free delivery or a lifetime warranty.

Product differentiation is the process of developing and promoting differences between one’s products and all competitive products. It is a fact of life for the producers of many consumer goods, from soaps to clothing to furniture to shoes. A furniture manufacturer such as Thomasville sees what looks like a mob of competitors, all trying to chip away at its share of the market. By differentiating each of its products from all similar products produced by competitors, Thomasville obtains some limited control over the market price of its product.

monopolistic competition a market situation in which there are many buyers along with a relatively large number of sellers who differentiate their products from the products of competitors

product differentiation the process of developing and promoting differences between one’s products and all competitive products

Figure 1-7 Supply Curve and Demand Curve

The interaction of a supply curve and a demand curve is called the equilibrium or market price. This interaction indicates a single price and quantity at which suppliers will sell products and buyers will purchase them.

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26 Part 1 The Environment of Business

meet the teenaged Founder of Fish Flops

When Madison Robinson was 8 years old, she drew colorful fish, starfish, and whales over outlines of flip- flops and called them “Fish Flops.” Her father, Dan Robinson, liked the product idea, so he reserved the FishFlops.com domain name. That initial $10 investment in a website address put the Houston-based Robinson family on the road to a fast-growing fashion business that now rings up more than $1.2 million in yearly retail sales.

At first, Robinson was too busy with his T-shirt business to look into manufacturing possibilities. His daughter kept drawing more sea creatures and refining her idea of fun flip-flops for children that would light up with each step. A few years later, Robinson commissioned product samples, took them to a trade show in Florida, and came home with dozens of orders. Fish Flops was officially in business.

Since the beginning, the teenaged founder has been in charge of product design. She also researches potential retail buyers, attends industry shows, and makes media appearances on behalf of Fish Flops. Early on, she wrote the shoe buyer for Nordstrom—and as a result of that contact, she was asked to develop three new flip-flop designs to be sold exclusively in the Nordstrom chain. Fish Flops has sold more than 100,000 pairs of flip-flops in three years. With future growth in mind, the company is currently expanding into a line of casual clothing under the Madison Nicole brand name—the founder’s first and middle names.

sources: Based on information in Joy sewing, “teen grows Fashion Business from FishFlops to Fifth avenue,” Houston Chronicle, June 18, 2014, www.houstonchronicle.com; silvana ordonez, andy rothman, and tyler mathisen, “Bright Ideas: Fish Flops,” Nightly Business News, cnBc, september 9, 2013, http://nbr.com; adrienne Burke, “How a 15-Year-old entrepreneur got Her Product into nordstrom,” Yahoo News: Profit Minded, may 30, 2013, http://news.yahoo.com; http://fishflops.com.

Entrepreneurial Success

1-6c oligopoly An oligopoly is a market (or industry) situation in which there are few sellers. Generally, these sellers are quite large, and sizable investments are required to enter into their market. Examples of oligopolies are the automobile, airline, car rental, cereal, and farm implement industries.

Because there are few sellers in an oligopoly, the market actions of each seller can have a strong effect on competitors’ sales and prices. If General Motors, for example, reduces its automobile prices, Ford, Honda, Toyota, and Nissan usually do the same to retain their market shares. For instance, when Ford and General Motors began offering cash incentives to encourage consumers to purchase a new automobile at the end of 2015, Chrysler, Honda, Nissan, and Toyota began offering similar incentives and for the same reason—to attract new-car buyers. In the absence of much price competition, product differentiation becomes the major competitive weapon; this is very evident in the advertising of the major automobile manufacturers.

1-6d monopoly A monopoly is a market (or industry) with only one seller, and there are barriers to keep other firms from entering the industry. In a monopoly, there is no close substitute for the product or service. Because only one firm is the supplier of a product, it would seem that it has complete control over price. However, no firm can set its price at some astronomical figure just because there is no competition; the firm would soon find that it has no customers or sales revenue either. Instead, the firm in a monopoly position must consider the demand for its product and set the price at the most profitable level.

oligopoly a market (or industry) in which there are few sellers

monopoly a market (or industry) with only one seller, and there are barriers to keep other firms from entering the industry

Chapter 1 Exploring the World of Business and Economics 27

Classic examples of monopolies in the United States are public utilities, including companies that provide local gas, water, or electricity. Each utility firm operates in a natural monopoly, an industry that requires a huge investment in capital and within which any duplication of facilities would be wasteful. Natural monopolies are permitted to exist because the public interest is best served by their existence, but they operate under the scrutiny and control of various state and federal agencies. Although many public utilities are still classified as natural monopolies, there is increased competition in many areas of the country. For example, there have been increased demands for consumer choice when selecting a company that provides electrical service to both homes and businesses.

A legal monopoly—sometimes referred to as a limited monopoly—is created when a government entity issues a franchise, license, copyright, patent, or trademark. For example, a copyright exists for a specific period of time and can be used to protect the owners of written materials from unauthorized use by competitors that have not shared in the time, effort, and expense required for their development. Because Microsoft owns the copyright on its popular Windows software, it enjoys a legal-monopoly position. Except for natural monopolies and legal monopolies, federal antitrust laws prohibit both monopolies and attempts to form monopolies in order to ensure that competitive markets exist and customers have a choice for products they need or want to purchase.

1-7 ameriCan Business tOdaY Although our economic system is far from perfect, it provides Americans with a high standard of living compared with people in other countries throughout the world. Standard of living is a loose, subjective measure of how well off an individual or a society is, mainly in terms of want satisfaction through goods and services. Also, our economic system offers solutions to many of the problems that plague society and provides opportunities for people who are willing to work and to continue learning.

To understand the current business environment and the challenges ahead, it helps to understand how business developed.

1-7a Early Business development Our American business system has its roots in the knowledge, skills, and values that the earliest settlers brought to this country. The first settlers in the United States were concerned mainly with providing themselves with basic necessities—food, clothing, and shelter. Almost all families lived on farms, and the entire family worked at the business of surviving. They used their surplus for trading, mainly by barter, among themselves and with the English trading ships that called at the colonies. Barter is a system of exchange in which goods or services are traded directly for other goods or services without using money. As this trade increased, small businesses began to appear. Some settlers were able to use their skills and their excess time to work under the domestic system of production. The domestic system was a method of manufacturing in which an entrepreneur distributed raw materials to various homes, where families would process them into finished goods. The entrepreneur then offered the goods for sale.

Then, in 1793, a young English apprentice mechanic named Samuel Slater opened a textile factory in Pawtucket, Rhode Island, to spin raw cotton into thread. Slater’s ingenuity resulted in America’s first use of the factory system of manufacturing, in which all the materials, machinery, and workers required to manufacture a product are assembled in one place. The Industrial Revolution in America was born.

Learning Objective

1-7Summarize the factors that affect the business environment and the challenges that American businesses will encounter in the future.

standard of living a loose, subjective measure of how well off an individual or a society is, mainly in terms of want satisfaction through goods and services

barter a system of exchange in which goods or services are traded directly for other goods or services without using money

domestic system a method of manufacturing in which an entrepreneur distributes raw materials to various homes, where families process them into finished goods to be offered for sale by the merchant entrepreneur

factory system a system of manufacturing in which all the materials, machinery, and workers required to manufacture a product are assembled in one place

Concept Check ✓✓ Is competition good for business? Is it good for consumers?

✓✓ compare the four forms of competition.

✓✓ What is the relationship between supply and demand?

✓✓ explain how the equilibrium, or market, price of a product is determined.

28 Part 1 The Environment of Business

A manufacturing technique called specialization was used to improve productivity. Specialization is the separation of a manufacturing process into distinct tasks and the assignment of the different tasks to different individuals.

The years from 1820 to 1900 were the golden age of invention and innovation in machinery. At the same time, new means of transportation greatly expanded the domestic markets for American products. Certainly, many basic characteristics of our modern business system took form during this time period.

1-7b Business development in the 1900s Industrial growth and prosperity continued well into the 20th century. Henry Ford’s moving automotive assembly line, which brought the work to the worker, refined the concept of specialization and helped spur on the mass production of consumer goods. Fundamental changes occurred in business ownership and management as well. No longer were the largest businesses owned by one individual; instead, ownership was in the hands of thousands of corporate shareholders who were willing to invest in—but not to operate—a business.

The Roaring Twenties ended with the sudden crash of the stock market in 1929 and the near collapse of the economy. The Great Depression that followed in the 1930s was a time of misery and human suffering. People lost their faith in business and its ability to satisfy the needs of society without government involvement. After Franklin D. Roosevelt became president in 1933, the federal government devised a number of programs to get the economy moving again. In implementing these programs, the government got deeply involved in business.

To understand the major events that shaped the United States during the remainder of the 20th century, it helps to remember that the economy was compared to a roller-coaster ride earlier in this chapter—periods of economic growth followed by periods of economic slowdown. The following are major events that shaped the nation’s economy during the period from 1940 to 2000:

specialization the separation of a manufacturing process into distinct tasks and the assignment of the different tasks to different individuals

Do you recognize this machine? While quite different than today’s technology, this type of computer was the only game in town in the late 1950s. Ironically, even though it is huge by today’s standards, it couldn’t compute as much information as a laptop computer can today. Looking at this picture, gives you an historical perspective on how far technology, computers, laptops, and tablets have come.

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Chapter 1 Exploring the World of Business and Economics 29

• World War II, the Korean War, and the Vietnam War • Rapid economic growth and higher standard of living during the 1950s and

1960s • The social responsibility movement during the 1960s • A shortage of crude oil and higher prices for most goods in the mid-1970s • High inflation, high interest rates, and reduced business profits during the last

part of the 1970s and early 1980s • Sustained economic growth in the 1990s

Unfortunately, by the last part of the 1990s, a larger number of business failures and declining stock values were initial signs that larger economic problems were on the way.

1-7c a new Century: 2000 and Beyond According to many economic experts, the first part of the 21st century might be characterized as the best of times and the worst of times rolled into one package. On the plus side, technology became available at an affordable price. Both individuals and businesses could now access information with the click of a button. They also could buy and sell merchandise online.

In addition to information technology, the growth of service businesses also changed the way American firms do business in the 21st century. Because service businesses employ approximately 85 percent of the nation’s workforce, we now have a service economy.13 A service economy is an economy in which more effort is devoted to the production of services than to the production of goods. Typical service businesses include restaurants, laundries and dry cleaners, real estate, movie theaters, repair companies, and other services that we often take for granted. More information about how service businesses affect the economy is provided in Chapter 8, Producing Quality Goods and Services.

On the negative side, it is hard to watch television, surf the Web, listen to the radio, or read the newspaper without hearing some news about the economy. Because many of the economic indicators described in Table 1-2 on page 21 still indicate troubling economic problems, there is still a certain amount of pessimism surrounding the nation’s economy and the global economy. In addition to concerns about the economy, there are other concerns including social unrest and political uncertainty on the national, state, and local levels.

1-7d the Current Business Environment Before reading on, answer the following question:

In today’s competitive business world, which of the following environments affects business?

a. The competitive environment b. The global environment c. The technological environment d. The economic environment e. All of the above

Correct Answer: e. All the environments listed in the above question affect business today.

thE CompEtitiVE EnVironmEnt As noted earlier in this chapter, competition is a basic component of capitalism. Every day, business owners must

service economy an economy in which more effort is devoted to the production of services than to the production of goods

30 Part 1 The Environment of Business

figure out what makes their businesses successful and how the goods and services they provide are different from the competition. Often, the answer is contained in the basic definition of business provided on page 10. Just for a moment, review the definition:

Business is the organized effort of individuals to produce and sell, for a profit, the goods and services that satisfy society’s needs.

In the definition of business, note the phrase satisfy society’s needs. These three words say a lot about how well a successful firm competes with competitors. If you meet customer needs, then you have a better chance at success.

thE GloBal EnVironmEnt Related to the competitive environment is the global environment. Not only do American businesses have to compete with other American businesses, but they also must compete with businesses from all over the globe. Firms in other countries including China, Japan, India, Germany, and most of the remaining European and Asian countries around the world also compete with U.S. firms. There was once a time when the label “Made in the United States” gave U.S. businesses an inside edge both at home and in the global marketplace. Today, because business firms in other countries manufacture and sell goods, the global marketplace has never been more competitive.

While many foreign firms are attempting to sell goods and services to U.S. customers, U.S. firms are also increasing both sales and profits by selling goods and services to customers in other countries. In fact there are many “potential” customers in developing nations that will buy goods and services manufactured by U.S. firms. For example, Procter & Gamble sells laundry detergent, soap, health and grooming products, and baby products in Asia, Europe, India, the

Middle East, Africa, Latin America, and North America.14 And Procter & Gamble is not alone. Unilever, DuPont, Johnson & Johnson, General Motors, and many more U.S. companies are also selling goods and services to customers in countries all over the globe.

thE tEChnoloGy EnVironmEnt The technology environment for U.S. businesses has never been more challenging. Changes in manufacturing equipment, distribution of products, and communication with customers are all examples of how technology has changed everyday business practices. For example, many businesses are now using social media to provide customers with information about products and services. If you ask different people, you will often find different definitions for social media, but for our purposes social media is defined as online interaction that allows people and businesses to communicate and share ideas, personal information, and information about products or services. To illustrate how

popular social media is, consider that Facebook with over 1.3 billion monthly active users was launched in 2004.15 Because of rapid developments in social media and the increased importance of technology and information, businesses will need to spend additional money to keep abreast of an ever-changing technology environment and even more money to train employees to use the new technology.

thE EConomiC EnVironmEnt The economic environment must always be considered when making business decisions. This fact is especially important when the nation’s economy takes a nosedive or an individual firm’s sales revenue and profits are declining. For example, both small and large business firms reduce both spending and hiring new employees when the economy is in a recession. On the other hand, businesses increase spending and hiring new employees when the economy is recovering and sales and profits are increasing. As pointed out earlier in this chapter, businesses often introduce new products and services during the peak period of the business cycle to take advantage of consumers’ increased buying power.

In addition to economic pressures, today’s socially responsible managers and business owners must be concerned about the concept of sustainability. According to the U.S. Environmental Protection Agency, sustainability creates and maintains the conditions under which humans and nature can exist in productive harmony, that permit fulfilling the social, economic, and other requirements of present and future generations.16 Although the word green used to mean a color in a box of crayons, today green means a new way of doing business. As a result, a combination of forces, including economic factors, growth in population, increased energy use, and concerns for the environment, is changing the way individuals live and businesses operate.

When you look back at the original question we asked at the beginning of this section, clearly, each different type of environment—competitive, global, technological, and economic—affects the way a business does business. As a result, there are always opportunities for improvement and challenges that must be considered.

1-7e the Challenges ahead There it is—the American business system in brief.

When it works well, it provides jobs for those who are willing to work, a standard of living that few countries can match, and many opportunities for personal advancement for those willing to work hard and continue to learn. However, like every other system devised by humans, it is not perfect. Our business system may give us prosperity, but it also gave us the Great Depression of the 1930s, the economic problems of the 1970s and the early 1980s, and the recent economic crisis.

Obviously, the system can be improved. Certainly, there are plenty of people who are willing to tell us exactly what they think the American economy needs. However, these people often provide us only with conflicting opinions. Who is right and who is wrong? Even the experts cannot agree.

The experts do agree, however, that several key issues will challenge our economic system (and our nation) over the next decade. Some of the questions to be resolved include:

• How can we create a more stable economy and create new jobs for the unemployed?

social media the online interaction that allows people and businesses to communicate and share ideas, personal information, and information about products or services

sustainability creates and maintains the conditions under which humans and nature can exist in productive harmony, that permit fulfilling the social, economic, and other requirements of present and future generations

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social media: government agencies go social Do you know what to do in case of a Zombie Apocalypse—or more common disasters, such as hurricanes and tornadoes? If you click to follow the U.S. Centers for Disease Control (CDC) on Twitter (https://twitter.com/CDCgov) or like its Facebook page (https:// www.facebook.com/CDC), you’ll have the tips you need to cope with emergency situations.

The CDC is only one of many government agencies using social media to increase transparency and facilitate communication with individuals and organizations on the federal, state, and local level. Not only is social media a great way for the government to dis- seminate information, it also allows agency personnel to answer questions and gauge public reaction to policies and actions. Another plus: social media is a cost-effective way to communicate with geographically-dispersed audiences. The CDC spent less than $100 to launch its “zombie” social media campaign, which attracted national attention and increased awareness of the need for emergency preparedness.

The U.S. Small Business Administration (SBA) is also active in social media, using YouTube, Facebook, Twitter, Google+, and blogs to connect with entrepreneurs and small business owners. In support of Small Business Saturday every November, the SBA posts Facebook messages (on www.facebook.com/SBAgov) and tweets (on http://twitter.com/sbagov) to encourage businesses to prepare and consumers to patronize local shops and restaurants. To verify whether a particular social media account is really con- nected with the federal government, go to http://www.usa.gov/ Agencies.shtml.

sources: Based on information in m.J. clark, “small Business saturday set for nov. 29,” Wyoming Business Report, november 21, 2014, www.wyomingbusinessreport.com; melanie Haiken, “Is the cDc Planning for a Walking Dead Zombie apocalypse?” Forbes, march 18, 2014, www.forbes.com; missy graham and elizabeth Johnson avery, “government Public relations and social media: an analysis of the Perceptions and trends of social media Use at the Local government Level,” Public Relations Journal, vol. 7, no. 4 (2013), www.prsa.org.

Chapter 1 Exploring the World of Business and Economics 31

1-7e the Challenges ahead There it is—the American business system in brief.

The experts do agree, however, that several key issues will challenge our economic system (and our nation) over the next decade. Some of the questions to be resolved include:

• How can we create a more stable economy and create new jobs for the unemployed?

social media the online interaction that allows people and businesses to communicate and share ideas, personal information, and information about products or services

For some businesses, green may be a new way of doing business! When a business wants to help sustain the planet or develop a green initiative, it must create a product or service that enables humans and nature to exist in productive harmony. At the same time, businesses must still generate sales revenues and profits in order to stay in business.

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32 Part 1 The Environment of Business

• How do we reduce the national debt and still stimulate business growth? • How do we restore investor confidence in the financial and banking system? • How can we use technology to make American workers more productive and

American firms more competitive in the global marketplace? • How can we preserve the benefits of competition and small business in our

American economic system? • How can we conserve natural resources and sustain our environment? • How can we resolve social unrest, discrimination, and inequality in society? • How can we meet the needs of two-income families, single parents, older

Americans, and the less fortunate who need health care and social programs to exist?

• How can we combat terrorism and resolve conflict with Iran, North Korea, and other countries throughout the world?

The answers to these questions are anything but simple. In the past, Americans have always been able to solve their economic problems through ingenuity and creativity. Now, as we continue the journey through the 21st century, we need that same ingenuity and creativity not only to solve our current problems but also to compete in the global marketplace and build a nation and economy for future generations.

The American business system is not perfect by any means, but it does work reasonably well. We discuss some of its problems in Chapter 2 as we examine the topics of social responsibility and business ethics.

Concept Check ✓✓ How does your standard of living affect the products or services you buy?

✓✓ What is the difference between the domestic system and the factory system?

✓✓ choose one of the environments that affect business and explain how it affects a small electronics manufacturer located in Portland, oregon.

✓✓ What do you consider the most important challenge that will face people in the United states in the years ahead?

Summary

1-1 discuss what you must do to be successful in the world of business. For many years, people in business—both employees and managers—assumed that prosperity would continue. When faced with both economic problems and increased competition, a large number of these people began to ask the question: What do we do now? Although this is a fair question, it is difficult to answer. Certainly, for a college student taking business courses or an employee just starting a career, the question is even more difficult to answer. And yet there are still opportunities out there for people who are willing to work hard, continue to learn, and possess the ability to adapt to change. By studying business, you can become a better employee or manager or you may decide to start your own business. You can also become a better consumer and investor.

1-2 define business and identify potential risks and rewards. Business is the organized effort of individuals to produce and sell, for a profit, the goods and services that satisfy society’s needs. Four kinds of resources— material, human, financial, and informational—must be combined to start and operate a business. The

three general types of businesses are service businesses, manufacturers, and marketing intermediaries. Today, marketing intermediaries sell goods and services in brick-and-mortar stores, online, or both. Profit is what remains after all business expenses are deducted from sales revenue. It is the payment that owners receive for assuming the risks of business—primarily the risks of not receiving payment and of losing whatever has been invested in the firm. Although many people believe that profit is literally the bottom line or most important goal for a business, the ultimate objective of a successful business is to satisfy the needs of its customers. In addition to profit, many corporations are careful to point out their efforts to sustain the planet, participate in the green ecological movement, and help people to live better lives.

1-3 define economics and describe the two types of economic systems: capitalism and command economy.

Economics is the study of how wealth is created and distributed. An economic system must answer four questions: What goods and services will be produced? How will they be produced? For whom will they be produced? And Who owns and who controls the

Chapter 1 Exploring the World of Business and Economics 33

major factors of production? The factors of production are land and natural resources, labor, capital, and entrepreneurship. Capitalism (on which our economic system is based) is an economic system in which individuals own and operate the majority of businesses that provide goods and services. Capitalism stems from the theories of Adam Smith. Smith’s pure laissez- faire capitalism is an economic system based on the assumptions described in Figure 1-4.

Our economic system today is a mixed economy and exhibits elements of both capitalism and socialism. In the circular flow that characterizes our business system (see Figure 1-5), households and businesses exchange resources for goods and services, using money as the medium of exchange. In a similar manner, the government collects taxes from businesses and households and purchases products and resources with which to provide services.

In a command economy, government, rather than individuals, owns many of the factors of production and provides the answers to the three other economic questions. Socialist and communist economies are—at least in theory—command economies.

1-4 identify the ways to measure economic performance. One way to evaluate the performance of an economic system is to assess changes in productivity, which is the average level of output per worker per hour. Gross domestic product (GDP) can also be used to measure a nation’s economic health and is the total dollar value of all goods and services produced by all people within the boundaries of a country during a one-year period. It is also possible to adjust GDP for inflation and thus to measure real GDP. Other economic indicators include a nation’s balance of trade, consumer confidence index, consumer price index (CPI), corporate profits, inflation rate, national income, new housing starts, prime interest rate, producer price index (PPI), and unemployment rate.

1-5 examine the different phases in the typical business cycle. A nation’s economy fluctuates rather than grows at a steady pace every year. These fluctuations are generally referred to as the business cycle. Generally, the business cycle consists of four states: the peak (sometimes called prosperity), recession, the trough, and recovery (sometimes called expansion). Some experts believe that effective use of monetary policy (the Federal Reserve’s decisions that determine the size of the supply of money and the level of interest rates) and fiscal policy (the government’s influence on the amount of savings and expenditures) can speed up recovery.

A federal deficit occurs when the government spends more than it receives in taxes and other revenues. At the time of publication, the national debt is over $18 trillion or approximately $56,000 for every man, woman, and child in the United States.

1-6 Outline the four types of competition. Competition is essentially a rivalry among businesses for sales to potential customers. In a capitalist economy, competition works to ensure the efficient and effective operation of business. Competition also ensures that a firm will survive only if it serves its customers well by providing goods and services that meet their needs. Economists recognize four degrees of competition. Ranging from most to least competitive, the four degrees are perfect competition, monopolistic competition, oligopoly, and monopoly. The factors of supply and demand generally influence the price that customers pay producers for goods and services.

1-7 summarize the factors that affect the business environment and the challenges that american businesses will encounter in the future.

From the beginning of the Industrial Revolution to the phenomenal expansion of American industry in the 1800s and early 1900s, our government maintained an essentially laissez-faire or hands off attitude toward business. However, during the Great Depression of the 1930s, the federal government began to provide a number of social services to its citizens and government got deeply involved in business.

To understand the major events that shaped the United States during the remainder of the 20th and 21st century, it helps to remember that the economy was compared to a roller-coaster ride earlier in this chapter—periods of economic growth followed by periods of economic slowdown. Events and a changing business environment including wars, rapid economic growth, the social responsibility movement, a shortage of crude oil, high inflation, high interest rates, reduced business profits, increased use of technology, and social media all have shaped business and the economy.

Now more than ever before, the way a business operates is affected by the competitive environment, global environment, technological environment, and economic environment. As a result, business has a number of opportunities for improvement and challenges for the future.

34 Part 1 The Environment of Business

Key Terms

You should now be able to define and give an example relevant to each of the following terms:

free enterprise (4) cultural (or workplace)

diversity (6) business (10) e-business (11) profit (12) stakeholders (12) economics (12) microeconomics (13) macroeconomics (13) economy (13) factors of production (13) entrepreneur (13) capitalism (14)

invisible hand (14) market economy (15) mixed economy (15) consumer products (16) command economy (17) productivity (18) gross domestic product

(GDP) (19) inflation (19) deflation (19) unemployment rate (20) consumer price index

(CPI) (20) producer price index (PPI) (20)

business cycle (21) recession (21) depression (21) monetary policies (22) fiscal policy (22) federal deficit (22) national debt (22) competition (23) perfect (or pure)

competition (23) supply (24) demand (24) market price (24)

monopolistic competition (25)

product differentiation (25) oligopoly (26) monopoly (26) standard of living (27) barter (27) domestic system (27) factory system (27) specialization (28) service economy (29) social media (30) sustainability (31)

Discussion Questions

1. What factors caused American business to develop into a mixed economic system rather than some other type of economic system?

2. Does an individual consumer really have a voice in answering the basic four economic questions described on pages 14–15?

3. Is gross domestic product a reliable indicator of a nation’s economic health? What might be a better indicator?

4. Discuss this statement: “Business competition encour- ages improved product quality and increased customer satisfaction.”

5. Is government participation in our business system good or bad? What factors can be used to explain your position.

6. Choose one of the challenges listed on pages 31–32 and describe possible ways in which business and society could help to solve or eliminate the problem in the future.

Video Case kliptech turns recycled paper into products and profits

Joel Klippert became an entrepreneur at the urging of his wife, LeeAnn Klippert, who believed in his unusual idea of turning recycled paper into a superstrong surface for skateboard ramps. For months he had tried, without success, to find a manufacturer willing to work with him in developing a durable composite ramp surface made from recycled and eco-friendly materials. Even his closest friends were skeptical. However, because Klippert and his wife were convinced that there was a viable market for this kind of sustainable product, they moved ahead to form KlipTech in 2000.

For the next two years, Klippert wrote and fine-tuned a business plan as he had manufacturing experts test various materials and production processes for transforming his invention from an idea to a reality. Despite unenthusiastic responses from most of the bankers he approached for possible financing, Klippert introduced his new skateboard ramp surface product in 2002. Later that same year, he

pioneered yet another green product by introducing kitchen and bathroom countertops made from a composite of recycled materials.

Despite ever-higher sales of these products, Klippert still faced the challenge of enhancing the aesthetic appearance of his paper-based composite countertops for home use. At the time, such composite products were produced only in dark colors because of the resins used in the manufacturing process. Klippert recognized that a broader range of colors would make the countertops more appealing to more consumers. Working with a partner, he created an innovative countertop composite made with both recycled paper and bamboo and capable of being dyed in either light or dark colors. This new type of countertop attracted the attention of mainstream buyers, not just green-minded buyers, and gave KlipTech the edge it needed to compete more effectively with some of the biggest names in the industry.

Chapter 1 Exploring the World of Business and Economics 35

KlipTech continues to build revenues and profits by introducing new products made from recycled paper. More recently, it launched EcoClad, a line of composites used for exterior siding on commercial buildings and residences. Not only is EcoClad attractive and durable, it also helps buildings qualify as green under the U.S. Green Building Council’s standards, confirming its environmentally-sound qualities.

Today, KlipTech is a profitable business with multiple product lines, a global customer base, two manufacturing plants in the United States, and a reputation for dedication to sustainability. The company also has plans to expand production in foreign countries and introduce its products in Asia, the Middle East, and the United Kingdom.

What lessons has Joel Klippert learned in the years since becoming a successful entrepreneur? First, he found out first hand that an entrepreneur must have the confidence, patience, and perseverance to take the practical steps necessary to turn a good idea into an actual product that can meet customers’ needs. It took many months of experimentation to perfect the skateboard ramp surface that gave KlipTech its start in the business world, but Klippert never gave up.

Second, the product must be unique so the company can, in effect, make its own market rather than go head-to- head with major competitors in an established market. When Klippert introduced his first skateboard ramp surface, no one else was making such products from recycled paper. The same was true for KlipTech’s first kitchen counter surface, as well as its later products. KlipTech’s innovations resulted in unique products that really fit the needs of its customers.

Third, Klippert learned that a nimble startup has an important advantage over large competitors. “The great part about being a small business is you’re like a speed boat on

the water,” he explains. This means KlipTech can respond very quickly, “on the fly,” to emerging trends in the business environment. “Innovation is the key to the future and we will be working day after day to bring this to our current and future customers.” says Klippert. In contrast, big rivals need more time to make and implement decisions about adapting to the same changes in the business environment.

Klippert also advises entrepreneurs to do their homework early on legal issues and financing possibilities, so they have experts and resources in place before problems arise. From experience, he knows that small business owners must understand finance and plan to pay vendors and employees before paying themselves. He’s always thinking about how to improve one of his products or listening to customers talk about a new product they’d like to see. Succeeding in the global economy is far from easy, but Klippert remains enthusiastic about the opportunities he faces every day as the co-founder and co-owner of a successful business.17

questions 1. Joel Klippert says he pays himself last, after he pays his

vendors and employees. Explain this decision in terms of the principle of business profit. Do you agree with his payment priorities?

2. When compared to larger manufacturing firms in the building products industry, what advantages have helped KlipTech become successful?

3. How have the competitive, global, technological, and economic environments helped KlipTech to become a successful business? Which of the above environments might pose the most challenges in the next few years, and why?

Building Skills for Career Success

1. Social Media Exercise Today, many companies have a social media presence on Facebook, Twitter, Flickr, and other sites beyond their corporate website. Think of three of your favorite car companies and conduct a quick search using a search engine like Google or Yahoo! Then answer the following: 1. Name the social networks for each company. 2. Compare each of their Facebook pages. How many

“likes” does each company have? Are there multiple pages for the company? How much interaction (or engagement) is on each Facebook page?

3. What business goals do you think each company is trying to reach through their Facebook presence?

2. Building Team Skills Over the past few years, employees have been expected to function as productive team members instead of working

alone. People often believe that they can work effectively in teams, but many people find working with a group of people to be a challenge.

College classes that function as teams are more interesting and more fun to attend, and students generally learn more about the topics in the course. One way to begin creating a team is to learn something about each student in the class. This helps team members to feel comfortable with each other and fosters a sense of trust.

assignment 1. Find a partner, preferably someone you do not know. 2. Each partner has two to three minutes to answer the

following questions: a. What is your name, and where do you work? b. What interesting or unusual thing have you done in your

life? (Do not talk about work or college; rather, focus on such things as hobbies, travel, family, and sports.)

36 Part 1 The Environment of Business

c. Why are you taking this course, and what do you expect to learn? (Satisfying a degree requirement is not an acceptable answer.)

3. Introduce your partner to the class. Use one to two min- utes, depending on the size of the class.

3. Researching Different Careers In this chapter, entrepreneurship is defined as the willingness to take risks and the knowledge and ability to use the other fac - tors of production efficiently. An entrepreneur is a person who risks time, effort, and money to start and operate a business. Often, people believe that these terms apply only to small business. However, employees with entrepreneurial attitudes have recently advanced more rapidly in large companies as well.

assignment 1. Go to the local library or use the Internet to research

how large firms, especially corporations, are rewarding employees who have entrepreneurial skills.

2. Find answers to the following questions: a. Why is an entrepreneurial attitude important in large

corporations today? b. What makes an entrepreneurial employee different

from other employees? c. How are these employees being rewarded, and are

the rewards worth the effort? 3. Write a two-page report that summarizes your findings.

Endnotes

1 Based on information in Tanya Agrawal, “Visa Sees Mobile Payment as Big Growth Driver,” Reuters, October 29, 2014, www.reuters.com; Daniel Roberts, “Visa’s Open-Armed Leader,” Fortune, September 22, 2014, p. 22; Gaurav Raghuvanshi, “Visa Aims to Boost Electronic Payments,” Wall Street Journal, August 10, 2014, www.wsj.com; www.visa.com.

2 The Horatio Alger website at www.horatioalger.org (accessed December 12, 2014).

3 Ibid. 4 “Nick D’Aloisio, Creator of Summly, on the Latest Changes to Yahoo

News Digest,” The What Mobile website at www.whatmobile.net (accessed December 12, 2014).

5 Idy Fernandez, “Julie Stav,” Hispanic, June–July 2005, 204. 6 The General Mills website at www.generalmills.com (accessed

December 15, 2014). 7 The Bureau of Economic Analysis website at www.bea.gov (accessed

December 15, 2014). 8 The Bureau of Economic Analysis website at www.bea.gov (accessed

December 15, 2013). 9 The Bureau of Labor Statistics website at www.bls.gov (accessed

December 15, 2014).

10 The Bureau of Economic Analysis website at www.bea.gov (accessed December 16, 2014).

11 The U.S. Debt Clock website at www.usdebtclock.org (accessed December 16, 2014).

12 The Investopedia website at www.investopedia.com (accessed December 16, 2014).

13 The Bureau of Labor Statistics website at www.bls.gov (accessed December 16, 2014).

14 The Procter & Gamble website at www.pg.com (accessed December 17, 2014).

15 The Digital Marketing Ramblings website at www.expandedramblings. com (accessed December 17, 2014).

16 The Environmental Protection Agency website at www.epa.gov (accessed December 18, 2014).

17 Sources: Based on information from the KlipTech website at www.kliptech.com (accessed December 18, 2014); “Editor’s Choice: The Hot 50 Products 2012,” Green Builder, February 2012, www.greenbuildermag.com/hot502012; Wanda Lau, “KlipTech EcoClad XP,” Architect, January 2012, www.architectmagazine.com; and the Cengage video, “The Entrepreneurial Life: KlipTech.”

Learning Objectives Once you complete this chapter, you will be able to:

2-1 Understand what is meant by business ethics. 2-2 Identify the types of ethical concerns that arise in the business world. 2-3 Discuss the factors that affect the level of ethical behavior in organizations. 2-4 Explain how ethical decision making can be encouraged. 2-5 Describe how our current views on the social responsibility of business have

evolved.

2-6 Discuss the factors that led to the consumer movement and list some of its results.

2-7 Analyze how present employment practices are being used to counteract past abuses.

2-8 Describe the major types of pollution, their causes, and their cures. 2-9 Identify the steps a business must take to implement a program of social

responsibility.

Why Should You Care? Business ethics and social

responsibility issues have become

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tesla Motors

tesla Motors, headed by tech-savvy entrepreneur elon Musk, says its goal is to “accelerate the world’s transition to electric mobility with a full range of increasingly affordable electric cars. We’re cata- lyzing change in the industry.” the current product line, available in 37 countries, includes cars and SuVs priced about $70,000, with lower priced models soon to be introduced. one model is outfitted with self-driving features, which only adds to the growing interest in tesla’s earth-friendly vehicles and technology.

tesla’s upscale electric vehicles are stylish and much greener than those with gasoline engines or hybrid gas-electric motors. design is a major strength, as is manufacturing know-how. When tesla can’t find vehicle components that meet its exacting environ- mental and quality standards, internal experts develop, patent, and produce their own. tesla invites other automakers to use its patents, and it says a few firms have already taken the company up on this unusual offer.

now tesla is spending $5 billion to build a Gigafactory, the world’s largest and most sophisticated lithium-ion battery factory, in

nevada. For environmental reasons, it is pioneering a supply chain to use only raw materials from north America at the new factory. the long-term plan is to reduce the cost of batteries and lower the price tag for tesla’s vehicles, giving the firm an even more compel- ling competitive advantage in the global market for green vehicles.

Knowing that car buyers care about convenience, as well as keeping the planet safe, tesla is building a multinational network of supercharger stations for its electric vehicles. these publicly-available charging stations will top up one of its batteries to 50 percent of capacity in 20 minutes, and charge to 100 percent of capacity in 75 minutes. the supercharger stations will also be supplied with batteries made in the nevada Gigafactory, enabling tesla to use its cutting-edge technology for vital support services, as well as in each of its vehicles.1

Did You Know? Tesla is building a $5 billion Gigafactory in Nevada to make lithium-ion batteries for its electric vehicles.

InsIde BusIness

Obviously, organizations like Tesla Motors want to be recognized as responsible corporate citizens. These companies recognize the need to harmonize their operations with environmental demands and other social concerns. Not all firms, however, have taken steps to include social responsibility and ethics in their decisions and day-to-day activities. Some managers still regard such business programs as a poor investment, in which the cost is not worth the return. Other managers—indeed, most managers—view the cost of these programs as a necessary business expense, similar to wages or rent.

Most managers today are finding ways to balance an agenda of socially responsible activities with the drive to generate profits. This also happens to be a good way for organizations to demonstrate their values and to attract like-minded employees, customers, and shareholders. In a highly competitive global business environment, an increasing number of companies are seeking to set themselves apart by developing a reputation for ethical and socially responsible behavior.

We begin this chapter by defining business ethics and examining ethical issues. Next, we look at the standards of behavior in organizations and how ethical behavior can be encouraged. We then turn to the topic of social responsibility. We explore the evolution of the idea of social responsibility, compare and contrast two present-day models of social responsibility, and present arguments for and against increasing the social responsibility of business. We then explore business responsibilities toward the public. We discuss how social responsibility in business has affected employment practices and environmental concerns. Finally, we consider the commitment and planning that go into a firm’s program of social responsibility.

2-1 Business ethics DefineD Ethics is the study of right and wrong and of the morality of the choices individuals make. An ethical decision or action is one that is “right” according to some standard of behavior. When there is strong consensus regarding a particular unethical action, society may demand laws to outlaw it. Business ethics is the application of moral standards to business situations. Recent court cases involving unethical behavior have helped to make business ethics a matter of public concern. In one such case, the former president of Houston’s Riverside Hospital, along with several others, was convicted of fraud for submitting false and fraudulent mental health care claims to Medicare. The Department of Justice claimed that Earnest Gibson III, the former president of Riverside, had the hospital bill Medicare for $158 million in psychiatric services that patients did not qualify for or never received.2 Regardless of their legality, all business decisions can be judged as right or wrong.

2-2 ethicaL issues Ethical issues often arise out of a business’s relationship with investors, customers, employees, creditors, suppliers, or competitors. Each of these stakeholder groups has specific concerns and usually exerts pressure on the organization’s managers. For example, investors want management to make sensible financial decisions that will boost sales, profits, and returns on their investments. Customers expect a firm’s products to be safe, reliable, and reasonably priced. Employees demand to be treated fairly in hiring, promotion, and compensation decisions. Creditors require accounts to be paid on time and the accounting information furnished by the firm to be accurate. Competitors expect the firm’s competitive practices to be fair and honest. Canadian-based Coffee Club sued Keurig Green Mountain, Inc., which markets Keurig coffee makers and single-serving K-Cups for use in its coffee makers, arguing that Keurig’s newest coffee makers include “lock-out technology” that prevent the use of single-serving beverage products made by other firms, such as the environmentally friendly ones marketed by Coffee Club. Coffee Club’s suit contends that Keurig’s new system effectively excludes competitors from the market and that Keurig’s marketers have spread lies about competing products in order to confuse consumers and obtain exclusive agreements with third parties. A court will have to resolve the dispute.3

Businesspeople face ethical issues every day, and some of these issues can be difficult to assess. Although some types of issues arise infrequently, others occur regularly. Let’s take a closer look at several ethical issues.

2-2a Fairness and honesty Fairness and honesty in business are two important ethical concerns. Besides obeying all laws and regulations, businesspeople are expected to refrain from knowingly deceiving, misrepresenting, or intimidating others. The consequences of failing to do so can be expensive. Recently, for example, Juan Alejandro Rodriguez Cuya faces decades in prison after being convicted of deceiving and intimidating Spanish-speaking customers of a call center into fraudulent settlements. In court, prosecutors explained that Cuya extorted victims into believing that they had to pay for deliveries of nonexistent products or else be subject to huge fines and lawsuits and even deportation.4 Gerber came under fire for promoting that its Good Start Gentle baby formula can prevent or reduce allergies in children. The Federal Trade Commission ruled that Gerber’s claim lacked

Learning Objective

2-1Understand what is meant by business ethics.

ethics the study of right and wrong and of the morality of the choices individuals make

business ethics the application of moral standards to business situations

Learning Objective

2-2Identify the types of ethical concerns that arise in the business world.

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40 Part 1 The Environment of Business

scientific evidence and asked the company to remove the statement from its advertising and product labels.5

If consumers feel they have been deceived or that companies have been unfair, they will take their business elsewhere and may even ask regulators to intervene. The Federal Trade Commission filed suit against AT&T for “throttling” or reducing Internet speeds for heavy smartphone users who signed up for unlimited plans. Some consumers saw their speeds reduced by as much as 90 percent. The head of the FTC contends that AT&T’s actions are unfair to consumers who paid for “unlimited” plans with the expectation of limitless usage and speed.6

2-2b Organizational Relationships A businessperson may be tempted to place his or her personal welfare above the welfare of others or the welfare of the organization. For example, Joyce Ziehli

was convicted of misappropriating more than $800,000 of funds belonging to the New Glarus Home, a Wisconsin nursing home where she worked as the bookkeeper.7 Aside from the legality of such actions, they may threaten the livelihood of employees and the business itself and harm relations with customers, suppliers, and others.

Relationships among co-workers often create ethical problems. Unethical behavior in these areas includes taking credit for others’ ideas or work, not meeting one’s commitments in a mutual agreement, and pressuring others to behave unethically. One issue related to fairness and honesty is plagiarism—knowingly taking someone else’s words, ideas, or other original material without acknowledging the source. When exposed, the consequences of plagiarism can be grave. For example, the U.S. Army War College rescinded the master’s degree that it had awarded U.S. Senator John Walsh after an academic review by the college determined that Walsh had copied significant parts of his final paper from other sources. Walsh withdrew from his re-election campaign soon after the scandal.8

When misconduct occurs in business, investors also suffer. Investors and owners must be able to trust that companies are acting in their best interests and reporting their activities truthfully. They have the right to expect that all actions by a firm contribute toward a return on their investment. Two issues that raise flags for investors are executive compensation packages that are out of line with performance and the conflict of interest that may occur when a chief executive officer also sits on the board of directors—the group that oversees the CEO. Investors have increasingly protested high executive compensation, particularly when those executives do not generate strong profits for the owners. Shareholders have voted against executive compensation packages at a number of companies, including Staples, Abercrombie & Fitch, Chipotle, and more.9 Activist investors have also protested companies whose CEOs also sit on the board of directors, which can result in a conflict of interest when the CEOs performance is under review.

2-2c Conflict of Interest Conflict of interest results when a businessperson takes advantage of a situation for his or her own personal interest rather than for the employer’s interest. Examples of situations involving conflicts of interest generally involve an employee who has divided loyalties, such as a manager who is dating a subordinate, an employee with a close relative who works for a competitor, a purchasing manager who chooses to do business with another firm in which he is an investor, or a firm

plagiarism knowingly taking someone else’s words, ideas, or other original material without acknowledging the source

Ethics Violations Ethics violations can be more than humiliating. Ethics violators sometimes go to prison, pay large fines, lose their jobs, lose their families, and pay expensive legal fees.

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that advises clients without informing them that it has a relationship with some of the products it recommends. Even the appearance of a conflict of interest can jeopardize a businessperson’s credibility. For example, the Securities and Exchange Commission charged a Houston investment advisory firm of fraud because the Robare Group, Ltd. failed to notify clients of mutual funds that it recommended, that it was receiving compensation from the broker offering the mutual funds.10 In such cases, consumers have the right to know that their investment advisor may be recommending certain funds over others in order to receive the extra compensation received regardless of whether those funds are most suitable.

Conflicts of interest may occur when payments and gifts make their way into business deals. Although bribes—gifts, favors, or payments offered with the intent of influencing an outcome—are often part of business negotiations overseas, it is illegal for American businesspersons to use bribes in the U.S. or abroad. Defending against bribery charges can be costly and affect future business negotiations. Walmart, for example, reported to U.S. regulators that it had uncovered evidence that employees and subcontractors of its Mexican division had paid $24 million in bribes in order to open new stores in Mexico more quickly than if they had gone through conventional channels. Moreover, the firm found evidence that the employees of its Mexican division had attempted to cover up the bribes, which are illegal under the U.S. Foreign Corrupt Practices Act. Although Walmart reported the bribery to U.S. authorities, it spent $439 million investigating the wrongdoing and expects to pay millions more in fines. The company also faces shareholder lawsuits as a result of the crime.11 A wise rule to remember is that anything given to a person that might unfairly influence that person’s business decision is a bribe, and all bribes are unethical.

At Procter & Gamble Company (P&G), all employees are obligated to act at all times solely in the best interests of the company. P&G defines a conflict of interest as when an employee has a personal relationship or financial or other interest that could interfere with this obligation, or when an employee uses his or her position with the company for personal gain. P&G requires employees to disclose all potential conflicts of interest and to take prompt actions to eliminate a conflict when the company asks them to do so. Generally, P&G prohibits employees from receiving gifts, entertainment, or other gratuities from people with whom the company does business because doing so could imply an obligation on the part of the company and potentially pose a conflict of interest.12

2-2d Communications Business communications, especially advertising, can present ethical questions. False and misleading advertising is illegal and unethical, and it can infuriate customers. For example, the makers of Red Bull energy drink agreed to pay $13 million to settle a class-action lawsuit from customers who felt that the company’s advertising contained false claims that lacked scientific support, including its longtime slogan, “Red Bull gives you wings.”13 Sponsors of advertisements aimed at children must be especially careful to avoid misleading messages. Advertisers of health-related products also must take precautions to guard against deception when using such descriptive terms as low fat, fat free, and light. In fact, the Federal Trade Commission has issued guidelines on the use of these labels.

2-3 factOrs affecting ethicaL BehaviOr Is it possible for an individual with strong moral values to make ethically questionable decisions in a business setting? What factors affect a person’s inclination to make either ethical or unethical decisions in a business organization? Although the answers

Learning Objective

2-3Discuss the factors that affect the level of ethical behavior in organizations

Concept Check ✓✓ What is meant by business ethics?

✓✓ What are the different types of ethical concerns that may arise in the business world?

✓✓ explain and give an example of how advertising can present ethical questions.

42 Part 1 The Environment of Business

to these questions are not entirely clear, three general sets of factors do appear to influence the standards of behavior in an organization14 As shown in Figure 2-1, the sets consist of individual factors, social factors, and opportunities.

2-3a Individual Factors affecting Ethics Several individual factors influence the level of ethical behavior in an organization, including personal knowledge, values, and goals. How much an individual knows about an issue is one factor. A decision maker with a greater amount of knowledge regarding a situation may take steps to avoid ethical problems, whereas a less- informed person may take action unknowingly that could lead to ethical problems. An individual’s moral values and central, value-related attitudes also clearly influence his or her business behavior and choices. Most organizations do not try to change an employee’s personal ethics but instead strive to hire people with good character and values that complement their own. The actions of specific individuals in scandal- plagued companies, such as Adelphia, Arthur Anderson, Enron, Halliburton, Qwest, and WorldCom, often raise questions about individuals’ personal character and integrity. Finally, most people join organizations to accomplish personal goals. The types of personal goals an individual aspires to and the manner in which these goals are pursued have a significant impact on that individual’s behavior in an organization.

2-3b Social Factors affecting Ethics Many social factors can affect ethical behavior within a firm, including cultural norms, actions and decisions of co-workers, values and attitudes of “significant others,” and the use of the Internet. A person’s behavior in the workplace, to some degree, is

determined by cultural norms, and these social factors vary from one culture to another. For example, in some countries it is acceptable and

ethical for customs agents to receive gratuities for performing ordinary, legal tasks that are a part of their jobs, whereas

in other countries these practices would be viewed as unethical and perhaps illegal. The actions and decisions

of co-workers may also shape a person’s sense of business ethics. For example, if your co-workers peruse YouTube and Instagram on company time and at company expense, you might view that

behavior as acceptable and ethical because everyone does it. The moral values and attitudes of “significant

others”—spouses, friends, and relatives, for instance— also can affect an employee’s perception of what is ethical and unethical behavior in the workplace.

figure 2-1 Factors That Affect the Level of Ethical Behavior in an Organization

LEVEL OF ETHICAL BEHAVIOR

Individual factors

Social factors Opportunity

Source: based on o. c. Ferrell and Larry Gresham, “A contingency Framework for understanding ethical decision Making in Marketing,” Journal of Marketing (Summer 1985), 89.

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chapter 2 Being Ethical and Socially Responsible 43

Even the Internet presents new challenges for firms whose employees enjoy easy access through convenient high-speed connections at work. An employee’s behavior online can be viewed as offensive to co-workers and possibly lead to lawsuits against the firm if employees engage in unethical behavior on controversial websites not related to their job. Moreover, if an employee posts controversial content using their employer’s email, Instagram, or Twitter account, that content may run counter to the company’s core values and reflect negatively on the company. Interestingly, one recent survey of employees found that most workers assume that their use of technology at work will be monitored. A large majority of employees approved of most monitoring methods such as monitoring faxes and e-mail, tracking Web use, and even recording telephone calls.

2-3c Opportunity as a Factor affecting Ethics Several opportunity factors affect ethics in an organization. Opportunity refers to the amount of freedom an organization affords an employee to behave unethically if he or she makes that choice. If the employee is rewarded in some way for an unethical choice—praise or a bonus, for example—or fails to suffer any kind of consequence, he or she is more likely to make that same choice in the future. In some organizations, certain company policies and procedures reduce the opportunity to be unethical. For example, at some fast-food restaurants, one employee takes your order and receives your payment, and another fills the order. This procedure reduces the opportunity to be unethical because the person handling the money is not dispensing the product, and the person giving out the product is not handling the money.

The existence of codes of ethics and other policies on ethics, as well as the importance management places on these policies are other elements of opportunity (codes of ethics are discussed in more detail in the next section). The degree of enforcement of company policies, procedures, and ethical codes is a major force affecting opportunity. When violations are dealt with consistently and firmly, the opportunity to be unethical is reduced.

Now that we have considered some of the factors believed to influence the level of ethical behavior in the workplace, let us explore what can be done to encourage ethical behavior and to discourage unethical behavior.

2-4 encOuraging ethicaL BehaviOr Most authorities agree that there is room for improvement in business ethics. A more problematic question is: Can business be made more ethical in the real world? The majority opinion on this issue suggests that government, trade associations, and individual firms indeed can promote acceptable levels of ethical behavior.

2-4a Government’s Role in Encouraging Ethics The government can encourage ethical behavior in business by enacting more stringent regulations. For example, the landmark Sarbanes–Oxley Act of 2002 provides sweeping new legal protection for those who report corporate misconduct. Among other things, the law deals with corporate responsibility, conflicts of interest, and corporate accountability. However, rules require enforcement, and the unethical businessperson frequently seems to “slip something by” without getting caught. Increased regulation may help, but it cannot solve the entire ethics problem.

Learning Objective

2-4Explain how ethical decision making can be encouraged.

Sarbanes-Oxley Act of 2002 provides sweeping new legal protection for employees who report corporate misconduct

Concept Check ✓✓ describe several individual factors that influence the level of ethical behavior in an organization.

✓✓ explain several social factors that affect ethics in an organization.

✓✓ how does opportunity influence the level of ethical behavior in the workplace?

44 Part 1 The Environment of Business

2-4b trade associations’ Role in Encouraging Ethics Trade associations can and often do provide ethical guidelines for their members. These organizations, which operate within particular industries, are in an excellent position to exert pressure on members to stop engaging in questionable business practices that may harm all firms in the industry. For example, a pharmaceutical trade group adopted a new set of guidelines intended to end the extravagant dinners and expensive gifts sales representatives often give to physicians to persuade them to prescribe a particular medicine. However, enforcement and authority vary from association to association. Because trade associations exist for the benefit of their members, harsh measures may be self-defeating. Trade associations must also ensure that their codes do not contain provisions that may run afoul of antitrust laws.

2-4c Individual Companies’ Role in Encouraging Ethics

Codes of ethics are perhaps the most effective way to encourage ethical behavior. A code of ethics is a written guide to acceptable and ethical behavior as defined by an organization; it outlines uniform policies, standards, and punishments for violations. Because a code of ethics informs employees what is expected of them and what will happen if they violate the rules, it can go a long way toward encouraging ethical behavior. However, codes cannot possibly cover every situation. Companies also must create an environment in which employees recognize the importance of complying with the written code. Managers must provide direction by fostering communication, actively modeling and encouraging ethical decision making, and training employees to make ethical decisions. Figure 2-2 offers snippets of some of the guiding principles behind well-known companies’ codes of ethics.

Beginning in the 1980s, an increasing number of organizations created and implemented ethics codes. Today, about 95 percent of Fortune 1000 firms have a formal code of ethics or conduct. For example, the ethics code of Starbucks defines the firm’s mission and values and includes provisions relating to policies and procedures; laws and regulations; relationships with customers, suppliers, competitors, and the community; conflicts of interest; handling of proprietary information; and more. Starbucks’ code also details how employees can express concerns or find guidance in ambiguous situations and even provides a graphical decision-making framework that employees can apply to difficult decisions.15

In the wake of a number of corporate scandals and the Sarbanes-Oxley Act, many large companies now have created a new executive position, the chief ethics (or compliance) officer. Assigning an ethics officer who guides ethical conduct provides employees someone to consult if they are not sure of the right thing to do. An ethics officer meets with employees and top management to provide ethical advice, establishes and maintains an anonymous confidential service to answer questions about ethical issues, and takes action on ethics code violations.

Sometimes even employees who want to act ethically may find it difficult to do so. Unethical practices can become ingrained in an organization. Employees with high personal ethics may then take a controversial step called whistle-blowing. Whistle- blowing is informing the press or government officials about unethical practices within an organization. Consider Josh Harmon, who brought a lawsuit against Trinity Industries under the False Claims Act, which permits whistle-blowers to sue companies they believe have defrauded the government. Harmon, who installed roadway guardrails that are supposed to cushion vehicles in the event of an accident,

code of ethics a guide to acceptable and ethical behavior as defined by the organization

whistle-blowing informing the press or government officials about unethical practices within one’s organization

Sarbanes-Oxley Act The Sarbanes-Oxley Act of 2002 includes tough provisions to deter and punish corporate and accounting fraud and corruption. The legislation passed with unanimous support.

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believed that Trinity failed to notify regulators and others that it had redesigned its guardrail end caps in such a way that they became unsafe and caused injuries and fatalities during vehicle accidents instead of reducing them. A federal jury ultimately decided that Trinity had indeed made false claims to regulators about the product’s redesign and owed $175 million in damages.16

Whistle-blowing, however, can have serious repercussions for employees: Those who “blow whistles” may face retaliation and sometimes even lose their jobs. The Sarbanes–Oxley Act of 2002 protects whistle-blowers who report corporate misconduct. Any executive who retaliates against a whistle-blower can be held criminally liable and imprisoned for up to ten years. Federal employees who report misconduct are likewise protected by the Whistleblower Protection Act of 1989.

When companies set up anonymous hotlines to handle ethically questionable situations, employees actually may be more likely to engage in whistle-blowing. When firms instead create an environment that educates employees and nurtures ethical behavior, fewer ethical problems arise. Ultimately, the need for whistle- blowing is greatly reduced.

It is difficult for an organization to develop ethics codes, programs, and procedures to deal with all relationships and every situation. Michael Josephson, an expert on workplace ethics, says, “The objective of such programs is to establish a business culture in which it’s easier to do the right thing than the wrong thing, and where concerned co-workers and vigilant supervisors repress illegal or improper conduct that can potentially endanger or embarrass the company.”17 When no company policies or procedures exist or apply, a quick test to determine if a behavior is ethical is to see if others—co-workers, customers, and suppliers—approve of it. Ethical decisions will always withstand scrutiny. Openness and communication about choices will often build trust and strengthen business relationships. Table 2-1 provides some general guidelines for making ethical decisions.

figure 2-2 Defining Acceptable Behavior at Starbucks, Nike, and Apple

Nike “NIKE’s good name and

reputation result in large part from our collective actions. That means the work-related activities of every employee must re�ect standards of honesty, loyalty,

trustworthiness, fairness, concern for others, and

accountability.”

Starbucks “Individual actions at work shape how the world views

Starbucks, which is why it’s so important that we each take responsibility for Our Starbucks Mission and

acting ethically in all situations.”

Code of Ethics

Snippets Apple

“Apple conducts business ethically, honestly, and in full compliance with all laws and

regulations. This applies to every business decision in every area

of the company worldwide.”

Source: Starbucks, “business ethics and compliance: Standards of business conduct,” p. 6, http://globalassets.starbucks.com/assets/eecd184d6d2141d58966319744393d1f.pdf (accessed october 30, 2014); nike, “Inside the Lines: the nIKe code of ethics,” p. 4, http://nike.q4web.com/files/2011%20Inside%20the%20Lines%20online%20booklet%20FInAL%2011-10-26.pdf (accessed october 30, 2014); Apple, “business conduct: the Way We do business Worldwide,” p. 2, http://files.shareholder.com/downloads/AAPL/3565008853x0x443008/5f38b1e6- 2f9c-4518-b691-13a29ac90501/business_conduct_policy.pdf (accessed october 30, 2014).

46 Part 1 The Environment of Business

2-4d Social Responsibility Social responsibility is the recognition that business activities have an impact on society and the consideration of that impact in business decision making. Target, for example, has donated $418 million to public schools through its Take Charge of Education program that rewards more than 84,000 schools designated by Target REDcard holders. The company also offers access to fresh food to families in need through their schools as well as grants for educational programs.18 Obviously, social responsibility costs money. It is perhaps not so obvious—except in isolated cases— that social responsibility is also good business. Many companies contribute resources, knowledge, and products as well as money to help neighbors and others during times of crisis. For example, Procter & Gamble’s orange Loads of Hope trucks are a welcome sight during disaster relief efforts. Residents in disaster areas can drop off loads of dirty laundry at the mobile laundromats, and volunteers use Tide products and high- efficiency machines to wash, dry, and even fold their clothes. Thus far, the program has

social responsibility the recognition that business activities have an impact on society and the consideration of that impact in business decision making

taBLe 2-1 Guidelines for Making Ethical Decisions

1. Listen and learn Recognize the problem or decision-making opportunity that confronts your company, team, or unit. Don’t argue, criticize, or defend yourself—keep listening and reviewing until you are sure that you understand others.

2. Identify the ethical issues Examine how co-workers and consumers are affected by the situation or decision at hand. Examine how you feel about the situation, and attempt to understand the viewpoint of those involved in the decision or in the consequences of the decision.

3. Create and analyze options Try to put aside strong feelings such as anger or a desire for power and prestige and come up with as many alternatives as possible before developing an analysis. Ask everyone involved for ideas about which options offer the best long-term results for you and the company. Then decide which option will increase your self-respect even if, in the long run, things don’t work out the way you hope they will.

4. Identify the best option from your point of view

Consider it and test it against some established criteria, such as respect, understanding, caring, fairness, honesty, and openness.

5. Explain your decision and resolve any differences that arise

This may require neutral arbitration from a trusted manager or taking “time out” to reconsider, consult, or exchange written proposals before a decision is reached.

Source: based on information in tom rusk with d. Patrick Miller, “doing the right thing,” Sky (delta Airlines), August 1993, 18–22.

Social responsibility is good business Natural disasters create opportunities for companies to engage in socially responsible behavior. Procter & Gamble’s Loads of Hope program takes in disaster victims’ dirty laundry and returns it to them clean and folded, allowing them to deal with more important problems.

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done more than 55,000 loads of laundry and brought a sense of normalcy and hope back to victims so that they can focus on more pressing matters.19 Efforts like these bring positive associations for brands that can help them stand out in a competitive market. Customers eventually find out which firms act responsibly and which do not. Just as easily as they can purchase a product made by a company that is socially responsible, they can choose against buying from the firm that is not.

Even small businesses can develop social responsibility programs. For example, P. Terry’s, which operates nine fast-food hamburger stands in Austin, Texas, donates 100 percent of its profits from one day each quarter to a local charity. The company lets customers know about upcoming charity days through its social media accounts.20 In general, people are more likely to want to work for and buy from such organizations.

Increasingly, companies large and small are striving to be good corporate citizens. Corporate citizenship is adopting a strategic approach to fulfilling economic, ethical, environmental, and social responsibilities. This requires balancing the needs, desires, and demands of a diverse group of stakeholders including investors, employees, cus- tomers, regulators, competitors, neighborhoods and communities, and social activists. Hilton Hotels, for example, offers military veterans points from its Hilton HHonors rewards program for free nights in Hilton-owned hotel rooms while they are searching for jobs or undergoing training.21 Table 2-2 lists the best corporate citizens.

2-5 the evOLutiOn Of sOciaL resPOnsiBiLity in Business Business is far from perfect in many respects, but its record of social responsibility today is much better than that in past decades. In fact, present demands for social responsibility have their roots in outraged reactions to the abusive business practices of the early 1900s.

2-5a historical Evolution of Business Social Responsibility During the first quarter of the 20th century, businesses were free to operate pretty much as they chose. Government protection of workers and consumers was minimal. As a result, people either accepted what business had to offer or they did without. Working conditions often were deplorable by today’s standards.

corporate citizenship adopting a strategic approach to fulfilling economic, ethical, environmental, and social responsibilities

Concept Check ✓✓ how can the government encourage the ethical behavior of organizations?

✓✓ What is trade associations’ role in encouraging ethics?

✓✓ What is whistle-blowing? Who protects the whistle-blowers?

✓✓ What is social responsibility? how can business be socially responsible?

Learning Objective

2-5Describe how our current views on the social responsibility of business have evolved.

taBLe 2-2 Corporate Responsibility Magazine’s 10 Best Corporate Citizens

1. Bristol-Myers Squibb Co.

2. Johnson & Johnson

3. Gap, Inc.

4. Microsoft Corporation

5. Mattel, Inc.

6. Weyerhaeuser, Inc.

7. Ecolab, Inc.

8. Intel Corp.

9. Coco-Cola Co.

10. Walt Disney Co.

Source: “cr’s 100 best corporate citizens 2014,” CR, http://www.thecro.com/files/100bestList.pdf (accessed october 24, 2014).

48 Part 1 The Environment of Business

The average workweek in most industries exceeded 60 hours, no minimum-wage law existed, and employee benefits were almost nonexistent. Work places were crowded and unsafe, and industrial accidents were the rule rather than the exception. To improve working conditions, employees organized and joined labor unions. During the early 1900s, however, businesses—with the help of government—were able to use court orders, brute force, and even the few existing antitrust laws to defeat union attempts to improve working conditions.

During this period, consumers generally were subject to the doctrine of caveat emptor, a Latin phrase meaning “let the buyer beware.” In other words, “what you see is what you get,” and if it is not what you expected, too bad. Although victims of unscrupulous business practices could take legal action, going to court was very expensive, and consumers rarely won their cases. Moreover, no consumer groups or government agencies existed to publicize their consumers’ grievances or to hold sellers accountable for their actions.

Before the 1930s, most people believed that competition and the action of the marketplace would, in time, correct abuses. Government, therefore, became involved in day-to-day business activities only in cases of obvious abuse of the free-market system. Six of the most important business-related federal laws passed between 1887 and 1914 are described in Table 2-3. As you can see, these laws were aimed more at encouraging competition than at correcting abuses, although two of them did deal with the purity of food and drug products.

The collapse of the stock market on October 29, 1929, triggered the Great Depression. Factory production fell by almost half, and up to 25 percent of the nation’s workforce was unemployed. Public pressure soon mounted for the government to “do something” about the economy and about worsening social conditions. Soon after Franklin D. Roosevelt became president in 1933, he instituted programs to restore the economy and improve social conditions. The government passed laws to correct what many viewed as the monopolistic abuses of big business, and provided various social services for individuals. These massive federal programs became the foundation for increased government involvement in the dealings between business and society.

As government involvement has increased, so has everyone’s awareness of the social responsibility of business. Today’s business owners are concerned about the return on their investment, but at the same time most of them demand ethical behavior from employees. In addition, employees demand better working conditions, and consumers want safe, reliable products. Various advocacy groups echo these concerns and also call for careful consideration of Earth’s delicate ecological balance. Therefore, managers must operate in a complex business environment—one in which they are just

caveat emptor a Latin phrase meaning “let the buyer beware”

taBLe 2-3 Early Government Regulations That Affected American Business

Government Regulation Major Provisions

Interstate Commerce Act (1887)

First federal act to regulate business practices; provided regulation of railroads and shipping rates

Sherman Antitrust Act (1890)

Prevented monopolies or mergers where competition was endangered

Pure Food and Drug Act (1906)

Established limited supervision of interstate sales of food and drugs

Meat Inspection Act (1906)

Provided for limited supervision of interstate sales of meat and meat products

Federal Trade Commission Act (1914)

Created the Federal Trade Commission to investigate illegal trade practices

Clayton Antitrust Act (1914)

Eliminated many forms of price discrimination that gave large businesses a competitive advantage over smaller firms

chapter 2 Being Ethical and Socially Responsible 49

as responsible for their managerial actions as for their actions as individual citizens. Interestingly, today’s high-tech and Internet-based firms fare relatively well when it comes to environmental issues, worker conditions, the representation of minorities and women in upper management, animal testing, and charitable donations.

2-5b two Views of Social Responsibility Government regulation and public awareness are external forces that have increased the social responsibility of business. However, business decisions are made within the firm—there, social responsibility begins with the attitude of management. Two contrasting philosophies, or models, define the range of management attitudes toward social responsibility.

According to the traditional concept of business, a firm exists to produce quality goods and services, earn a reasonable profit, and provide jobs. In line with this concept, the economic model of social responsibility holds that society will benefit most when business is left alone to produce and market profitable products that society needs. The economic model has its origins in the 18th century, when businesses were owned primarily by entrepreneurs or owner-managers. Competition was vigorous among small firms, and short-run profits and survival were the primary concerns. To the manager who adopts this traditional attitude, social responsibility is someone else’s job. After all, stockholders invest in a corporation to earn a return on their investment, not because the firm is socially responsible, and the firm is legally obligated to act in the economic interest of its stockholders. Moreover, profitable firms pay federal, state, and local taxes that are used to meet the needs of society. Thus, managers who concentrate on profit believe that they fulfill their social responsibility indirectly through the taxes paid by their firms. As a result, social responsibility becomes the problem of the government, various environmental groups, charitable foundations, and similar organizations.

In contrast, some managers believe that they have a responsibility not only to stockholders but also to customers, employees, suppliers, and the general public. This broader view is referred to as the socioeconomic model of social responsibility, which places emphasis not only on profits but also on the impact of business decisions on society.

Recently, increasing numbers of managers and firms have adopted the socioeconomic model, and they have done so for at least three reasons. First, business is dominated by the corporate form of ownership, and the corporation is a creation of society. If a corporation does not perform as a good citizen, society can and will demand changes. Second, many firms have begun to take pride in their social responsibility records, among them Starbucks, Hewlett-Packard, Colgate- Palmolive, and Coca-Cola. Of course, many other corporations are much more socially responsible today than they were ten years ago. Third, many businesspeople believe that it is in their best interest to take the initiative in this area. The alternative may be legal action brought against the firm by some special-interest group; in such a situation, the firm may lose control of its activities.

2-5c the pros and Cons of Social Responsibility Business owners, managers, customers, and government officials have debated the pros and cons of the economic and socioeconomic models for years. Each side seems to have four major arguments to reinforce its viewpoint.

Proponents of the socioeconomic model maintain that a business must do more than simply seek profits. To support their position, they offer the following arguments:

1. Because business is a part of our society, it cannot ignore social issues. 2. Business has the technical, financial, and managerial resources needed to tackle

today’s complex social issues.

economic model of social responsibility the view that society will benefit most when business is left alone to produce and market profitable products that society needs

socioeconomic model of social responsibility the concept that business should emphasize not only profits but also the impact of its decisions on society.

50 Part 1 The Environment of Business

3. By helping resolve social issues, business can create a more stable environment for long-term profitability.

4. Socially responsible decision making by firms can prevent increased government intervention, which would force businesses to do what they fail to do voluntarily.

These arguments are based on the assumption that a business has a responsibility not only to its stockholders but also to its customers, employees, suppliers, and the general public.

Opponents of the socioeconomic model argue that business should do what it does best: earn a profit by manufacturing and marketing products that people want. Those who support this position argue as follows:

1. Business managers are responsible primarily to stockholders, so management must be concerned with providing a return on owners’ investments.

2. Corporate time, money, and talent should be used to maximize profits, not to solve society’s problems.

3. Social problems affect society in general, so individual businesses should not be expected to solve these problems.

4. Social issues are the responsibility of government officials who are elected for that purpose and who are accountable to the voters for their decisions.

These arguments obviously are based on the assumption that the primary objective of business is to earn profits and that government and social institutions should deal with social problems.

Businesses Feel pressure Over Conditions in Suppliers’ Factories

Should businesses be blamed for problems that occur in suppliers’ factories? Even when a supplier is located half a world away, many stakeholders expect manufacturers and retailers to help improve the lives of workers who make the products these businesses sell.

Nike, for example, has worked for years to curb problems like child labor and hazardous conditions in suppliers’ facilities. After its brand was tarnished in the 1990s by accusations of unsafe factories and underage workers, Nike established a supplier code of conduct, instituted site visits to check on compliance, and changed production details to improve safety. Company executives will drop suppliers that fail to comply, even if that means higher costs and lower profit margins.

Apple has also felt pressure to deal with reported problems at Chinese factories where phones and computers are assembled for sale in stores worldwide. Like Nike, Apple requires suppliers to meet standards for on-the- job safety and employee living conditions. The company sends inspectors to audit suppliers and also relies on site

visits conducted by independent groups like the Fair Labor Association.

The world’s largest retailer, Walmart, is well known for low prices—made possible, in part, by buying from low- cost suppliers in China, among other areas. Over the years, Walmart has been criticized for abuses at suppliers’ factories, and has set up specific workplace standards for their suppliers. It conducts surprise inspections, maintains a hotline for tips about potential problems, and has a “zero tolerance” policy for suppliers that don’t meet its standards.

Should Walmart, Apple, Nike, and other businesses be blamed for the actions of their suppliers?

Sources: based on information in christina Farr, “Apple Address Labor Violations at Quanta chinese Factories After 2013 Audit,” Reuters, August 15, 2014, www.reuters.com; Shelly banjo, “Inside nike’s Struggle to balance cost and Worker Safety in bangladesh,” Wall Street Journal, April 21, 2014, www.wsj.com; Paul Mozur, chao deng, and eva dou, “Worker Group Alleges Abuses at Apple Supplier in china,” Wall Street Journal, July 29, 2013, www.wsj.com; Stephanie clifford and Steven Greenhouse, “Fast and Flawed Inspections of Factories Abroad,” New York Times, September 1, 2013, www.nytimes.com.

Ethical Success or Failure

Concept Check ✓✓ outline the historical evolution of business social responsibility.

✓✓ What are the six important business-related federal laws passed between 1887 and 1914?

✓✓ explain two views on the social responsibility of business.

✓✓ What are the arguments for increased social responsibility?

✓✓ What are the arguments against increased social responsibility?

chapter 2 Being Ethical and Socially Responsible 51

Today, few firms are either purely economic or purely socioeconomic in outlook; most have chosen some middle ground between the two extremes. However, our society generally seems to want—and even to expect—some degree of social responsibility from business. Thus, within this middle ground, businesses are leaning toward the socioeconomic view. In the next several sections, we look at some results of this movement in four specific areas: the public, employment practices, the environment, and implementation of social responsibility programs.

2-6 PuBLic resPOnsiBiLities Of Business Business responsibilities to the public can be classified with regard to consumers and public health.

2-6a Consumerism Consumerism consists of all activities undertaken to protect the rights of consumers. The fundamental issues pursued by the consumer movement fall into three categories: environmental protection, product performance and safety, and information disclosure. Although consumerism has been with us to some extent since the early 19th century, the consumer movement became stronger in the 1960s. It was then that President John F. Kennedy declared that the consumer was entitled to a new “Bill of Rights.”

thE BaSIC RIGhtS OF COnSuMERS President Kennedy’s Consumer Bill of Rights asserted that consumers have a right to safety, to be informed, to choose, and to be heard. Two additional rights added since 1975 are the right to consumer education and the right to courteous service. These six rights are the basis of much of the consumer-oriented legislation passed during the last 45 years. These rights also provide an effective outline of the objectives and accomplishments of the consumer movement.

The Right To Safety. The consumers’ right to safety means that the products they purchase must be safe for their intended use, must include thorough and explicit directions for proper use, and must be tested by the manufacturer to ensure product quality and reliability. Federal agencies, such as the Food and Drug Administration and the Consumer Product Safety Commission, have the power to force businesses that make or sell defective products to take corrective actions such as offering refunds, recalling defective products, issuing public warnings, and reimbursing consumers—all of which can be expensive. Moreover, consumers and the government have been winning an increasing number of product- liability lawsuits against sellers of defective products. The amount of the awards in these suits has been increasing steadily. For example, a Florida woman won $23.6 billion in a wrongful death lawsuit against R.J. Reynolds Tobacco Company after her husband, a long-time smoker, died of lung cancer.22 Yet another major reason for improving product safety is consumers’ demand for safe products. People simply will stop buying a product they believe is unsafe or unreliable.

The Right To Be Informed. The right to be informed means that consumers must have access to complete information about a product before they buy it. Detailed information about ingredients and nutrition must be provided on food containers, information about fabrics and

Learning Objective

2-6Discuss the factors that led to the consumer movement and list some of its results.

consumerism all activities undertaken to protect the rights of consumers

The right to safety The Consumer Bill of Rights as - serts buyers’ basic rights. The right to safety means that products must be safe for their intended use and tested by the producer to ensure product quality and safety.

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52 Part 1 The Environment of Business

laundering methods must be attached to clothing, and lenders must disclose the true cost of borrowing the money they make available to customers who purchase merchandise on credit. In addition, manufacturers must inform consumers about the potential dangers of using their products. Manufacturers that fail to provide such information can be held responsible for personal injuries suffered because of their products. For example, Maytag provides customers with a lengthy booklet that describes how they should use a washing machine. Sometimes such warnings seem excessive, but they are necessary if user injuries (and resulting lawsuits) are to be avoided.

The Right To Choose. The right to choose means that consumers must have a choice of products, offered by different manufacturers and sellers, to satisfy a particular need. The government has done its part by encouraging competition through antitrust legislation. The greater the competition, the greater is the choice available to consumers. Competition and the resulting freedom of choice provide additional benefits for customers by reducing prices. For example, when personal computers were introduced, they cost more than $5,000. Thanks to intense competition and technological advancements, personal computers today can be purchased for less than $500.

The Right To Be Heard. The right to be heard means that someone will listen and take appropriate action when customers complain. Actually, management began to listen to consumers after World War II, when competition between businesses that manufactured and sold consumer goods increased. One way that firms gained a competitive edge was to listen to consumers and provide the products they said they wanted and needed. Today, businesses are listening even more attentively, and many larger firms have consumer relations departments that can be contacted easily via toll-free telephone numbers. Other groups listen, too. Most large cities and some states have consumer affairs offices to act on citizens’ complaints.

Additional Consumer Rights. In 1975, President Gerald Ford added to the Consumer Bill of Rights the right to consumer education, which entitles people to be fully informed about their rights as consumers. In 1994, President Bill Clinton added a sixth right, the right to service, which entitles consumers to convenience, courtesy, and responsiveness from manufacturers and sellers of consumer products.

MajOR COnSuMERISM FORCES The major forces in consumerism are individual consumer advocates and organizations, consumer education programs, and consumer laws. Consumer advocates, such as Ralph Nader, take it on themselves to protect the rights of consumers. They band together into consumer organizations, either independently or under government sponsorship. Some consumer advocates and organizations encourage consumers to boycott products and businesses to which they have objections.

Do you always know what you’re buying?

Keep these consumer rights in mind when you shop around for goods or services, buy something, or have a problem with a purchase. You’re entitled to be informed, to have choices, to be heard, to buy safe products, to have responsive service, and to know your rights.

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chapter 2 Being Ethical and Socially Responsible 53

Educating consumers to make wiser purchasing decisions is perhaps one of the most far-reaching aspects of consumerism. Increasingly, consumer education is becoming a part of high school and college curricula and adult-education programs. These programs cover many topics—for instance, what major factors should be considered when buying specific products, such as insurance, real estate, automobiles, appliances and furniture, clothes, and food; the provisions of certain consumer- protection laws; and the sources of information that can help individuals become knowledgeable consumers.

Major advances in consumerism have come through federal legislation. Some laws enacted in the last 50 years to protect your rights as a consumer are listed and described in Table 2-4.

Most businesspeople now realize that they ignore consumer issues only at their own peril. Managers know that improper handling of consumer complaints can result in lost sales, bad publicity, and lawsuits.

2-6b public health Many people believe that businesses have a basic responsibility to contribute to the general wellbeing of the public, starting with ensuring that their products do not harm anyone. Beyond this basic responsibility, however, there is contention with regard to how far businesses’ responsibility to public health extends, especially about issues such as obesity, smoking, heart disease, alcohol use, and even smartphone use while driving. These issues are not black and white, but exploring them can help us find balance among the desires and demands of various stakeholders.

Obesity has become a major public health topic in recent years, with more than one-third of adult Americans being categorized as obese. Other countries are experiencing similar trends. People who are obese or significantly overweight face higher rates of diabetes, strokes, heart disease, and some types of cancer, and the swelling numbers of these illnesses place a great burden on the healthcare system, the costs of which are borne by society. Public health advocates have called for companies—particularly those that market sugary drinks and fast food—to modify their products or at least their advertising in an effort to reduce the consumption of these products, which have been shown to contribute to rising rates of obesity. Perhaps as a result, some producers of these products have suffered losses and are responding with new ideas and products. Coca-Cola, for example, is testing a lower- calorie soft drink called Coca-Cola Life, which has 89 calories and is sweetened by Stevia, compared to regular Coca-Cola, which has 140 calories sweetened by high- fructose corn syrup. Life represents Coke’s efforts to find a middle ground between

social Media: the ftc Blogs and tweets too The U.S. lawmakers who wrote the original Federal Trade Commission Act in 1914 never envisioned that a century later, FTC staff members would be responsible for monitoring business activ- ity on Facebook, Twitter, YouTube, Tumblr, and Pinterest—and for using social media to help keep consumers informed about their rights.

When the FTC takes action against a business for an unfair trade practice, staff members tweet about it on the agency’s Twitter account (http://twitter.com/ftc). They also tweet consumer tips for saving money, safeguarding credit, avoiding scams, and protecting children’s privacy, reaching tens of thousands of followers with each message. Knowing that many U.S. consumers are Facebook users, the FTC also has a very active account there (www.facebook.com/ federaltradecommission).

The FTC’s blog (at www.consumer.ftc.gov/blog, available in English and Spanish) carries longer messages to alert consum- ers to recent agency enforcement activities, smart shopping techniques, shady financial practices, and other developments. Businesses can learn more about FTC guidelines through the blog, as well. Videos posted on the FTC YouTube channel (www.youtube. com/user/FTCvideos) educate consumers (in English and Spanish) about how to get a mortgage, how to avoid identity fraud, and how to file a complaint with the agency. More than a million people have viewed FTC videos on YouTube.

In its regulatory role, the FTC is taking steps to prevent consum- ers from being misled via social media. For instance, companies must disclose when a message, image, or video is posted for advertising purposes. Otherwise, an advertiser or ad agency will get a warning letter or be charged with a violation. And the FTC will blog or tweet about it, too.

Sources: based on information in “Ftc’s charges Against deutsch LA Seen as a twitter Wake-up call for Industry,” Wall Street Journal, november 28, 2014, www.wsj.com; Jeremy Quittner, “how to Avoid the Ftc’s Ire When Advertising on Social Media,” Inc., october 22, 2014, www.inc.com; Katy bachman, “Ftc dings cole haan for Wandering Sole Promo on Pinterest,” Adweek, April 3, 2014, www.adweek.com; www.ftc.gov.

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taBLe 2-4 Major Federal Legislation Protecting Consumers Since 1960

Legislation Major Provisions

Federal Hazardous Substances Labeling Act (1960)

Required warning labels on household chemicals if they were highly toxic

Kefauver-Harris Drug Amendments (1962) Established testing practices for drugs and required manufacturers to label drugs with generic names in addition to trade names

Cigarette Labeling Act (1965) Required manufacturers to place standard warning labels on all cigarette packages and advertising

Fair Packaging and Labeling Act (1966)

Called for all products sold across state lines to be labeled with net weight, ingredients, and manufacturer’s name and address

Motor Vehicle Safety Act (1966) Established standards for safer cars

Truth in Lending Act (1968) Required lenders and credit merchants to disclose the full cost of finance charges in both dollars and annual percentage rates

Credit Card Liability Act (1970) Limited credit-card holder’s liability to $50 per card and stopped credit-card companies from issuing unsolicited cards

Fair Credit Reporting Act (1971) Required credit bureaus to provide credit reports to consumers regarding their own credit files; also provided for correction of incorrect information

Consumer Product Safety Commission Act (1972)

Established an abbreviated procedure for registering certain generic drugs

Fair Credit Billing Act (1974) Amended the Truth in Lending Act to enable consumers to challenge billing errors

Equal Credit Opportunity Act (1974) Provided equal credit opportunities for males and females and for married and single individuals

Magnuson–Moss Warranty–Federal Trade Commission Act (1975)

Provided for minimum disclosure standards for written consumer-product warranties for products that cost more than $15

Amendments to the Equal Credit Opportunity Act (1976, 1994)

Prevented discrimination based on race, creed, color, religion, age, and income when granting credit

Fair Debt Collection Practices Act (1977)

Outlawed abusive collection practices by third parties

Nutrition Labeling and Education Act (1990)

Required the Food and Drug Administration to review current food labeling and packaging focusing on nutrition label content, label format, ingredient labeling, food descriptors and standards, and health messages

Telephone Consumer Protection Act (1991)

Prohibited the use of automated dialing and prerecorded-voice calling equipment to make calls or deliver messages

Consumer Credit Reporting Reform Act (1997)

Placed more responsibility for accurate credit data on credit issuers; required creditors to verify that disputed data are accurate and to notify a consumer before reinstating the data

Children’s Online Privacy Protection Act (2000)

Placed parents in control over what information is collected online from their children younger than 13 years; required commercial website operators to maintain the confidentiality, security, and integrity of personal information collected from children

Do Not Call Implementation Act (2003)

Directed the FCC and the FTC to coordinate so that their rules are consistent regarding telemarketing call practices including the Do Not Call Registry and other lists, as well as call abandonment

Credit Card Accountability, Responsibility, and Disclosure Act (2009)

Provided the most sweeping changes in credit card protections since the Truth in Lending Act of 1968

Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010

Promoted the financial stability of the United States by improving accountability and responsibility in the financial system; established a new Consumer Financial Protection Agency to regulate home mortgages, car loans, and credit cards; became Public Law on July 21, 2010

chapter 2 Being Ethical and Socially Responsible 55

those decrying sugary soft drinks and those who adamantly oppose artificial sweeteners that may have their own health issues.23 Other companies, including Panera and Starbucks, are posting the calories in their offerings right on their menus to help people make better choices. Many companies have removed unhealthy trans fats from their product formulas. In the meantime, First Lady Michelle Obama has brought industry representatives and public health advocates together to search for a middle ground that allows firms to continue producing and marketing their products as long as they are within the law, yet dials back marketing toward those most impressionable. Obama recently called for companies to stop marketing junk food at children during the school day.24

Another major public health topic facing business relates to smoking and tobacco products. The relationship between smoking—even second-hand smoke— and cancer has been well documented, but some consumers still demand to buy cigarettes and smoking products. While most people agree that businesses should not knowingly sell products that harm customers, what should they do when consumers continue to demand those products? CVS Caremark earned much publicity when it announced that it would no longer sell cigarettes in its stores, even though it would lose $2 billion in revenue from doing so.25 In recent years, the rise of e-cigarettes, which are battery-powered smoking devices that deliver nicotine as a vapor rather than smoke, has further compounded the issue. Marketers of e-cigarettes insist that their products are safer than cigarettes and even tout them as a method to stop smoking. Health advocates, however, say they are still harmful, and worry that the vapors—which come in flavors such as bubblegum and piña colada—may be especially attractive to minors. Some cities have banned e-cigarettes along with conventional ones, and federal regulators are studying the devices to determine whether further regulation is needed.

There are other issues businesses face with regard to public health, including labeling products that contain genetically modified organisms (GMOs), making questionable claims of the health benefits of supplements and ingredients, where and how to provide affordable housing for the homeless, and many others. One growing concern is the use of smartphones and smartphone apps while driving. Should cell phone service providers take steps to prevent customers from texting and using apps that distract from driving or merely advise them to refrain from these activities? AT&T launched its “It Can Wait” promotion campaign to ask customers to avoid texting while driving, and more than 5 million users pledged not to. The cell phone service provider asked customers to use the hashtag #X to alert their friends and followers that they are about to be unreachable on social media because they are driving.26

2-7 eMPLOyMent Practices Everyone should have the opportunity to land a job for which he or she is qualified and to be rewarded on the basis of ability and performance. This is a fundamental issue for Americans, and it also makes good business sense. Yet, over the years, this opportunity has been denied to members of various minority groups. A minority is a racial, religious, political, national, or other group regarded as different from the larger group of which it is a part and that is often singled out for unfavorable treatment.

The federal government responded to the outcry of minority groups during the 1960s and 1970s by passing a number of laws forbidding discrimination in the workplace. (These laws are discussed in Chapter 9 in the context of human resources management.) Yet, more than 50 years after passage of the Civil Rights Act of 1964, abuses still exist. An example is the disparity in income levels for whites, blacks, Hispanics, and Asians, as illustrated in Figure 2-3. Lower incomes and higher unemployment rates also characterize Native Americans, handicapped persons, and women. Responsible managers have instituted a number of programs to counteract the results of discrimination.

Concept Check ✓✓ describe the six basic rights of consumers.

✓✓ What are the major forces in consumerism today?

✓✓ What are some of the federal laws enacted in the last 50 years to protect your rights as a consumer?

✓✓ What are some of the issues businesses must consider with regard to public health?

Learning Objective

2-7Analyze how present employment practices are being used to counteract past abuses.

minority a racial, religious, political, national, or other group regarded as different from the larger group of which it is a part and that is often singled out for unfavorable treatment

56 Part 1 The Environment of Business

2-7a affirmative action programs An affirmative action program is a plan designed to increase the number of minority employees at all levels within an organization. Employers with federal contracts of more than $50,000 per year must have written affirmative action plans. The objective of such programs is to ensure that minorities are represented within the organization in approximately the same proportion as in the surrounding community. If 25 percent of the electricians in a geographic area in which a company is located are African Americans, then approximately 25 percent of the electricians it employs also should be African Americans. Affirmative action plans encompass all areas of human resources management: recruiting, hiring, training, promotion, and pay.

Unfortunately, affirmative action programs have been plagued by two problems. The first involves quotas. In the beginning, many firms pledged to recruit and hire a certain number of minority members by a specific date. To achieve this goal, they were forced to consider only minority applicants for job openings; if they hired nonminority workers, they would be defeating their own purpose. However, the courts have ruled that such quotas are unconstitutional even though their purpose is commendable. They are, in fact, a form of discrimination called reverse discrimination.

The second problem is that although most such programs have been reasonably successful, not all businesspeople are in favor of affirmative action programs. Managers not committed to these programs can “play the game” and still discriminate against workers. To help solve this problem, Congress created (and later strengthened) the Equal Employment Opportunity Commission (EEOC), a government agency with the power to investigate complaints of employment discrimination and sue firms that practice it.

affirmative action program a plan designed to increase the number of minority employees at all levels within an organization

Equal Employment Opportunity Commission (EEOC) a government agency with the power to investigate complaints of employment discrimination and the power to sue firms that practice it

Cultural diversity A company with a culturally diverse workforce benefits in a number of ways.

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chapter 2 Being Ethical and Socially Responsible 57

The threat of legal action has persuaded some corporations to amend their hiring and promotional policies, but the discrepancy between men’s and women’s salaries still exists, as illustrated in Figure 2-4. For more than 50 years, women have consistently earned only about 77 cents for each dollar earned by men.

2-7b training programs for the hard-Core unemployed For some firms, social responsibility extends far beyond placing a help-wanted advertisement in the local newspaper. These firms have assumed the task of helping the hard-core unemployed, workers with little education or vocational training and a long history of unemployment. For example, the Hard Rock Hotel & Casino teamed up with the College of Menominee Nation and Gateway Technical College in Kenosha, Wisconsin, to create a Jobs Training Institute to recruit and train Native Americans for casino and related jobs in the Kenosha area.27 In the past, such workers often were turned down routinely by personnel managers, even for the most menial jobs.

2-7c programs to Reduce Sexual harassment and abusive Behavior Another hot button issue in the workplace is addressing sexual harassment and other abusive behaviors. The Workplace Bullying Institute (WBI) defines bullying in the workplace as repeated work sabotage; verbal abuse; and/or abusive conduct that is threatening, humiliating, or intimidating. The stress of bullying can result in physical and mental health issues that can ultimately cost employers many hours of lost worker productivity as well as lower morale and higher turnover. The WBI has found that 27 percent of respondents to a survey have suffered abusive conduct at work; 21 percent say they have witnessed it in the workplace.28 Other researchers have found much higher rates of bullying. Moreover, research by the WBI suggests that half of victims do not report their bullying out of fear of further harassment because their bully is in a position of power.29 Even football players can be subject

hard-core unemployed workers with little education or vocational training and a long history of unemployment

figure 2-4 Relative Earnings of Male and Female Workers

The ratio of women’s to men’s annual full-time earnings was 78 percent in 2013, up from 74 percent first reached in 1996.

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58 Part 1 The Environment of Business

to bullying in the workplace: Former Miami Dolphins tackle Jonathan Martin left the team because he felt he could not continue to do his job in the face of repeated bullying from other teammates.30

When bullying takes on sexual overtones, it becomes sexual harassment, which the U. S. Equal Employment Opportunity Commission defines as unwelcome sexual advances, requests for sexual favors, and other verbal or physical harassment of a physical nature. Unlike bullying, sexual harassment is illegal.31 It can also result in poor morale, high turnover, and expensive lawsuits. For example, four women filed suit against Ford Motor Company, claiming that the sexual harassment they endured at a Ford plant in Chicago created a “hostile work environment” for all women working at the plant. In addition to those charges, the women claimed the company did not respond when they complained to its harassment hotline, and that at least one of the women endured retaliation for her complaints.32

To create a workplace environment that stifles bullying, sexual harassment, and other abusive conduct, managers need to provide programs, much like the ones that are used, to foster more ethical conduct in the workplace. In addition to creating formal policies that define and prohibit unacceptable abusive conduct, companies should strive to create an anti-bullying organizational culture by modeling good behavior and sending a strong message that improper conduct will be punished. Companies may even want to go a step further and offer training and additional services through employee assistance programs such as counseling to ensure that all employees feel supported.33

2-8 envirOnMentaL cOncerns A growing social consciousness by the public and some business managers, fostered by government legislation, has led to major efforts to reduce environmental pollution, conserve natural resources, and reverse some of the worst damage caused by past negligence in this area.

A significant environmental issue is the amount of waste produced by businesses and society. For example, by some estimates, the United States throws out one-third of all the food produced, and grocery stores are responsible for as much as 10 percent of that. One reason for the large amount of grocery waste is consumer expectations: Consumers bypass fruits and vegetables that do not appear to be perfect, so supermarkets discard any produce that doesn’t meet that expectation, even when that produce is otherwise safe and healthy.34 The disposal problem has been deteriorating over the past few years because modern technology has continued to produce increasing amounts of chemical and radioactive waste. U.S. manufacturers produce an estimated 40 to 60 million tons of contaminated oil, solvents, acids, and sludge each year. Service businesses, utility companies, hospitals, and other industries also dump vast amounts of wastes into the environment. While companies today strive to reduce waste from operations as much as possible, much still winds up in landfills. A shortage of landfills, owing to stricter regulations, makes garbage disposal a serious problem in some areas. Incinerators help to solve the landfill-shortage problem, but they bring with them their own problems. They reduce the amount of garbage but also leave tons of ash to be buried—ash that often has a higher concentration of toxicity than the original garbage.

Another major environmental issue is pollution, the contamination of water, air, or land through the actions of people in an industrialized society. Pollution harms water and air quality, threatens human and animal health, degrades habitats, and contributes to climate change. Among the serious threats to people posed by pollutants are respiratory irritation, cancer, kidney and liver damage, anemia, and heart failure. Businesspeople harm the environment when they unwittingly— or knowingly—dump hazardous chemicals and waste in unapproved ways. For example, Leading Edge Aviation Services, Inc., was fined $1 million for improper

Concept Check ✓✓ What is an affirmative action program? What is its purpose?

✓✓ Why did congress create (and later strengthen) the equal employment opportunity commission?

✓✓ how can businesses reduce sexual harassment and abusive behavior at the workplace?

Learning Objective

2-8Describe the major types of pollution, their causes, and their cures.

pollution the contamination of water, air, or land through the actions of people in an industrialized society

chapter 2 Being Ethical and Socially Responsible 59

handling and storage of paint stripping chemicals at a Mississippi airport; the company will also have to pay to clean up the site.35 For decades, environmentalists have been warning us about the dangers of industrial pollution. Unfortunately, business and government leaders either ignored the problem or were not concerned about it until pollution became a threat to life and health in America.

2-8a pollution Oil spills can have long-lasting effects on our wildlife and other natural resources. As our population and businesses expand, the need to reduce pollution at its source becomes more important.

2-8b Effects of Environmental Legislation As in other areas of concern to our society, legislation and regulations play a crucial role in pollution control. The laws outlined in Table 2-5 reflect the scope of current environmental legislation: laws to promote clean air, clean water, and even quiet work and living environments. Of major importance was the creation of the Environmental Protection Agency (EPA), the federal agency charged with enforcing laws designed to protect the environment.

When they are aware of a pollution problem, many firms respond to it rather than wait to be cited by the EPA. Other owners and managers, however, take the position that environmental standards are too strict. Pre

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aiming to Be a Chief Sustainability Officer?

Would you like to be a CSO? Nike, Dow Chemical, IKEA, DuPont, and a growing number of other major companies have established the position of chief sustainability officer (CSO) to champion green business practices throughout the organization. The CSO assesses the company’s environmental impact, monitors whether the firm is in compliance with laws and regulations, and determines how the company’s operations affect natural resources (such as scarce raw materials and energy sources). The next step is to identify opportunities and implement strategies for achieving sustainability goals that complement or enhance financial goals (such as energy-conservation measures that also save money). Some CSOs go further, using innovation to put sustainability at the heart of new operations, new products, and new markets.

At Nike, for instance, CSO Hannah Jones is involved in bringing together an international group of product designers, scientists, and other outside experts working on innovations in

sustainable materials and production processes. By forging ties with specialists worldwide, Jones promotes the development of earth-friendly materials and manufacturing approaches—which, in turn, benefits Nike and its customers. Jones’s responsibilities are wider ranging: She also looks at environmental and social responsibility issues affecting Nike’s suppliers and works for positive change throughout the supply chain.

To be effective at this senior management level, a CSO needs an in-depth understanding of the business and its practices, familiarity with the regulatory process, and a flair for communication. Most important, a CSO should have the conceptual ability to envision far-reaching changes that will protect the planet while supporting the company’s mission.

Sources: based on information in christopher P. Skroupa, “building Innovation into Sustainability,” Forbes, november 3, 2014, www.forbes.com; dina Gerdeman, “What do chief Sustainability officers do?” Forbes, october 8, 2014, www.forbes.com; “nike’s Launch Project expands Search for Sustainable Materials Innovations,” The Guardian (UK), March 14, 2014, www.theguardian.com.

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60 Part 1 The Environment of Business

(Loosely translated, this means that compliance with present standards is too expensive.) Consequently, it often has been necessary for the EPA to take legal action to force firms to install antipollution equipment and to clean up waste storage areas. Oregon-based Jerome Cheese, for example, had to pay $88,000 to settle charges that it failed to follow EPA regulations regarding the uncontrolled or accidental release of toxic anhydrous ammonia.36

Experience has shown that the combination of environmental legislation, voluntary compliance, and EPA action can succeed in cleaning up the environment and keeping it clean. However, much still remains to be done.

2-8c Business Response to Environmental Concerns One of the most effective ways that companies can reduce their impact on the environment is to reduce waste from operations and other activities. Identifying and eliminating inefficiencies in production and operations is where most firms begin that process. Finding alternative uses for waste is another. For example, leftover food from supermarkets and restaurants is often donated to local food banks or sold to farmers who feed it to livestock. Most companies strive to recycle as much as possible. Recycling involves converting used materials into new products or components for new products in order to prevent their unnecessary disposal. Companies can recycle waste paper, plastic packaging, glass, rubber, metals, and other chemicals so

Recycling converting used materials into new products or components for new products in order to prevent their unnecessary disposal

taBLe 2-5 Summary of Major Environmental Laws

Legislation Major Provisions

National Environmental Policy Act (1970)

Established the Environmental Protection Agency (EPA) to enforce federal laws that involve the environment

Clean Air Amendment (1970) Provided stringent automotive, aircraft, and factory emission standards

Water Quality Improvement Act (1970)

Strengthened existing water pollution regulations and provided for large monetary fines against violators

Resource Recovery Act (1970) Enlarged the solid-waste disposal program and provided for enforcement by the EPA

Water Pollution Control Act Amendment (1972)

Established standards for cleaning navigable streams and lakes and eliminating all harmful waste disposal by 1985

Noise Control Act (1972) Established standards for major sources of noise and required the EPA to advise the Federal Aviation Administration on standards for airplanes

Clean Air Act Amendment (1977) Established new deadlines for cleaning up polluted areas; also required review of existing air- quality standards

Resource Conservation and Recovery Act (1984)

Amended the original 1976 act and required federal regulation of potentially dangerous solid- waste disposal

Clean Air Act Amendment (1987) Established a national air-quality standard for ozone

Oil Pollution Act (1990) Expanded the nation’s oil-spill prevention and response activities; also established the Oil Spill Liability Trust Fund

Clean Air Act Amendments (1990) Required that motor vehicles be equipped with onboard systems to control about 90 percent of refueling vapors

Food Quality Protection Act (1996) Amended the Federal Insecticide, Fungicide and Rodenticide Act and the Federal Food Drug and Cosmetic Act; the requirements included a new safety standard—reasonable certainty of no harm—that must be applied to all pesticides used on foods

American Recovery and Reinvestment Act (2009)

Provided $7.22 billion to the EPA to protect and promote “green” jobs and a healthier environment

chapter 2 Being Ethical and Socially Responsible 61

that they or their components can be reprocessed into new products and kept out of landfills. The Coca-Cola Bottling Company of Northern New England, for example, donates waste plastic and paper to other manufacturing firms in the area, which turn those leftover materials into synthetic fibers and composite decking material that become components of new products.37

Another way businesses strive to be more environmentally conscious is through the use of “greener” forms of power to counter their use of huge quantities of energy during operations and other activities. Companies can audit their operations to identify places where more efficient and environmentally friendly products can be used to save energy, such as using CFL or LED light bulbs—which reduce heat as well as power use—and even natural sunlight to light workplaces. Many companies are turning to alternative forms of power generation, including solar and wind power which do not rely on diminishing sources of fossil fuels. New Belgium Brewing in Fort Collins, Colorado, became the first company to be 100 percent powered by the wind, but many other companies have followed suit. A number of the world’s largest businesses, including IKEA, Mars, Nestle, and H&M, have pledged to convert to 100 percent renewable energy sources such as wind and solar by 2020.38

Recognizing public demand for greater environmental responsibility, more and more firms are adopting environmentally friendly practices and products that are less harmful to the environment. Green marketing is the process of creating, making, delivering, and promoting products that are environmentally safe. It may include making modifications to products, manufacturing processes, packaging, and/or promotion activities to make or deliver products that are better for the environment. Chipotle Mexican Grill, for example, built its reputation as a green marketer by strictly adhering to its “Food with Integrity” manifesto, which describes the company’s “commitment to finding the very best ingredients with respect for the animals, the environment, and the farmers.” To live by that manifesto, the company’s products include only natural animal products (treated humanely and fed a vegetarian diet that does not include growth hormones or antibiotics). It also became the first food chain to label genetically modified ingredients. It is significant that Chipotle has not yet achieved all its sustainability goals, but its manifesto guides the firm in all decision making and activities.39

Green marketers must ensure that their claims are backed by evidence that shows a significant environmental benefit and does not mislead consumers or they may run afoul of the Federal Trade Commission.40 Companies that take their green marketing efforts too far, without relevance or substantiating their environmental claims risk being labeled guilty of green washing.

Who will pay for the environmental cleanup? Many business leaders offer one answer–tax money should be used to clean up the environment and to keep it clean. They reason that business is not the only source of pollution, so business should not be forced to absorb the entire cost of the cleanup. Environmentalists disagree. They believe that the cost of proper treatment and disposal of industrial wastes is an expense of doing business. In either case, consumers probably will pay a large part of the cost—either as taxes or in the form of higher prices for goods and services.

green marketing the process of creating, making, delivering, and promoting products that are environmentally safe

Concept Check ✓✓ What are the major environmental issues facing society today?

✓✓ Summarize major provisions of federal environmental laws enacted since 1970?

✓✓ What is businesses’ response to environmental concerns?

Reducing dependence on fossil fuels Today’s businesses (and consumers) are more open to alternative sources of energy because they are concerned about the negative impact of conventional energy sources.

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2-9 iMPLeMenting a PrOgraM Of sOciaL resPOnsiBiLity A firm’s decision to be socially responsible is a step in the right direction—but only the first step. The firm then must develop and implement a program to reach this goal. The program will be affected by the firm’s size, financial resources, past record in the area of social responsibility, and competition. Above all, however, the program must have the firm’s total commitment or it will fail.

An effective program for social responsibility takes time, money, and organization. In most cases, developing and implementing such a program will require four steps: securing the commitment of top executives, planning, appointing a director, and preparing a social audit.

2-9a Commitment of top Executives Without the support of top executives, any program will soon falter and become ineffective. For example, the Boeing Company’s Ethics and Business Conduct Committee is responsible for the ethics program. The committee is appointed by the Boeing board of directors, and its members include the company chairman and CEO, the president and chief operating officer, the presidents of the operating groups, and senior vice presidents. As evidence of their commitment to social responsibility, top managers should develop a policy statement that outlines key areas of concern. This statement sets a tone of positive support and later will serve as a guide for other employees as they become involved in the program.

2-9b planning Next, a committee of managers should be appointed to plan the program. Whatever form their plan takes, it should deal with each of the issues described in the top managers’ policy statement. If necessary, outside consultants can be hired to help develop the plan.

2-9c appointment of a Director After the social responsibility plan is established, a top-level executive should be appointed to implement the organization’s plan. This individual should be charged with recommending specific policies and helping individual departments to understand and live up to the social responsibilities the firm has assumed. Depending on the size of the firm, the director may require a staff to handle the program on a day-to-day basis. For example, at the Boeing Company, the director of ethics and business conduct administers the ethics and business conduct program.

2-9d the Social audit At specified intervals, the program director should prepare a social audit for the firm. A social audit is a comprehensive report of what an organization has done and is doing with regard to social issues that affect it. This document provides the information the firm needs to evaluate and revise its social responsibility program. Typical subject areas include human resources, community involvement, the quality and safety of products, business practices, and efforts to reduce pollution and improve the environment. The information included in a social audit should be as accurate and as quantitative as possible, and the audit should reveal both positive and negative aspects of the program. Caesars Entertainment, which operates casinos, evaluates its corporate citizenship efforts annually and then issues a report describing

Learning Objective

2-9Identify the steps a business must take to implement a program of social responsibility.

social audit a comprehensive report of what an organization has done and is doing with regard to social issues that affect it

chapter 2 Being Ethical and Socially Responsible 63

its performance for a variety of stakeholders including employees, investors, and the media. Caesars’ Corporate Citizenship Report details its performance in meeting goals in the areas of responsible gaming, employee development, environmental stewardship, and community investment.41

Today, many companies listen to concerned individuals within and outside the company. For example, the Boeing Ethics Line listens to and acts on concerns expressed by employees and others about possible violations of company policies, laws, or regulations, such as improper or unethical business practices, as well as health, safety, and environmental issues. Employees are encouraged to communicate their concerns, as well as ask questions about ethical issues. The Ethics Line is available to all Boeing employees, including Boeing subsidiaries. It is also available to concerned individuals outside the company.

Concept Check ✓✓ What steps must a business take to implement a program of social responsibility?

✓✓ What is the social audit? Who should prepare a social audit for the firm?

Summary

2-1 understand what is meant by business ethics. Ethics is the study of right and wrong and of the morality of choices. Business ethics is the application of moral standards to business situations.

2-2 identify the types of ethical concerns that arise in the business world.

Ethical issues arise often in business situations out of relationships with investors, customers, employees, creditors, or competitors. Businesspeople should make every effort to be fair, to consider the welfare of customers and others within the firm, to avoid conflicts of interest, and to communicate honestly.

2-3 Discuss the factors that affect the level of ethical behavior in organizations.

Individual, social, and opportunity factors all affect the level of ethical behavior in an organization. Individual factors include knowledge level, moral values and attitudes, and personal goals. Social factors include cultural norms and the actions and values of co-workers and significant others. Opportunity factors refer to the amount of leeway that exists in an organization for employees to behave unethically if they choose to do so.

2-4 explain how ethical decision making can be encouraged. Governments, trade associations, and individual firms can establish guidelines for defining ethical behavior. Governments can pass stricter regulations. Trade associations provide ethical guidelines for their members. Companies provide codes of ethics—written

guides to acceptable and ethical behavior as defined by an organization—and create an atmosphere in which ethical behavior is encouraged. An ethical employee working in an unethical environment may resort to whistle-blowing to bring a questionable practice to light.

2-5 Describe how our current views on the social responsibility of business have evolved.

In a socially responsible business, management realizes that its activities have an impact on society and considers that impact in the decision-making process. Before the 1930s, workers, consumers, and government had very little influence on business activities; as a result, business leaders gave little thought to social responsibility. All this changed with the Great Depression. Government regulations, employee demands, and consumer awareness combined to create a demand that businesses act in socially responsible ways.

The basic premise of the economic model of social responsibility is that society benefits most when business is left alone to produce profitable goods and services. According to the socioeconomic model, business has as much responsibility to society as it has to its owners. Most managers adopt a viewpoint somewhere between these two extremes.

2-6 Discuss the factors that led to the consumer movement and list some of its results.

Consumerism consists of all activities undertaken to protect the rights of consumers. The consumer movement generally has demanded—and received— attention from business in the areas of product safety, product information, product choices through competition, and the resolution of complaints about

64 Part 1 The Environment of Business

products and business practices. Although concerns over consumer rights have been around to some extent since the early 19th century, the movement became more powerful in the 1960s when President John F. Kennedy initiated the Consumer Bill of Rights. The six basic rights of consumers include the right to safety, the right to be informed, the right to choose, the right to be heard, and the rights to consumer education and courteous service. Today, many people believe that businesses have a basic responsibility to contribute to the general wellbeing of the public. Other issues businesses face relate to public health, including labeling products that contain genetically modified organisms.

2-7 analyze how present employment practices are being used to counteract past abuses.

Legislation and public demand have prompted some businesses to correct past abuses in employment practices—mainly with regard to minority groups. Affirmative action and training of the hard-core unemployed are two types of programs that have been used successfully. Another issue in the workplace is addressing sexual harassment and other abusive behaviors, such as bullying and verbal abuse.

2-8 Describe the major types of pollution, their causes, and their cures.

Pollution is the contamination of water, air, or land through the actions of people in an industrialized society. Pollution harms water and air quality, threatens human and animal health, degrades habitats, and contributes to climate change. Current environmental laws, enforced by the Environmental Protection Agency, promote clean air, clean water, and even quiet work and living environments. However, much still remains to be done. Many companies are turning to alternative forms of power generation, including solar and wind power which do not rely on diminishing sources of fossil fuels. More and more firms are adopting environmentally friendly practices and products that are less harmful to the environment.

2-9 identify the steps a business must take to implement a program of social responsibility.

A program to implement social responsibility in a business begins with total commitment by top management. The program should be planned carefully, and a capable director should be appointed to implement it. Social audits should be prepared periodically as a means of evaluating and revising the program.

Key Terms

You should now be able to define and give an example relevant to each of the following terms:

ethics (39) business ethics (39) plagiarism (40) Sarbanes–Oxley Act

of 2002 (43) code of ethics (44) whistle-blowing (44)

social responsibility (46) corporate citizenship (47) caveat emptor (48) economic model of social

responsibility (49) socioeconomic model of

social responsibility (49)

consumerism (51) minority (55) affirmative action

program (56) Equal Employment

Oppor tunity Commission (EEOC) (56)

hard-core unemployed (57) pollution (58) recycling (60) green marketing (61) social audit (62)

Discussion Questions

1. When a company acts in an ethically questionable man- ner, what types of problems are caused for the organiza- tion and its customers?

2. How can an employee take an ethical stand regarding a business decision when his or her superior already has taken a different position?

3. Overall, would it be more profitable for a business to fol- low the economic model or the socioeconomic model of social responsibility?

4. Why should business take on the task of training the hard-core unemployed?

5. To what extent should the blame for vehicular air pol- lution be shared by manufacturers, consumers, and government?

6. Why is there so much government regulation involving social responsibility issues? Should there be less?

chapter 2 Being Ethical and Socially Responsible 65

Video Case portionpac Chemical Is people-Friendly, planet-Friendly

When Marvin Klein and Syd Weisberg founded PortionPac Chemical Corporation (www.portionpaccorp.com) in 1964, they were thinking “green” long before the word came to describe an international environmental movement. The partners shared the belief that cleaning solutions didn’t have to be toxic or caustic to be effective. They also realized that both water and packaging went to waste when manufacturers poured premixed cleaning liquids into spray bottles that customers would throw away when empty. One more thing the cofounders agreed on: They wanted to do business with integrity, dealing with employees, suppliers, and customers in an ethical way.

With commercial customers in mind, Weisberg tested and developed concentrated cleaning formulas that did away with grease and dirt in offices, kitchens, and bathrooms without endangering people or the planet. He and Klein prepared small packages of concentrate to be mixed with water for full-strength cleaning in elementary schools, companies, factories, and correctional facilities. To be sure the cleaning solution wasn’t too strong or too weak, the entrepreneurs gave custodians, janitors, and other cleaning staff careful instructions about exactly how to dilute the concentrate. And to avoid mountains of empty bottles piling up in local landfills, they had customers use refillable spray bottles.

Chicago-based PortionPac’s core principles of safety and sustainability were way ahead of their time. Now that environmental issues are in the public eye, the company is thriving, with $20 million in annual sales, 84 employees, and an ever-expanding customer base. Unlike most businesses, however, PortionPac rewards its salespeople for selling only the amount of cleaning products that customers need. This policy reflects its respect for the environment as well as its emphasis on ethical business practices. If customers buy too much, they may use too much and put their staff or the environment at risk, not to mention spending more than they should. PortionPac also provides customers with on-site and online training about the proper use of cleaning products and timesaving ways to get the job done. No wonder so many of PortionPac’s customers remain loyal buyers year after year.

PortionPac pays just as much attention to the needs of its employees as it does to the needs of its customers

and the planet. Machines in the company’s Chicago factory have been designed to operate with minimal noise, so that employees can talk or listen to music as they work. Sunshine streams through large skylights, potted plants brighten the factory floor, and thoughtful sculptures follow the themes of plumbing and cleaning. Rather than operate three shifts around the clock, PortionPac arranges family-friendly work schedules that allow managers and employees to balance their personal and professional obligations.

Once every year, on Front to Back Day, top executives and all non production managers and employees go into the factory to work side by side with frontline employees. This experience gives them a better understanding of everyday challenges and conditions on the factory floor, which, in turn, helps senior managers make more informed decisions about production. At the end of the day, the entire workforce joins in a barbecue that reinforces the company’s close-knit family feeling. It’s not surprising that turnover is exceptionally low. More than half the workforce has been with PortionPac for more than a decade. On the few occasions when positions do open up, employees encourage their brothers, sisters, or adult children to apply. Recognizing the company’s commitment to its employees, Inc. magazine has named PortionPac to its list of Winning Workplaces.

Marvin Klein, who now serves as chairman, stresses that PortionPac’s dedication to business ethics and integrity is actually a matter of common sense. It’s also a two- way street: He wants to do business with suppliers and customers that do the right thing. As PortionPac celebrates its 50th anniversary, Klein and the entire management team are planning for a people-friendly, planet-friendly future.42

Questions 1. PortionPac is family-owned. How does this private own-

ership affect the company’s ability to follow the socioeco- nomic model of social responsibility?

2. If you were appointed to conduct a social audit of PortionPac, what type of information would you collect? What questions would you ask? Explain your answer.

3. Do you agree with Marvin Klein’s assessment of business ethics as a matter of common sense? Why or why not?

Building Skills for Career Success 1. Social Media Exercise In 2010, Pepsi decided to develop a new social media–based project, called Pepsi Refresh Project, aimed at Millennials and allowing consumers to post ideas for improving their

communities. This replaced the $20 million they spent on Superbowl advertising. The project received more than 57 million votes.

66 Part 1 The Environment of Business

1. Do you think this was an effective strategy for Pepsi? Do you think this resonated with the Millennial generation?

2. Do you think this is a good example of corporate social responsibility (CSR)? Why or why not?

3. How does this CSR example for Pepsi compare with that of its main rival Coca-Cola (see http://www. thecoca-colacompany.com/citizenship/index.html)?

2. Building Team Skills A firm’s code of ethics outlines the kinds of behaviors expected within the organization and serves as a guideline for encouraging ethical behavior in the workplace. It reflects the rights of the firm’s workers, shareholders, and consumers.

assignment 1. Working in a team of four, find a code of ethics for a busi-

ness firm. Start the search by asking firms in your commu- nity for a copy of their codes, by visiting the library, or by searching and downloading information from the Internet.

2. Analyze the code of ethics you have chosen, and answer the following questions: a. What does the company’s code of ethics say about

the rights of its workers, shareholders, consumers, and suppliers? How does the code reflect the com- pany’s attitude toward competitors?

b. How does this code of ethics resemble the informa- tion discussed in this chapter? How does it differ?

c. As an employee of this company, how would you per- sonally interpret the code of ethics? How might the code influence your behavior within the workplace? Give several examples.

3. Researching Different Careers Business ethics has been at the heart of many discussions over the years and continues to trouble employees and shareholders. Stories about dishonesty and wrongful behavior in the workplace appear on a regular basis in newspapers and on the national news.

assignment Prepare a written report on the following: 1. Why can it be so difficult for people to do what is right? 2. What is your personal code of ethics? Prepare a code

outlining what you believe is morally right. The docu- ment should include guidelines for your personal behavior.

3. How will your code of ethics affect your decisions about: a. The types of questions you should ask in a job

interview? b. Selecting a company in which to work?

Endnotes

1 Sources: Based on information in “Tesla’s Electric Man,” The Economist Technology Quarterly, December 6, 2014, pp. 19-20; Chris Woodyard, “Elon Musk Says Rivals Are Now Using Tesla Patents,” USA Today, October 15, 2014, www.usatoday.com; Joseph B. White, “Tesla Aims to Leapfrog Rivals,” Wall Street Journal, October 10, 2014, www.wsj.com; Vivek Wadhwa, “Tesla’s Success Is a Victory for Anyone Who Loves the Environment,” Washington Post, March 4, 2014, www.washingtonpost. com; “Tesla, Citing Environment, to Use North American Materials for Battery Plant,” Bloomberg, March 29, 2014, www.bloomberg.com; www.teslamotors.com.

2 Press Release, U.S. Department of Justice, October 20, 2014, http:// www.justice.gov/opa/pr/president-houston-hospital-and-three-others- convicted-158-million-medicare-fraud-scheme; Dane Schiller, “Riverside Hospital’s ex-CEO, 3 Others, Convicted in Medicare Fraud Case,” The Houston Chronicle, October 20, 2014, http://www.chron.com/ news/houston-texas/houston/article/Riverside-Hospital-CEO-3-others- convicted-in-5835279.php.

3 Ashante Infantry, “Canadian Coffee Firm Sues Keurig, Alleges Unfair Competition,” The (Toronto) Star, October 1, 2014, U.S. Department of Justice website at http://www.thestar.com/business/2014/10/01/ canadian_coffee_firm_sues_keurig_alleges_unfair_competition.html.

4 “Jury Convicts Peruvian Man of Defrauding and Extorting Spanish- Speaking Customers through Fraudulent Call Centers,” Press Release, U.S. Department of Justice, October 17, 2014, http://www.justice.gov/ opa/pr/jury-convicts-peruvian-man-defrauding-and-extorting-spanish- speaking-customers-through.

5 “Gerber Accused of False Claims on Baby Formula,” NBC News, October 30, 2014, http://www.nbcnews.com/health/kids-health/gerber- accused-false-claims-baby-formula-n237781.

6 “Feds Sue AT&T for Unfair Slowing of Mobile Customer Data,” NBC News, October 28, 2014, http://www.nbcnews.com/business/consumer/ feds-sue-t-unfair-slowing-mobile-customer-data-n235716.

7 Rob Schulz, “Joyce Ziehli Convicted of Five Counts of Embezzlement from New Glarus Home,” Wisconsin State Journal, October 8, 2014,

http://host.madison.com/news/local/crime_and_courts/joyce-ziehli- convicted-of-five-counts-in-embezzlement-from-new/article_345488e0- 00a0-56d1-be3e-63e934b5b19e.html.

8 Jonathan Martin, “Plagiarism Costs Degree for Senator John Walsh,” The New York Times, October 10, 2014, http://www.nytimes. com/2014/10/11/us/politics/plagiarism-costs-degree-for-senator-john- walsh.html?_r=0

9 Nick Turner, “Staples Shareholders Vote against Executive- Compensation Plan,” Bloomberg News, June 2, 2014, http://www. bloomberg.com/news/2014-06-03/staples-shareholders-vote-against- executive-compensation-plan.html.

10 U.S. Securities & Exchange Commission, “Houston-Based Advisory Firm and Co-Owners Charged with Failing to Disclose Conflict of Interest,” Press Release, September 2, 2014, http://www.sec. gov/News/PressRelease/Detail/PressRelease/1370542808249#. VE6ASfnF8oM.

11 Mark Friedman, “Wal-Mart Spends $230 Million on Mexican Bribery Investigation,” Arkansas Business, June 10, 2013, http://www. arkansasbusiness.com/article/92905/wal-mart-spends-230-million-on- mexican-bribery-investigation?page=all; David Voreacos and Renee Dudley, “Wal-Mart Says Bribe Probe Cost $439 Million in Two Years,” Bloomberg News, March 26, 2014, http://www.bloomberg.com/ news/2014-03-26/wal-mart-says-bribery-probe-cost-439-million-in- past-two-years.html.

12 Procter & Gamble Company, Our Worldwide Business Conduct Manual, p. 23, http://www.pg.com/en_US/downloads/company/governance/ Policy_Worldwide_Business_Conduct_Manual.pdf.

13 Lara O’Reilly, “Red Bull Will Pay $10 to Customers Disappointed the Drink Didn’t Actually Give Them ‘Wings’,” Business Insider, October 8, 2014, http://www.businessinsider.com/red-bull-settles-false-advertising- lawsuit-for-13-million-2014-10.

14 O. C. Ferrell and Larry Gresham, “A Contingency Framework for Understanding Ethical Decision Making in Marketing,” Journal of Marketing (Summer 1985), 89.

chapter 2 Being Ethical and Socially Responsible 67

15 Starbucks, “Business Ethics and Compliance: Standards of Business Conduct,” p. 6, http://globalassets.starbucks.com/assets/eecd184d6d2 141d58966319744393d1f.pdf (accessed October 30, 2014).

16 Katy Stech, “Trinity Industries Whistleblower Awarded $175 Million in Guardrail Suit,” The Wall Street Journal, October 20, 2014, http:// online.wsj.com/articles/jury-awards-trinity-whistleblower-175-million-in- guardrail-suit-1413838696.

17 Michael Josephson, “Can Corporate Ethics Programs Do Any Good,” Josephson Institute blog, December 27, 2013, http://josephsoninstitute. org/business/blog/2013/12/can-corporate-ethics-programs-do-any- good/.

18 Target, “Schools,” https://corporate.target.com/corporate-responsibility/ education/schools (accessed October 31, 2014).

19 Procter & Gamble, Tide’s Loads of Hope, http://www.tide.com/en-US/ loads-of-hope/index.jspx (accessed November 10, 2014.

20 Lyndsey Taylor, “P. Terry’s Burger Stand,” Community Impact (Austin Metro edition), September 24, 2014, http://impactnews.com/austin- metro/northwest-austin/p-terrys-burger-stand/.

21 Barbara Miller, “Hilton Hotels Offer Veterans Hotel ‘Points’ for Use During Job Searches,” The Patriot-News, October 29, 2014, http://www. pennlive.com/midstate/index.ssf/2014/10/hilton_hotels_offer_free_point. html.

22 Jacob Passy, “Florida Jury Awards $23.6B Verdict in Big Tobacco Lawsuit,” NBC News, July 19, 2014, http://www.nbcnews.com/ news/us-news/florida-jury-awards-23-6b-verdict-big-tobacco- lawsuit-n160241.

23 Claire Suddath, “Coke’s New Low-Cal, Low-Sugar Soda is Designed to Quiet Critics,” BusinessWeek, June 17, 2014, http://www.businessweek. com/articles/2014-06-17/cokes-new-low-cal-low-sugar-soda-is- designed-to-quiet-critics.

24 Alexandra Sifferlin, “Why Michele Obama Went After Junk Food Ads,” Time, February 25, 2014, http://healthland.time.com/2014/02/25/what- food-marketing-changes-means-for-health/.

25 Sarah Hedgecock, “Lots of Smoke as CVS Withdraws Cigarettes,” Forbes, September 5, 2014, http://www.forbes.com/sites/ sarahhedgecock/2014/09/05/lots-of-smoke-as-cvs-withdraws- cigarettes/.

26 Caitlyn Bohannon, “AT&T’s It Can Wait Texting Campaign Adds Hashtag, Sends Unclear Message,” Mobile Marketer, July 30, 2014, http://www.mobilemarketer.com/cms/news/messaging/18338.html.

27 Brittany Baumann, “Menominee Tribe, Hard Rock Team Up with Colleges for Job Training Program,” WDJT, October 31, 2014, http:// www.cbs58.com/story/27179838/menominee-tribe-hard-rock-team-up- with-colleges-for-job-training-program.

28 “The 2014 WBI U.S. Workplace Bullying Survey,” Workplace Bullying Institute, February 2014, http://workplacebullying.org/multi/pdf/WBI- 2014-US-Survey.pdf (accessed October 24, 2014).

29 Lisa Evans, “Why the Office Bully Is Getting Promoted,” Fast Company, October 23,2014, http://www.fastcompany.com/3037427/why-the- office-bully-is-getting-promoted.

30 Robin Abcarian, “Just as We Thought: Richie Incognito Bullied Jonathan Martin,” Los Angeles Times, February 14, 2014, http://articles.latimes. com/2014/feb/14/local/la-me-ra-report-miami-dolphins-jonathan-martin- bullied-by-richie-incognito–20140214.

31 “Sexual Harassment,” U.S. Equal Employment Opportunity Commission, http://www.eeoc.gov/laws/types/sexual_harassment.cfm (accessed November 4, 2014).

32 Alejandra Cancino, “Years After Sexual Harassment Settlement, Ford Plant Sued Again,” Chicago Tribune, November 4, 2014, http://www. chicagotribune.com/business/ct-ford-lawsuit-1104-biz-20141103-1- story.html.

33 Evans, “Why the Office Bully Is Getting Promoted.” 34 Harrison Jacobs, “Why Grocery Stores Like Trader Joe’s Throw Out so

Much Perfectly Good Food,” Business Insider, October 15, 2014, http:// www.businessinsider.com/why-grocery-stores-throw-out-so-much- food-2014-10.

35 “Company Fined $1M on Waste,” Star-Telegram, November 6, 2014, http://www.star-telegram.com/2014/11/06/6265529/company-fined-1m- on-waste.html.

36 Alison Gene Smith, “Jerome Cheese to Pay $88K Fine to EPA,” (Twin Falls) Times-News, October 16, 2014, http://magicvalley.com/news/ local/jerome-cheese-to-pay-k-fine-to-epa/article_619f9c69-075d-5d46- 9dc0-ab50f013ad71.html.

37 “Coca-Cola New England Teaches a Lesson in Recycling,” New Hampshire Business Review, October 17, 2014, http://www.nhbr. com/October-17-2014/Coca-Cola-New-England-teaches-a-lesson-in- recycling/.

38 Heather Clancy, “IKEA, Swiss Re, Mars, H&M Go All-In on Renewable Energy,” GreenBiz, September 22, 2014, http://www.greenbiz.com/ blog/2014/09/22/ikea-swiss-re-mars-hm-make-100-renewable-energy- pledges.

39 Andrew J. Czaplewski, Erik M. Olson, and Peggy McNulty, Going Green Puts Chipotle in the Black,” Marketing News, March 2014, https:// www.ama.org/publications/MarketingNews/Pages/Going-Green–Puts- Chipotle-in-the-Black.aspx.

40 Missy Baxter, “FTC Clarifies Green Marketing Guidelines,” Credit Union Times, May 7, 2014, http://www.cutimes.com/2014/05/07/ftc-clarifies- green-marketing-guidelines.

41 “Caesar’s Entertainment Exceeds Corporate Citizenship Goals by Taking a Serious Approach to Play,” Entertainment & Travel, October 11, 2014, p. 76.

42 Based on information in “NIST Visit to Chicago Spotlights Manufacturing Success,” Department of Commerce, July 20, 2012, http://www.commerce.gov; Hosea Sanders, “Less Is More for Green Business,” ABC WLS-TV, January 21, 2011, http://abclocal.go.com; Leigh Buchanan, “A Look Inside the Un-Factory,” Inc., June 8, 2010, http://www.inc.com; “Top Workplaces: PortionPac Chemical,” Inc., June 1, 2010, http://www.inc.com; Nicole J. Bowman, “PortionPac Chemical Corp.,” ISSA, March 23, 2010, http://current.issa.com; http://www. portionpaccorp.com (accessed November 9, 2014).

Learning Objectives Once you complete this chapter, you will be able to:

3-1 Explain the economic basis for international business. 3-2 Explore the methods by which a firm can organize for and enter into

international markets.

3-3 Discuss the restrictions nations place on international trade, the objectives of these restrictions, and their results.

3-4 Outline the extent of international business and the economic outlook for trade. 3-5 Discuss international trade agreements and international economic

organizations working to foster trade.

3-6 Describe the various sources of export assistance. 3-7 Identify the institutions that help firms and nations finance international

business.

Exploring Global BusinessChaptEr

3 Why Should You Care? Free trade—are you for or against

it? Most economists support

free-trade policies, but public

support can be lukewarm, and

certain groups are adamantly

opposed, alleging that “trade harms

large segments of U.S. workers,”

“degrades the environment,” and

“exploits the poor.”

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Chapter 3 Exploring Global Business 69

Walmart is just one of a growing number of companies, large and small, that are doing business with firms in other countries. Some companies, such as General Electric, sell to firms in other countries; others, such as Pier 1 Imports, buy goods around the world to import into the United States. Combustion Associates of Corona, California, is a small business founded by husband and wife immigrants of Bangladesh. The company makes and exports large power generators to more than forty developing countries. Whether they buy or sell products across national borders, these companies are all contributing to the volume of international trade that is fueling the global economy.

Theoretically, international trade is every bit as logical and worthwhile as interstate trade between, say, California and Washington. Yet, nations tend to restrict the import of certain goods for a variety of reasons. For example, in the early 2000s, the United States restricted the import of Mexican fresh tomatoes because they were undercutting price levels of domestic fresh tomatoes.

Despite such restrictions, international trade has increased almost steadily since World War II. Many of the industrialized nations have signed trade agreements intended to eliminate problems in international business and to help less-developed nations participate in world trade. Individual firms around the world have seized the opportunity to compete in foreign markets by exporting products and increasing foreign production, as well as by other means.

Signing the Trade Act of 2002, President George W. Bush remarked, “Trade is an important source of good jobs for our workers and a source of higher growth

Walmart’s Global Business Strategy

Walmart has expanded from a single arkansas store in 1962 to 11,000 outlets worldwide today, plus online stores in 10 countries. the world’s largest retailer rings up sales of $485.7 billion in 27 countries. Whether the name over the door or on the web site is Walmart, Bodega aurrera, asda, Yihaodian, seiyu, or superama, Walmart’s global business strategy is to offer merchandise that local customers need at low prices they can afford.

although Walmart has enjoyed considerable success world- wide, it has also suffered setbacks. the company entered and then left both germany and south korea after failing to achieve its financial goals in either market. it became a minority investor in the Japanese supermarket chain seiyu in 2002 and acquired it as a wholly-owned subsidiary in 2008. coping with Japan’s struggling economy, however, has led Walmart to close as many as 30 seiyu stores in recent years.

in 1996, Walmart opened its first stores in china, eyeing the ever-higher buying power of local consumers. since then, the retailer has experienced both ups and downs in china. it recently announced the closing of 29 underperforming stores there, even as it opens

dozens of new, smaller stores in more promising urban areas. the retailer is also spending heavily to expand e-commerce operations in china, targeting the growing number of customers who shop by smart phone, tablet, or computer.

to enter india, another market where household incomes have been rising, Walmart formed a joint venture with a local corpora- tion and opened cash-and-carry wholesale outlets starting in 2009. at the time, india protected its small merchants by strictly limiting foreign ownership of wholesale and retail businesses. after some of those restrictions were eased in 2012, the joint venture was dis- solved, allowing the local partner to concentrate on its own retail expansion. For its part, Walmart plans to keep adding new cash- and-carry wholesale outlets until india simplifies the rules for foreign direct investment in retailing.1

Did You Know? Founded in 1962, Walmart now rings up $485.7 billion in annual sales and employs 2.2 million people worldwide.

InsIde BusIness

70 Part 1 The Environment of Business

for our economy. Free trade is also a proven strategy for building global prosperity and adding to the momentum of political freedom. Trade is an engine of economic growth. In our lifetime, trade has helped lift millions of people and whole nations out of poverty and put them on the path of prosperity.”2 In his national best seller, The World Is Flat, Thomas L. Friedman states, “The flattening of the world has presented us with new opportunities, new challenges, new partners but, also, alas new dangers, particularly as Americans it is imperative that we be the best global citizens that we can be—because in a flat world, if you don’t visit a bad neighborhood, it might visit you.”

We describe international trade in this chapter in terms of modern specialization, whereby each country trades the surplus goods and services it produces most efficiently for products in short supply. We explore several methods of entering international markets and explain the restrictions nations place on products and services from other countries and present some of the possible advantages and disadvantages of these restrictions. We describe the extent of international trade and identify the organizations working to foster it. We then outline the various sources of export assistance available from the federal government. Finally, we identify some of the institutions that provide the complex financing necessary for modern international trade.

3-1 THE BASIS FOR INTERNATIONAL BUSINESS International business encompasses all business activities that involve exchanges across national boundaries. Thus, a firm is engaged in international business when it buys some portion of its input from, or sells some portion of its output to, an organization located in a foreign country. (A small retail store may sell goods produced in some other country. However, because it purchases these goods from American distributors, it is not engaged in international trade.)

3-1a absolute and Comparative advantage Some countries are better equipped than others to produce particular goods or services. The reason may be a country’s natural resources, its labor supply, or even

Learning Objective

3-1Explain the economic basis for international business.

International business all business activities that involve exchanges across national boundaries

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A U.S. Absolute Advantage. The United States has long specialized in the production of wheat. Because of its natural resource, the United States and some other countries enjoy an absolute advantage—their ability to produce wheat more efficiently than countries in other parts of the world.

Chapter 3 Exploring Global Business 71

customs or a historical accident. Such a country would be best off if it could specialize in the production of such products so that it can produce them most efficiently. The country could use what it needed of these products and then trade the surplus for products it could not produce efficiently on its own.

Saudi Arabia thus has specialized in the production of crude oil and petroleum products; South Africa, in diamonds; and Australia, in wool. Each of these countries is said to have an absolute advantage with regard to a particular product. An absolute advantage is the ability to produce a specific product more efficiently than any other nation.

One country may have an absolute advantage with regard to several products, whereas another country may have no absolute advantage at all. Yet it is still worthwhile for these two countries to specialize and trade with each other. To see why this is so, imagine that you are the president of a successful manufacturing firm and that you can accurately type 90 words per minute. Your assistant can type 80 words per minute but would run the business poorly. Thus, you have an absolute advantage over your assistant in both typing and managing. However, you cannot afford to type your own letters because your time is better spent in managing the business. That is, you have a comparative advantage in managing. A comparative advantage is the ability to produce a specific product more efficiently than any other product.

Your assistant, on the other hand, has a comparative advantage in typing because he or she can do that better than managing the business. Thus, you spend your time managing, and you leave the typing to your assistant. Overall, the business is run as efficiently as possible because you are each working in accordance with your own comparative advantage.

The same is true for nations. Goods and services are produced more efficiently when each country specializes in the products for which it has a comparative advantage. Moreover, by definition, every country has a comparative advantage in some product. The United States has many comparative advantages—in research and development, high-technology industries, and identifying new markets, for instance.

3-1b Exporting and Importing Suppose that the United States specializes in producing corn. It then will produce a surplus of corn, but perhaps it will have a shortage of wine. France, on the other hand, specializes in producing wine but experiences a shortage of corn. To satisfy both needs—for corn and for wine—the two countries should trade with each other. The United States should export corn and import wine. France should export wine and import corn.

Exporting is selling and shipping raw materials or products to other nations. The Boeing Company, for example, exports its airplanes to a number of countries for use by their airlines. Figure 3-1 shows the top ten merchandise-exporting states in the United States.

Importing is purchasing raw materials or products in other nations and bringing them into one’s own country. Thus, buyers for Macy’s department stores may purchase rugs in India or raincoats in England and have them shipped back to the United States for resale.

Importing and exporting are the principal activities in international trade. They give rise to an important concept called the balance of trade. A nation’s balance of trade is the total value of its exports minus the total value of its imports over some period of time. If a country imports more than it exports, its balance of trade is negative and is said to be unfavorable. (A negative balance of trade is unfavorable because the country must export money to pay for its excess imports.)

absolute advantage the ability to produce a specific product more efficiently than any other nation

comparative advantage the ability to produce a specific product more efficiently than any other product

exporting selling and shipping raw materials or products to other nations

importing purchasing raw materials or products in other nations and bringing them into one’s own country

balance of trade the total value of a nation’s exports minus the total value of its imports over some period of time

72 Part 1 The Environment of Business

In 2013, the United States imported $2,757 billion worth of goods and services and exported $2,280 billion worth. It thus had a trade deficit of $477 billion. A trade deficit is a negative balance of trade (see Figure 3-2). However, the United States has consistently enjoyed a large and rapidly growing surplus in services. For example, in 2013, the United States imported $462.1 billion worth of services and exported $687.4 billion worth, thus creating a favorable balance of $225.3 billion.3

Question: Are trade deficits bad?

Answer: In testimony before the Senate Finance Committee, Daniel T. Griswold, associate director of the Center for Trade Policy at the Cato Institute, remarked, “The trade deficit is not a sign of economic distress, but of rising domestic demand and investment. Imposing new trade barriers will only make Americans worse off while leaving the trade deficit virtually unchanged.”

On the other hand, when a country exports more than it imports, it is said to have a favorable balance of trade. This has consistently been the case for Japan over the last two decades or so.

A nation’s balance of payments is the total flow of money into a country minus the total flow of money out of that country over some period of time. Balance of payments, therefore, is a much broader concept than balance of trade. It includes imports and exports, of course. However, it also includes investments, money spent by foreign tourists, payments by foreign governments, aid to foreign governments, and all other receipts and payments.

A continual deficit in a nation’s balance of payments (a negative balance) can cause other nations to lose confidence in that nation’s economy. Alternatively, a continual surplus may indicate that the country encourages exports but limits imports by imposing trade restrictions.

trade deficit a negative balance of trade

balance of payments the total flow of money into a country minus the total flow of money out of that country over some period of time

Learning Objective

3-2Explore the methods by which a firm can organize for and enter into international markets.

Concept Check ✓✓ Why do firms engage in international trade?

✓✓ What is the difference between an absolute advantage and a comparative advantage?

✓✓ What is the difference between balance of trade and balance of payments?

FIgURE 3-1 The Top Ten Merchandise-Exporting States

Texas and California accounted for about one-fifth of all 2013 U.S. merchandise exports.

Texas

Billions of dollars, 2013 merchandise exports

Total 2013 U.S. exports: $2,280 billion

$279.7

California $168.1

New York $86.5

$66.1Illinois

Louisiana

$81.9Washington

$61.3Florida

$63.3

$58.5Michigan

$50.5Ohio

source: international trade administration, www.trade.gov/mas/ian/statereports/ (accessed January 1, 2015).

Chapter 3 Exploring Global Business 73

Question: Are trade deficits bad?

On the other hand, when a country exports more than it imports, it is said to have a favorable balance of trade. This has consistently been the case for Japan over the last two decades or so.

trade deficit a negative balance of trade

balance of payments the total flow of money into a country minus the total flow of money out of that country over some period of time

Learning Objective

3-2Explore the methods by which a firm can organize for and enter into international markets.

3-2 METHODS OF ENTERINg INTERNATIONAL BUSINESS A firm that has decided to enter international markets can do so in several ways. We will discuss several different methods. These different approaches require varying degrees of involvement in international business. Typically, a firm begins its international operations at the simplest level. Then, depending on its goals, it may progress to higher levels of involvement.

3-2a Licensing Licensing is a contractual agreement in which one firm permits another to produce and market its product and use its brand name in return for a royalty or other

licensing a contractual agreement in which one firm permits another to produce and market its product and use its brand name in return for a royalty or other compensation

FIgURE 3-2 U.S. International Trade in Goods and Services

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Balance of Trade

If a country imports more goods than it exports, the balance of trade is negative, as

it was in the United States from 2000 to 2013.

source: u.s. Department of commerce, international trade administration, www.trade.gov/mas/ian/build/groups/public/tg_ian/documents (accessed January 2, 2015).

74 Part 1 The Environment of Business

compensation. For example, Yoplait yogurt is a French yogurt licensed for production in the United States. The Yoplait brand maintains an appealing French image, and in return, the U.S. producer pays the French firm a percentage of its income from sales of the product.

Licensing is especially advan tageous for small manufacturers wanting to launch a well-known domestic brand internationally. For example, all Spalding sporting products are licensed worldwide. The licensor, the Questor Corporation, owns the Spalding name but produces no goods itself. Licensing thus provides a simple method for expanding into a foreign market with virtually no investment. On the other hand, if the licensee does not maintain the licensor’s product standards, the product’s image may be damaged. Another possible disadvantage is that a licensing arrangement may not provide the original producer with any foreign marketing experience.

3-2b Exporting A firm also may manufacture its products in its home country and export them for sale in foreign markets. As with licensing, exporting can be a relatively low-risk method of entering foreign markets. Unlike licensing, however, it is not a simple method; it opens up several levels of involvement to the exporting firm.

At the most basic level, the exporting firm may sell its products outright to an export–import merchant, which is essentially a merchant wholesaler. The merchant assumes all the risks of product ownership, distribution, and sale. It may even purchase the goods in the producer’s home country and assume responsibility for exporting the goods. An important and practical issue for domestic firms dealing with foreign customers is securing payment. This is a two-sided issue that reflects the mutual concern rightly felt by both parties to the trade deal: The exporter would like to be paid before shipping the merchandise, whereas the importer obviously would prefer to know that it has received the shipment before releasing any funds. Neither side wants to take the risk of fulfilling its part of the deal only to discover later that the other side has not. The result would lead to legal costs and complex, lengthy dealings that would waste everyone’s resources. This mutual level of mistrust, in fact, makes good business sense and has been around since the beginning of trade centuries ago. The solution then was the same as it still is today—for both parties to use a mutually trusted go-between who can ensure that the payment is held until the merchandise is in fact delivered according to the terms of the trade contract. The go-between representatives employed by the importer and exporter are still, as they were in the past, the local domestic banks involved in international business.

EXpOrtING tO INtErNatIONaL MarKEtS American companies may manufacture their products in the United States and export them for sale in foreign markets. Exporting can be a relatively low-risk method of entering foreign markets.

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Here is a simplified version of how it works. After signing contracts detailing the merchandise sold and terms for its delivery, an importer will ask its local bank to issue a letter of credit for the amount of money needed to pay for the merchandise. The letter of credit is issued “in favor of the exporter,” meaning that the funds are tied specifically to the trade contract involved. The importer’s bank forwards the letter of credit to the exporter’s bank, which also normally deals in international transactions. The exporter’s bank then notifies the exporter that a letter of credit has been received in its name, and the exporter can go ahead with the shipment. The carrier transporting the merchandise provides the exporter with evidence of the shipment in a document called a bill of lading. The exporter signs over title to the merchandise (now in transit) to its bank by delivering signed copies of the bill of lading and the letter of credit.

In exchange, the exporter issues a draft from the bank, which orders the importer’s bank to pay for the merchandise. The draft, bill of lading, and letter of credit are sent from the exporter’s bank to the importer’s bank. Acceptance by the importer’s bank leads to return of the draft and its sale by the exporter to its bank, meaning that the exporter receives cash and the bank assumes the risk of collecting the funds from the foreign bank. The importer is obliged to pay its bank on delivery of the merchandise, and the deal is complete.

In most cases, the letter of credit is part of a lending arrangement between the importer and its bank. Of course, both banks earn fees for issuing letters of credit and drafts and for handling the import–export services for their clients. Furthermore, the process incorporates the fact that both importer and exporter will have different local currencies and might even negotiate their trade in a third currency. The banks look after all the necessary exchanges. For example, the vast majority of international business is negotiated in U.S. dollars, even though the

letter of credit issued by a bank on request of an importer stating that the bank will pay an amount of money to a stated beneficiary

bill of lading document issued by a transport carrier to an exporter to prove that merchandise has been shipped

draft issued by the exporter’s bank, ordering the importer’s bank to pay for the merchandise, thus guaranteeing payment once accepted by the importer’s bank

advice from Global Entrepreneurs

Entrepreneurial businesses are increasingly looking for growth by expanding into global markets. Here’s what seasoned entrepreneurs have learned from their experiences with international business:

• Get local help. Asking for suggestions and ideas from consultants, suppliers, or even potential customers in the local area is a good way to avoid potential pitfalls that could hurt a global business. A Boston-based entrepreneur expanding abroad says that talking with customers “allowed us to get a grasp of the local customs” in that area.

• Innovate, innovate, innovate. Global markets are ripe with opportunities for entrepreneurs who can provide innovative goods and services to meet the needs of local consumers or businesses. A small business expert sums up international business opportunities this way: “The options are practically limitless.”

• Remember time differences. As basic as this sounds, it means that entrepreneurs must be available to their local employees or distributors during working hours in the market(s) where they do business. One entrepreneur recalls the challenge of working during the U.S. business day, and then putting in even more hours at night to deal with overseas business issues.

• Be prepared for the unexpected. “Nothing ever works out as smoothly as you think, and timelines always get stretched out further,” observes a technology entrepreneur. Global entrepreneurs need more than patience and a positive attitude—they should be ready to search for creative, out-of- the-ordinary solutions when problems pop up without warning.

sources: Based on information in “how to expand overseas (and not get overwhelmed), Inc., march 28, 2014, www.inc.com; tanya edwards, “steal this start-up advice from entrepreneurs making a Difference,” Glamour, march 24, 2014, www.glamour.com; Dan schawbel, “Why You should think globally as an entrepreneur,” Forbes.com, october 29, 2013, www.forbes.com.

Entrepreneurial Success

76 Part 1 The Environment of Business

trade may be between countries other than the United States. Thus, although the importer may end up paying for the merchandise in its local currency and the exporter may receive payment in another local currency, the banks involved will exchange all necessary foreign funds in order to allow the deal to take place.

Alternatively, the exporting firm may ship its products to an export–import agent, which arranges the sale of the products to foreign intermediaries for a commission or fee. The agent is an independent firm—like other agents—that sells and may perform other marketing functions for the exporter. The exporter, however, retains title to the products during shipment and until they are sold.

An exporting firm also may establish its own sales offices, or branches, in foreign countries. These installations are international extensions of the firm’s distribution system. They represent a deeper involvement in international business than the other exporting techniques we have discussed— and thus they carry a greater risk. The exporting firm maintains control over sales, and it gains both experience in and knowledge of foreign markets. Eventually, the firm also may develop its own sales force to operate in conjunction with foreign sales offices.

3-2c Joint Ventures A joint venture is a partnership formed to achieve a specific goal or to operate for a specific period of time. A joint venture with an established firm in a foreign country provides immediate market knowledge and access, reduced risk, and control over product attributes. However, joint-venture agreements established

across national borders can become extremely complex. As a result, joint-venture agreements generally require a very high level of commitment from all the parties involved.

A joint venture may be used to produce and market an existing product in a foreign nation or to develop an entirely new product. Recently, for example, Archer Daniels Midland Company (ADM), one of the world’s leading food processors, entered into a joint venture with Gruma SA, Mexico’s largest corn flour and tortilla company. Besides a 22 percent stake in Gruma, ADM also received stakes in other joint ventures operated by Gruma. One of them will combine both companies’ U.S. corn flour operations, which account for about 25 percent of the U.S. market. ADM also has a 40 percent stake in a Mexican wheat flour mill. ADM’s joint venture increased its participation in the growing Mexican economy, where ADM already produces corn syrup, fructose, starch, and wheat flour.

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Joint Venture. Large pipelines can involve multiple countries. They can be organized based on the use of joint ventures.

Personal App

The cars you and your friends drive or admire may have parts made in far-flung parts of the world, one clue to the multinational scale of companies like Ford, Toyota, Volkswagen, and Hyundai. Often multinational automakers open assembly plants close to the markets where they sell—which means a car bearing an international brand may actually be made in North America, not in Japan, Germany or South Korea. Because of their multinational perspective, these automakers can apply what they learn in each region to improve their business operations all over the world.

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Chapter 3 Exploring Global Business 77

3-2d totally Owned Facilities At a still deeper level of involvement in international business, a firm may develop totally owned facilities, that is, its own production and marketing facilities in one or more foreign nations. This direct investment provides complete control over operations, but it carries a greater risk than the joint venture. The firm is really establishing a subsidiary in a foreign country. Most firms do so only after they have acquired some knowledge of the host country’s markets.

Direct investment may take either of two forms. In the first, the firm builds or purchases manufacturing and other facilities in the foreign country. It uses these facilities to produce its own established products and to market them in that country and perhaps in neighboring countries. Firms such as General Motors, Union Carbide, and Colgate-Palmolive are multinational companies with worldwide manufacturing facilities. Colgate-Palmolive factories are becoming Eurofactories, supplying neighboring countries as well as their own local markets.

A second form of direct investment in international business is the purchase of an existing firm in a foreign country under an arrangement that allows it to operate independently of the parent company. When Sony Corporation (a Japanese firm) decided to enter the motion picture business in the United States, it chose to purchase Columbia Pictures Entertainment, Inc., rather than start a new motion picture studio from scratch.

3-2e Strategic alliances A strategic alliance, the newest form of international business structure, is a partnership formed to create competitive advantage on a worldwide basis. Strategic alliances are very similar to joint ventures. The number of strategic alliances is growing at an estimated rate of about 20 percent per year. In fact, in the automobile and computer industries, strategic alliances are becoming the predominant means of competing. International competition is so fierce and the costs of competing on a global basis are so high that few firms have all the resources needed to do it alone. Thus, individual firms that lack the internal resources essential for international success may seek to collaborate with other companies.

An example of such an alliance is the New United Motor Manufacturing, Inc. (NUMMI), formed by Toyota and General Motors to make automobiles of both firms. This enterprise united the quality engineering of Japanese cars with the marketing expertise and market access of General Motors.

3-2f trading Companies A trading company provides a link between buyers and sellers in different countries. A trading company, as its name implies, is not involved in manufacturing or owning assets related to manufacturing. It buys products in one country at the lowest price consistent with quality and sells to buyers in another country. An important function of trading companies is taking title to products and performing all the activities necessary to move the products from the domestic country to a foreign country. For example, large grain-trading companies operating out of home offices both in the United States and overseas control a major portion of the world’s trade in basic food commodities. These trading companies sell homogeneous agricultural commodities that can be stored and moved rapidly in response to market conditions.

3-2g Countertrade In the early 1990s, many developing nations had major restrictions on converting domestic currency into foreign currency. Therefore, exporters had to resort to barter

strategic alliance a partnership formed to create competitive advantage on a worldwide basis

trading company provides a link between buyers and sellers in different countries

78 Part 1 The Environment of Business

agreements with importers. Countertrade is essentially an international barter transaction in which goods and services are exchanged for different goods and services. Examples include Saudi Arabia’s purchase of ten 747 jets from Boeing with payment in crude oil and Philip Morris’s sale of cigarettes to Russia in return for chemicals used to make fertilizers.

3-2h Multinational Firms A multinational enterprise is a firm that operates on a worldwide scale without ties to any specific nation or region. The multinational firm represents the highest level of involvement in international business. It is equally “at home” in most countries of the world. In fact, as far as the operations of the multinational enterprise are concerned, national boundaries exist only on maps. It is, however, organized under the laws of its home country.

Table 3-1 shows the ten largest foreign and U.S. public multinational companies; the ranking is based on a composite score reflecting each company’s best three out of four rankings for sales, profits, assets, and market value. Table 3-2 describes steps in entering international markets.

According to the former chairman of the board of Dow Chemical Company, a multinational firm of U.S. origin, “The emergence of a world economy and of the multinational corporation has been accomplished hand in hand.” He sees multinational enterprises moving toward what he calls the “anational company,” a firm that has no nationality but belongs to all countries. In recognition of this movement, there already have been international conferences devoted to the question of how such enterprises would be controlled.

3-3 RESTRICTIONS TO INTERNATIONAL BUSINESS Specialization and international trade can result in the efficient production of want- satisfying goods and services on a worldwide basis. As we have noted, international business generally is increasing. Yet the nations of the world continue to erect barriers to free trade. They do so for reasons ranging from internal political and economic pressures to simple mistrust of other nations. We examine first the types of restrictions that are applied and then the arguments for and against trade restrictions.

countertrade an international barter transaction

Concept Check ✓✓ two methods of engaging in international business may be categorized as either direct or indirect. how would you classify each of the methods described in this chapter? Why?

✓✓ What is a letter of credit? a bill of lading? a draft?

✓✓ in what ways is a multinational enterprise different from a large corporation that does business in several countries?

✓✓ What are the steps in entering international markets?

multinational enterprise a firm that operates on a worldwide scale without ties to any specific nation or region

Learning Objective

3-3 Discuss the restrictions nations place on international trade, the objectives of these restrictions, and their results.

TABLE 3-1 The Ten Largest Foreign and U.S. Multinational Corporations

2014 Rank Company Business Country Revenue ($ millions)

1 Walmart Stores General Merchandise United States 476,294

2 Royal Dutch Shell Energy Netherlands 459,599

3 Sinopec Energy China 457,201

4 China National Petroleum Energy China 432,007

5 ExxonMobil Energy United States 407,666

6 BP Energy United Kingdom 396,217

7 State Grid Power Grids China 333,386

8 Volkswagen Automobiles Germany 261,539

9 Toyota Automobiles Japan 256,454

10 Glencore Commodities Switzerland 232,694

source: http://fortune.com/global500/ (accessed January 1, 2015).

Chapter 3 Exploring Global Business 79

3-3a types of trade restrictions Nations generally are eager to export their products. They want to provide markets for their industries and to develop a favorable balance of trade. Hence, most trade restrictions are applied to imports from other nations.

tarIFFS Perhaps the most commonly applied trade restriction is the customs (or import) duty. An import duty (also called a tariff) is a tax levied on a particular foreign product entering a country. For example, the United States imposes a 2.2 percent import duty on fresh Chilean tomatoes, an 8.7 percent duty if tomatoes are dried and packaged, and nearly 12 percent if tomatoes are made into ketchup or salsa. The two types of tariffs are revenue tariffs and protective tariffs; both have the effect of raising the price of the product in the importing nations, but for different reasons. Revenue tariffs are imposed solely to generate income for the government. For example, the United States imposes a duty on Scotch whiskey solely for revenue purposes. Protective tariffs, on the other hand, are imposed to protect a domestic industry from competition by keeping the price of competing imports level with or higher than the price of

import duty (tariff) a tax levied on a particular foreign product entering a country

TABLE 3-2 Steps in Entering International Markets

Step Activity Marketing Tasks

1 Identify exportable products. Identify key selling features. Identify needs that they satisfy. Identify the selling constraints that are imposed.

2 Identify key foreign markets for the products.

Determine who the customers are. Pinpoint what and when they will buy. Do market research. Establish priority, or “target,” countries.

3 Analyze how to sell in each priority market (methods will be affected by product characteristics and unique features of country/market).

Locate available government and private-sector resources. Determine service and backup sales requirements.

4 Set export prices and payment terms, methods, and techniques.

Establish methods of export pricing. Establish sales terms, quotations, invoices, and conditions of sale. Determine methods of international payments, secured and unsecured.

5 Estimate resource requirements and returns.

Estimate financial requirements. Estimate human resources requirements (full- or part-time export department or operation). Estimate plant production capacity. Determine necessary product adaptations.

6 Establish overseas distribution network.

Determine distribution agreement and other key marketing decisions (price, repair policies, returns, territory, performance, and termination). Know your customer (use U.S. Department of Commerce international marketing services).

7 Determine shipping, traffic, and documentation procedures and requirements.

Determine methods of shipment (air or ocean freight, truck, rail). Finalize containerization. Obtain validated export license. Follow export-administration documentation procedures.

8 Promote, sell, and be paid. Use international media, communications, advertising, trade shows, and exhibitions. Determine the need for overseas travel (when, where, and how often?). Initiate customer follow-up procedures.

9 Continuously analyze current marketing, economic, and political situations.

Recognize changing factors influencing marketing strategies. Constantly re-evaluate.

source: u.s. Department of commerce, international trade administration, Washington, Dc.

80 Part 1 The Environment of Business

similar domestic products. Because fewer units of the product will be sold at the increased price, fewer units will be imported. The French and Japanese agricultural sectors would both shrink drastically if their nations abolished the protective tariffs that keep the price of imported farm products high. Today, U.S. tariffs are the lowest in history, with average tariff rates on all imports under 3 percent.

Some countries rationalize their protectionist policies as a way of offsetting an international trade practice called dumping. Dumping is the exportation of large quanti ties of a product at a price lower than that of the same product in the home market.

Thus, dumping drives down the price of the domestic item. Recently, for example, the Pencil Makers Association, which represents eight U.S. pencil manufacturers, charged that low-priced pencils from Thailand and the People’s Republic of China were being sold in the United States at less than fair value prices. Unable to compete with these inexpensive imports, several domestic manufacturers had to shut down. To protect themselves, domestic manufacturers can obtain an antidumping duty through the government to offset the advantage of the foreign product. Recently, for example, the U.S. Department of Commerce imposed antidumping duties of up to 99 percent on a variety of steel products imported from China, following allegations by U.S. Steel Corp. and other producers that the products were being dumped at unfair prices.

NONtarIFF BarrIErS A nontariff barrier is a nontax measure imposed by a government to favor domestic over foreign suppliers. Nontariff barriers create obstacles to the marketing of foreign goods in a country and increase costs for exporters. The following are a few examples of government-imposed nontariff barriers:

• An import quota is a limit on the amount of a particular good that may be imported into a country during a given period of time. The limit may be set in terms of either quantity (so many pounds of beef) or value (so many dollars’ worth of shoes). Quotas also may be set on individual products imported from specific countries. Once an import quota has been reached, imports are halted until the specified time has elapsed.

• An embargo is a complete halt to trading with a particular nation or of a particular product. The embargo is used most often as a political weapon. At present, the United States has import embargoes against Iran and North Korea—both as a result of extremely poor political relations.

• A foreign-exchange control is a restriction on the amount of a particular foreign currency that can be purchased or sold. By limiting the amount of foreign currency importers can obtain, a government limits the amount of goods importers can purchase with that currency. This has the effect of limiting imports from the country whose foreign exchange is being controlled.

• A nation can increase or decrease the value of its money relative to the currency of other nations. Currency devaluation is the reduction of the value of a nation’s currency relative to the currencies of other countries.

Devaluation increases the cost of foreign goods, whereas it decreases the cost of domestic goods to foreign firms. For example, suppose that the British pound is worth $2. In this case, an American-made $2,000 computer can be purchased for £1,000. However, if the United Kingdom devalues the pound so that it is worth only $1, that same computer will cost £2,000. The increased cost, in pounds, will reduce the import of American computers—and all foreign goods—into England.

On the other hand, before devaluation, a £500 set of English bone china will cost an American $1,000. After the devaluation, the set of china will cost only $500. The decreased cost will make the china—and all English goods—much more

dumping exportation of large quantities of a product at a price lower than that of the same product in the home market

nontariff barrier a nontax measure imposed by a government to favor domestic over foreign suppliers

import quota a limit on the amount of a particular good that may be imported into a country during a given period of time

embargo a complete halt to trading with a particular nation or in a particular product

foreign-exchange control a restriction on the amount of a particular foreign currency that can be purchased or sold

currency devaluation the reduction of the value of a nation’s currency relative to the currencies of other countries

Chapter 3 Exploring Global Business 81

attractive to U.S. purchasers. Bureaucratic red tape is more subtle than the other forms of nontariff barriers. Yet it can be the most frustrating trade barrier of all. A few examples are the unnecessarily restrictive application of standards and complex requirements related to product testing, labeling, and certification.

CULtUraL BarrIErS Another type of nontariff barrier is related to cultural attitudes. Cultural barriers can impede acceptance of products in foreign countries. For example, illustrations of feet are regarded as despicable in Thailand. Even so simple a thing as the color of a product or its package can present a problem. In Japan, black and white are the colors of mourning, so they should not be used in packaging. In Brazil, purple is the color of death. And in Egypt, green is never used on a package because it is the national color. When customers are unfamiliar with particular products from another country, their general perceptions of the country itself affect their attitude toward the product and help to determine whether they will buy it. Because Mexican cars have not been viewed by the world as being quality products, Volkswagen, for example, may not want to advertise that some of its models sold in the United States are made in Mexico. Many retailers on the Internet have yet to come to grips with the task of designing an online shopping site that is attractive and functional for all global customers.

Gifts to authorities—sometimes quite large ones—may be standard business procedure in some countries. In others, including the United States, they are called bribes or payoffs and are strictly illegal.

3-3b reasons for trade restrictions Various reasons are given for trade restrictions either on the import of specific products or on trade with particular countries. We have noted that political considerations usually are involved in trade embargoes. Other frequently cited reasons for restricting trade include the following:

• To equalize a nation’s balance of payments. This may be considered necessary to restore confidence in the country’s monetary system and in its ability to repay its debts.

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Restricting trade through tariffs. Due to the recent increase in inexpensive solar products from China and Taiwan, many American manufactures were forced out of business. To help fix this issue, the United States placed a tariff on Chinese and Taiwanese produced solar panels. Some industry experts believe that the increased prices caused by the tariffs could curb the adoption of solar energy in the United States.

82 Part 1 The Environment of Business

• To protect new or weak industries. A new, or infant, industry may not be strong enough to withstand foreign competition. Temporary trade restrictions may be used to give it a chance to grow and become self-sufficient. The problem is that once an industry is protected from foreign competition, it may refuse to grow, and “temporary” trade restrictions will become permanent. For example, a recent report by the Government Accountability Office (GAO), the congressional investigative agency, has accused the federal government of routinely imposing quotas on foreign textiles without “demonstrating the threat of serious damage” to U.S. industry. The GAO said that the Committee for the Implementation of Textile Agreements sometimes applies quotas even though it cannot prove the textile industry’s claims that American companies have been hurt or jobs have been eliminated.

• To protect national security. Restrictions in this category generally apply to technological products that must be kept out of the hands of potential enemies. For example, strategic and defense-related goods cannot be exported to unfriendly nations.

• To protect the health of citizens. Products may be embargoed because they are dangerous or unhealthy (e.g., farm products contaminated with insecticides).

• To retaliate for another nation’s trade restrictions. A country whose exports are taxed by another country may respond by imposing tariffs on imports from that country.

• To protect domestic jobs. By restricting imports, a nation can protect jobs in domestic industries. However, protecting these jobs can be expensive. For example, protecting 9,000 jobs in the U.S. carbon-steel industry costs $6.8 billion, or $750,000 per job. In addition, Gary Hufbauer and Ben Goodrich, economists at the Institute for International Economics, estimate that the tariffs could temporarily save 3,500 jobs in the steel industry, but at an annual cost to steel users of $2 billion, or $584,000 per job saved. Yet recently the United States imposed tariffs of up to 616 percent on steel pipes imported from China, South Korea, and Mexico. Similarly, it is estimated that we spent more than $100,000 for every job saved in the apparel manufacturing industry—jobs that seldom paid more than $35,000 a year.

3-3c reasons against trade restrictions Trade restrictions have immediate and long-term economic consequences—both within the restricting nation and in world trade patterns. These include the following:

• Higher prices for consumers. Higher prices may result from the imposition of tariffs or the elimination of foreign competition, as described earlier. For example, imposing quota restrictions and import protections adds $25 billion annually to U.S. consumers’ apparel costs by directly increasing costs for imported apparel.

• Restriction of consumers’ choices. Again, this is a direct result of the elimination of some foreign products from the marketplace and of the artificially high prices that importers must charge for products that are still imported.

• Misallocation of international resources. The protection of weak industries results in the inefficient use of limited resources. The economies of both the restricting nation and other nations eventually suffer because of this waste.

• Loss of jobs. The restriction of imports by one nation must lead to cutbacks— and the loss of jobs—in the export-oriented industries of other nations. Furthermore, trade protection has a significant effect on the composition of employment. U.S. trade restrictions—whether on textiles, apparel, steel, or automobiles—benefit only a few industries while harming many others. The gains in employment accrue to the protected industries and their primary suppliers, and the losses are spread across all other industries. A few states gain employment, but many other states lose employment.

Concept Check ✓✓ list and briefly describe the principal restrictions that may be applied to a nation’s imports.

✓✓ What reasons are generally given for imposing trade restrictions?

✓✓ What are the general effects of import restrictions on trade?

Learning Objective

3-4Outline the extent of international business and the economic outlook for trade.

Chapter 3 Exploring Global Business 83

• To protect the health of citizens. Products may be embargoed because they are dangerous or unhealthy (e.g., farm products contaminated with insecticides).

• To retaliate for another nation’s trade restrictions. A country whose exports are taxed by another country may respond by imposing tariffs on imports from that country.

Concept Check ✓✓ list and briefly describe the principal restrictions that may be applied to a nation’s imports.

✓✓ What reasons are generally given for imposing trade restrictions?

✓✓ What are the general effects of import restrictions on trade?

Learning Objective

3-4Outline the extent of international business and the economic outlook for trade.

3-4 THE EXTENT OF INTERNATIONAL BUSINESS Restrictions or not, international business is growing. Although the worldwide recessions of 1991 and 2001–2002 slowed the rate of growth, and the 2008– 2009 global economic crisis caused the sharpest decline in more than 75 years, globalization is a reality of our time. In the United States, international trade now accounts for over one-fourth of Gross Domestic Product (GDP). As trade barriers decrease, new competitors enter the global marketplace, creating more choices for consumers and new opportunities for job seekers. International business will grow along with the expansion of commercial use of the Internet.

3-4a the Economic Outlook for trade Although the global economy continued to grow robustly until 2007, economic performance was not equal: growth in the advanced economies slowed and then stopped in 2009, whereas emerging and developing economies continued to grow. Looking ahead, the International Monetary Fund (IMF), an international bank with 188 member nations, expected a gradual global growth to continue in 2014 and 2015 in both advanced and emerging developing economies. The IMF expected the world economic growth to be 3.3 per cent and 3.8 per cent in 2014 and 2015, respectively.4

CaNaDa aND WEStErN EUrOpE The U.S.-Canada economic relationship is the most efficient, most integrated, and most dynamic in the world. Together, the two nations generated $736 billion in bilateral trade in 2013—more than $2 billion a day, or $23,000 every second. More than 96,000 American companies currently export to Canada, and 70 percent of Canada’s exports come to the United States.5 In the euro area, expected growth is only about 1 percent. While growth in Spain has resumed, Italy has suffered its third consecutive year of negative growth, and France and Germany showed weak growth. Regardless, the U.S. trade with EU is one of the largest and most complex in the world; generating an estimated goods and trade flow of over $2.7 billion a day, and representing an estimated

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International expansion. Netflix continues its globalization efforts by expanding into France, Germany, Austria, Switzerland, Belgium, and Luxembourg. Other regions in which Netflix operates include North America (except Cuba), South America, and the U.K.

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30 percent of global trade.6 In most other advanced economies, including Norway, Sweden, Switzerland, and the United Kingdom, growth is expected to be robust.

MEXICO aND LatIN aMErICa According to the International Monetary Fund (IMF), Latin American exports are growing by a steady 3 to 4 percent annually. This region is home to 11 Free Trade Area countries. In addition to Mexico, these countries include Chile, Colombia, Peru, and the six countries of the Dominican Republic-Central America FTA or “CAFTA-DR” (Costa Rica, The Dominican Republic, El Salvador, Guatemala, Honduras, and Nicaragua)7.

JapaN Japan is the world’s third largest economy and the United States’ fourth largest trading partner. After nearly two decades of deflation and low growth, Japan’s economy is showing signs of recovery.

OthEr aSIaN COUNtrIES The economic growth in Asia remained relatively strong in 2013 and 2014 despite the global recession. China’s emergence as a global economic power has been among the most dramatic economic developments of recent decades. Indeed, China has grown to be the world’s second largest economy, and the United States shares half-trillion dollars in annual bilateral trade—our third- largest trading relationship. Also, as the emerging middle class in India, the world’s largest democracy, buys U.S. products, it means jobs and income for U.S. middle class. With a market of 1.2 billion of the world’s consumers and per capita incomes expected to grow at a rate of 8 percent over the next several years, India’s vast market promises U.S. companies’ continued strong demand for goods and services. In short, the key emerging economies in Asia are leading the global recovery.

aFrICa Sub-Saharan Africa is home to seven of the top ten fastest growing economies in the world—with estimated future growth of 5 to 6 percent for each of the next two years. U.S. trade to and from Africa has tripled over the past decade, and U.S. exports to this region exceed $21 billion. The growth in the African continent is projected to be positive, but uncertain.8

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U.S. Exports. U.S. aircraft and spacecraft products represent the 5th largest U.S. exports.

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EXpOrtS aND thE U.S. ECONOMY In 2013, U.S. exports supported more than 11.3 million full- and part-time jobs during a historic time, when exports as a percentage of GDP reached the highest levels since 1916. The new record, 13.5 percent of GDP in 2013, shows that U.S. businesses have great opportunities in the global marketplace. Even though the global economic crisis caused the number of jobs supported by exports to decline sharply to 8.5 million in 2009, globalization represents a huge opportunity for all countries—rich or poor. Indeed, in 2013, for the first time, the U.S. exports exceeded $2.3 trillion and supported 11.3 million jobs, an increase of 1.6 million jobs since 2009.9 The 15-fold increase in trade volume over the past 65 years has been one of the most important factors in the rise of living standards around the world. During this time, exports have become increasingly important to the U.S. economy. Exports as a percentage of U.S. GDP have increased steadily since 1985, except in the 2001 and 2008 recessions. Our exports to developing and newly industrialized countries are on the rise. Table 3-3 shows U.S. exports and imports for selected world areas in 2013, and Table 3-4 shows the value of U.S. merchandise

TABLE 3-4 Value of U.S. Merchandise Exports and Imports, 2014

Rank/Trading Partner

Exports ($ billions)

Rank/Trading Partner

Imports ($ billions)

1) Canada 312.0 1) China 466.7

2) Mexico 240.3 2) Canada 346.1

3) China 124.0 3) Mexico 294.2

4) Japan 67.0 4) Japan 133.9

5) United Kingdom 53.9 5) Germany 123.2

6) Germany 49.4 6) South Korea 69.6

7) South Korea 44.5 7) United Kingdom 54.0

8) Netherlands 43.7 8) Saudi Arabia 47.0

9) Brazil 42.4 9) France 47.0

10) Belgium 34.8 10) India 45.2

source: u.s. Department of commerce, census Bureau, top trading partners http://www.census.gov/foreign-trade/statistics/highlights/top/ index.html (accessed may 4, 2015).

TABLE 3-3 U.S. Exports and Imports for Selected World Areas in 2013 In billions of dollars

Selected World Area* Exports Imports

North America $433 $611

Europe $290 $452

Euro Area $175 $297

European Union $232 $382

Pacific Rim $351 $767

South/Central America $165 $152

Africa $34 $50

OPEC $78 $141

Re-Exports $207 —

*countries may be included in more than one area grouping. source: u.s. Department of commerce, census Bureau, www.census.gov/foreign-trade/press-release/2013pr/aip/related_party/ rp13-exh1.pdf (accessed January 2, 2015).

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exports to, and imports from, each of the nation’s ten major trading partners. Note that Canada and Mexico are our best partners for our exports; China and Canada, for imports.

Figure 3-3 shows the U.S. goods export and import shares in 2013. Major U.S. exports and imports are manufactured goods, agricultural products, and mineral fuels.

3-5 INTERNATIONAL TRADE AgREEMENTS

3-5a the General agreement on tariffs and trade and the World trade Organization At the end of World War II, the United States and 22 other nations organized the body that came to be known as GATT. The General Agreement on Tariffs and Trade (GATT) is an international organization of 160 nations dedicated to reducing or eliminating tariffs and other barriers to world trade. These 160 nations accounted for more than 97 percent of the world’s merchandise trade. GATT, headquartered in Geneva, Switzerland, provided a forum for tariff negotiations and a means for settling international trade disputes and problems. Most-favored-nation status (MFN) was the famous principle of GATT. It meant that each GATT member nation was to be treated equally by all contracting nations. Therefore, MFN ensured that any tariff reductions or other trade concessions were extended automatically to all GATT members. From 1947 to 1994, the body sponsored eight rounds of negotiations to reduce trade restrictions. Three of the most fruitful were the Kennedy Round, the Tokyo Round, and the Uruguay Round.

Learning Objective

3-5Discuss international trade agreements and international economic organizations working to foster trade.

Concept Check ✓✓ according to the imF, what are the economic growth projections for 2014 and 2015?

✓✓ What is the importance of exports to the u.s. economy?

✓✓ Which nations are the principal trading partners of the united states? What are the major u.s. imports and exports?

General Agreement on Tariffs and Trade (GATT) an international organization of 160 nations dedicated to reducing or eliminating tariffs and other barriers to world trade.

FIgURE 3-3 U.S. Goods Export and Import Shares in 2013

Goods export shares, 2013 Goods import shares, 2013

Mexico 14.19%

China 7.64%

Germany 2.97%

Canada 18.34%

Other OECD

15.49% France 1.99%

All Other 31.71%

U.K. 3.5%

China 19.20%

Japan 6.04%

Germany 4.98%

Canada 14.49%Other

OECD 12.42%

France 1.99%

All Other 26.35%

U.K. 2.30%

Mexico 12.23%

Japan 4.09%

source: Federal reserve Bank of st. louis, National Economic Trends, December 2014, p. 18.

Chapter 3 Exploring Global Business 87

thE KENNEDY rOUND (1964–1967) In 1962, the United States Congress passed the Trade Expansion Act. This law gave President John F. Kennedy the authority to negotiate reciprocal trade agreements that could reduce U.S. tariffs by as much as 50 percent. Armed with this authority, which was granted for a period of five years, President Kennedy called for a round of negotiations through GATT.

These negotiations, which began in 1964, have since become known as the Kennedy Round. They were aimed at reducing tariffs and other barriers to trade in both industrial and agricultural products. The participants succeeded in reducing tariffs on these products by an average of more than 35 percent. However, they were less successful in removing other types of trade barriers.

thE tOKYO rOUND (1973–1979) In 1973, representatives of approximately 100 nations gathered in Tokyo for another round of GATT negotiations. The Tokyo Round was completed in 1979. The participants negotiated tariff cuts of 30 to 35 percent, which were to be implemented over an eight-year period. In addition, they were able to remove or ease such nontariff barriers as import quotas, unrealistic quality standards for imports, and unnecessary red tape in customs procedures.

thE UrUGUaY rOUND (1986–1993) In 1986, the Uruguay Round was launched to extend trade liberalization and widen the GATT treaty to include textiles, agricultural products, business services, and intellectual-property rights. This most ambitious and comprehensive global commercial agreement in history concluded overall negotiations on December 15, 1993, with delegations on hand from 109 nations. The agreement included provisions to lower tariffs by greater than one-third, to reform trade in agricultural goods, to write new rules of trade for intellectual property and services, and to strengthen the dispute-settlement process. These reforms were expected to expand the world economy by an estimated $200 billion annually.

The Uruguay Round also created the World Trade Organization (WTO) on January 1, 1995. The WTO was established by GATT to oversee the provisions of the Uruguay Round and resolve any resulting trade disputes. Membership in the WTO obliges 160 member nations to observe GATT rules.

World Trade Organization (WTO) powerful successor to GATT that incorporates trade in goods, services, and ideas

aiming for an Overseas Job?

Are you interested in working abroad? Want the benefits of traveling and living in another country while you gain on-the- job experience? With the global economic climate beginning to improve, businesses are once again planning to create new positions abroad or send U.S. employees on overseas assignments. Many are looking for candidates with specific skills, knowledge, and attitudes, not necessarily familiarity with the local language. Multinational employers in particular understand the value of helping employees and managers develop a global perspective by working in other nations.

Whether you’re aiming for a brief overseas stint or want to spend much of your career in another country, start now to prepare for a successful experience. You’ll need to think global—so learn more about international events, political trends, and economic issues. Also research social influences and business customs in the region where you expect to work.

Before you apply, determine what employers with international openings are looking for in a job candidate, such as the ability to work independently, good relationship- building skills, solid communication skills, and respect for cultural differences. Ask for advice and suggestions from the professionals in your school’s career office and from classmates and alumni who have worked overseas. Most importantly, maintain an open mind and be ready to adapt to situations and decisions that are novel or unexpected— which you will certainly encounter if you work abroad.

sources: Based on information in valerie sweeten, “Who makes a good candidate for Job in another country?” Houston Chronicle, December 12, 2014, www.chron.com; Francesca Donner, “Want to Work overseas? now’s Your chance,” Wall Street Journal, December 1, 2014, www. wsj.com; kenny Buck, “grads Find Work overseas,” The Advocate (Minnesota State University- Moorhead), november 24, 2014, http://msumadvocate.com.

Career Success

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3-5b International Economic Organizations Working to Foster trade The primary objective of the WTO is to remove barriers to trade on a worldwide basis. On a smaller scale, an economic community is an organization of nations formed to promote the free movement of resources and products among its members and to create common economic policies. A number of economic communities now exist.

thE EUrOpEaN UNION Operating as a single market with 28 countries, the European Union (EU), also known as the European Economic Community and the Common Market, was formed in 1957 by six countries—France, the Federal Republic of Germany, Italy, Belgium, the Netherlands, and Luxembourg. Its objective was freely conducted commerce among these nations and others that might later join. As shown in Figure 3-4, many more nations have joined the EU since then. The EU, with a population of over 507 million is now an economic force with a collective economy larger than much of the United States or Japan.

Since January 2002, 19 member nations of the EU have been participating in the new common currency, the euro. The euro, used by over 339 million Europeans, is the single currency of the European Monetary Union nations. However, three EU members, Denmark, the United Kingdom, and Sweden, still maintain their own currencies.

thE NOrth aMErICaN FrEE traDE aGrEEMENt The North American Free Trade Agreement (NAFTA) joined the United States with its first- and second-largest export trading partners, Canada and Mexico. Implementation of NAFTA on January 1, 1994, created a market of more than 475 million people. This

economic community an organization of nations formed to promote the free movement of resources and products among its members and to create common economic policies

FIgURE 3-4 The Evolving European Union

Member states

Candidate countries

Black Sea

Mediterranean Sea

ATLANTIC OCEAN

SWEDEN

NORWAY

FINLAND

ESTONIA

LATVIA

LITHUANIA RUSSIA

POLAND

DENMARK

GERMANYBELGIUM

LUXEMBOURG

FRANCE

ITALY

SWITZERLAND AUSTRIA

SLOVENIA CROATIA

BOSNIA & HERZEGOVINA

MONTENEGRO

ALBANIA MACEDONIA

GREECE TURKEY

CYPRUS

HUNGARY

ROMANIA

BULGARIA

MOLDOVA

UKRAINE

BELARUS

RUSSIA

SLOVAKIA

CZECH REPUBLIC

MALTA

SPAIN

MOROCCO ALGERIA TUNISIA

PORTUGAL

NETHERLANDS IRELAND

UNITED KINGDOM

source: http://ec.europa.eu/avservices/photo/photoDetails.cfm?sitelang=en&mgid=38#0 (accessed may 4, 2015).

Chapter 3 Exploring Global Business 89

market consists of Canada (population 35 million), the United States (320 million), and Mexico (120 million). According to the Office of the U.S. Trade Representative, after 21 years, NAFTA has achieved its core goals of expanding trade and investment between the United States, Canada, and Mexico. For example, from 1993 to 2013, trade among the NAFTA nations increased nearly five-fold, from $297 billion to $1,400 billion.

NAFTA is built on the Canadian Free Trade Agreement, signed by the United States and Canada in 1989, and on the substantial trade and investment reforms undertaken by Mexico since the mid-1980s. Initiated by the Mexican government, formal negotiations on NAFTA began in June 1991 among the three governments. The support of NAFTA by President Bill Clinton, former Presidents Ronald Reagan and Jimmy Carter, and Nobel Prize– winning economists provided the impetus for U.S. congressional ratification of NAFTA in November 1993. By 2008, NAFTA had gradually eliminated all tariffs and quotas on goods produced and traded among Canada, Mexico, and the United States to provide for a totally free-trade area.

However, NAFTA is not without its critics. Critics maintain that NAFTA

• has not achieved its goals • has resulted in job losses • hurts workers by eroding labor standards and lowering wages • undermines national sovereignty and independence • does nothing to help the environment, and • hurts the agricultural sector

The proponents of NAFTA call the agreement a remarkable economic success story for all three partners. They maintain that NAFTA

• has contributed to significant increases in trade and investment • has benefited companies in all three countries • has resulted in increased sales, new partnerships, and new opportunities • has created high-paying export-related jobs, and • better prices and selection in consumer goods

thE CENtraL aMErICaN FrEE traDE aGrEEMENt The Central American Free Trade Agreement (CAFTA) was created in 2003 by the United States and four Central American countries—El Salvador, Guatemala, Honduras, and Nicaragua. The CAFTA became CAFTA-DR when the Dominican Republic joined the group in 2007. On January 1, 2009, Costa Rica joined CAFTA-DR as the sixth member. CAFTA-DR creates the third-largest U.S. export market in Latin America, behind only Mexico and Brazil.

thE aSSOCIatION OF SOUthEaSt aSIaN NatIONS The Association of Southeast Asian Nations, with headquarters in Jakarta, Indonesia, was established in 1967 to promote political, economic, and social cooperation among its seven member countries: Indonesia, Malaysia, the Philippines, Singapore, Thailand, Brunei, and Vietnam. With the three new members, Cambodia, Laos, and Myanmar, this region of more than 620 million people, and GDP of $2.2 trillion, is already our fifth-largest trading partner.

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NAFTA. The North American Free Trade Agreement is over 21 years old. NAFTA is the world’s largest free trade area, linking 475 million people producing $17 trillion worth of goods and services. NAFTA partners exchange nearly $2.6 billion in products each day.

90 Part 1 The Environment of Business

thE COMMONWEaLth OF INDEpENDENt StatES The Commonwealth of Independent States was established in December 1991 by the newly independent states as an association of 11 republics of the former Soviet Union.

traNS-paCIFIC partNErShIp (tpp) On November 12, 2011, the leaders of the nine countries—Australia, Brunei Darussalam, Chile, Malaysia, New Zealand, Peru, Singapore, Vietnam, and the United States—formed the Trans-Pacific Partnership. This partnership will boost economies of the member countries, lower barriers to trade and investment, increase exports, and create more jobs. Together, these eight economies would be America’s fifth-largest trading partner.

thE COMMON MarKEt OF thE SOUthErN CONE (MErCOSUr) Headquartered in Montevideo, Uruguay, the Common Market of the Southern Cone (MERCOSUR) was established in 1991 under the Treaty of Asuncion to unite Argentina, Brazil, Paraguay, and Uruguay as a free-trade alliance; Colombia, Ecuador, Peru, Bolivia, and Chile joined later as associates.

thE OrGaNIZatION OF pEtrOLEUM EXpOrtING COUNtrIES The Organization of Petroleum Exporting Countries was founded in 1960 in response to reductions in the prices that oil companies were willing to pay for crude oil. The organization was conceived as a collective bargaining unit to provide oil-producing nations with some control over oil prices.

3-6 SOURCES OF EXPORT ASSISTANCE In August 2010, President Obama announced the National Export Initiative (NEI) to revitalize U.S. exports. Under the NEI, many federal agencies assist U.S. firms in developing export-promotion programs. The export services and programs of these agencies can help American firms to compete in foreign markets and create new jobs in the United States. For example, recently the International Trade Administration coordinated 77 trade missions to 38 countries. More than 1,120 companies secured over $1.25 billion in export sales during these missions. Table 3-5 provides an overview of selected export assistance programs.

Learning Objective

3-6Describe the various sources of export assistance.

Concept Check ✓✓ Define and describe the major objectives of the World trade organization (Wto) and the international economic communities.

✓✓ What is the north american Free trade agreement (naFta)? What is its importance for the united states, canada, and mexico?

TABLE 3-5 U.S. Government Export Assistance Programs

1 U.S. Export Assistance Centers, www.sba.gov/oit/export/useac.html

Provides assistance in export marketing and trade finance

2 International Trade Administration, www.ita. doc.gov/

Offers assistance and information to exporters through its domestic and overseas commercial officers

3 U.S. and Foreign Commercial Services, www.export.gov/

Helps U.S. firms compete more effectively in the global marketplace and provides information on foreign markets

4 Advocacy Center, www.ita.doc.gov/advocacy Facilitates advocacy to assist U.S. firms competing for major projects and procurements worldwide

5 Trade Information Center, http://export.gov/ exportbasics/eg_main_017458.asp

Provides U.S. companies information on federal programs and activities that support U.S. exports

6 STAT-USA/Internet, www.stat-usa.gov/ Offers a comprehensive collection of business, economic, and trade information on the Web

7 Small Business Administration, www.sba.gov/oit/

Publishes many helpful guides to assist small- and medium-sized companies

8 National Trade Data Bank, www.stat-usa.gov/tradtest.nsf

Provides international economic and export-promotion information supplied by more than 20 U.S. agencies

Chapter 3 Exploring Global Business 91

These and other sources of export information enhance the business opportunities of U.S. firms seeking to enter expanding foreign markets. Another vital energy factor is financing.

3-7 FINANCINg INTERNATIONAL BUSINESS International trade compounds the concerns of financial managers. Currency exchange rates, tariffs and foreign exchange controls, and the tax structures of host nations all affect international operations and the flow of cash. In addition, financial managers must be concerned both with the financing of their international operations and with the means available to their customers to finance purchases.

Fortunately, along with business in general, a number of large banks have become international in scope. Many have established branches in major cities around the world. Thus, like firms in other industries, they are able to provide their services where and when they are needed. In addition, financial assistance is available from U.S. government and international sources.

The U.S. Small Business Administration provides up to $5 million in short-term loans to U.S. small business exporters. The agency also provides small businesses that have exporting potential, but need funds to cover the initial costs of entering an export market with up to $500,000 in export development financing to buy, produce goods, or provide services for exports. Several of today’s international financial organizations were founded many years ago to facilitate free trade and the exchange of currencies among nations. Some, such as the Inter-American Development Bank, are supported internationally and focus on developing countries. Others, such as the Export-Import Bank, are operated by one country but provide international financing.

3-7a the Export-Import Bank of the United States The Export-Import Bank of the United States, created in 1934, is an independent agency of the U.S. government whose function is to assist in financing the exports of American firms. Ex-Im Bank, as it is commonly called, extends and guarantees credit to overseas buyers of American goods and services and guarantees short- term financing for exports. It also cooperates with commercial banks in helping American exporters to offer credit to their overseas customers. In 2014, the Ex-Im Bank approved $20.5 billion in total guarantees, supporting $27.5 billion in U.S. exports and 164,000 American jobs.

According to Fred P. Hochberg, chairman and president of Ex-Im Bank, “Working with private lenders we are helping U.S. exporters put Americans to work producing the high quality goods and services that foreign buyers prefer. As part of President Obama’s National Export Initiative, Ex-Im Bank’s export financing is contributing to the goal of doubling of U.S. exports within the next five years.”

3-7b Multilateral Development Banks A multilateral development bank (MDB) is an internationally supported bank that provides loans to developing countries to help them grow. The most familiar is the World Bank, a cooperative of 188 member countries, which operates worldwide. Established in 1944 and headquartered in Washington, DC, the bank provides

Learning Objective

3-7Identify the institutions that help firms and nations finance international business.

Export-Import Bank of the United States an independent agency of the U.S. government whose function is to assist in financing the exports of American firms

multilateral development bank (MDB) an internationally supported bank that provides loans to developing countries to help them grow

Concept Check ✓✓ list some key sources of export assistance. how can these sources be useful to small business firms?

92 Part 1 The Environment of Business

low-interest loans, interest-free credits, and grants to developing countries. The loans and grants help these countries to:

• supply safe drinking water • build schools and train teachers • increase agricultural productivity • expand citizens’ access to markets, jobs, and housing • improve health care and access to water and sanitation • manage forests and other natural resources • build and maintain roads, railways, and ports, and • reduce air pollution and protect the environment.10

Four other MDBs operate primarily in Central and South America, Asia, Africa, and Eastern and Central Europe. All five are supported by the industrialized nations, including the United States.

thE INtEr-aMErICaN DEVELOpMENt BaNK The Inter-American Development Bank (IDB), the oldest and largest regional bank, was created in 1959 by 19 Latin American countries and the United States. The bank, which is headquartered in Washington, DC, makes loans and provides technical advice and assistance to countries. Today, the IDB is owned by 48 member states.

thE aSIaN DEVELOpMENt BaNK With 67 member nations, the Asian Development Bank (ADB), created in 1966 and headquartered in the Philippines, promotes economic and social progress in Asian and Pacific regions. The U.S. government is the second-largest contributor to the ADB’s capital, after Japan.

thE aFrICaN DEVELOpMENt BaNK The African Development Bank (AFDB), also known as Banque Africaines de Development, was established in 1964 with headquarters in Abidjan, Ivory Coast. Its members include 53 African and 24 non-African countries from the Americas, Europe, and Asia. The AFDB’s goal is to

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Chapter 3 Exploring Global Business 93

foster the economic and social development of its African members. The bank pursues this goal through loans, research, technical assistance, and the development of trade programs.

EUrOpEaN BaNK FOr rECON- StrUCtION aND DEVELOpMENt Established in 1991 to encourage reconstruction and development in the Eastern and Central European countries, the London-based European Bank for Reconstruction and Development is owned by 64 countries and 2 intergovernmental institutions. Its loans are geared toward develop- ing market-oriented economies and promoting private enterprise.

3-7c the International Monetary Fund The International Monetary Fund (IMF) is an international bank with 188 member nations that makes short-term loans to developing countries experiencing balance-of-payment deficits. This financing is contributed by member nations, and it must be repaid with interest. Loans are provided primarily to fund international trade. Created in 1945 and headquartered in Washington, DC, the bank’s main goals are to:

• promote international monetary cooperation • facilitate the expansion and balanced growth

of international trade • promote exchange rate stability • assist in establishing a multilateral system of

payments, and • make resources available to members experiencing balance-of-payment

difficulties.

3-7d the Challenges ahead The challenge of the 21st century is to build on common bonds and shared values to help fully integrate the United States, Europe, and other established economies with a new group of rapidly emerging economies—such as China, India, Brazil, Russia, and others. There are over 302,000 exporters in the United States and more than 58 percent sell to only one foreign country, usually Canada or Mexico. This group of U.S. exporters together represent less than 5 percent of overall U.S. exports. Free Trade Agreements have helped to open markets such as Australia, Canada, Central America, Chile, Israel, Jordan, Korea, Mexico, and Singapore. The challenge, for large and small businesses, is to reach these markets.

In a recent speech at Oxford University, Pascal Lamy, former Director-General of the World Trade Organization stated, “We live in a world of ever-growing

International Monetary Fund (IMF) an international bank with 188 member nations that makes short-term loans to developing countries experiencing balance-of- payment deficits

Social Media: The IMF goes Social Around the World No matter where businesses and public policy-makers are located, they can use social media to stay in touch with news and views from the International Monetary Fund. The IMF maintains a Social Media Hub (www.imf.org/external/social.htm) with links to the many social-media networks where it posts messages, files, photos, and videos. The organization uses Twitter (http://twitter.com/IMFNews) for alerts and breaking news about world finance. A separate Twitter account (http://twitter.com/IMFLive) posts announcements made at IMF meetings. For Chinese audiences, the IMF posts mes- sages in Chinese on the Weibo microblog site (www.weibo.com).

Since the IMF joined YouTube in 2009, it has uploaded dozens of videos about economic conditions around the world and in spe- cific regions. It has also posted videos teaching the basics of inter- national finance, the business cycle, and other key concepts. The IMF’s Finance and Development Magazine has a Facebook page (www.facebook.com/FinanceandDevelopment) with links to articles (in six languages) about the global economic situation, monetary policy, and other timely topics.

To provide more in-depth information and commentary, the IMF has several blogs, including the IMF Direct Forum (http://blog- imfdirect.imf.org/) and the Spanish-language Diálogo a Fondo (http:// blog-dialogoafondo.imf.org/). Visitors to the organization’s Flickr site (www.flickr.com/photos/imfphoto) can browse thousands of photos taken at IMF events over the years. Finally, the IMF uses LinkedIn (www.linkedin.com/company/international-monetary-fund) to intro- duce itself to potential job candidates and post open positions.

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Concept Check ✓✓ What is the export-import Bank of the united states? how does it assist u.s. exporters?

✓✓ What is a multilateral development bank (mDB)? Who supports these banks?

✓✓ What is the international monetary Fund? What types of loans does the imF provide?

94 Part 1 The Environment of Business

independence and interconnectedness. Our interdependence has grown beyond anyone’s imagination. The world of today is virtually unrecognizable from the world in which we lived one generation ago.” The most striking example of globalization is Apple. Apple’s iPod is designed in the United States, manufactured with components from Japan, Korea, and several other Asian countries, and assembled in China by a company from Chinese Taipei. Nowadays, most products are not “Made in the UK” or “Made in France”; they are in fact “Made in the World.”11

Summary

3-1 Explain the economic basis for international business. International business encompasses all business activities that involve exchanges across national boundaries. International trade is based on specialization, whereby each country produces the goods and services that it can produce more efficiently than any other goods and services. A nation is said to have a comparative advantage relative to these goods. International trade develops when each nation trades its surplus products for those in short supply.

A nation’s balance of trade is the difference between the value of its exports and the value of its imports. Its balance of payments is the difference between the flow of money into and out of the nation. Generally, a negative balance of trade is considered unfavorable.

3-2 Explore the methods by which a firm can organize for and enter into international markets.

A firm can enter international markets in several ways. It may license a foreign firm to produce and market its products. It may export its products and sell them through foreign intermediaries or its own sales organization abroad, or it may sell its exports outright to an export–import merchant. It may enter into a joint venture with a foreign firm. It may establish its own foreign subsidiaries, or it may develop into a multinational enterprise.

Generally, each of these methods represents an increasingly deeper level of involvement in international business, with licensing being the simplest and the development of a multinational corporation the most involved.

3-3 Discuss the restrictions nations place on international trade, the objectives of these restrictions, and their results.

Despite the benefits of world trade, nations tend to use tariffs and nontariff barriers (import quotas, embargoes, and other restrictions) to limit trade. These restrictions

typically are justified as being needed to protect a nation’s economy, industries, citizens, or security. They can result in the loss of jobs, higher prices, fewer choices in the marketplace, and the misallocation of resources.

3-4 Outline the extent of international business and the economic outlook for trade.

World trade is generally increasing. Trade between the United States and other nations is increasing in dollar value but decreasing in terms of our share of the world market. Exports as a percentage of U.S. GDP have increased steadily since 1985, except in the 2001 and 2008 recessions.

3-5 Discuss international trade agreements and international economic organizations working to foster trade.

The General Agreement on Tariffs and Trade (GATT) was formed to dismantle trade barriers and provide an environment in which international business can grow. Today, the World Trade Organization (WTO) and various economic communities carry on this mission. These world economic communities include the European Union, the NAFTA, the CAFTA, the Association of Southeast Asian Nations, the Pacific Rim, the Commonwealth of Independent States, the Caribbean Basin Initiative, the Common Market of the Southern Cone, the Organization of Petroleum Exporting Countries, and the Organization for Economic Cooperation and Development.

3-6 Describe the various sources of export assistance. Many government and international agencies provide export assistance to U.S. and foreign firms. Sources of export assistance include U.S. Export Assistance Centers, the International Trade Administration, U.S. and Foreign Commercial Services, Export Legal Assistance Network, Advocacy Center, National Trade Data Bank, and other government and international agencies.

Chapter 3 Exploring Global Business 95

3-7 Identify the institutions that help firms and nations finance international business.

The financing of international trade is more complex than that of domestic trade. Institutions such as the

Ex-Im Bank and the International Monetary Fund have been established to provide financing and ultimately to increase world trade for American and international firms.

Key Terms

You should now be able to define and give an example relevant to each of the following terms:

international business (70) absolute advantage (71) comparative advantage (71) exporting (71) importing (71) balance of trade (71) trade deficit (72) balance of payments (72) licensing (73)

letter of credit (75) bill of lading (75) draft (75) strategic alliance (77) trading company (77) countertrade (78) multinational enterprise (78) import duty (tariff) (79) dumping (80)

nontariff barrier (80) import quota (80) embargo (80) foreign-exchange control (80) currency devaluation (80) General Agreement on Tariffs

and Trade (GATT) (86) World Trade Organization

(WTO) (87)

economic community (88) Export-Import Bank of the

United States (91) multilateral development bank

(MDB) (91) International Monetary Fund

(IMF) (93)

Discussion Questions

1. The United States restricts imports but, at the same time, supports the WTO and international banks whose objective is to enhance world trade. As a member of Congress, how would you justify this contradiction to your constituents?

2. What effects might the devaluation of a nation’s currency have on its business firms, its consumers, and the debts it owes to other nations?

3. Should imports to the United States be curtailed by, say, 20 percent to eliminate our trade deficit? What might happen if this were done?

4. When should a firm consider expanding from strictly domestic trade to international trade? When should it consider becoming further involved in international trade? What factors might affect the firm’s decisions in each case?

5. How can a firm obtain the expertise needed to produce and market its products in, for example, the EU?

Video Case Keeping Brazil’s Economy hot

It’s been hot in Brazil. No, we’re not talking about the country’s temperature: We’re talking about its economy, which has been growing at a heated pace. In 2010, the country’s GDP grew by 7.5 percent. That’s a growth rate developed countries such as the United States haven’t experienced for years, if not decades. Although Brazil’s growth rate slowed considerably in 2011 and 2012 due to the global economic crisis, it has fared better than many other nations. Recently it surpassed the United Kingdom as the sixth-largest economy in the world.

Why has Brazil done so well economically? Increased world trade is one reason why. The country has an abundant amount of natural resources firms in other countries around the world are eager to buy—especially companies in the fast- growing nation of China. Greater exports have also helped 40 million Brazilians rise up out of poverty and into the middle class. Their massive spending power is creating new markets for multinational companies ranging from McDonald’s and Whirlpool to Nestlé, Avon, and Volkswagen. Brazil has become Avon’s largest market. Volkswagen now sells more

96 Part 1 The Environment of Business

cars in Brazil than it does Germany, where the company is headquartered. “China may have over a billion inhabitants, but Brazil has 200,000 consumers,” explains Ivan Zurita, the president of Nestle’s Brazil division.

Clouds on the horizon threaten to cool off Brazil’s growth, however. To begin with, the country is concerned that its trade with China is out of balance. Although China purchases more natural resources from Brazil than any other nation, it doesn’t purchase near as many manufactured goods from Brazil as it exports to it.

A bigger issue is the appreciation of Brazil’s currency, the real. Massive amounts of money have been flowing into Brazil to take advantage of the nation’s high interest rates and growth opportunities. This has increased the demand for the real, causing its value to rise by nearly 50 percent relative to other currencies. The good news is that the stronger real has made imported products cheaper for Brazilians to buy. The bad news is that products made in Brazil have become more expensive for the rest of the world to purchase, slowing the country’s exports and growth.

Businesses in Brazil have lobbied the government to weaken the real so their products are better able to compete against imports. Their efforts appear to have paid off. Recently, Guido Mantega, Brazil’s minister of finance, said the country will take steps “as needed” to weaken the real. The government has also imposed tariffs on a number of imported products, including cars, shoes, chemicals,

and textiles, and signed a trade deal with Mexico that put a quota on the number of automobiles imported from that country.

Imports and the value of the real are not the only clouds threatening Brazil, though. Businesses in the country face a great deal of bureaucratic red tape, heavy regulations, and tax rates that are some of the highest in the world. To deal with these problems, Brazilian President Dilma Rousseff has announced that her administration will eliminate payroll taxes for employers in industries hardest hit by imports. To further ease the nation’s growing pains, Brazil’s development bank, BDM, will subsidize business loans to boost the production of many products, including tablets and off-shore oil rigs. The goal is to stimulate technological innovations that will enable manufacturers to produce higher-value products so Brazil doesn’t have to rely on natural resources to fuel its growth. “Look, a government isn’t made on the second or third day,” Rousseff has said about her administration’s incremental efforts to keep Brazil’s emerging economy moving forward. “It’s made over time. Things mature.”12

Questions 1. Do you think the efforts of Brazil’s government to keep

the economy growing will be successful? Why or why not?

2. What downsides might Brazil experience by implementing quotas, tariffs, and measures to devalue its currency?

Building Skills for Career Success

1. Social Media Exercise Although Nike was founded in the Pacific Northwest and still has its corporate headquarters near Beaverton, Oregon, the company has become a multinational enterprise. The firm employs more than 35,000 people across six continents and is now a global marketer of footwear, apparel, and athletic equipment.

Because it operates in 160 countries around the globe and manufactures products in over 900 factories in 47 different countries, sustainability is a big initiative for Nike. Today, Nike uses the YouTube social media site to share its sustainability message with consumers, employees, investors, politicians, and other interested stakeholders. To learn about the company’s efforts to sustain the planet, follow these steps:

• Make an Internet connection and go to the YouTube website (www.youtube.com).

• Enter the words “Nike” and “Sustainability” in the search window and click the search button.

1. View at least three different YouTube videos about Nike’s sustainability efforts.

2. Based on the information in the videos you watched, do you believe that Nike is a good corporate citizen because of its efforts to sustain the planet? Why or why not?

3. Prepare a one to two page report that describes how Nike is taking steps to reduce waste, improve the envi- ronment, and reduce its carbon footprint while manufac- turing products around the globe.

2. Building Team Skills The North American Free Trade Agreement among the United States, Mexico, and Canada went into effect on January 1, 1994. It has made a difference in trade among the countries and has affected the lives of many people.

assignment 1. Working in teams and using the resources of your library,

investigate NAFTA. Answer the following questions: a. What are NAFTA’s objectives? b. What are its benefits? c. What impact has NAFTA had on trade, jobs, and

travel?

Chapter 3 Exploring Global Business 97

d. Some Americans were opposed to the implementa- tion of NAFTA. What were their objections? Have any of these objections been justified?

e. Has NAFTA influenced your life? How? 2. Summarize your answers in a written report. Your team

also should be prepared to give a class presentation.

3. Researching Different Careers Today, firms around the world need employees with

special skills. In some countries, such employees are not always available, and firms then must search abroad for qualified applicants. One way they can do this is through global workforce databases. As business and trade operations continue to grow globally, you may one day find yourself working in a foreign country, perhaps for an American company doing business there or for a foreign company. In what foreign country would you like to work? What problems might you face?

assignment 1. Choose a country in which you might like to work. 2. Research the country. The National Trade Data Bank is a

good place to start. Find answers to the following questions: a. What language is spoken in this country? Are you

proficient in it? What would you need to do if you are not proficient?

b. What are the economic, social, and legal systems like in this nation?

c. What is its history? d. What are its culture and social traditions like? How

might they affect your work or your living arrange- ments?

3. Describe what you have found out about this country in a written report. Include an assessment of whether you would want to work there and the problems you might face if you did.

98 Part 1 The Environment of Business

1p6

Running a Business Part 1

Let’s Go Get a Graeter’s!

Only a tiny fraction of family-owned businesses are still growing four generations after their founding, but happily for lovers of premium-quality ice cream, Graeter’s is one of them.

Now a $30 million firm with national distribution, Graeter’s was founded in Cincinnati in 1870 by Louis Charles Graeter and his wife, Regina Graeter. The young couple made ice cream and chocolate candies in the back room of their shop, sold them in the front room, and lived upstairs. Ice cream was a special treat in this era before refrigeration, and the Graeters started from scratch every day to make theirs from the freshest, finest ingredients. Even after freezers were invented, the Graeters continued to make ice cream in small batches to preserve the quality, texture, and rich flavor.

After her husband’s death, Regina’s entrepreneurial leadership became the driving force behind Graeter’s expansion from 1920 until well into the 1950s. At a time when few women owned or operated a business, Regina opened 20 new Graeter’s stores in the Cincinnati area and added manufacturing capacity to support this ambitious—and successful— growth strategy. Her sons and grandchildren followed her into the business and continued to open ice-cream shops all around Ohio and beyond. Today, three of Regina’s great-grandsons run Graeter’s with the same attention to quality that made the firm famous. In her honor, the street in front of the company’s ultramodern Cincinnati factory is named Regina Graeter Way.

The Scoop on Graeter’s Success Graeter’s fourth-generation owners are Richard Graeter II (CEO), Robert (Bob) Graeter (vice president of operations), and Chip Graeter (vice president of retail operations). They grew up in the business, learning through hands-on experience how to do everything from packing a pint of ice cream to locking up the store at night. They also absorbed the family’s dedication to product quality, a key reason for the company’s enduring success. “Our family has always been contented to make a little less profit in order to ensure our long-term survival,” explains the CEO.

Throughout its history, Graeter’s has used a unique, time-consuming manufacturing process to produce its signature ice creams in small batches. “Our competition is making thousands and thousands of gallons a day,”

says Chip Graeter. “We are making hundreds of gallons a day at the most. All of our ice cream is packed by hand, so it’s a very laborious process.” Graeter’s “French pot” manufacturing method ensures that very little air gets into the

product. As a result, the company’s ice cream is dense and creamy, not light and fluffy—so dense, in fact, that

each pint weighs nearly a pound. Another success factor is the use of simple,

fresh ingredients like high-grade chocolate, choice seasonal fruits, and farm-fresh cream. Graeter’s imports some ingredients, such as vanilla from Madagascar, and buys other ingredients from U.S. producers known for their quality. “We use a really great grade

of chocolate,” says Bob Graeter. “We don’t cut corners on that … Specially selected great black

raspberries, strawberries, blueberries, and cherries go into our ice cream because we feel that we want to provide flavor not from artificial or unnatural ingredients but from really quality, ripe, rich fruits.” Instead of tiny chocolate chips, Graeter’s products

contain giant chunks formed when liquid chocolate is poured into the ice-cream base just before the mixture

is frozen and packed into pints.

Maintaining the Core of Success Graeter’s “fanatical devotion to product quality” and its

time-tested recipes have not changed over the years. The current generation of owners is maintaining this core of

the company’s success while mixing in a generous dash of innovation. “If you just preserve the core,” Bob Graeter says, “ultimately you stagnate. And if you are constantly stimulating progress and looking for new ideas, well, then you risk losing what was important.… Part of your secret to long-term success is knowing what your core is and holding to that. Once you know what you’re really all about and what is most important to you, you can change everything else.”

One of those “important” things is giving back to the community and its families via local charities and other initiatives. “Community involvement is just part of being a good corporate citizen,” observes Richard Graeter. When Graeter’s celebrated a recent new store opening, for example, it made a cash donation to the neighborhood public library. It is also a major sponsor of The Cure Starts Now Foundation, a research foundation seeking a cure for pediatric brain cancer. In line with its focus on natural goodness, Graeter’s has been doing its part to preserve

98 Part 1 The Environment of Business

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Chapter 3 Exploring Global Business 99

the environment by recycling and by boosting production efficiency to conserve water, energy, and other resources.

Graeter’s Looks to the Future Even though Graeter’s recipes reflect its 19th century heritage, the company is clearly a 21st century operation. It has 170,544 Facebook “likes,” connects with brand fans on Twitter, and invites customers to subscribe to its e-mail newsletter. The company sells its products online and ships orders via United Parcel Service to ice-cream lovers across the continental United States. Its newly-opened production facility uses state-of-the-art refrigeration, storage, and sanitation—yet the ice cream is still mixed by hand rather than by automated equipment. With an eye toward future growth, Graeter’s is refining its information system to provide managers with all the details they need to make timely decisions in today’s fast-paced business environment.

Graeter’s competition ranges from small, local businesses to international giants such as Unilever, which owns Ben & Jerry’s, and Nestle, which owns Haagen-Dazs.

Throughout the economic ups and downs of recent years, Graeter’s has continued to expand, and its ice creams are now distributed through 6,200 stores in 46 states. Oprah Winfrey and other celebrities have praised its products in public. But the owners are just as proud of their home- town success. “Graeter’s in Cincinnati is synonymous with ice cream,” says Bob Graeter. “People will say, ‘Let’s go get a Graeter’s.’”13

Questions 1. How have Graeter’s owners used the four factors of pro-

duction to build the business over time? 2. Which of Graeter’s stakeholders are most affected by the

family’s decision to take a long-term view of the business rather than aiming for short-term profit? Explain your answer.

3. Knowing that Graeter’s competes with multinational cor- porations as well as small businesses, would you recom- mend that Graeter’s expand by licensing its brand to a company in another country? Why or why not?

Chapter 3 Exploring Global Business 99

100 Part 1 The Environment of Business

A business plan is a carefully constructed guide for a person starting a business. The purpose of a well-prepared business plan is to show how practical and attainable the entrepreneur’s goals are. It also serves as a concise document that potential investors can examine to see if they would like to invest or assist in financing a new venture. A business plan should include the following 12 components:

• Introduction

• Executive summary

• Benefits to the community

• Company and industry

• Management team

• Manufacturing and operations plan

• Labor force

• Marketing plan

• Financial plan

• Exit strategy

• Critical risks and assumptions

• Appendix

A brief description of each of these sections is provided in Chapter 5. This is the first of seven exercises that appear at the ends of each of the seven major parts in this textbook. The goal of these exercises is to help you work through the preceding components to create your own business plan. For example, in the exercise for this part, you will make decisions and complete the research that will help you to develop the introduction for your business plan and the benefits to the community that your business will provide. In the exercises for Parts 2 through 6, you will add more components to your plan and eventually build a plan that actually could be used to start a business. The flowchart shown in Figure 3-5 gives an overview of the steps you will be taking to prepare your business plan.

The First Step: Choosing Your Business One of the first steps for starting your own business is to decide what type of business you want to start. Take some time to think about this decision. Before proceeding, answer the following questions:

• Why did you choose this type of business?

• Why do you think this business will be successful?

• Would you enjoy owning and operating this type of business?

Warning: Do not rush this step. This step often requires much thought, but it is well worth the time and effort. As an added bonus, you are more likely to develop a quality business plan if you really want to open this type of business.

Now that you have decided on a specific type of business, it is time to begin the planning process. The goal for this part is to complete the introduction and benefits-to- the-community components of your business plan.

Before you begin, it is important to note that the business plan is not a document that is written and then set aside. It is a living document that an entrepreneur should refer to continuously in order to ensure that plans are being carried through appropriately. As the entrepreneur begins to execute the plan, he or she should monitor the business environment continuously and make changes to the plan to address any challenges or opportunities that were not foreseen originally.

Throughout this course, you will, of course, be building your knowledge about business. Therefore, it will be appropriate for you to continually revisit parts of the plan that you have already written in order to refine them based on your more comprehensive knowledge. You will find that writing your plan is not a simple matter of starting at the beginning and moving chronologically through to the end. Instead, you probably will find yourself jumping around the various components, making refinements as you go. In fact, the second component—the executive summary—should be written last, but because of its comprehensive nature and its importance to potential investors, it appears after the introduction in the final business plan. By the end of this course, you should be able to put the finishing touches on your plan, making sure that all the parts create a comprehensive and sound whole so that you can present it for evaluation.

The Introduction Component 1.1. Start with the cover page. Provide the business name,

street address, telephone number, Web address (if any), name(s) of owner(s) of the business, and the date the plan is issued.

1.2. Next, provide background information on the company and include the general nature of the business: retailing, manufacturing, or service; what your product or service is; what is unique about it; and why you believe that your business will be successful.

1.3. Then include a summary statement of the business’s financial needs, if any. You probably will need to revise

Building a Business Plan: Part 1

Chapter 3 Exploring Global Business 101

FIgURE 3-5 Business Plan

Identify product/service/ concept opportunity (The Big Idea).

Compute �nancial ratios for each year projected in the �nancial statements; compare ratios to industry averages.

Prepare executive summary of plan.

Estimate the initial capital requirements for the business.

Present plan to lenders or investors.

Determine market feasibility/ potential.

Go/no go decision (proceed or look for another opportunity).

Determine market size (in units and dollars).

Develop marketing strategy.

Identify marketing mix components (product, place, price, promotion).

Determine beginning inventory and project your seasonal inventory for the next three years.

List possible sources of startup capital and the amount you expect from each.

Identify critical risks and assumptions to develop alternate plans.

Prepare pro forma pro�t and loss statements for the �rst three years of operation.

Prepare an opening balance sheet for the business, based on �gures from steps 11 and 14.

Prepare pro forma balance sheets for the �rst three years of operation.

Determine location, size, type, and layout of necessary physical facilities.

Establish administrative organization and personnel requirements.

Complete competitive analysis.

Choose the legal form of your organization.

Estimate monthly (or seasonal) cash �ows for each of the �rst three years of operation.

109

Steps in creating a business plan

102 Part 1 The Environment of Business

your financial needs summary after you complete a detailed financial plan later in Part 6.

1.4. Finally, include a statement of confidentiality to keep important information away from potential competitors.

The Benefits-to-the- Community Component In this section, describe the potential benefits to the community that your business could provide. Chapter 2 in your textbook, “Being Ethical and Socially Responsible,” can help you in answering some of these questions. At the very least, address the following issues: 1.5. Describe the number of skilled and nonskilled jobs the

business will create, and indicate how purchases of sup- plies and other materials can help local businesses.

1.6. Next, describe how providing needed goods or services will improve the community and its standard of living.

1.7. Finally, state how your business can develop new technical, management, or leadership skills; offer attractive wages; and provide other types of individual growth.

Review of Business Plan Activities Read over the information that you have gathered. Because the Building a Business Plan exercises at the end of Parts 2 through 7 are built on the work you do in Part 1, make sure that any weaknesses or problem areas are resolved before continuing. Finally, write a brief statement that summarizes all the information for this part of the business plan.

Endnotes

1 Sources: Based on information in “Not Reversing Multi-Brand Law Gives Walmart Hope for Retail,” Times of India, December 4, 2014, http://timesofindia.com; Hiroko Tabuchi and Rachel Abrams, “After a Bump in Sales, Walmart Braces for a Competitive Holiday Season,” New York Times, November 13, 2014, www.nytimes.com; Rhitu Chatterjee, “Indian Shopkeepers Greet Wal-Mart’s Expansion Plans with Protests,” National Public Radio, November 20, 2014, www. npr.org; “Walmart to Incur Higher Charges on India Joint Venture Split,” Economic Times (India), February 20, 2014, http://articles. economictimes.indiatimes.com; Bruce Einhorn, “Wal-Mart Tries Again in India,” Bloomberg Businessweek, October 23, 2014, www. businessweek.com; Nandita Bose and Adam Rose, “Wal-Mart’s China Syndrome a Symptom of International Woes,” Reuters, February 21, 2014, www.reuters.com; www.walmart.com.

2 The White House, Office of the Press Secretary, Press Release, August 6, 2002.

3 U.S. Census Bureau, Foreign Trade Division, www.census.gov/ foreign-trade/statistics/historical/exhibit_history (accessed December 27, 2014).

4 International Monetary Fund website at http://www.imf.org/external/ns/ cs/aspx?id=29 (accessed January 5, 2015).

5 U.S. Department of Commerce website at http://www.commerce.gov/ print/news/secretary-speeches/2014/10/30/us-secretary-commerce- penny-pritzker-discusses-us-canada-trade-and-commercial- relationship-in-ottawa (accessed January 2, 2015).

6 U.S. Department of State website at http://www.state.gov/r/pa/ pl/2013/211144.htm (accessed January 1, 2015).

7 U.S. Census Bureau website at http://www.census.gov/foreign-trade/ aes/tradesource_july2013.pdf (accessed January 3, 2015).

8 U.S. Census Bureau website at http://www.census.gov/foreign-trade/ aes/tradesource_jan2014.pdf (accessed January 3, 2015).

9 U.S. Department of Commerce, Economics and Statistics Administration, International Trade Administration, “The Role of Exports in the U.S. Economy,” May 13, 2014, www.trade.gov/neinext/role-of- exports-in-us-economy.pdf (accessed January 4, 2015).

10 The World Trade Organization website at www.wto.org/english/news_e/ sppl_e/spp1220_htm (accessed February 6, 2013).

11 Ibid. 12 Sources: Andre Soliani, “Surge,” Bloomberg BusinessWeek, April 3,

2012, www.businessweek.com; “Invigorated Roussef Shifts Focus to ‘Brazil Cost,’” Reuters, April 2, 2012, www.reuters.com; Komal Sri-Kumar, “Brazil Should Embrace a Freer Market,” Financial Times, March 6, 2012, www.ft.com; “Multinationals Choose Brazilian Investment,” Obelisk Investment News, May 4, 2011, www.obeliskinternational.com.

13 Sources: Based on information from Kimberly L. Jackson, “Graeter’s Premium Chocolate Chip Ice Cream Lands at Stop & Shop,” Newark Star-Ledger (NJ), April 4, 2012, www.nj.com; “Graeter’s Ice Cream Debuts in Bay Area,” Tampa Bay Times (St. Petersburg, FL), January 10, 2012, p. 4B; Jim Carper, “Graeter’s Runs a Hands-on Ice Cream Plant,” Dairy Foods, August 2011, pp. 36+; Jim Carper, “The Greater Good,” Dairy Foods, August 2011, pp. 95+; “Graeter’s Unveils New ‘Mystery Flavor,’” Dayton Daily News, March 29, 2012, www.daytondailynews. com; Bob Driehaus, “A Cincinnati Ice Cream Maker Aims Big,” New York Times, September 11, 2010, www.nytimes.com; Lucy May, “Graeter’s Northern Kentucky Franchisee Puts Stores on the Block,” Business Courier, August 6, 2010, http://cincinnati.bizjournals.com; www.graeters.com; interviews with company staff and Cengage videos about Graeter’s.

Learning Objectives Once you complete this chapter, you will be able to:

4-1 Describe the advantages and disadvantages of sole proprietorships. 4-2 Explain the different types of partners and the importance of partnership

agreements.

4-3 Describe the advantages and disadvantages of partnerships. 4-4 Summarize how a corporation is formed.

4-5 Describe the advantages and disadvantages of a corporation.

4-6 Examine special types of businesses, including S corporations, limited- liability companies, and not-for-profit corporations.

4-7 Discuss the purpose of a joint venture and syndicate. 4-8 Explain how growth from within and growth through mergers can enable a

business to expand.

Choosing a Form of Business Ownership

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4 Why Should You Care? There’s a good chance that during

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If at first you don’t succeed, try and try again. While many would-be entrepreneurs would just give up after two failures, Nick Woodman still remembered his goal of becoming a successful entrepreneur. To accomplish that goal, he turned an idea for a wearable camera into a very successful business. Along the way, Woodman had to make decisions that would eventually shape his new venture and at the same time find start-up funding to turn his dream into a reality. Remembering how it felt to lose other people’s money, initial funding for GoPro came from his mother and father and his own savings. He also made the decision to incorporate his business. Although he could have chosen the sole proprietorship or partnership or other specialized forms of business ownership, he chose the corporation because of the advantages that this type of ownership provides. Within a few months, demand for wearable cameras was so strong that the company enjoyed early profits. Based on continued success, a few years later Woodman was able to obtain millions from outside investors that could be used to grow the business. As the company continued to grow, Woodman made another decision to obtain seasoned experts to help the young company grow—a step that many entrepreneurs don’t take because they don’t want to give up control of their business. In 2014, GoPro sold stock to the public to obtain even more financing. Today, GoPro is a success because it provides quality products. It also has a management team that makes smart decisions and has developed a business plan that evolved over time to meet the ever-changing needs of a growing company. At a time when many would-be entrepreneurs hear stories about how hard it is start a successful business and the number of business failures, entrepreneurs can still achieve their dreams. If you

Gopro’s Global Growth Began by Bootstrapping

When surfer Nick Woodman graduated from University of California, San Diego in 1997, his goal was to become a suc- cessful entrepreneur by the age of 30. However, his first startup was a failure. His second, a contest site named FunBug.com, raised sev- eral million dollars in venture capital—but it wasn’t successful, either. Even though FunBug was a corporation, which limited his personal liability, Woodman felt terrible about losing other people’s money.

After FunBug, Woodman took time off to surf the world while he thought about trying another startup or looking for a job. He rigged a waterproof disposable camera to a wrist strap so he could pho- tograph his surfing adventures. By the time he returned home, five months and many in-water tests later, Woodman was ready to build a new business around his idea of wearable cameras for use while surfing and in other outdoor activities.

He incorporated the new venture as Woodman Labs in 2002 and, remembering how it felt to lose outside investors’ money, he initially sought funding only from his family. His mother invested $35,000 and his father invested $200,000, to which the founder added his own $30,000, intending to bootstrap growth as he generated sales

revenue. When Woodman launched his first GoPro wearable camera in 2004, demand was so strong that the company quickly became profitable. Before Woodman celebrated his 30th birthday, his com- pany (soon renamed GoPro) was earning millions of dollars.

In 2011 and again in 2012, the firm received tens of millions of dollars in outside investment and welcomed seasoned indus- try experts to its board of directors, preparing for more aggres- sive expansion as GoPro products flew off the shelves in Best Buy, REI, and many other stores. In 2014, with worldwide yearly sales approaching $1 billion, GoPro began selling stock to the public. Looking ahead, the founder sees a bright financial future in helping GoPro users find new ways to digitally share their adventures with friends and fans.1

Did You Know? GoPro rings up $1 billion in annual sales of wearable cameras, selling through 25,000 retail outlets in 100 countries.

InsIde BusIness

106 Part 2 Business Ownership and Entrepreneurship

doubt this statement, remember Nick Woodman and how he turned his dream into a multi-million dollar company.

We begin this chapter by describing the three common forms of business ownership: sole proprietorships, partnerships, and corporations. We discuss how these types of businesses are formed and note the advantages and disadvantages of each. Next, we consider several types of business ownership usually chosen for special purposes, including S corporations, limited-liability companies (LLCs), not- for-profit corporations, joint ventures, and syndicates. We conclude the chapter with a discussion of how businesses can grow through internal expansion or through mergers with other companies.

4-1 SOLe PrOPrietOrShiPS A sole proprietorship is a business that is owned (and usually operated) by one person. Although a few sole proprietorships are large and have many employees, most are small. In most instances, the owner (the sole proprietor) simply decides that he or she is in business and begins operations. Some of today’s largest corporations, including Walmart, JCPenney, and Procter & Gamble Company, started out as tiny—and in many cases, struggling—sole proprietorships.

Often entrepreneurs with a promising idea choose the sole proprietorship form of ownership. Annie Withey, for example, created a cheddar cheese–flavored popcorn snack food. Annie’s popcorn, called Smartfood, became one of the fastest- selling snack foods in U.S. history. After a few years, Frito-Lay bought the brand for about $15 million. Ms. Withey went on to develop an all-natural white-cheddar macaroni and cheese product. Although her firm, Annie’s Homegrown, has grown and become a major player in a very competitive industry, Annie always remained the entrepreneurial heart of the company and still thinks like a sole proprietor. It’s still possible for a sole proprietor to develop an idea that meets customer needs, to start a business, and to enjoy the financial rewards of a successful business. If you doubt the above statement, consider this: General Mills paid $820 million for Annie’s Homegrown in 2014.2 And while the money did not all go to Ms. Withey, it does illustrate that a good idea and a successful business can be worth a lot of money.

As you can see in Figure 4-1, there are approximately 31 million sole proprietorships in the United States. They account for 73 percent of the country’s

Learning Objective

4-1Describe the advantages and disadvantages of sole proprietorships.

sole proprietorship a business that is owned (and usually operated) by one person

Figure 4-1 Relative Percentages of Sole Proprietorships, Partnerships, and Corporations in the United States

Partnerships 4 million

10%

Sole Proprietorships 31 million

73%

Corporations 7 million

17%

Source: “Statistics of Income,” The Internal Revenue Service website at www.irs.gov (accessed January 5, 2014).

Chapter 4 Choosing a Form of Business Ownership 107

business firms. Although the most popular form of ownership when compared with partnerships and corporations, they rank last in total sales revenues. As shown in Figure 4-2, sole proprietorships account for about $1.3 trillion, or about 4 percent of total annual sales.

Sole proprietorships are most common in retailing, service, and agriculture. Thus, the clothing boutique, corner grocery, appliance-repair shop down the street, and small, independent farmers are likely to be sole proprietorships.

4-1a advantages of Sole proprietorships Most of the advantages of sole proprietorships arise from the two main characteristics of this form of ownership: simplicity and individual control.

eaSe OF Start-Up and ClOSUre Sole proprietorship is the simplest way to start a business. A sole proprietorship can be, and most often is, established without the services of an attorney. The legal requirements often are limited to registering the name of the business and obtaining any necessary licenses or permits.

If the enterprise does not succeed, the firm can be closed as easily as it was opened. Creditors must be paid, of course, but generally, the owner does not have to go through any legal procedure before hanging up an “Out of Business” sign.

pride OF OwnerShip A successful sole proprietor is often very proud of her or his accomplishments—and rightfully so. In almost every case, the owner deserves a great deal of credit for solving the day-to-day problems associated with operating a sole proprietorship. Unfortunately, the reverse is also true. When the business fails, it is often the sole proprietor who is to blame.

retentiOn OF all prOFitS Because all profits become the personal earnings of the owner, the owner has a strong incentive to succeed. This direct financial reward attracts many entrepreneurs to the sole proprietorship form of business and, if the business succeeds, is a source of great satisfaction.

Figure 4-2 Total Sales Receipts of Sole Proprietorships, Partnerships, and Corporations in the United States

Corporations $28.3 trillion

79%

Sole Proprietorships $1.3 trillion

4% Partnerships

$6 trillion 17%

Source: “Statistics of Income,” The Internal Revenue Service website at www.irs.gov (accessed January 5, 2014).

108 Part 2 Business Ownership and Entrepreneurship

nO SpeCial taxeS Profits earned by a sole proprietorship are taxed as the personal income of the owner. As a result, a sole proprietor must report business profit or loss and certain other financial information for a business on the Internal Revenue Service’s Schedule C which becomes part of their personal income tax return. They must also make estimated quarterly tax payments to the federal government.

FlexiBility OF BeinG yOUr Own BOSS A sole proprietor is completely free to make decisions about the firm’s operations. Without asking or waiting for anyone’s approval, a sole proprietor can move a shop’s location, open a new store, or close an old one. And, he or she can make an immediate change in business hours. The manager of a store in a large corporate chain such as Best Buy Company may have to seek the approval of numerous managers and company officials before making such changes.

4-1b disadvantages of Sole proprietorships The disadvantages of a sole proprietorship stem from the fact that these businesses are owned by one person. Some capable sole proprietors experience no problems. Individuals who start out with few management skills and little money are most at risk for failure.

Unlimited liaBility Unlimited liability is a legal concept that holds a business owner personally responsible for all the debts of the business. There is legally no difference between the debts of the business and the debts of the proprietor. If the business fails, or if the business is involved in a lawsuit and loses, the owner’s personal property—including savings and other assets—can be seized (and sold if necessary) to pay creditors.

Unlimited liability is perhaps the major factor that tends to discourage would-be entrepreneurs with substantial personal wealth from using the sole proprietor form of business organization. Unlimited liability is also a reason why many sole proprietors switch to the corporate form of ownership or some other type of business organization once their businesses become successful.

laCk OF COntinUity Legally, the sole proprietor is the business. If the owner retires, dies, or is declared legally incompetent, the business essentially ceases to exist. In many cases, however—especially when the business is a profitable enterprise—the owner may sell the business or the owner’s heirs may take it over and either sell it or continue to operate it. The business also can suffer if the sole proprietor becomes ill and cannot work for an extended period of time. If the owner, for example, has a heart attack, there is often no one who can step in and manage the business. An illness can be devastating if the sole proprietor’s personal skills are what determine if the business is a success or a failure.

laCk OF mOney Banks, suppliers, and other lenders usually are often unwilling to lend large sums of money to sole proprietorships. Only one person—the sole proprietor—can be held responsible for repaying such loans, and the assets of most

unlimited liability a legal concept that holds a business owner personally responsible for all the debts of the business

Owning your own business can be frustrating! While there are many advantages to sole proprietorships, there are disadvantages. For many sole proprietors there aren’t enough hours in the day to get everything done. For others, the pressure of making decisions on a daily basis can be overwhelming. And yet, even with the disadvantages, sole proprietorships are still the most popular form of business ownership when compared to partnerships and corporations.

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sole proprietors usually are limited. Moreover, these assets may have been used already as security or collateral for personal borrowing (a home mortgage or car loan) or for short-term credit from suppliers. Lenders also worry about the lack of continuity of sole proprietorships: Who will repay a loan if the sole proprietor dies? Finally, many lenders are concerned about the large number of sole proprietorships that fail—a topic discussed in Chapter 5.

The limited ability to borrow money can prevent a sole proprietorship from growing. It is the main reason that many business owners, when in need of relatively large amounts of capital, change from a sole proprietorship to a partnership or corporate form of ownership.

limited manaGement SkillS The sole proprietor is often the sole manager—in addition to being the only salesperson, buyer, accountant, and, on occasion, janitor. Even the most experienced business owner is unlikely to have expertise in all these areas. Unless he or she obtains the necessary expertise by hiring employees, assistants, or consultants, the business can suffer in the areas in which the owner is less knowledgeable. For the many sole proprietors who cannot afford to hire the help they need, there just are not enough hours in the day to do everything that needs to be done.

diFFiCUlty in hirinG emplOyeeS The sole proprietor may find it hard to attract and keep competent help. Potential employees may feel that there is no room for advancement in a firm whose owner assumes all managerial responsibilities. And when those who are hired are ready to take on added responsibility, they may find that the only way to do so is to quit the sole proprietorship and go to work for a larger firm or start up their own businesses. The lure of higher salaries and increased benefits also may cause existing employees to change jobs.

4-1c Beyond the Sole proprietorship Like many others, you may decide that the major disadvantage of a sole proprietorship is the limited amount that one person can do in a workday. One way to reduce the effect of this disadvantage (and retain many of the advantages) is to form a partnership and have more than one owner.

4-2 PartnerShiPS A person who would not think of starting and running a sole proprietorship business alone may enthusiastically seize the opportunity to form a business partnership. The U.S. Uniform Partnership Act defines a partnership as a voluntary association of two or more persons to act as co-owners of a business for profit. For example, in 1990, two young African-American entrepreneurs named Janet Smith and Gary Smith started IVY Planning Group—a company that provides full-service

Concept Check ✓✓ What is a sole proprietorship?

✓✓ What are the advantages of a sole proprietorship?

✓✓ What are the disadvantages of a sole proprietorship?

Learning Objective

4-2Explain the different types of partners and the importance of partnership agreements.

partnership a voluntary association of two or more persons to act as co-owners of a business for profit

Social Media: Small Business resources Whether you’re thinking about starting a sole proprietorship, part- nership, or corporation or want to take your business to the next level, check out the many resources available on social-media sites. For example, Inc. magazine’s popular Facebook page (www.facebook.com/Inc) has informative posts, links, and videos with “everything you need to know to start and grow your busi- ness now.” More than 600,000 Facebook users have clicked to like the Inc. page and follow what the editors’ post. The Inc. Twitter account (http://twitter.com/inc) has more than 63,000 tweets and well over 1 million followers.

Entrepreneur magazine has attracted nearly 2 million Facebook likes (www.facebook.com/EntMagazine) because of the many resources available on its page. The magazine also keeps entrepre- neurs informed through the links, photos, and videos on its Twitter account (http://twitter.com/entrepreneur), inspiring photos on its Pinterest page (www.pinterest.com/entmagazine), and discussions on its LinkedIn page (www.linkedin.com/company/entrepreneur-media).

Every month, American Express uploads a variety of small- business videos to its OPEN YouTube channel (www.youtube.com/ user/americanexpressOPEN). The videos cover tips for startups, small business success stories, customer relations, employee relations, marketing ideas, new technology, government contracts, and other topics of interest for entrepreneurs of all ages and in all industries.

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110 Part 2 Business Ownership and Entrepreneurship

management consulting for clients. Today, over 25 years later, the company has evolved into a multimillion-dollar company that has hired a diverse staff of employees and provides cultural diversity training for Fortune 1000 firms, large not- for-profit organizations, and government agencies including PepsiCo, MetLife, Verizon, Target, and the U.S. Social Security Administration. In recognition of its efforts, IVY Planning Group has been recognized by www.DiversityBusiness.com as one of the top 50 minority-owned companies. And both Janet Smith and Gary Smith have been named “1 of 50 Influential Minorities in Business” by Minority Business and Professionals Network.3

As shown in Figures 4-1 and 4-2, there are approximately 4 million partnerships in the United States, and this type of ownership accounts for about $6 trillion in sales receipts each year. Note, however, that this form of ownership is much less common than the sole proprietorship or the corporation. In fact, as Figure 4-1 shows, partnerships represent only about 10 percent of all American businesses. Although there is no legal maximum on the number of partners a partnership may have, most have only two. Regardless of the number of people involved, a partnership often represents a pooling of special managerial skills and talents; at other times, it is the result of a sole proprietor taking on a partner for the purpose of obtaining more capital.

4-2a types of partners All partners are not necessarily equal. Some may be active in running the business, whereas others may have a limited role.

General partnerS A general partner is a person who assumes full or shared responsibility for operating a business. General partners are active in day-to-day business operations, and each partner can enter into contracts on behalf of the other partners. He or she also assumes unlimited liability for all debts, including debts incurred by any other general partner without his or her knowledge or consent. To avoid

future liability, a general partner who withdraws from the partnership must give notice to creditors, customers, and suppliers.

limited partnerS A limited partner is a person who invests money in a business but who has no management responsibility or liability for losses beyond his or her investment in the partnership. Typically, the general partner or partners collect management fees and receive a percentage of profits. Limited partners receive a portion of profits and tax benefits. Limited partnerships, for example, may be formed to finance real estate, oil and gas, motion picture, and other business ventures.

Because of potential liability problems, special rules apply to limited partnerships. These rules are intended to protect customers and creditors who deal with limited partnerships. For example, prospective partners in a limited partnership must file a formal declaration, usually with the secretary of state, that describes the essential details of the partnership and the liability status of each partner involved in the business. At least one general partner must be responsible for the debts of the limited partnership. Also, some states prohibit the use of the limited partner’s name in the partnership’s name.

general partner a person who assumes full or shared responsibility for operating a business

limited partner a person who invests money in a business but has no management responsibility or liability for losses beyond the amount he or she invested in the partnership

Partnership Pride. Don’t ask these two entrepreneurs about their business unless you want to hear their story. Like most small business owners, talking about their businesses is easy and is a source of pride—especially when the partnership is profitable and the owners pool their management skills to build a successful business.

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4-2b the partnership agreement Articles of partnership refers to an agreement listing and explaining the terms of the partnership. Although both oral and written partnership agreements are legal and can be enforced in the courts, a written agreement has an obvious advantage. It is not subject to lapses of memory.

Figure 4-3 shows a typical partnership agreement. The partnership agreement should state

• Who will make the final decisions • What each partner’s duties will be • The investment each partner will make • How much profit or loss each partner receives or is responsible for • What happens if a partner wants to dissolve the partnership or dies

Concept Check ✓✓ How does a sole proprietorship differ from a partnership?

✓✓ Explain the difference between a general partner and a limited partner.

✓✓ Describe the issues that should be included in a partnership agreement.

Figure 4-3 Articles of Partnership

The articles of partnership is a written or oral agreement that lists and explains the terms of a partnership.

PARTNERSHIP AGREEMENT

This agreement, made June 20, 2015, between Penelope Wolfburg of 783A South Street, Hazelton, Idaho, and Ingrid Swenson of RR 5, Box 96, Hazelton, Idaho.

1. The above named persons have this day formed a partnership that shall operate under the name of W-S Jewelers, located at 85 Broad Street, Hazelton, Idaho 83335, and shall engage in jewelry sales and repairs.

2. The duration of this agreement will be for a term of fifteen (15) years, beginning June 20, 2015, or for a shorter period if agreed upon in writing by both partners.

3. The initial investment by each partner will be as follows: Penelope Wolfburg, assets and liabilities of Wolfburg’s Jewelry Store, valued at a capital investment of $40,000; Ingrid Swenson, cash of $20,000. These investments are partnership property.

4. Each partner will give her time, skill, and attention to the operation of this partnership and will engage in no other business enterprise unless permission is

granted in writing by the other partner.

5. The salary for each partner will be as follows: Penelope Wolfburg, $40,000 per year; Ingrid Swenson, $30,000 per year. Neither partner may withdraw cash or other assets from the business without express permission in writing from the other partner. All profits and losses of the business will be shared as follows: Penelope Wolfburg, 60 percent; Ingrid Swenson, 40 percent.

6. Upon the dissolution of the partnership due to termination of this agreement, or to written permission by each of the partners, or to the death or incapacitation of one or both partners, a new contract may be entered into by the partners or the sole continuing partner has the option to purchase the other partner’s interest in the business at a price that shall not exceed the balance in the terminating partner’s capital account. The payment shall be made in cash in equal quarterly installments from the date of termination.

7. At the conclusion of this contract, unless it is agreed by both partners to continue the operation of the business under a new contract, the assets of the partnership, after the liabilities are paid, will be divided in proportion to the balance in each partner’s capital account on that date.

Penelope Wolfburg Ingrid Swenson

Date Date

Names of partners

Nature, name, and address of business

Duration of partnership

Contribution of capital

Duties of each partner

Salaries, withdrawals, and distribution of profits

Termination

Signatures

Date June 20, 2015 June 20, 2015

Source: Adapted from Goldman and Sigismond, Cengage Advantage Books: Business Law 9E.

112 Part 2 Business Ownership and Entrepreneurship

Although the people involved in a partnership can draft their own agreement, most experts recommend consulting an attorney.

When entering into a partnership agreement, partners would be wise to let a neutral third party—a consultant, an accountant, a lawyer, or a mutual friend— assist with any disputes that might arise.

4-3 advantageS and diSadvantageS OF PartnerShiPS When compared to sole proprietorships and corporations, partnerships are the least popular form of business ownership. Still there are situations when forming a partnership makes perfect sense. Before you make a decision to form a partnership, all the people involved should consider both the advantages and disadvantages of a partnership.

4-3a advantages of partnerships Partnerships have many advantages. The most important are described as follows.

eaSe OF Start-Up Partnerships are relatively easy to form. As with a sole proprietorship, the legal requirements often are limited to registering the name of the business and obtaining any necessary licenses or permits. It may not even be necessary to prepare written articles of partnership, although doing so is generally a good idea.

availaBility OF Capital and Credit Because partners can pool their funds, a partnership usually has more capital available than a sole proprietorship does. This additional capital, coupled with the general partners’ unlimited liability and combined management skills, may encourage banks and suppliers to extend more credit or approve larger loans to a partnership than to a sole proprietor. This does not mean that partnerships can borrow all the money they need. Many partnerships have found it hard to get long-term financing simply because lenders

worry about the possibility of management disagreements and lack of continuity.

perSOnal intereSt General partners are very concerned with the operation of the firm—perhaps even

more so than sole proprietors. After all, they are responsible for the actions of all other general partners, as well

as for their own. The pride of ownership from solving the day-to-day problems of operating a business—with the help of another person(s)—is a strong motivating force and often makes all the people involved in the partnership work harder to become more successful.

COmBined BUSineSS SkillS and knOwledGe Partners often have

complementary skills. The weakness of one partner—in manufacturing, for example—may be offset

by another partner’s strength in that area. Moreover, the ability to discuss important decisions with another concerned individual often

relieves some pressure and leads to more effective decision making.

Learning Objective

4-3Describe the advantages and disadvantages of partnerships.

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Chapter 4 Choosing a Form of Business Ownership 113

retentiOn OF prOFitS As in a sole proprietorship, all profits belong to the owners of the partnership. The partners share directly in the financial rewards and therefore are highly motivated to do their best to make the firm succeed. As noted, the partnership agreement should state how much profit or loss each partner receives or is responsible for.

nO SpeCial taxeS Although a partnership pays no income tax, the Internal Revenue Service requires partnerships to file an annual information return that states the names and addresses of all partners involved in the business. Then each partner is required to report his or her share of profit (or loss) from the partnership on his or her individual tax return. Ultimately each partner’s share of the partnership profit is taxed in the same way a sole proprietor is taxed.

4-3b disadvantages of partnerships Although partnerships have many advantages when compared with sole proprietorships and corporations, they also have some disadvantages, which anyone thinking of forming a partnership should consider.

Unlimited liaBility As we have noted, each general partner has unlimited liability for all debts of the business. Each partner is legally and personally responsible for the debts, taxes, and actions of any other partner conducting partnership business, even if that partner did not incur those debts or do anything wrong. General partners thus run the risk of having to use their personal assets to pay creditors. Limited partners, however, risk only their original investment.

Today, many states allow partners to form a limited-liability partnership (LLP), in which a partner may have limited-liability protection from legal action resulting from the malpractice or negligence of the other partners. Many states that allow LLPs restrict this type of ownership to certain types of professionals such as accountants, architects, attorneys, and similar professionals. (Note the difference between a limited partnership and an LLP. A limited partnership must have at least one general partner that has unlimited liability. On the other hand, all partners in an LLP may have limited liability for the malpractice and negligence of the other partners.)

manaGement diSaGreementS What happens to a partnership if one of the partners brings a spouse or a relative into the business? What happens if a partner wants to withdraw more money from the business? Notice that each of these situations—and for that matter, most of the other problems that can develop in a partnership—involves one partner doing something that disturbs the other partner(s). This human factor is especially important because business partners— with egos, ambitions, and money on the line—are especially susceptible to friction. When partners begin to disagree about decisions, policies, or ethics, distrust may build and get worse as time passes—often to the point where it is impossible to operate the business successfully.

laCk OF COntinUity Partnerships are terminated if any one of the general partners dies, withdraws, or is declared legally incompetent. However, the remaining partners can purchase that partner’s ownership share. For example, the partnership agreement may permit surviving partners to continue the business after buying a deceased partner’s interest from his or her estate. However, if the partnership loses an owner whose specific management or technical skills cannot be replaced, it is not likely to survive.

FrOzen inveStment It is easy to invest money in a partnership, but it is sometimes quite difficult to get it out. This is the case, for example, when remaining

114 Part 2 Business Ownership and Entrepreneurship

partners are unwilling to buy the share of the business that belongs to a partner who retires. To avoid such difficulties, the partnership agreement should include some procedure for buying out a partner.

In some cases, a partner must find someone outside the firm to buy his or her share. How easy or difficult it is to find an outsider depends on how successful the business is and how willing existing partners are to accept a new partner.

4-3c Beyond the partnership The main advantages of a partnership over a sole proprietorship are increased availability of capital and credit and the combined business skills and knowledge of the partners. However, some of the basic disadvantages of the sole proprietorship also plague the general partnership. A third form of business ownership, the corporation, overcomes many of these disadvantages.

4-4 COrPOratiOnS Back in 1837, William Procter and James Gamble—two sole proprietors—formed a partnership called Procter & Gamble (P&G) and set out to compete with 14 other soap and candle makers in Cincinnati, Ohio. Then, in 1890, Procter & Gamble incorporated to raise additional capital for expansion that eventually allowed the company to become a global giant. P&G brands serve over 5 billion of the 7 billion people in the world today because the corporation operates in 180 countries around the globe.4 Like many large corporations, P&G’s market capitalization is greater than the gross domestic product of many countries. Although this corporation is a corporate giant, the firm’s executives and employees believe it also has a responsibility to be an ethical corporate citizen. For example, P&G’s purpose statement (or mission) is

We will provide branded products and services of superior quality and value that improve the lives of the world’s consumers, now and for generations to come. As a result, consumers will reward us with leadership sales, profit and value creation, allowing our people, our shareholders and the communities in which we live and work to prosper.5

While not all sole proprietorships and partnerships become corporations, there are reasons why business owners choose the corporate form of ownership. Let’s begin with a definition of a corporation. Perhaps the best definition of a corporation was given by Chief Justice John Marshall in a famous Supreme Court decision in 1819. A corporation, he said, “is an artificial person, invisible, intangible, and existing only in contemplation of the law.” In other words, a corporation (sometimes referred to as a regular or C-corporation) is an artificial person created by law, with most of the legal rights of a real person. These include

• The right to start and operate a business • The right to buy or sell property • The right to borrow money • The right to sue or be sued • The right to enter into binding contracts

Unlike a real person, however, a corporation exists only on paper. There are approximately 7 million corporations in the United States. They comprise about 17 percent of all businesses, but they account for 79 percent of sales revenues (see Figures 4-1 and 4-2).

Concept Check ✓✓ What are the advantages of a partnership?

✓✓ What are the disadvantages of a partnership?

Learning Objective

4-4Summarize how a corporation is formed.

corporation an artificial person created by law with most of the legal rights of a real person, including the rights to start and operate a business, to buy or sell property, to borrow money, to sue or be sued, and to enter into binding contracts

Chapter 4 Choosing a Form of Business Ownership 115

4-4a Corporate Ownership The shares of ownership of a corporation are called stock. The people who own a corporation’s stock—and thus own part of the corporation—are called stockholders. Once a corporation has been formed, it may sell its stock to individuals or other companies that want to invest in the corporation. It also may issue stock as a reward to key employees or as a return to investors in place of cash payments.

A closed corporation is a corporation whose stock is owned by relatively few people and is not sold to the general public. As an example, Mars—the company famous for M&Ms, Snickers, Dove, Milky Way, Twix, and other chocolate candy—is a privately held, family-owned, closed corporation. Although many people think that a closed corporation is a small company, there are exceptions. Mars, for example, has annual sales of more than $33 billion, employs more than 75,000 associates worldwide, and operates in over 70 different countries.6

An open corporation is one whose stock can be bought and sold by any individual. Examples of open corporations include General Electric, Microsoft, Apple, and Sony.

4-4b Forming a Corporation Although you may think that incorporating a business guarantees success, it does not. There is no special magic about placing the word Incorporated or the abbreviation Inc. after the name of a business. Unfortunately, like sole proprietorships or partnerships, corporations can go broke. The decision to incorporate a business, therefore, should be made only after carefully considering whether the corporate form of ownership suits your needs better than the sole proprietorship or partnership forms.

If you decide that the corporate form is the best form of organization for you, most experts recommend that you begin the incorporation process by consulting a lawyer to be sure that all legal requirements are met. While it may be possible to incorporate a business without legal help, it is well to keep in mind the old saying, “A man who acts as his own attorney has a fool for a client.” Table 4-1 lists some aspects of starting and running a business that may require legal help.

where tO inCOrpOrate A business is allowed to incorporate in any state that it chooses. Most small- and medium-sized businesses are incorporated in the state where they do the most business. The founders of larger corporations or of those that will do business nationwide often compare the benefits that various states provide to corporations. The decision on where to incorporate usually is based on two factors: (1) the cost of incorporating in one state compared with the cost in another state and (2) the advantages and disadvantages of each state’s corporate laws and tax structure. Some states are more hospitable than others, and some offer fewer restrictions, lower taxes, and other benefits to attract new firms. Delaware, Nevada, and Wyoming are often chosen by corporations that do business in more than one state because of their corporation-friendly laws and pro-business climate.7

stock the shares of ownership of a corporation

stockholder a person who owns a corporation’s stock

closed corporation a corporation whose stock is owned by relatively few people and is not sold to the general public

open corporation a corporation whose stock can be bought and sold by any individual

What a success story. Back in 1955, a man named Ray Kroc founded the McDonald’s Corporation. A mere five years later McDonalds had sold 100 million hamburgers. Over the years, the McDonald’s Corporation continued to grow and change its menu options to reflect consumer tastes for healthier food. Today, McDonalds is one of the world’s leading food service retailers serving nearly 70 million people every day in 36,000 restaurants around the globe.

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An incorporated business is called a domestic corporation in the state in which it is incorporated. In all other states where it does business, it is called a foreign corporation. Sears Holdings Corporation, the parent company of Sears and Kmart, is incorporated in Delaware, where it is a domestic corporation. In the remaining 49 states, Sears is a foreign corporation. Sears must register in all states where it does business and also pay taxes and annual fees to each state. A corporation chartered by a foreign government and conducting business in the United States is an alien corporation. Volkswagen AG and Sony Corporation are examples of alien corporations.

domestic corporation a corporation in the state in which it is incorporated

foreign corporation a corporation in any state in which it does business except the one in which it is incorporated

alien corporation a corporation chartered by a foreign government and conducting business in the United States

Should your Company Be a Benefit Corporation?

Entrepreneurs who put social responsibility high on their list of priorities should investigate the pros and cons of the “benefit corporation.” This form of business ownership, currently available in more than two dozen states, gives a for-profit corporation the legal authority to operate for the benefit of societal stakeholders, not just for stockholders. As a result, a benefit corporation’s board of directors can’t be sued for pursuing non-financial goals such as protecting the environment or giving back to the community.

Becoming a benefit corporation is a way to demonstrate a commitment to social responsibility and attract customers, investors, and employees who share those values. It can also serve as a way to differentiate your company in a competitive marketplace. However, because the benefit corporation is a fairly new form of business ownership, states are still working out the regulatory details. For example, what happens if the benefit corporation does not achieve its non-financial goals? Should benefit corporations be subject to special government

oversight to ensure that they are actually involved in socially- responsible initiatives?

B Lab, a nonprofit organization, takes the idea of a benefit corporation one step further with its “B Corp” certification. To qualify, a business must follow the legal rules for incorporating as a benefit corporation and be certified by B Lab that it meets specific standards of social and environmental performance, community involvement, fair and equitable treatment of employees, accountability, and transparency. Patagonia, Ben & Jerry’s, and Etsy are among the hundreds of successful businesses that proudly proclaim their status as certified B Corps. In fact, B Corp certification has become a badge of honor!

Sources: Based on information in Jeffrey Stinson, “Rules Recognizing Benefit Corporations,” Albuquerque Business Journal, December 28, 2014, www.abqjournal.com; Doug Bend and Alex King, “Why Consider a Benefit Corporation?” Forbes, May 30, 2014, www.forbes.com; David R. Sands, “Benefit Corporations Raise Legal, Regulatory Questions,” Washington Times, December 7, 2014, www.washingtontimes.com; Steve Parrish, “Three Companies Doing Well by Doing Good,” Forbes, December 15, 2014, www.forbes.com; www.bcorporation.net.

Entrepreneurial Success

taBLe 4-1 Ten Aspects of Business That May Require Legal Help

1. Choosing either the sole proprietorship, partnership, corporate, or some special form of ownership

2. Constructing a partnership agreement

3. Incorporating a business

4. Registering a corporation’s stock

5. Obtaining a trademark, patent, or copyright

6. Filing for licenses or permits at the local, state, and federal levels

7. Purchasing an existing business or real estate

8. Creating valid contracts

9. Hiring employees and independent contractors

10. Extending credit and collecting debts

Chapter 4 Choosing a Form of Business Ownership 117

the COrpOrate Charter Once a home state has been chosen, the incorporator(s) submits articles of incorporation to the secretary of state. When the articles of incorporation are approved, they become a contract, often called the corporate charter, between a corporation and the state in which the state recognizes the formation of the artificial person that is the corporation. Usually, the articles of incorporation include the following information:

• The firm’s name and address • The incorporators’ names and addresses • The purpose of the corporation • The maximum amount of stock and types

of stock to be issued • The rights and privileges of stockholders • The length of time the corporation is to exist

To help you to decide if the corporate form of organization is the right choice, you may want to visit the library. You can also use an Internet search engine and enter the term “business incorporation” for useful websites. In addition, before making a decision to organize your business as a corporation, you may want to consider two additional areas: stockholders’ rights and the importance of the organizational meeting.

StOCkhOlderS’ riGhtS There are two basic types of stock. Owners of common stock may vote on corporate matters. Generally, an owner of common stock has one vote for each share owned. However, any claims of common-stock owners on profits, dividends, and assets of the corporation are paid after the claims of others. The owners of preferred stock usually have no voting rights, but their claims on dividends are paid before those of common-stock owners. Although some large corporations may issue both common and preferred stock, generally smaller corporations issue only common stock.

Perhaps the most important right of owners of both common and preferred stock is to share in the profit earned by the corporation through the payment of dividends. A dividend is a distribution of earnings to the stockholders of a corporation. Other rights include receiving information about the corporation, voting on changes to the corporate charter, and attending the corporation’s annual stockholders’ meeting, where they may exercise their right to vote.

Because common stockholders usually live all over the nation, very few actually may attend a corporation’s annual meeting. Instead, they vote by proxy. A proxy is a legal form listing issues to be decided at a stockholders’ meeting and enabling stockholders to transfer their voting rights to some other individual or individuals. The stockholder can register a vote and transfer voting rights simply by signing and returning the form. Today, most corporations also allow stockholders to exercise their right to vote by proxy by accessing the Internet or using a toll-free phone number.

OrGanizatiOnal meetinG As the last step in forming a corporation, the incorporators and original stockholders meet to adopt corporate bylaws and elect

common stock stock owned by individuals or firms who may vote on corporate matters but whose claims on profits and assets are subordinate to the claims of others

preferred stock stock owned by individuals or firms who usually do not have voting rights but whose claims on dividends are paid before those of common-stock owners

dividend a distribution of earnings to the stockholders of a corporation

proxy a legal form listing issues to be decided at a stockholders’ meeting and enabling stockholders to transfer their voting rights to some other individual or individuals

are you a stockholder?

Personal App

Even if you own a single share of common stock, you’re legally a part owner of the corporation. You’re entitled to receive any dividends paid to stockholders and you can vote on important matters such as electing the board of directors. Your vote is counted—and it counts.

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their first board of directors. (Later, directors will be elected or reelected at the corporation’s annual meetings by the firm’s stockholders.) The board members are directly responsible to the stockholders for the way they operate the firm.

4-4c Corporate Structure The organizational structure of most corporations is more complicated than that of a sole proprietorship or partnership. In a corporation, both the board of directors and the corporate officers are involved in management.

BOard OF direCtOrS As an artificial person, a corporation can act only through its directors,

who represent the corporation’s stockholders. The board of directors is the top governing body of a corporation and is elected by the stockholders. In theory, then, the stockholders are able to control the activities of the entire corporation through its directors because they are the group that elects the board of directors (see Figure 4-4).

Board members can be chosen from within the corporation or from outside it. Note: For a small corporation, only one director is required in many states although you can choose to have more. Directors who are elected from within the corporation are usually its top managers—the president and executive vice presidents, for example. Those elected from outside the corporation generally are experienced managers or entrepreneurs with proven leadership ability and/or specific talents the organization seems to need. In smaller corporations, majority stockholders usually serve as board members.

The major responsibilities of the board of directors are to set company goals and develop general plans (or strategies) for meeting those goals. The board also is responsible for the firm’s overall operation and appointing corporate officers.

COrpOrate OFFiCerS Corporate officers are appointed by the board of directors. Although a small corporation may not have all of the following officers, the chairman of the board, president, executive vice presidents, corporate secretary, and treasurer are all corporate officers. They help the board to make plans, carry out strategies established by the board, hire employees, and manage day-to-day business activities. Periodically (usually each month), they report to the board of directors. And at the annual meeting, the directors report to the stockholders.

board of directors the top governing body of a corporation, the members of which are elected by the stockholders

Concept Check ✓✓ Explain the difference between an open corporation and a closed corporation.

✓✓ How is a domestic corporation different from a foreign corporation and an alien corporation?

✓✓ Outline the incorporation process, and describe the basic corporate structure.

✓✓ What rights do stockholders have?

corporate officers the chairman of the board, president, executive vice presidents, corporate secretary, treasurer, and any other top executive appointed by the board of directors

What’s it take to lead a major corporation? Simple answer: Leadership. Apple co-founder, Steve Jobs, was always known for his leadership style that helped to create technology-based products that enabled Apple to become a leader in the very competitive technology industry. The people at Apple will miss his leadership skills, but the world will miss his creative genius.

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Figure 4-4 Hierarchy of Corporate Structure

Stockholders exercise a great deal of influence through their right to elect the board of directors.

Stockholders (owners)

Elect Board of directors

Appoints Of�cers Hire Employees

Chapter 4 Choosing a Form of Business Ownership 119

4-5 advantageS and diSadvantageS OF COrPOratiOnS When Warren Buffett started his first partnership more than 50 years ago, he never dreamed he would wind up putting together a wildly diverse collection of businesses under one corporate umbrella. It all started when Buffett set up a series of partnerships with family and friends to pool cash for buying big blocks of stock in companies he had researched. Not all of the companies Buffett chose paid off, but many were so successful that Buffett quickly earned a worldwide reputation for his ability to pick just the “right” company. Today, Berkshire Hathaway now owns more than 50 different corporations, brings in almost $200 billion in annual revenue, and employees 300,000 people.

Although Warren Buffett started with partnerships, he eventually chose the corporate form of ownership because it provided a number of advantages when compared to a partnership or the other forms of business ownership. Typical advantages of the corporate form of ownership include limited liability, ease of raising capital, ease of transfer of ownership, perpetual life, and specialized management.

4-5a advantages of Corporations

limited liaBility One of the most attractive features of corporate ownership is limited liability. With few exceptions, each owner’s financial liability is limited to the amount of money he or she has paid for the corporation’s stock. This feature arises from the fact that the corporation is itself a legal person, separate from its owners. If a corporation fails or is involved in a lawsuit and loses, creditors have a claim only on the corporation’s assets. Because it overcomes the problem of unlimited liability connected with sole proprietorships and general partnerships, limited liability is one of the chief reasons why entrepreneurs often choose the corporate form of organization. For example, Manny Ruiz, with the help of a team of media specialists, founded a corporation called Hispanic PR Wire back in 2000. They chose the corporate form of ownership because of limited liability and the other advantages this type of ownership provided that other forms of business ownership did not offer. After the firm’s initial success, Hispanic PR Wire was sold to PR Newswire—a larger company—but the original company continues to provide important news and entertainment coverage for the Hispanic market.8

eaSe OF raiSinG Capital The corporation is one of the most effective forms of business ownership for raising capital. Like sole proprietorships and partnerships, corporations can borrow from lending institutions. However, they also can raise additional sums of money by selling stock. In fact, the amount of capital that can be raised by selling stock can be staggering. Alibaba, the Chinese e-commerce company, raised $25

Learning Objective

4-5Describe the advantages and disadvantages of a corporation.

limited liability a feature of corporate ownership that limits each owner’s financial liability to the amount of money that he or she has paid for the corporation’s stock

How much money can a corporation raise by selling stock? Good question. While the amount of money a corporation can raise by selling stock depends on many factors, Alibaba—the Chinese e-commerce company—raised $25 billion by selling stock. The money can be used to fund expansion, to repay debt, or for any valid business reasons.

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billion by selling stock in late 2014. This was the largest global initial public stock offering—often referred to as an IPO—in history.9 Money from an IPO can be used by a corporation for expansion, to repay debt, or for any valid reason. While not all IPOs are as large as Alibaba’s, individuals are more willing to invest in corporations than in other forms of business because of limited liability, and they can generally sell their stock easily—hopefully for a profit.

eaSe OF tranSFer OF OwnerShip Accessing a brokerage firm website or a telephone call to a stockbroker is all that is required to put most stock up for sale. Willing buyers are available for most stocks at the current market price. Ownership is transferred when the sale is made, and practically no restrictions apply to the sale and purchase of stock issued by an open corporation.

perpetUal liFe Since it is essentially a legal “person,” a corporation exists independently of its owners and survives them. The withdrawal, death, or incompetence of a key executive or owner does not cause the corporation to be terminated. Sears, Roebuck and Co. was originally founded in 1893 and is one of the nation’s largest retailing corporations, even though its original founders, Richard Sears and Alvah Roebuck, have been dead for decades.

SpeCialized manaGement Typically, corporations are able to recruit more skilled, knowledgeable, and talented managers than proprietorships and partnerships. This is so because they pay bigger salaries, offer excellent employee benefits, and are large enough to offer considerable opportunity for advancement. Within the corporate structure, administration, human resources, finance, marketing, operations, and manufacturing are placed in the charge of experts in these fields.

4-5b disadvantages of Corporations Like its advantages, many of a corporation’s disadvantages stem from its legal definition as an artificial person or legal entity. The most serious disadvantages are described in the following text. Also see Table 4-2 for a comparison of some of the advantages and disadvantages of a sole proprietorship, general partnership, and corporation.

diFFiCUlty and expenSe OF FOrmatiOn Forming a corporation can be a relatively complex and costly process. The use of an attorney is usually necessary to complete the legal forms that are submitted to the secretary of state. Application fees, attorney’s fees, registration costs associated with selling stock, and other organizational costs can amount to thousands of dollars for even a medium-sized

taBLe 4-2 Some Advantages and Disadvantages of a Sole Proprietorship, Partnership, and Corporation

Sole Proprietorship

General Partnership

Regular C-Corporation

Protecting against liability for debts

Difficult Difficult Easy

Raising money Difficult Difficult Easy

Ownership transfer Difficult Difficult Easy

Preserving continuity Difficult Difficult Easy

Government regulations Few Few Many

Formation Easy Easy Difficult

Income taxation Once Once Twice

Chapter 4 Choosing a Form of Business Ownership 121

corporation. The costs of incorporating, in terms of both time and money, discourage many owners of smaller businesses from forming corporations. Before deciding to incorporate a small business, you may want to review the material in the section “Forming a Corporation” discussed earlier in this chapter.

GOvernment reGUlatiOn and inCreaSed paperwOrk A corporation must register and meet various government standards before it can sell its stock to the public. Then it must file many reports on its business operations and finances with local, state, and federal governments. In addition, the corporation must make periodic reports to its stockholders. To prepare all the necessary reports, even small corporations often need the help of an attorney, certified public accountant, and other professionals on a regular basis. In addition, a corporation’s activities are restricted by law to those spelled out in its corporate charter.

COnFliCt within the COrpOratiOn Because a large corporation may employ thousands of employees, some conflict is inevitable. For example, the pressure to increase sales revenue, reduce expenses, and increase profits often leads to increased stress and tension for both managers and employees. This is especially true when a corporation operates in a competitive industry, attempts to develop and market new products, or must downsize the workforce to reduce employee salary expense. For example, both Coca Cola and McDonalds—two of America’s strongest corporations—announced plans to lay off workers in the first part of 2015 in order to reduce expenses. According to Ann Moore, a Coca-Cola spokeswoman, “We do not take decisions about job impacts lightly.”10

dOUBle taxatiOn Corporations must pay a tax on their profits. In addition, stockholders must pay a personal income tax on profits received as dividends. Corporate profits thus are taxed twice—once as corporate income and a second time as the personal income of stockholders. Note: Both the S corporation and the limited-liability company (LLC) discussed in the next section eliminate the disadvantage of double taxation and are a primary reason why business owners choose these special types of business ownership.

laCk OF SeCreCy Because open corporations are required to submit detailed reports to government agencies and to stockholders, they cannot keep all of their operations confidential. Competitors can study these corporate reports and then use the information to compete more effectively. In effect, every public corporation has to share some of its secrets about its management, finances, and other business activities with its competitors.

4-6 SPeCiaL tyPeS OF BuSineSS OwnerShiP In addition to the sole proprietorship, partnership, and the regular corporate form of organization, some entrepreneurs choose other forms of organization that meet their special needs. Additional organizational options include S corporations, LLCs, and not-for-profit corporations.

4-6a S Corporations If a corporation meets certain requirements, its directors may apply to the Internal Revenue Service for status as an S corporation. An S corporation is a corporation that is taxed as though it were a partnership. In other words, the corporation’s income is taxed only as the personal income of its stockholders. Corporate profits

Learning Objective

4-6Examine special types of businesses, including S corporations, limited-liability companies, and not-for-profit corporations.

S corporation a corporation that is taxed as though it were a partnership

Concept Check ✓✓ What are the advantages of a corporation?

✓✓ What are the disadvantages of a corporation?

122 Part 2 Business Ownership and Entrepreneurship

or losses “pass through” the business and are reported on the owners’ personal income tax returns.

To qualify for the special status of an S corporation, the first step is to file the necessary paperwork to become a corporation. A number of issues described in the section “Forming a Corporation” must be decided and paperwork must be filed with the secretary of state. Once the corporation is established, the corporation must complete Form 2553 and submit it to the IRS. In addition to completing the form, a firm must meet the following criteria:11

1. No more than 100 stockholders are allowed. 2. Stockholders must be individuals, estates, or certain trusts. 3. There can be only one class of outstanding stock. 4. The firm must be a domestic corporation eligible to file for S corporation status. 5. All stockholders must agree to the decision to form an S corporation.

Becoming an S corporation can be an effective way to avoid double taxation while retaining the corporation’s legal benefit of limited liability.

4-6b limited-liability Companies A limited-liability company (LLC) is a form of business ownership that combines the benefits of a corporation and a partnership while avoiding some of the restrictions and disadvantages of those forms of ownership. Chief advantages of an LLC are as follows:

1. Like a sole proprietorship or partnership, an LLC enjoys pass-through taxation. This means that owners—which are called members in an LLC—report their share of profits or losses in the company on their individual tax returns and avoid the double taxation imposed on most corporations. LLCs with at least two members are taxed like a partnership. LLCs with just one member are taxed

like a sole proprietorship. LLCs can even elect to be taxed as a corporation or S corporation if there are benefits to offset the corporate double taxation and other restrictions. 2. Like a corporation, it provides limited-

liability protection for acts and debts of the LLC. An LLC thus extends the concept of personal-asset protection to small business owners.

3. The LLC type of organization provides more management flexibility and fewer restrictions when compared with corporations. A corporation, for example, is required to hold annual meetings and record meeting minutes; an LLC is not.

Although many experts believe that the LLC is nothing more than a variation of the S corporation, there is a difference. An LLC is not restricted to 100 stockholders—a common drawback of the S corporation. Although the laws for forming an LLC are slightly different in each state, the owners of an LLC may file the required articles of organization in any state. Most choose to file in their home state—the state where they do most of their business.

limited-liability company (LLC) a form of business ownership that combines the benefits of a corporation and a partnership while avoiding some of the restrictions and disadvantages of those forms of ownership

BMW of North America: A Limited Liability Company. A limited liability company doesn’t have to be small. BMW sells luxury automobiles all over the world including Europe, Asia, Africa, South America—and of course North America. BMW of North America chose the limited-liability company form of ownership to avoid some of the restrictions and disadvantages of other forms of business ownership.

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Even though most LLCs are small- to medium-sized businesses, an LLC doesn’t have to be small. BMW of North America—an LLC that sells luxury automobiles and motorcycles—chose the LLC type of business ownership because it provided limited liability for investors and avoided some of the restrictions and disadvantages of other forms of business ownership.

For help in understanding the differences between a regular corporation, S corporation, and an LLC, see Table 4-3.

4-6c not-for-profit Corporations A not-for-profit corporation (sometimes referred to as non-profit) is a corporation organized to provide a social, educational, religious, or other service rather than to earn a profit. Various charities, museums, private schools, colleges, and charitable organizations are organized in this way, primarily to ensure limited liability.

While the process used to organize a not-for-profit corporation is similar to the process used to create a regular corporation, each state does have different laws. Once approved by state authorities, not-for-profit corporations must meet specific Internal Revenue Service guidelines in order to obtain tax-exempt status.

Today, there is a renewed interest in not-for-profits because these organizations are often formed to improve communities and change lives. For example, Habitat for Humanity is a not-for-profit corporation and was formed to provide homes for qualified lower income people who cannot afford housing. Even though this corporation may receive more money than it spends, any surplus funds are “reinvested” in building activities to provide low-cost housing to qualified individuals.

Many not-for-profit corporations operate in much the same way as for-profit businesses. Employees of not-for-profit businesses are responsible for making sure the organization achieves its goals and objectives, ensuring accountability for finances and donations, and monitoring activities to improve the performance of both paid employees and volunteers. If you are interested in a business career, don’t rule out the non-profit sector. You might consider volunteering in a local not-for- profit organization to see if you enjoy this type of challenge.

4-7 JOint ventureS and SyndiCateS Today, two additional types of business organizations—joint ventures and syndicates—are used for special purposes. Each of these forms of organization is unique when compared with more traditional forms of business ownership.

not-for-profit corporation a corporation organized to provide a social, educational, religious, or other service rather than to earn a profit

Learning Objective

4-7Discuss the purpose of a joint venture and syndicate.

taBLe 4-3 Some Advantages and Disadvantages of a Regular Corporation, S Corporation, and Limited-Liability Company

Regular C-Corporation S Corporation

Limited-Liability Company

Double taxation Yes No No

Limited liability and personal asset protection

Yes Yes Yes

Management flexibility No No Yes

Restrictions on the number of owners/stockholders

No Yes No

Internal Revenue Service tax regulations

Many Many Fewer

Concept Check ✓✓ Explain the difference between an S corporation and a limited- liability company.

✓✓ How does a regular (C) corporation differ from a not-for- profit corporation?

124 Part 2 Business Ownership and Entrepreneurship

4-7a Joint ventures A joint venture is an agreement between two or more groups to form a business entity in order to achieve a specific goal or to operate for a specific period of time. Both the scope of the joint venture and the liabilities of the people or businesses involved usually are limited to one project. Once the goal is reached, the period of time elapses, or the project is completed, the joint venture is dissolved.

Corporations, as well as individuals, may enter into joint ventures. Major oil producers often have formed a number of joint ventures to share the extremely high cost of exploring for offshore petroleum deposits. And many U.S. companies are forming joint ventures with foreign firms in order to enter new markets around the globe. Back in 1991, General Mills and Nestle formed the joint venture Cereal Partners Worldwide to market breakfast cereals in 130 countries around the globe. Today, more than 25 years later, the joint venture accounts for over $1 billion in

sales each year. This joint venture has been a great success because it marries the production and marketing expertise of General Mills and the worldwide presence of Nestle, which also has local market knowledge and distribution strength. The General Mills and Nestle joint venture also continues to expand its operations by opening a new factory in western Turkey to produce breakfast cereals for the Turkish market as well as other countries in the

Middle East and North Africa.12

4-7b Syndicates A syndicate is a temporary association of individuals or firms organized to perform a specific task that requires a large amount of capital. The syndicate is formed because no one person or firm is willing to put up the entire amount required for

joint venture an agreement between two or more groups to form a business entity in order to achieve a specific goal or to operate for a specific period of time

syndicate a temporary association of individuals or firms organized to perform a specific task that requires a large amount of capital

tough decisions for entrepreneurs in tough Situations

As an entrepreneur launching a small business, you’ll face lots of tough decisions. What do you think is the right thing to do in the following situations?

1. A potential customer wants to visit your place of business. Should you introduce friends as “employees” so your firm looks bigger and busier?

2. Suppliers have sent you free samples so you can examine products before placing an order. Once you buy, is it ethical to sell the samples while you wait for your delivery?

3. A supplier offers to cut its price and not collect sales tax if you pay cash and don’t require a receipt. Money is tight— should you do this?

Experts say it’s important for entrepreneurs to set a tone of honesty and integrity and earn the trust of their employees, bankers, suppliers, customers, distributors, and investors.

A fledgling business known for ethical dealings will have a smoother path to success than a business that’s suspected of shady dealings.

So in situation #1, the ethical course of action is to invite your suppliers and introduce them as your network of experts that are on hand to answer a customer’s questions and offer advice. In situation #2, give the freebies away to customers who order other products—a good way to gain goodwill and let them sample new products without risk. As for situation #3, do you want to do business with a tax cheat or have this supplier tell others that you participated in a scheme to avoid paying taxes?

Sources: Based on information in Gael O’Brien, “The Ethics Coach’s Top 3 Strategies for Creating an Ethical Workplace,” Entrepreneur, June 2014; Gael O’Brien, “The Ethics Coach on Cash Deals, Transparency, and More,” Entrepreneur, January 2014; Gael O’Brien, “The Ethics Coach on Misrepresentation,” Entrepreneur, April 2013.

Ethical Success or Failure

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the undertaking. Like a joint venture, a syndicate is dissolved as soon as its purpose has been accomplished.

Syndicates are used most commonly to underwrite large insurance policies, loans, and investments. To share the risk of default, banks have formed syndicates to provide loans to developing countries. Stock brokerage firms usually join together in the same way to market a new issue of stock. In early 2015, Box, Inc., a company that provides cloud-based data management services to over 32 million people and 275,000 companies, sold stock to investors. With the help of a syndicate of Wall Street firms, including Morgan Stanley, Credit Suisse, and J.P. Morgan, Box raised approximately $150 million through its initial public offering, often referred to as an IPO. (An initial public offering is the term used to describe the first time a corporation sells stock to the general public.) Once the stock was sold, Box used the money to improve its cash balance and fund growth and expansion.13

4-8 COrPOrate grOwth Growth seems to be a basic characteristic of business. One reason for seeking growth has to do with profit: A larger firm generally has greater sales revenue and thus greater profit. Another reason is that in a growing economy, a business that does not grow is actually shrinking relative to the economy. A third reason is that business growth is a means by which some executives boost their power, prestige, and reputation.

Growth poses new problems and requires additional resources that first must be available and then must be used effectively. The main ingredient in growth is capital—and as we have noted, capital is most readily available to corporations.

4-8a Growth from within Most corporations grow by expanding their present operations. Some introduce and sell new but related products. Others expand the sale of present products to new geographic markets or to new groups of consumers in geographic markets already served. Although Walmart was started by Sam Walton in 1962 with one discount store, today Walmart has nearly 11,000 stores in the United States and 27 other countries, serves 245 million customers each week, and has long-range plans for expanding into additional international markets.14

Growth from within, especially when carefully planned and controlled, can have relatively little adverse effect on a firm. For the most part, the firm continues to do what it has been doing, but on a larger scale. For instance, Larry Ellison, co-founder and CEO of Oracle Corporation of Redwood Shores, California, built the firm’s annual revenues up from a mere $282 million in 1988 to approximately $38 billion today.15 Much of this growth has taken place over the last 25 years as Oracle capitalized on its global leadership in information management software.

4-8b Growth through mergers and acquisitions Another way a firm can grow is by purchasing another company. The combining of two corporations or other business entities to form one business is called a merger. An acquisition is essentially the same thing as a merger, but the term usually is used in reference to a large corporation’s purchases of other corporations. Although most mergers and acquisitions are often friendly, hostile takeovers also occur. A hostile takeover is a situation in which the management and board of directors of a firm targeted for acquisition disapprove of the merger.

Concept Check ✓✓ In your own words, define a joint venture and a syndicate.

✓✓ In what ways are joint ventures and syndicates alike? In what ways do they differ?

Learning Objective

4-8Explain how growth from within and growth through mergers can enable a business to expand.

merger the combining of two corporations or other business entities to form one business

hostile takeover a situation in which the management and board of directors of a firm targeted for acquisition disapprove of the merger

126 Part 2 Business Ownership and Entrepreneurship

When a merger or acquisition becomes hostile, a corporate raider— another company or a wealthy investor— may make a tender offer or start a proxy fight to gain control of the target company. A tender offer is an offer to purchase the stock of a firm targeted for acquisition at a price just high enough to tempt stockholders to sell their shares. Corporate raiders also may initiate a proxy fight. A proxy fight is a technique used to gather enough stockholder votes to control a targeted company.

If the corporate raider is successful and takes over the targeted company, existing management usually is replaced. Faced with this probability, existing management may take specific actions, sometimes referred to as “poison pills,” “shark repellents,” or “porcupine provisions,” to maintain control of the firm and avoid the hostile takeover. Whether mergers are friendly

or hostile, they are generally classified as horizontal, vertical, or conglomerate (see Figure 4-5).

hOrizOntal merGerS A horizontal merger is a merger between firms that make and sell similar products or services in similar markets. The merger between American Airlines and US Airways is an example of a horizontal merger because both firms provide customers with air travel to destinations in the United States and around the globe. This type of merger tends to reduce the number of firms in an industry—and thus may reduce competition. While this merger was challenged by the U.S. Department of Justice on the basis the merger would reduce competition in the airline industry, it was eventually approved when the airlines agreed to divest some takeoff and landing rights at major U.S. airports.

vertiCal merGerS A vertical merger is a merger between firms that operate at different but related levels in the production and marketing of a product. Generally, one of the merging firms is either a supplier or a customer of the other. A vertical merger occurred when computer software and hardware giant Oracle acquired BlueKai. At the time of the merger, BlueKai, based in Cupertino, California, was a much smaller company that had developed a data management platform used by more than 300 customers to personalize their marketing efforts. Rather than develop its own software and data management program for its marketing products, Oracle simply purchased the BlueKai company.16

COnGlOmerate merGerS A conglomerate merger takes place between firms in completely different industries. A conglomerate merger occurred when financial conglomerate Berkshire Hathaway acquired Duracell. While both companies were recognized as successful companies that have a history of increasing sales revenues and profits, they operate in different industries. Berkshire Hathaway, led by its CEO Warren Buffett, has a long history of acquiring firms that have great financial potential. According to Mr. Buffett, “Duracell is a leading global brand with top quality products and it will fit well within Berkshire Hathaway.”17

tender offer an offer to purchase the stock of a firm targeted for acquisition at a price just high enough to tempt stockholders to sell their shares

proxy fight a technique used to gather enough stockholder votes to control a targeted company

Facebook continues to grow. Just about everyone knows that Facebook is the world’s largest social networking site, but did you know that part of the reason for its success is that management is always on a lookout for companies that the company can acquire. In fact, Facebook has a history of business acquisitions—especially successful companies that have talented people with a vision of the future.

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4-8c merger and acquisition trends for the Future Economists, financial analysts, corporate managers, and stockholders still hotly debate whether mergers and acquisitions are good for the economy—or for individual companies—in the long run. Takeover advocates argue that for companies that have been taken over, the purchasers have been able to make the company more profitable and productive by installing a new top-management team, by reducing expenses, and by forcing the company to concentrate on one main business.

Takeover opponents argue that takeovers do nothing to enhance corporate profitability or productivity. These critics argue that the only people who benefit from takeovers are investment bankers, brokerage firms, and takeover “artists,” who receive financial rewards by manipulating corporations rather than by producing tangible products or services.

While there have always been mergers and acquisitions, the current economy has changed the dynamics of how and why firms merge. Most experts now predict that mergers and acquisitions after the 2008 economic crisis will be the result of cash-rich companies looking to acquire businesses that will enhance their position in the marketplace or an industry. Analysts also anticipate more mergers that involve companies or investors from other countries. Regardless of the companies involved or where the companies are from, future mergers and acquisitions will be driven by solid business logic and the desire to compete in the international marketplace.

Whether they are sole proprietorships, partnerships, corporations, or some other form of business ownership, most U.S. businesses are small. In the next chapter, we focus on these small businesses. We examine, among other things, the meaning of the word small as it applies to business and the place of small business in the American economy.

Figure 4-5 Three Types of Growth by Merger

Today, mergers are classified as horizontal, vertical, or conglomerate.

HORIZONTAL MERGER

Networking (Oracle)

VERTICAL MERGER

Data Management (BlueKai)

Financial Conglomerate (Berkshire Hathaway) +

CONGLOMERATE MERGER

Consumer Goods (Duracell)

Airline (American Airlines)

Airline (US Airways)

Concept Check ✓✓ What happens when a firm makes a decision to grow from within?

✓✓ What is a hostile takeover? How is it related to a tender offer and a proxy fight?

✓✓ Explain the three types of mergers.

✓✓ Describe the current merger trends and how they affect the businesses involved and their stockholders.

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Summary

4-1 describe the advantages and disadvantages of sole proprietorships.

In a sole proprietorship, all business profits become the property of the owner, but the owner is also personally responsible for all business debts. A successful sole proprietorship can be a great source of pride for the owner. When comparing different types of business ownership, the sole proprietorship is the simplest form of business to enter, control, and leave. It also pays no special taxes. Perhaps for these reasons, 73 percent of all American business firms are sole proprietorships. Sole proprietorships nevertheless have disadvantages, such as unlimited liability and limits on one person’s ability to borrow or to be an expert in all fields. As a result, this form of ownership accounts for only 4 percent of total revenues when compared with partnerships and corporations.

4-2 explain the different types of partners and the importance of partnership agreements.

Like sole proprietors, general partners are responsible for running the business and for all business debts. Limited partners receive a share of the profit in return for investing in the business. However, they are not responsible for business debts beyond the amount they have invested. Regardless of the type of partnership, it is always a good idea to have a written agreement (or articles of partnership) setting forth the terms of a partnership.

4-3 describe the advantages and disadvantages of partnerships. Although partnership eliminates some of the disadvantages of sole proprietorship, it is the least popular of the major forms of business ownership. The major advantages of a partnership include ease of start-up, availability of capital and credit, personal interest, combined skills and knowledge, retention of profits, and possible tax advantages. The effects of management disagreements are one of the major disadvantages of a partnership. Other disadvantages include unlimited liability (in a general partnership), lack of continuity, and frozen investment. By forming a limited partnership, the disadvantage of unlimited liability may be eliminated for the limited partner(s). This same disadvantage may be eliminated for partners that form a limited liability partnership (LLP). Of course,

special requirements must be met if partners form either the limited partnership or the LLP.

4-4 Summarize how a corporation is formed. A corporation is an artificial person created by law, with most of the legal rights of a real person, including the right to start and operate a business, to buy or sell property, to borrow money, to be sued or sue, and to enter into contracts. With the corporate form of ownership, stock can be sold to individuals to raise capital. The people who own a corporation’s common or preferred stock are called stockholders. Stockholders are entitled to receive any dividends paid by the corporation, and common stockholders can vote either in person or by proxy.

Most experts believe that the services of a lawyer are necessary when making decisions about where to incorporate and about obtaining a corporate charter, issuing stock, holding an organizational meeting, and all other legal details involved in incorporation. In theory, stockholders are able to control the activities of the corporation because they elect the board of directors who appoint the corporate officers.

4-5 describe the advantages and disadvantages of a corporation. Perhaps the major advantage of the corporate form is limited liability—stockholders are not liable for the corporation’s debts beyond the amount they paid for its stock. Other important advantages include ease of raising capital, ease of transfer of ownership, perpetual life, and specialized management. A major disadvantage of a large corporation is double taxation: All profits are taxed once as corporate income and again as personal income because stockholders must pay a personal income tax on their dividend income. Other disadvantages include difficulty and expense of formation, government regulation, conflict within the corporation, and lack of secrecy.

4-6 examine special types of businesses, including S corporations, limited-liability companies, and not-for-profit corporations.

S corporations are corporations that are taxed as though they were partnerships but that enjoy the benefit of limited liability. To qualify as an S corporation, a number of criteria must be met. An LLC is a form of

Chapter 4 Choosing a Form of Business Ownership 129

business ownership that provides limited liability and has fewer restrictions when compared to a regular corporation or an S corporation. LLCs also avoid the double taxation imposed on most corporations. When compared with a regular corporation or an S corporation, an LLC is more flexible. Not-for-profit corporations are formed to provide social services and to improve communities and change lives rather than to earn profits.

4-7 discuss the purpose of a joint venture and syndicate. Two additional forms of business ownership—the joint venture and a syndicate—are used by their owners to meet special needs. A joint venture is formed when two or more groups form a business entity in order to achieve a specific goal or to operate for a specific period of time. Once the goal is reached, the period of time elapses, or the project is completed, the joint venture is dissolved. A syndicate is a temporary association of individuals or firms organized to perform a specific task that requires large amounts of capital. Like a joint

venture, a syndicate is dissolved as soon as its purpose has been accomplished.

4-8 explain how growth from within and growth through mergers can enable a business to expand.

A corporation may grow by expanding its present operations or through a merger or an acquisition. Although most mergers are friendly, hostile takeovers also occur. A hostile takeover is a situation in which the management and board of directors of a firm targeted for acquisition disapprove of the merger. Mergers generally are classified as horizontal, vertical, or conglomerate.

While economists, financial analysts, corporate managers, and stockholders debate the merits of mergers, some trends should be noted. First, experts predict that future mergers will be the result of cash-rich companies looking to acquire businesses that will enhance their position in the marketplace or an industry. Second, more mergers are likely to involve foreign companies or investors. Third, mergers will be driven by business logic and the desire to compete in the international marketplace.

Key Terms

You should now be able to define and give an example relevant to each of the following terms:

sole proprietorship (106) unlimited liability (108) partnership (109) general partner (110) limited partner (110) corporation (114) stock (115) stockholder (115)

closed corporation (115) open corporation (115) domestic corporation (116) foreign corporation (116) alien corporation (116) common stock (117) preferred stock (117) dividend (117)

proxy (117) board of directors (118) corporate officers (118) limited liability (119) S corporation (121) limited-liability company

(LLC) (122) not-for-profit corporation (123)

joint venture (124) syndicate (124) merger (125) hostile takeover (125) tender offer (126) proxy fight (126)

Discussion Questions

1. If you were to start a business, which ownership form would you choose? What factors might affect your choice?

2. Why might an investor choose to become a partner in a limited partnership instead of purchasing the stock of an open corporation?

3. Discuss the following statement: “Corporations are not really run by their owners.”

4. What kinds of services do not-for-profit corporations provide? Would a career in a not-for-profit corporation appeal to you?

5. Is growth a good thing for all firms? How does manage- ment know when a firm is ready to grow?

130 Part 2 Business Ownership and Entrepreneurship

Building Skills for Career Success

1. Social Media Exercise Not-for-profit organizations have used social media to redefine how they can get funding for their missions. There are even a few that exist totally online. Check out www. donorschoose.org and www.kiva.org. Both of these depend on crowds (called crowdfunding) to either fund educational projects (Donors Choose) or lend money to support projects all over the world (Kiva) using the microfinancing model. a. Take a minute to explore both sites and view some of

the projects up for funding. Do you think social media is

an effective method of raising money for worthwhile proj- ects? Why or why not?

b. Both Donors Choose and Kiva are not-for-profits; do you think crowdfunding could be useful for “for-profit” busi- nesses? Why or why not?

2. Building Team Skills Suppose that you have decided to quit your job as an insurance adjuster and open a bakery. Your business is now growing, and you have decided to add a full line of catering

Video Case project repat Gives Old t-Shirts new life

Ross Lohr and Nathan Rothstein have built a thriving small business from the idea of giving old T-shirts new life by having them cut into squares and sewn into comfortable fleece-backed quilts. The Boston-based company is named Project Repat because it is dedicated to repatriating textile- industry jobs and helping U.S. workers earn a living wage by sewing T-shirt quilts made to order.

To start, customers visit the Project Repat website (www.projectrepat.com) and select the size of their quilt, based on the number of T-shirts they want sewn together. Then they choose the color of fleece for the backing, enter their payment information, and place the order. Project Repat responds with detailed instructions for preparing the T-shirts and shipping them to one of its two contract manufacturing centers, the one in Fall River, Massachusetts or the one in Morganton, North Carolina. Once the T-shirts arrive, the company confirms the receipt of the T-shirts by sending an e-mail to the customer. Within a month, the new quilt made of old T-shirts is on its way back to the customer, ready to be enjoyed for the warmth and the memories.

The original business plan was to make good use of T-shirts that had been discarded by U.S. consumers and wound up in Kenya. The cofounders raised money via crowdsourcing to pay for designing fashion accessories made from old T-shirts. Once designs were completed, local Kenyan artisans were then employed to turn the designs into finished products that were then shipped to America for sale. However, feedback from U.S. customers quickly led the company to refocus on creating something new from customers’ own T-shirts that had nostalgic value. So Project Repat switched from production of fashion accessories in Kenya to production of T-shirt quilts in America through contract manufacturers that paid and treated their workers well.

Project Repat was set up as a traditional corporation because it had the help of a business accelerator and it was

seeking funding from venture capitalists and angel investors. One of the original cofounders and a designer received some shares in the corporation. However, the current management team of CEO Ross Lohr and President Nathan Rothstein— who together are the primary shareholders—would have preferred to establish Project Repat as an S corporation or an LLC, in part because the tax bill would be a little lower. Lohr and Rothstein have also taken Project Repat through the process of qualifying as a B corporation, which signals their commitment to pursuing social responsibility goals as well as financial goals.

Now Project Repat is reaching out to potential customers via social media sites like Facebook, Twitter, YouTube, Pinterest, and Instagram. It sews as many as 1,000 T-shirt quilts every week, enabling customers to hold onto beloved T-shirts in a new form and relive happy memories every time they use the quilt. With over $2 million in annual revenue, the company has been responsible for recycling one million T-shirts that might otherwise have been relegated to landfills. Just as important, Project Repat’s rapid growth has resulted in the creation of dozens of jobs for U.S. workers, an economic benefit to the local communities where they live and work.18

Questions 1. Considering the tax benefits, why would investors not

want Project Repat to be an S corporation? 2. One of the cofounders of Project Repat is no longer

with the company, although he retains a small owner- ship stake. What complications might this change have caused if Project Repat was set up as a partnership rather than a corporation?

3. Imagine you’re an angel investor looking to invest in young companies. What questions would you ask the management team at Project Repat before making a final decision about investing in it?

Chapter 4 Choosing a Form of Business Ownership 131

services. This means more work and responsibility. You will need someone to help you, but you are undecided about what to do. Should you hire an employee or find a partner? If you add a partner, what type of decisions should be made to create a partnership agreement?

assignment 1. In a group, discuss the following questions:

a. What are the advantages and disadvantages of add- ing a partner versus hiring an employee?

b. Assume that you have decided to form a partnership. What articles should be included in a partnership agreement?

c. How would you go about finding a partner? 2. As a group, prepare an articles-of-partnership agree-

ment. Be prepared to discuss the pros and cons of your group’s agreement with other groups from your class, as well as to examine their agreements.

3. Summarize your group’s answers to these questions, and present them to your class.

3. Researching Different Careers Many people spend their entire lives working in jobs that they do not enjoy. Why? Often, it is because they have taken the first job they were offered without giving it much thought.

How can you avoid having this happen to you? First, you should determine your “personal profile” by identifying and analyzing your own strengths, weaknesses, things you enjoy, and things you dislike. Second, you should identify the types of jobs that fit your profile. Third, you should identify and research the companies that offer those jobs.

assignment a. Take two sheets of paper and draw a line down the

middle of each sheet, forming two columns on each page. Label column 1 “Things I Enjoy or Like to Do,” column 2 “Things I Do Not Like Doing,” column 3 “My Strengths,” and column 4 “My Weaknesses.”

b. Record data in each column over a period of at least one week. You may find it helpful to have a relative or friend give you input.

c. Summarize the data, and write a profile of yourself. d. Take your profile to a career counselor at your college

or to the public library and ask for help in identify- ing jobs that fit your profile. Your college may also offer testing to assess your skills and personality. The Internet is another resource.

e. Research the companies that offer the types of jobs that fit your profile.

f. Write a report on your findings.

Endnotes

1 Sources: Based on information in Charlie Rose, “Charlie Rose Talks to GoPro’s Nick Woodman,” Bloomberg Businessweek, October 2, 2014, www.businessweek.com; Serena Renner, “The Best Ride of Our Lives,” Triton (UC San Diego), Summer 2013, http://alumni.ucsd.edu; Ryan Mac, “GoPro Plans to Go Public, Files Confidential IPO Docs,” Forbes. com, February 7, 2014; Lizette Chapman, “How Family Ties Helped Nick Woodman Make GoPro Click,” Wall Street Journal, June 20, 2013, www.wsj.com.

2 Melvin Backman, “General Mills Buys Annie’s for $820 Million,” the Money/CNN website at www.money.cnn.com (accessed September 8, 2014).

3 The IVY Planning Group website at www.ivygroupllc.com (accessed January 5, 2015).

4 The Procter & Gamble website at www.pg.com (accessed January 7, 2015).

5 Ibid. 6 The Mars Corporate website at www.mars.com (accessed January 5, 2015). 7 The My New Company website at www.mynewcompany.com (accessed

January 6, 2015). 8 The Hispanic PR Wire website at www.hispanicprwire.com (accessed

January 6, 2015). 9 Liyan Chen, “Alibaba Claims Title for Largest Global IPO Ever With

Extra Share Sales,” the Forbes website at www.forbes.com (accessed September 22, 2014).

10 Bruce Horowitz, “Layoffs Hit Icons Coke and McDonalds,” the USA Today website at www.usatoday.com (accessed January 8, 2015).

11 The Internal Revenue Service website at www.irs.gov (accessed January 8, 2015).

12 The General Mills Corporate website at www.generalmills.com (accessed January 10, 2015).

13 The Renaissance Capital website at www.renaissancecapital.com (accessed January 9, 2015).

14 The Walmart Corporate website at www.walmartstores.com (accessed January 10, 2015).

15 The Oracle website at www.oracle.com (accessed January 10, 2015). 16 Larry Dignan, “Oracle Acquires BlueKai, Rounds Out Its Marketing

Cloud,” The ZDNet website at www.zdnet.com (accessed February 14, 2014).

17 “Berkshire Hathaway Acquires Duracell,” The Intelligent Insurer website at www.intelligentinsurer.com (accessed November 14, 2014).

18 Sources: Based on information in Autumn Spanne, “Want People to Buy a Product That Lasts? Sell Them an Emotional Connection,” The Guardian (UK), January 17, 2015, www.theguardian.com; Mike Ross, “Couch-Based Entrepreneurs,” Boston Globe, December 15, 2014, www.boston.com; Sara Castellanos, “Project Repat Turns Old T-Shirts into Quilts, Targets $2M in Revenue This Year,” Boston Business Journal, July 28, 2014, www.bizjournals.com/boston; www.projectrepat. com; Cengage Learning, Project Repat video.

Learning Objectives Once you complete this chapter, you will be able to:

5-1 Define what a small business is and recognize the fields in which small businesses are concentrated.

5-2 Identify the people who start small businesses and the reasons why some succeed and many fail.

5-3 Assess the contributions of small businesses to our economy. 5-4 Describe the advantages and disadvantages of operating a small

business.

5-5 Explain how the Small Business Administration helps small businesses. 5-6 Explain the concept and types of franchising. 5-7 Analyze the growth of franchising and its advantages and disadvantages.

Small Business, Entrepreneurship, and Franchises

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Chapter 5 Small Business, Entrepreneurship, and Franchises 133

Most businesses start small and those that survive usually stay small. However, they provide a solid foundation for our economy—as employers, as suppliers and purchasers of goods and services, and as taxpayers.

In this chapter, we do not take small businesses for granted. Instead, we look closely at this important business sector—beginning with a definition of small business, a description of industries that often attract small businesses, and a profile of some of the people who start small businesses. Next, we consider the importance of small businesses in our economy. We also present the advantages and disadvantages of smallness in business. We then describe services provided by the Small Business Administration, a government agency formed to assist owners and managers of small businesses. We conclude the chapter with a discussion of the pros and cons of franchising, an approach to small-business ownership that has become very popular in the last 55 years.

5-1 SmaLL BuSineSS: a PrOfiLe The Small Business Administration (SBA) defines a small business as “one which is independently owned and operated for profit and is not dominant in its field.” How small must a firm be not to dominate its field? That depends on the particular industry it is in. The SBA has developed the following specific “smallness” guidelines for the various industries, as shown in Table 5-1.2 The SBA periodically revises and simplifies its small-business size regulations.

Learning Objective

5-1Define what a small business is and recognize the fields in which small businesses are concentrated.

small business one that is independently owned and operated for profit and is not dominant in its field

Bark & Co. provides for pampered pooches

co-founded in 2011 by henrik Werdelin, carly strife, and Matt Meeker, new york-based Bark & co. is a fast-growing small business dedicated to helping u.s. and canadian pet-lovers pamper their pooches. its first service was BarkBox, offering subscribers a monthly delivery of doggie treats, toys, and accessories, customized for the dog’s size and weight (tiny, small and cute, just right, or big and bold).

BarkBox has attracted a highly loyal customer base of 200,000, with more than 90 percent of subscribers choosing to receive deliveries month after month after month. subscribers also have the option to pay a few more dollars for an extra dog toy every month. one out of five cus- tomers chooses this upgrade, boosting the firm’s revenues even further. and because BarkBox contributes 10 percent of its profits to dog-related charities, higher sales means higher donations.

ringing up annual revenues of $30 million, Bark & co. has raised money through a combination of venture capital and debt to continue its aggressive expansion. the company now offers Barkcare, an on-demand service that arranges for veterinarians to

give vaccinations or checkups to dogs at home. in addition, it oper- ates BarkPost.com, a content site loaded with dog-related photos, videos, and information. BarkBuddy is the company’s mobile app for matching would-be dog owners with pups in their area. yet another app, Barkcam, allows dog owners to take better smartphone photos of their pets and embellish with captions and other goodies, then share with friends. recently-launched Barkshop is an e-commerce site featuring a variety of dog merchandise, from beds and blankets to collars and chews.

Bark & co. is highly social, staying in touch with dog lovers through Facebook, twitter, instagram, and Pinterest. Watch for new tech-fueled services as this entrepreneurial business continues to grow by catering to the needs and interests of pet owners.1

Did You Know? Bark & Co. is a fast-growing small business competing for customers in the $58 billion market for pet products.

InsIde BusIness

134 Part 2 Business Ownership and Entrepreneurship

Annual sales in millions of dollars may not seem very small. However, for many firms, profit is only a small percentage of total sales. Thus, a firm may earn only $50,000 or $60,000 on yearly sales of $1 million—and that is small in comparison with the profits earned by most medium-sized and large firms. Moreover, most small firms have annual sales well below the maximum limits in the SBA guidelines.

Small businesses are very important to the U.S. economy. For example, small businesses

• represent 99.7 percent of all employer firms; • employ about half of all private sector employees; • pay 42 percent of total U.S. private payroll; • have generated 63 percent of net new jobs over the past 20 years; • create more than half of the nonfarm private GDP; • hire 37 percent of high-tech workers (scientists, engineers, computer

programmers, and others); • are 52 percent home-based and 2 percent franchises; • made up 97.5 percent of all identified exporters and produced 33 percent of

export value; and • produced 16.5 times more patents per employee than large patenting firms.3

5-1a the Small-Business Sector In the United States, it typically takes less than a week and $600 to establish a business as a legal entity. The steps include registering the name of the business, applying for tax IDs, and setting up unemployment and workers’ compensation insurance. In Japan, however, a typical entrepreneur spends more than $3,500 and 11 days to follow 8 different procedures.

A surprising number of Americans take advantage of their freedom to start a business. There are, in fact, about 28.2 million businesses in this country. Only just 17,700 of these employ more than 500 workers—enough to be considered large.

TaBLe 5-1 Industry Group–Size Standards

Small-business size standards are usually stated in number of employees or average annual sales. In the United States, 99.7 percent of all businesses are considered small.

Industry Group Size Standard

Manufacturing, mining industries 500 employees

Wholesale trade 100 employees

Agriculture $750,000

Retail trade, barber shops, beauty salons $7.5 million

General and heavy construction (except dredging) $36.5 million

Dredging $27.5 million

Special trade contractors $15 million

Travel agencies, tour operators $20.5 million

Department stores $32.5 million

Discount department stores $29.5 million

Furniture stores $20.5 million

Source: www.sba.gov/content/small-business-size-standards (accessed January 13, 2015).

Chapter 5 Small Business, Entrepreneurship, and Franchises 135

Interest in owning or starting a small business has never been greater than it is today. During the last decade, the number of small businesses in the United States has increased 49 percent. For the last few years, new-business formation in the United States has broken successive records, except during the 2001– 2002 and 2008 recessions. In 2013, 1,233,000 new businesses were started. Furthermore, part- time entrepreneurs have increased fivefold in recent years; they now account for one-third of all small businesses.4

According to a recent study, 69 percent of new businesses survive at least two years, about 50 percent survive at least five years, and 31 percent survive at least ten years.5 The primary reason for these failures is mismanagement resulting from a lack of business know-how. The makeup of the small-business sector thus is constantly changing. Despite the high failure rate, many small businesses succeed modestly. Some, like Apple Computer, Inc., are extremely successful—to the point where they can no longer be considered small. Taken together, small businesses are also responsible for providing a high percentage of the jobs in the United States. According to some estimates, the figure is well over 50 percent.

5-1b Industries that attract Small Businesses Some industries, such as auto manufacturing, require huge investments in machinery and equipment. Businesses in such industries are big from the day they are started—if an entrepreneur or group of entrepreneurs can gather the capital required to start one.

By contrast, a number of other industries require only a low initial investment and some special skills or knowledge. It is these industries that tend to attract new businesses. Growing industries, such as outpatient-care facilities, are attractive because of their profit potential. However, knowledgeable entrepreneurs choose areas with which they are familiar, and these are most often the more established industries.

Small enterprise spans the gamut from corner newspaper vending to the development of optical fibers. The owners of small businesses sell gasoline, flowers, and coffee to go. They publish magazines, haul freight, teach languages, and program computers. They make wines, movies, and high-fashion clothes. They build new homes and restore old ones. They fix appliances, recycle metals, and sell used cars. They drive cabs and fly planes. They make us well when we are ill, and they sell us the products of corporate giants. In fact, 74 percent of real estate, rental, and leasing industries; 61 percent of the businesses in the leisure and hospitality services; and 86 percent of the construction industries are dominated by small businesses. The various kinds of businesses generally fall into three broad categories of industry: distribution, service, and production.

Social media: Small Business Saturday Started by American Express in 2010, Small Business Saturday has now become a tradition on the Saturday after Thanksgiving. The idea is to support local stores, restaurants, and other small busi- nesses during the busy holiday shopping season. Only four years after the launch of Small Business Saturday, its Facebook page (www.facebook.com/SmallBusinessSaturday) had already attracted 3.5 million likes, 44,000 Twitter followers (http://twitter.com/ shopsmall), and more than 6,000 Instagram followers (http:// instagram.com/shopsmall). This late-November day even has its own hashtag, #ShopSmall, used on Twitter more than 125,000 times during a recent Small Business Saturday—with a growing number of tweets year after year as more businesses and custom- ers participate.

Individual businesses and regional retail and restaurant trade groups have jumped on the social media bandwagon to promote Small Business Saturday in communities across the country. For example, the Greater Dallas Restaurant Association and the Texas Restaurant Association post #DineSmall and #ShowUsYourMenu messages on social media sites like LinkedIn, Facebook, and Twitter to encourage dining at entrepreneur-owned restaurants.

In Boston, the Olives & Grace gift store begins posting on Facebook, Instagram, and Twitter four weeks ahead of Small Business Saturday, using #ShopSmall and its own #olive- sandgrace hashtag. Owner Sophie Madison is delighted by the positive response—especially on Instagram, where it has over 7,000 followers—and plans a new social-media campaign for every year’s Small Business Saturday.

sources: Based on information in Julissa trevino, “small Business saturday Draws Business, crowds,” Dallas Morning News, november 29, 2014, www.dallasnews.com; nicole Leinbach-reyhle, “small Business saturday 2014 stood strong among communities and small Businesses,” Forbes, December 2, 2014, www.forbes.com; amy gesenhues, “small Business saturday reminds consumers to shop Local after Black Friday Deals,” Marketing Land, november 28, 2014, http://marketingland.com.

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136 Part 2 Business Ownership and Entrepreneurship

DIStrIButIon InDuStrIES This category includes retailing, wholesaling, transportation, and communications— industries concerned with the movement of goods from producers to consumers. Distribution industries account for approximately 33 percent of all small businesses. Of these, almost three- quarters are involved in retailing, that is, the sale of goods directly to consumers. Clothing and jewelry stores, pet shops, bookstores, and grocery stores, for example, are all retailing firms. Slightly less than one-quarter of the small distribution firms are wholesalers. Wholesalers purchase products in quantity from manufacturers and then resell them to retailers.

SErvICE InDuStrIES This category accounts for more than 48 percent of all small businesses. Of these, about three-quarters provide such nonfinancial services as medical and dental care; watch, shoe, and TV repairs; haircutting and styling; restaurant meals; and dry cleaning. About 8 percent of the small service firms offer financial services, such as accounting, insurance, real estate, and investment counseling. An increasing number of self-employed Americans are running service businesses from home.

proDuCtIon InDuStrIES This last category includes the construction, mining, and manufacturing

industries. Only about 19 percent of all small businesses are in this group, mainly because these industries require relatively large initial investments. Small firms that do venture into production generally make parts and subassemblies for larger manufacturing firms or supply special skills to larger construction firms.

5-2 The PeOPLe in SmaLL BuSineSSeS: The enTrePreneurS The entrepreneurial spirit is alive and well in the United States. One study revealed that the U.S. population is quite entrepreneurial when compared with those of other countries. More than 70 percent of Americans would prefer being an entrepreneur to working for someone else. This compares with 46 percent of adults in Western Europe and 58 percent of adults in Canada. Another study on entrepreneurial activity found that of 36 countries studied, the United States was in the top third in entrepreneurial activity and was the leader when compared with Japan, Canada, and Western Europe.6

Small businesses typically are managed by the people who started and own them. Most of these people have held jobs with other firms and still could be so employed if they wanted. Yet owners of small businesses would rather take the risk of starting and operating their own firms, even if the money they make is less than the salaries they otherwise might earn.

Researchers have suggested a variety of personal factors as reasons why people go into business for themselves. These are discussed next.

Concept Check ✓✓ What information would you need to determine whether a particular business is small according to sBa guidelines?

✓✓ Which two areas of business generally attract the most small business? Why are these areas attractive to small business?

✓✓ Distinguish among service industries, distribution industries, and production industries.

Learning Objective

5-2Identify the people who start small businesses and the reasons why some succeed and many fail.

have you worked for a small business?

Sometime in your career, you’re likely to have a job in a small business. You might work in a store, in a service business, or in production. If you’re thinking of starting your own business, be sure to watch how these entrepreneurs manage their companies. Consider what you’d do differently if you were the owner—and make mental notes, so you can apply your knowledge and experience to any business you may start in the future.

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Chapter 5 Small Business, Entrepreneurship, and Franchises 137

5-2a Characteristics of Entrepreneurs Entrepreneurial spirit is the desire to create a new business. For example, Nikki Olyai always knew that she wanted to create and develop her own business. Her father, a successful businessman in Iran, was her role model. She came to the United States at the age of 17 and lived with a host family in Salem, Oregon, attending high school there. Undergraduate and graduate degrees in computer science led her to start Innovision Technologies while she held two other jobs to keep the business going and took care of her four-year-old son. Recently, Nikki Olyai’s business was honored by the Women’s Business Enterprise National Council’s “Salute to Women’s Business Enterprises” as one of 11 top successful firms. For three consecutive years, her firm was selected as a “Future 50 of Greater Detroit Company.”

5-2b other personal Factors Other personal factors in small-business success include

• independence; • a desire to determine one’s own destiny; • a willingness to find and accept a challenge; • family background (in particular, researchers think that people whose families

have been in business, successfully or not, are most apt to start and run their own businesses); and

• age (those who start their own businesses also tend to cluster around certain ages—more than 70 percent are between 24 and 44 years of age; see Figure 5-1).

Meet Cameron Johnson, a young entrepreneur. At a young age, Cameron started his own company selling holiday cards. Since then he has successfully created several other companies. Recently, he has been involved in television projects on Animal Planet, BBC, and ABC.

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figure 5-1 How Old is the Average Entrepreneur?

People in all age groups become entrepreneurs, but more than 70 percent are between 25 and 44 years of age.

1% 1%

17%

21% 18%

15%

9% 7%

Under 20

20–24 25–29 30–34 35–39 40–44 45–49 50–54 55–59 60 or older

source: Data developed and provided by the national Federation of independent Business Foundation and sponsored by the american express travel related services company, inc.

138 Part 2 Business Ownership and Entrepreneurship

5-2c Motivation There must be some motivation to start a business. A person may decide that he or she simply has “had enough” of working and earning a profit for someone else. Another may lose his or her job for some reason and decide to start the business he or she has always wanted rather than to seek another job. Still another person may have an idea for a new product or a new way to sell an existing product. Or the opportunity to go into business may arise suddenly, perhaps as a result of a hobby. For example, Cheryl Strand started baking and decorating cakes from her home while working full time as a word processor at Clemson University. Her cakes became so popular that she soon found herself working through her lunch breaks and late into the night to meet customer demand.

5-2d Women as Small-Business owners According to the latest 2015 data available from the SBA

• Women are 51 percent of the U.S. population, and according to the SBA, they owned at least 36 percent of all small businesses.

• Women already own 66 percent of the home-based businesses in this country, and the number of men in home-based businesses is growing rapidly.

• About 7.8 million women-owned businesses in the United States provide almost 7.6 million jobs and generate $1.2 trillion in sales.

• Women-owned businesses in the United States have proven that they are more successful; more than 40 percent have been in business for 12 years or more.

• Women-owned businesses are financially sound and credit-worthy, and their risk of failure is lower than average.

• Compared to other working women, self-employed women are older, better educated, and have more managerial experience.

plan now for an Entrepreneurial venture Later

Every job you hold, part-time or full-time, can help you prepare for the eventual launch of an entrepreneurial venture. What can you learn while working for others that will help you build your own business later?

Training and consulting entrepreneur Susan Steinbrecher says to avoid burning any bridges. Whether you’re leaving a job or having a disagreement with a business associate, you don’t want to look back in regret at the way you acted toward someone who might become a customer, employee, partner, or supplier when you go out on your own. She also emphasizes the importance of learning to delegate as you move up the career ladder. No entrepreneur can do everything—and delegating allows others to gain experience and demonstrate competence.

John Berkowitz of Yodle, an online marketing firm, points to the need to be prepared for change at any moment. Planning is a vital part of every job and every business

venture. Yet even the most brilliant plan will have to be tweaked if and when a problem pops up. So be realistic and ready to change, which will serve you well in any company and as an entrepreneur.

The advice of Priscilla Claman, cofounder of a career- coaching company, is to locate an experienced mentor, especially when you anticipate making a career change. Look for someone at a higher level who has broad knowledge of multiple companies and industries, and pay close attention to your mentor’s ideas and recommendations. Stay in touch as your career develops, be considerate of your mentor’s time, and show appreciation for your mentor’s support.

sources: Based on information in scott gerber, “the advice 13 entrepreneurs Would give their younger selves,” Mashable.com, December 9, 2014; susan steinbrecher, “5 golden Pieces of Leadership advice for young entrepreneurs,” Entrepreneur.com, september 29, 2014; gwen Moran, “how to Learn to Delegate Without giving up all your control,” Fast Company, June 10, 2014, www.fastcompany.com.

Career Success

Chapter 5 Small Business, Entrepreneurship, and Franchises 139

• Just over one-half of small businesses are home based, and 91 percent have no employees. About 60 percent of home-based businesses are in service industries, 16 percent in construction, 14 percent in retail trade, and the rest in manufacturing, finance, transportation, communications, wholesaling, and other industries.

Women’s Business Centers (WBCs), are the national network of nearly 100 educational centers throughout the United States. WBCs assist women in starting and growing small businesses and seek to “level the playing field” for women entrepreneurs, who still face unique obstacles in the business world. SBA’s Office of Women’s Business Ownership oversees the WBC Network, which provides entrepreneurs, especially women who are economically or socially disadvantaged, comprehensive training and counseling on business topics in several languages.7

5-2e teenagers as Small- Business owners High-tech teen entrepreneurship is definitely exploding. “There’s not a period in history where we’ve seen such a plethora of young entrepreneurs,” comments Nancy F. Koehn, associate professor of business administration at Harvard Business School. Still, teen entrepreneurs face unique pressures in juggling their schoolwork, their social life, and their high-tech workload. Some ultimately quit school, whereas others quit or cut back on their business activities. Consider Brian Hendricks at Winston Churchill High School in Potomac, Maryland. He is the founder of StartUpPc and VB Solutions, Inc. StartUpPc, founded in 2001, sells custom-built computers and computer services for home users, home offices, small businesses, and students. Brian’s services include design, installation of systems, training, networking, and on-site technical support. A year later, Brian founded VB Solutions, Inc., which develops and customizes websites and message boards. The firm sets up advertising contracts and counsels website owners on site improvements. The company has designed corporate ID kits, logos, and websites for clients from all over the world. Brian learned at a very young age that working for yourself is one of the best jobs available. According to Brian, a young entrepreneur must possess “the five P’s of entrepreneurship”—planning, persistence, patience, people, and profit. Brian knows what it takes to be a successful entrepreneur. His accolades include Junior Achievement’s “National Youth Entrepreneur of the Year” and SBA’s “Young Entrepreneur of the Year” awards. The SBA offers a wide range of resources and programs to help young entrepreneurs start, manage, and grow their business.8

In some people, the motivation to start a business develops slowly as they gain the knowledge and ability required for success as a business owner. Knowledge and ability— especially, management ability—are probably the most important factors involved. A new firm is very much built around the entrepreneur. The owner must be able to manage the firm’s finances, its personnel (if there are any employees), and its day-to-day operations. He or she must handle sales, advertising, purchasing, pricing, and a variety of other business functions. The knowledge and ability to do so are acquired most often through experience working for other firms in the same area of business.

5-2f Why Some Entrepreneurs and Small Businesses Fail Small businesses are prone to failure. Capital, management, and planning are the key ingredients in the survival of a small business, as well as the most common

Kool Kidz Sno Konez started by young entrepreneurs. At the ages of 11 and 12 years old, siblings Amaya Selmon and Jaden Wheeler started a snow cone business in their front yard. Now, they use a food truck to sell over 20 flavors of snow cones and even a few food items to customers all over Memphis. Jaden said “our goal with the food truck is to franchise it, so I don’t have to work when I grow up. What I mean is that I want to work smart instead of working hard.”

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140 Part 2 Business Ownership and Entrepreneurship

reasons for failure. Businesses can experience a number of money-related problems. It may take several years before a business begins to show a profit. Entrepreneurs need to have not only the capital to open a business but also the money to operate it in its possibly lengthy start-up phase. One cash flow obstacle often leads to others. Moreover, a series of cash flow predicaments usually ends in a business failure. This scenario is played out all too often by small and not-so-small start-up Internet firms that fail to meet their financial backers’ expectations and so are denied a second wave of investment dollars to continue their drive to establish a profitable online firm. According to Maureen Borzacchiello, co-owner of Creative Display Solutions, a trade show products company, “Big businesses such as Bear Stearns, Fannie Mae and Freddie Mac, and AIG can get bailouts, but small-business owners are on their own when times are tough and credit is tight.”

Many entrepreneurs lack the management skills required to run a business. Money, time, personnel, and inventory all need to be managed effectively if a small business is to succeed. Starting a small business requires much more than optimism and a good idea.

Success and expansion sometimes lead to problems. Frequently, entrepreneurs with successful small businesses make the mistake of overexpansion. Fast growth often results in dramatic changes in a business. Thus, the entrepreneur must plan carefully and adjust competently to new and potentially disruptive situations.

Every day, and in every part of the country, people open new businesses. For example, in 2012, 800,000 new businesses opened their doors. At the same time, however, 732,000 businesses closed their business and 40,075 businesses declared bankruptcy (see Table 5-2).9 Although many fail, others represent well- conceived ideas developed by entrepreneurs who have the expertise, resources, and determination to make their businesses succeed. As these well-prepared entrepreneurs pursue their individual goals, our society benefits in many ways from their work and creativity. Billion-dollar companies such as Apple Computer, McDonald’s Corporation, and Procter & Gamble are all examples of small businesses that expanded into industry giants.

5-3 The imPOrTanCe Of SmaLL BuSineSSeS in Our eCOnOmy This country’s economic history abounds with stories of ambitious men and women who turned their ideas into business dynasties. The Ford Motor Company started as a one-man operation with an innovative method for industrial production.

Concept Check ✓✓ What kinds of factors encourage certain people to start new businesses?

✓✓ What are the major causes of small-business failure? Do these causes also apply to larger businesses?

Learning Objective

5-3Assess the contributions of small businesses to our economy.

TaBLe 5-2 U.S. Business Start-ups, Closures, and Bankruptcies

New (In Thousands) Closures (In Thousands) Bankruptcies

2013 1,233 NA 33,212

2012 800 732 40,075

2011 782 752 47,806

2010 741 755 56,282

2009 702 877 60,837

2005 867 737 39,201

2000 826 759 35,472

NA = Not available.

source: u.s. small Business administration, office of advocacy, Small Business Quarterly Bulletin, 2nd Quarter 2014, released september 9, 2014, https://www.sba.gov/advocacy/small-business-quarterly-bulletins (accessed January 12, 2015).

Chapter 5 Small Business, Entrepreneurship, and Franchises 141

L.L. Bean, Inc., can trace its beginnings to a basement shop in Freeport, Maine. Both Xerox and Polaroid began as small firms with a better way to do a job. Indeed, every year since 1963, the president of the United States has proclaimed National Small Business Week to recognize the contributions of small businesses to the economic well-being of America.

5-3a providing technical Innovation Invention and innovation are part of the foundations of our economy. The increases in productivity that have characterized the past 200 years of our history are all rooted in one principal source: new ways to do a job with less effort for less money. Studies show that the incidence of innovation among small-business workers is significantly higher than among workers in large businesses. Small firms produce two-and-a-half times as many innovations as large firms relative to the number of persons employed. In fact, small firms employ 43 percent of all high-tech workers such as scientists, engineers, and computer specialists. No wonder small firms produce 16 to 17 times more patents per employee than large patenting firms.

Consider Waymon Armstrong, the owner of a small business that uses computer simulations to help government and other clients prepare for and respond to natural disasters, medical emergencies, and combat. In presenting the 2010 National Small Business Person of the Year award, Karen Mills, former Administrator of the U.S. Small Business Administration, said, “Waymon Armstrong is a perfect example of the innovation, inspiration, and determination that exemplify America’s most successful entrepreneurs. He believed in his brainchild to the point where he deferred his own salary for three years to keep it afloat. When layoffs loomed for his staff after 9/11, their loyalty and belief in the company was so great that they were willing to work without pay for four months.”

“Waymon’s commitment to his employees and to his business—Engineering & Computer Simulations, Inc.—demonstrates the qualities that make small businesses such a powerful force for job creation in the American economy and in their local communities,” said Mills. “It’s the same qualities that will lead us to economic recovery. We are especially proud that his company benefited from two grants under SBA’s Small Business Innovation and Research Program.” Waymon Armstrong was honored by President Barak Obama in Washington, D.C. during the National Small Business Week where the SBA recognizes small businesses that drive America’s economy.10

According to the U.S. Office of Management and Budget, more than half the major technological advances of the 20th century originated with individual inventors and small companies. Even just a sampling of those innovations is remarkable:

• Air-conditioning • Airplane • Automatic transmission • FM radio • Heart valve • Helicopter • Instant camera • Insulin

Using Technical Innovation. AMP Americas makes compressed natural gas from cow manure. One dairy farm is using AMP’s technological innovation to power its 42 tractor- trailers to transport milk to neighboring states.

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• Jet engine • Penicillin • Personal computer • Power steering

Perhaps even more remarkable—and important—is that many of these inventions sparked major new U.S. industries or contributed to an established industry by adding some valuable service.

5-3b providing Employment Small firms traditionally have added more than their proportional share of new jobs to the economy. Seven out of the ten industries that added the most new jobs were small-business-dominated industries. Small businesses creating the most new jobs recently included business services, leisure and hospitality services, and special trade contractors. Small firms hire a larger proportion of employees who are younger workers, older workers, women, or workers who prefer to work part time.

Furthermore, small businesses provide 67 percent of workers with their first jobs and initial on-the-job training in basic skills. According to the SBA, small businesses represent 99.7 percent of all employers, employ more than 50 percent of the private workforce, and provide about two-thirds of the net new jobs added to our economy.

In a 2015 news release, the SBA Administrator Maria Contreras-Sweet, stated, “Once again it was not large corporations, but entrepreneurs and small businesses powering us out of the greatest economic crisis since the Great Depression. Small businesses created nearly 2 million of the roughly 3 million private-sector jobs generated in 2014. More than 7 million of the 11 million jobs created during our recovery have been generated by startups and small enterprises”.11 Small businesses thus contribute significantly to solving unemployment problems.

5-3c providing Competition Small businesses challenge larger, established firms in many ways, causing them to become more efficient and more responsive to consumer needs. A small business cannot, of course, compete with a large firm in all respects. However, a number of small firms, each competing in its own particular area and its own particular way, together have the desired competitive effect. Thus, several small janitorial companies together add up to reasonable competition for the no-longer-small ServiceMaster.

5-3d Filling needs of Society and other Businesses Small firms also provide a variety of goods and services to each other and to much larger firms. Sears, Roebuck & Co. purchases merchandise from approximately 12,000 suppliers—and most of them are small businesses. General Motors relies on more than 32,000 companies for parts and supplies and depends on more than 11,000 independent dealers to sell its automobiles and trucks. Large firms generally buy parts and assemblies from smaller firms for one very good reason: It is less expensive than manufacturing the parts in their own factories. This lower cost eventually is reflected in the price that consumers pay for their products.

It is clear that small businesses are a vital part of our economy and that, as consumers and as members of the labor force, we all benefit enormously from their existence. Now let us look at the situation from the viewpoint of the owners of small businesses.

Concept Check ✓✓ Briefly describe four contributions of small business to the american economy.

✓✓ give examples of how small businesses fill needs of society and other businesses.

Chapter 5 Small Business, Entrepreneurship, and Franchises 143

5-4 The PrOS and COnS Of SmaLLneSS Do most owners of small businesses dream that their firms will grow into giant corporations—managed by professionals—while they serve only on the board of directors? Or would they rather stay small, in a firm where they have the opportunity (and the responsibility) to do everything that needs to be done? The answers depend on the personal characteristics and motivations of the individual owners. For many, the advantages of remaining small far outweigh the disadvantages.

5-4a advantages of Small Business Small-business owners with limited resources often must struggle to enter competitive new markets. They also have to deal with increasing international competition. However, they enjoy several unique advantages.

pErSonaL rELatIonShIpS WIth CuStoMErS anD EMpLoyEES For those who like dealing with people, small business is the place to be. The owners of retail shops get to know many of their customers by name and deal with them on a personal basis. Through such relationships, small-business owners often become involved in the social, cultural, and political life of the community.

Relationships between owner-managers and employees also tend to be closer in smaller businesses. In many cases, the owner is a friend and counselor as well as the boss.

These personal relationships provide an important business advantage. The personal service small businesses offer to customers is a major competitive weapon— one that larger firms try to match but often cannot. In addition, close relationships with employees often help the small-business owner to keep effective workers who might earn more with a larger firm.

aBILIty to aDapt to ChangE Being his or her own boss, the owner- manager of a small business does not need anyone’s permission to adapt to change. An owner may add or discontinue merchandise or services, change store hours, and experiment with various price strategies in response to changes in market conditions. And through personal relationships with customers, the owners of small businesses quickly become aware of changes in people’s needs and interests, as well as in the activities of competing firms.

SIMpLIFIED rECorD KEEpIng Many small firms need only a simple set of records. Record keeping might consist of a checkbook, a cash-receipts journal in which to record all sales, and a cash-disbursements journal in which to record all amounts paid out. Obviously, enough records must be kept to allow for producing and filing accurate tax returns.

InDEpEnDEnCE Small-business owners do not have to punch in and out,

Learning Objective

5-4Describe the advantages and disadvantages of operating a small business.

Getting personal. For those who like dealing with people, small business is the place to be. Here a business owner provides personalized service to a happy customer.

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144 Part 2 Business Ownership and Entrepreneurship

bid for vacation times, take orders from superiors, or worry about being fired or laid off. They are the masters of their own destinies—at least with regard to employment. For many people, this is the prime advantage of owning a small business.

othEr aDvantagES According to the SBA, the most profitable companies in the United States are small firms that have been in business for more than ten years and employ fewer than 20 people. Small-business owners also enjoy all the advantages of sole proprietorships, which were discussed in Chapter 4. These include being able to keep all profits, the ease and low cost of going into business and (if necessary) going out of business, and being able to keep business information secret.

5-4b Disadvantages of Small Business Personal contacts with customers, closer relationships with employees, being one’s own boss, less cumbersome record-keeping chores, and independence are the bright side of small business. In contrast, the dark side reflects problems unique to these firms.

rISK oF FaILurE As we have noted, small businesses (especially new ones) run a heavy risk of going out of business—about 50 percent survive at least five years. Older, well-established small firms can be hit hard by a business recession mainly because they do not have the financial resources to weather an extended difficult period.

LIMItED potEntIaL Small businesses that survive do so with varying degrees of success. Many are simply the means of making a living for the owner and his or her family. The owner may have some technical skill—as a hair stylist or electrician, for example—and may have started a business to put this skill to work. Such a business is unlikely to grow into big business. In addition, employees’ potential for advancement is limited.

LIMItED aBILIty to raISE CapItaL Small businesses typically have a limited ability to obtain capital. Figure 5-2 shows that most small-business financing comes out of the owner’s pocket. Personal loans from lending institutions provide only about one-fourth of the capital required by small businesses. About 50 percent of all new firms begin with less than $30,000 in total capital, according to Census Bureau and Federal Reserve surveys. In fact, almost 36 percent of new firms begin with less than $20,000, usually provided by the owner or family members and friends.12 According to the SBA, average capital for starting a new business is $80,000.

Although every person who considers starting a small business should be aware of the hazards and pitfalls we have noted, a well-conceived business plan may help to avoid the risk of failure. The U.S. government is also dedicated to helping small businesses make it. It expresses this aim most actively through the SBA.

5-4c the Importance of a Business plan Lack of planning can be as deadly as lack of money to a new small business. Planning is important to any business, large or small, and never should be overlooked or taken lightly. A business plan is a carefully constructed guide for the person starting a business. Consider it as a tool with three basic purposes: communication, management, and planning. As a communication tool, a business plan serves as a concise document that potential investors can examine to see if they would like to invest or assist in financing a new venture. It shows whether a business has the potential to make a profit. As a management tool, the business plan helps to track, monitor, and evaluate the progress. The business plan is a living document;

it is modified as the entrepreneur gains knowledge and experience. It also serves to establish time lines and milestones and allows comparison of growth projections against actual accomplishments. Finally, as a planning tool, the business plan guides a businessperson through the various phases of business. For example, the plan helps to identify obstacles to avoid and to establish alternatives. According to Robert Krummer, Jr., chairman of First Business Bank in Los Angeles, “The business plan is a necessity. If the person who wants to start a small business can’t put a business plan together, he or she is in trouble.”

5-4d Components of a Business plan Table 5-3 shows the 12 sections that a business plan should include. Each section is further explained at the end of each of the six major parts in the text. The goal of each end-of-the-part exercise is to help a businessperson create his or her own business plan. When constructing a business plan, the businessperson should strive to keep it easy to read, uncluttered, and complete. Like other busy executives, officials of financial institutions do not have the time to wade through pages of extraneous data. The business plan should answer the four questions banking officials and investors are most interested in: (1) What exactly is the nature and mission of the new venture? (2) Why is this new enterprise a good idea? (3) What are the businessperson’s goals? (4) How much will the new venture cost?

business plan a carefully constructed guide for the person starting a business

Chapter 5 Small Business, Entrepreneurship, and Franchises 145

business plan a carefully constructed guide for the person starting a business

figure 5-2 Sources of Capital for Entrepreneurs

Small businesses get financing from various sources; the most important is personal savings.

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Personal savings

Friends, relatives

Investors

Start-up

Banks

Sources of money

Suppliers Former owners

All others

Purchase

source: Data developed and provided by the national Federation of independent Business Foundation and sponsored by the american express travel related services company, inc.

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146 Part 2 Business Ownership and Entrepreneurship

The great amount of time and consideration that should go into creating a business plan probably will end up saving time later. For example, Sharon Burch, who was running a computer software business while earning a degree in business administration, had to write a business plan as part of one of her courses. Burch has said, “I wish I’d taken the class before I started my business. I see a lot of things I could have done differently. But it has helped me since because I’ve been using the business plan as a guide for my business.” Accuracy and realistic expectations are crucial to an effective business plan. It is unethical to deceive loan officers, and it is unwise to deceive yourself.

5-5 The SmaLL BuSineSS adminiSTraTiOn The Small Business Administration (SBA), created by Congress in 1953, is a governmental agency that assists, counsels, and protects the interests of small businesses in the United States. It helps people get into business and stay in business. The agency provides assistance to owners and managers of prospective, new, and established small businesses. Through more than 1,000 offices and resource centers throughout the nation, the SBA provides both financial assistance and management counseling. Recently, the SBA provided training, technical assistance, and education to more than 3.5 million small businesses. It helps small firms to bid for and obtain government contracts, and it helps them to prepare to enter foreign markets.

5-5a SBa Management assistance Statistics show that most failures in small business are related to poor management. For this reason, the SBA places special emphasis on improving the management ability of the owners and managers of small businesses. The SBA’s Management Assistance Program is extensive and diversified. It includes free individual counseling,

Concept Check ✓✓ What are the major advantages and disadvantages of smallness in business?

✓✓ What are the major components of a business plan? Why should an individual develop a business plan?

Learning Objective

5-5Explain how the Small Business Administration helps small businesses.

Small Business Administration (SBA) a governmental agency that assists, counsels, and protects the interests of small businesses in the United States

TaBLe 5-3 Components of a Business Plan

1. Introduction. Basic information such as the name, address, and phone number of the business; the date the plan was issued; and a statement of confidentiality to keep important information away from potential competitors.

2. Executive Summary. A one- to two-page overview of the entire business plan, including a justification why the business will succeed.

3. Benefits to the Community. Information on how the business will have an impact on economic development, community development, and human development.

4. Company and Industry. The background of the company, choice of the legal business form, information on the products or services to be offered, and examination of the potential customers, current competitors, and the business’s future.

5. Management Team. Discussion of skills, talents, and job descriptions of management team, managerial compensation, management training needs, and professional assistance requirements.

6. Manufacturing and Operations Plan. Discussion of facilities needed, space requirements, capital equipment, labor force, inventory control, and purchasing requirement.

7. Labor Force. Discussion of the quality of skilled workers available and the training, compensation, and motivation of workers.

8. Marketing Plan. Discussion of markets, market trends, competition, market share, pricing, promotion, distribution, and service policy.

9. Financial Plan. Summary of the investment needed, sales and cash flow forecasts, breakeven analysis, and sources of funding.

10. Exit Strategy. Discussion of a succession plan or going public. Who will take over the business?

11. Critical Risks and Assumptions. Evaluation of the weaknesses of the business and how the company plans to deal with these and other business problems.

12. Appendix. Supplementary information crucial to the plan, such as résumés of owners and principal managers, advertising samples, organization chart, and any related information.

source: From hatten, Small Business Management, 5e.

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courses, conferences, workshops, and a wide range of publications. Recently, the SBA provided management and technical assistance to nearly 1 million small businesses through its 900 Small Business Development Centers and 11,000 volunteers from the Service Corps of Retired Executives.

The SBA launched its 2015 Emerging Leaders Program in 48 U.S. cities. Since 2008, the program has trained more than 2,400 small business owners in underserved communities. According to SBA Administrator Maria Contreras- Sweet, “The Emerging Leaders Program is a resource that can open lucrative doors for America’s small businesses. The addition of over 20 new cities in 2015 will help serve even more entrepreneurs. Graduates of the Leadership Program have measurably increased their revenue, helped create jobs, and drive economic growth in their local communities.”13

ManagEMEnt CourSES anD WorKShopS The management courses offered by the SBA cover all the functions, duties, and roles of managers. Instructors may be teachers from local colleges and universities or other professionals, such as management consultants, bankers, lawyers, and accountants. Fees for these courses are quite low. The most popular such course is a general survey of eight to ten different areas of business management. In follow-up studies, businesspeople may concentrate in depth on one or more of these areas depending on their particular strengths and weaknesses. The SBA occasionally offers one-day conferences. These conferences are aimed at keeping owner-managers up-to-date on new management developments, tax laws, and the like. The SBA Learning Center is an online training network consisting of 23 SBA-run courses, workshops, and resources. Some of the most requested courses include Entrepreneurship, Starting and Managing Your Own Business, Developing a Business Plan, Managing the Digital Enterprise, Identify Your Target Market, and Analyze Profitability. Find out more at www.sba.gov/ training. Recently, more than 260,000 small-business owners benefited from SBA’s free online business courses.

SCorE The Service Corps of Retired Executives (SCORE), Counselors to America’s Small Business, created in 1964, is a group of more than 11,000 retired and active businesspeople, including more than 2,000 women who volunteer their services to small businesses through the SBA. The collective experience of SCORE volunteers spans the full range of American enterprise. These volunteers have worked for such notable companies as Eastman Kodak, General Electric, IBM, and Procter & Gamble. Experts in areas of accounting, finance, marketing, engineering, and retailing provide counseling and mentoring to entrepreneurs. In 2014, SCORE celebrated its 50th Anniversary and the volunteers donated more than 1.1 million hours to assist small businesses.

A small-business owner who has a particular problem can request free counseling from SCORE. An assigned counselor visits the owner in his or her establishment and, through careful observation, analyzes the business situation and the problem. If the problem is complex, the counselor may call on other volunteer experts to assist. Finally, the counselor offers a plan for solving the problem and helping the owner through the critical period.

Consider the plight of Elizabeth Halvorsen, a mystery writer from Minneapolis. Her husband had built up the family advertising and graphic arts firm for 17 years when he was called in 1991 to serve in the Persian Gulf War. The only one left behind to run the business was Mrs. Halvorsen, who admittedly had no business experience. Enter SCORE. With a SCORE management expert at her side, she kept the business on track. Recently, SCORE volunteers served more than 350,000 small- business people like Mrs. Halvorsen through its more than 320 offices. Since its inception, SCORE has assisted more than 10 million small-business people with online and face-to-face small business counseling. Recently, SCORE volunteers

Service Corps of Retired Executives (SCORE) a group of businesspeople who volunteer their services to small businesses through the SBA

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helped start 38,630 businesses, created 67,320 jobs, and mentored 124,600 small business owners and entrepreneurs.14

5-5b help for Minority- owned Small Businesses Americans who are members of minority groups have had difficulty entering the nation’s economic mainstream. Raising money is a nagging problem for minority business owners, who also may lack adequate training. Members of minority groups are, of course, eligible for all SBA programs, but the SBA makes a special effort to assist those minority groups who want to start small businesses or expand existing ones. For example, the Minority Business Development Agency awards grants to develop and increase business opportunities for members of racial and ethnic minorities.

Helping women become entrepreneurs is also a special goal of the SBA. Emily Harrington,

one of nine children, was born in Manila, the Philippines. She arrived in the United States in 1972 as a foreign-exchange student. Convinced that there was a market for hard-working, dedicated minorities and women, she launched Qualified Resources, Inc., a professional staffing services firm. Inc. magazine selected her firm as one of “America’s Fastest Growing Private Companies” just six years later. Harrington credits the SBA with giving her the technical support that made her first loan possible. Finding a SCORE counselor to work directly with her, she refined her business plan until she got a bank loan. Before contacting the SBA, Harrington was turned down for business loans “by all the banks I approached,” even though she worked as a manager of loan credit and collection for a bank. Later, Emily Harrington was SBA’s winner of the local, regional, and national Small Business Entrepreneurial Success Award for Rhode Island, the New England region, and the nation! For several years in a row, Qualified Resources, Inc., was named one of the fastest growing private companies in Rhode Island. Now with more than 100 Women’s Business Centers, entrepreneurs like Harrington can receive training and technical assistance, access to credit and capital, federal contracts, and international markets. The SBA’s Online Women’s Business Center (https://www.sba.gov/tools/local-assistance/wbc) is a state-of-the-art Internet site to help women expand their businesses. This free, interactive website offers women information about business principles and practices, management techniques, networking, industry news, market research and technology training, online counseling, and hundreds of links to other sites, as well as information about the many SBA services and resources available to them. In 2014, the SBA approved $6.5 billion in loans for 15,620 minority-owned businesses.

SMaLL-BuSInESS InStItutES Small-business institutes (SBIs), created in 1972, are groups of senior and graduate students in business administration who provide management counseling to small businesses. SBIs have been set up on more than 520 college campuses as another way to help business owners. The students work in small groups guided by faculty advisers and SBA management-assistance experts. Like SCORE volunteers, they analyze and help solve the problems of small- business owners at their business establishments.

SMaLL-BuSInESS DEvELopMEnt CEntErS Small-business development centers (SBDCs) are university-based groups that provide individual

small-business institutes (SBIs) groups of senior and graduate students in business administration who provide management counseling to small businesses

small-business development centers (SBDCs) university- based groups that provide individual counseling and practical training to owners of small businesses

Minority-owned businesses. Are you ready to start your business, but don’t know where to start or what opportunities are available to minority groups? The SBA provides information on federal government programs and services that help people start their own businesses.

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counseling and practical training to owners of small businesses. SBDCs draw from the resources of local, state, and federal governments, private businesses, and universities. These groups can provide managerial and technical help, data from research studies, and other types of specialized assistance of value to small businesses. In 2014, there were more than 900 SBDC locations, primarily at colleges and universities, assisting people such as Kathleen DuBois. After scribbling a list of her abilities and the names of potential clients on a napkin in a local restaurant, Kathleen DuBois decided to start her own marketing firm. Beth Thornton launched her engineering firm after a discussion with a colleague in the ladies room of the Marriott. When Richard Shell was laid off after 20 years of service with Nisource (Columbia Gas), he searched the Internet tirelessly before finding the right franchise option. Introduced by mutual friends, Jim Bostic and Denver McMillion quickly connected, built a high level of trust, and combined their diverse professional backgrounds to form a manufacturing company. Although these entrepreneurs took different routes in starting their new businesses in West Virginia, all of them turned to the West Virginia Small Business Development Center for the technical assistance to make their dreams become a reality.

SBa puBLICatIonS The SBA issues management, marketing, and technical publications dealing with hundreds of topics of interest to present and prospective managers of small firms. Most of these publications are available from the SBA free of charge. Others can be obtained for a small fee from the U.S. Government Printing Office.

5-5c SBa Financial assistance Small businesses seem to be constantly in need of money. An owner may have enough capital to start and operate the business. But then he or she may require more money to finance increased operations during peak selling seasons, to pay for required pollution control equipment, to finance an expansion, or to mop up after a natural disaster such as a flood or a terrorist attack. In early 2013, 90 days after Hurricane Sandy hit the Northeast, the SBA guaranteed over $1 billion in loans to more than 16,800 businesses, homeowners, and renters. In the year following the storm, the SBA had approved $2.4 billion in low-interest disaster loans.15 Earlier, the SBA offered economic injury loans to fishing and fishing-dependent small businesses as a result of the Deepwater BP spill that shut down commercial and recreational fishing waters. According to the SBA Administrator, “SBA remains committed to taking every step to help small businesses deal with the financial challenges they are facing as a result of the Deepwater BP oil spill.”16 The SBA offers special financial- assistance programs that cover all these situations. However, its primary financial function is to guarantee loans to eligible businesses.

rEguLar BuSInESS LoanS Most of the SBA’s business loans are actually made by private lenders such as banks, but repayment is partially guaranteed by the agency. That is, the SBA may guarantee that it will repay the lender up to 90 percent of the loan if the borrowing firm cannot repay it. Guaranteed loans approved may be as large as $5.0 million (this loan limit may be increased in the future). The average size of an SBA-guaranteed business loan is about $300,000, and its average duration is about eight years.

SMaLL-BuSInESS InvEStMEnt CoMpanIES Venture capital is money that is invested in small (and sometimes struggling) firms that have the potential to become very successful. In many cases, only a lack of capital keeps these firms from rapid and solid growth. The people who invest in such firms expect that their

venture capital money that is invested in small (and sometimes struggling) firms that have the potential to become very successful

The SBA provides a variety of services. When disaster strikes, the SBA makes available relief for stricken businesses. For example, the SBA provided disaster relief to small businesses affected by Hurricane Sandy.

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investments will grow with the firms and become quite profitable. Consider this: 36 years ago, a young computer programmer working out of his parents’ garage needed capital to create the world’s most user-friendly personal computer. He met a financier, John Hines, who managed an Illinois-based venture capital firm, licensed and supported by the U.S. Small Business Administration. Hines saw the potential and invested half a million dollars in the promising startup. Two years later, the young programmer took his company public, and the venture capital firm sold its stake for $44 million. Who was this programmer? His name is Steve Jobs.

The popularity of these investments has increased over the past 40 years, but most small firms still have difficulty obtaining venture capital. To help such businesses, the SBA licenses, regulates, and provides financial assistance to small- business investment companies (SBICs).

An SBIC is a privately owned firm that provides venture capital to small enterprises that meet its investment standards. Firms such as America Online, Apple Computer, Costco, Jenny Craig, Federal Express, Compaq Computer, Intel Corporation, Outback Steakhouse, and Staples, Inc., all were financed through SBICs during their initial growth period. More than 292 SBICs are intended to be profit-making organizations. The aid that SBA offers allows them to invest in small businesses that otherwise would not attract venture capital. Since Congress created the program in 1958, SBICs have financed more than 120,000 small businesses for a total of about $70 billion. In 2013, SBICs benefited 1,068 small businesses, and 30 percent of these firms were owned by women or other minorities.17

We have discussed the importance of the small-business segment of our economy. We have weighed the advantages and drawbacks of operating a small business as compared with a large one. But is there a way to achieve the best of both worlds? Can one preserve one’s independence as a business owner and still enjoy some of the benefits of “bigness”? Let’s take a close look at franchising.

5-6 franChiSing A franchise is a license to operate an individually owned business as if it were part of a chain of outlets or stores. Often, the business itself is also called a franchise. Among the most familiar franchises are McDonald’s, H&R Block, AAMCO Transmissions, GNC (General Nutrition Centers), and Dairy Queen. Many other franchises carry familiar names; this method of doing business has become very popular in the last 60 years or so. It is an attractive means of starting and operating a small business.

5-6a What Is Franchising? Franchising is the actual granting of a franchise. A franchisor is an individual or organization granting a franchise. A franchisee is a person or organization purchasing a franchise. The franchisor supplies a known and advertised business name, management skills, the required training and materials, and a method of doing business. The franchisee supplies labor and capital, operates the franchised business, and agrees to abide by the provisions of the franchise agreement. Table 5-4 lists the basic franchisee rights and obligations that would be covered in a typical franchise agreement.

5-6b types of Franchising Franchising arrangements fall into three general categories. In the first approach, a manufacturer authorizes a number of retail stores to sell a certain brand-name item. This type of franchising arrangement, one of the oldest, is prevalent in sales of passenger cars and trucks, farm equipment, shoes, paint, earth-moving equipment, and petroleum. About 90 percent of all gasoline is sold through franchised,

small-business investment companies (SBICs) privately owned firms that provide venture capital to small enterprises that meet their investment standards

Concept Check ✓✓ identify five ways in which the sBa provides management assistance to small businesses.

✓✓ identify two ways in which the sBa provides financial assistance to small businesses.

✓✓ Why does the sBa concentrate on providing management and financial assistance to small business?

✓✓ What is venture capital? how does the sBa help small businesses to obtain it?

Learning Objective

5-6Explain the concept and types of franchising.

franchise a license to operate an individually owned business as though it were part of a chain of outlets or stores

franchising the actual granting of a franchise

franchisor an individual or organization granting a franchise

franchisee a person or organization purchasing a franchise

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independent retail service stations, and franchised dealers handle virtually all sales of new cars and trucks. In the second type of franchising arrangement, a producer licenses distributors to sell a given product to retailers. This arrangement is common in the soft drink industry. Most national manufacturers of soft drink syrups— The Coca-Cola Company, Dr. Pepper/Seven-Up Companies, PepsiCo, Royal Crown Companies, Inc.—franchise independent bottlers who then serve retailers. In a third form of franchising, a franchisor supplies brand names, techniques, or other services instead of a complete product. Although the franchisor may provide certain production and distribution services, its primary role is the careful development and control of marketing strategies. This approach to franchising, which is the most typical today, is used by Avis, Hampton Hotels, 7-Eleven Inc., Anytime Fitness, Denny’s Inc., Pizza Hut Inc., McDonald’s, and SUBWAY, to name but a few.

Concept Check ✓✓ explain the relationships among a franchise, the franchisor, and the franchisee.

✓✓ Describe the three general categories of franchising arrangements.

TaBLe 5-4 Basic Rights and Obligations Delineated in a Franchise Agreement

Franchisee rights include:

1. use of trademarks, trade names, and patents of the franchisor;

2. use of the brand image and the design and decor of the premises developed by the franchisor;

3. use of the franchisor’s secret methods;

4. use of the franchisor’s copyrighted materials;

5. use of recipes, formulae, specifications, processes, and methods of manufacture developed by the franchisor;

6. conducting the franchised business upon or from the agreed premises strictly in accordance with the franchisor’s methods and subject to the franchisor’s directions;

7. guidelines established by the franchisor regarding exclusive territorial rights; and

8. rights to obtain supplies from nominated suppliers at special prices.

Franchisee obligations include:

1. to carry on the business franchised and no other business upon the approved and nominated premises;

2. to observe certain minimum operating hours;

3. to pay a franchise fee;

4. to follow the accounting system laid down by the franchisor;

5. not to advertise without prior approval of the advertisements by the franchisor;

6. to use and display such point-of-sale advertising materials as the franchisor stipulates;

7. to maintain the premises in good, clean, and sanitary condition and to redecorate when required to do so by the franchisor;

8. to maintain the widest possible insurance coverage;

9. to permit the franchisor’s staff to enter the premises to inspect and see if the franchisor’s standards are being maintained;

10. to purchase goods or products from the franchisor or his designated suppliers;

11. to train the staff in the franchisor’s methods to ensure that they are neatly and appropriately clothed; and

12. not to assign the franchise contract without the franchisor’s consent.

source: office of entrepreneurship education resources, http://www.sba.gov/offices/headquarters/oee/resources/3641#selecting a Franchise (accessed January 12, 2015).

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5-7 The grOwTh Of franChiSing Franchising, which began in the United States around the time of the Civil War, was used originally by large firms, such as the Singer Sewing Company, to distribute their products. Franchising has been increasing steadily in popularity since the early 1900s, primarily for filling stations and car dealerships; however, this retailing strategy has experienced enormous growth since the mid-1970s. The franchise proliferation generally has paralleled the expansion of the fast-food industry.

Of course, franchising is not limited to fast foods. Hair salons, tanning parlors, and dentists and lawyers are expected to participate in franchising arrangements in growing numbers. Franchised health clubs, pest exterminators, and campgrounds are already widespread, as are franchised tax preparers and travel agencies. The real estate industry also has experienced a rapid increase in franchising.

Also, franchising is attracting more women and minority business owners in the United States than ever before. One reason is that special outreach programs designed to encourage franchisee diversity have developed. Consider Angela Trammel, a young mother of two. She had been laid off from her job at the Marriott after 9/11. Since she was a member of a Curves Fitness Center and liked the concept of empowering women to become physically fit, she began researching the cost of purchasing a Curves franchise and ways to finance the business. “I was online looking for financing, and I linked to Enterprise Development Group in Washington, DC. I knew that they had diverse clients.” The cost for the franchise was $19,500, but it took $60,000 to open the doors to her fitness center. “Applying for a loan to start the business was much harder than buying a house,” said Trammel. Just three years later, Angela and her husband, Ernest, own three Curves Fitness Centers with 12 employees. Recently, since giving birth to her third child, she has found the financial freedom and flexibility needed to care for her busy family. In fact,

Learning Objective

5-7Analyze the growth of franchising and its advantages and disadvantages.

Is a Franchise in your Future?

A small but growing number of franchisees in their 20s see franchising as a path toward entrepreneurial success. Becoming a franchisee requires a sizeable financial investment—but so do many small businesses started from scratch. What attracts young franchisees is the opportunity to build on a recognized brand and proven operational processes. Adding their own creativity and enthusiasm, they can leverage the franchise model to fuel business growth.

Hailey Nault is happy with her decision to own a Pita Pit franchise in Ontario, Canada. Partnering with an existing Pita Pit owner to buy a franchise, Nault and her employees make healthy pita-bread sandwiches to order. Although she works long hours, Nault brings high energy and ambition to her franchise business. “If it succeeds, it’s because I did it,” she explains. “That’s more exciting than anything.”

Mit Patel is another franchisee under 30 who enjoys being part of a successful franchise, Forever Yogurt. Patel is

the son of an entrepreneur, so he understands the ups and downs of running a business—and he has a mentor in the family. His frozen yogurt shop is located close in a popular Baltimore neighborhood of restaurants and shops. Patel advises young franchisees to “ask a million questions” and take time choosing a location.

After Ivan Kenneth Taw graduated college in the Philippines, he worked in marketing and then shifted gears to consider franchising. His careful research led him to buy a 7-Eleven convenience store, with family financing. “The reliable support system allows me to work on my own, without being entirely on my own,” he says.

sources: Based on information in tracy hanes, “young entrepreneurs see Big opportunities in Franchising,” Globe and Mail (Canada), november 3, 2014, www.theglobeandmail.com; “young Franchisee gives Fresh Business insights for new graduates,” Philippine Star, april 7, 2014, www.philstar.com; kate taylor, “Franchise Players: a young Franchisee Brings Family’s Lessons to Forever yogurt,” Entrepreneur.com, March 12, 2014.

Entrepreneurial Success

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within a three-year period, the Trammels grew their annual household income from $80,000 to $250,000.18 Franchisors such as Wendy’s, McDonald’s, Burger King, and Church’s Chicken all have special corporate programs to attract minority and women franchisees. Just as important, successful women and minority franchisees are willing to get involved by offering advice and guidance to new franchisees.

Herman Petty, the first African-American McDonald’s franchisee, remembers that the company provided a great deal of help while he worked to establish his first units. In turn, Petty traveled to help other black franchisees, and he invited new franchisees to gain hands-on experience in his Chicago restaurants before starting their own establishments. In 1972, Petty also organized a support group, the National Black McDonald’s Operators Association, to help black franchisees in other areas. Today, members of this association own over 1,300 McDonald’s restaurants throughout the United States, South Africa, and the Caribbean with annual sales of more than $2.7 billion. “By staying together, we will realize the dream that our forefathers envisioned: an organization of successful African- American entrepreneurs who did not forget their humble beginnings,” says Roland G. Parrish, the McDonald’s franchisee who leads the group.

Dual-branded franchises, in which two franchisors offer their products together, are a new small-business trend. For example, in 1993, pleased with the success of its first co-branded restaurant with Texaco in Beebe, Arkansas, McDonald’s now has more than 400 co-branded restaurants in the United States. Also, an agreement between franchisors Doctor’s Associates, Inc., and TCBY Enterprises, Inc., now allows franchisees to sell SUBWAY sandwiches and TCBY yogurt in the same establishment.

5-7a are Franchises Successful? Franchising is designed to provide a tested formula for success, along with ongoing advice and training. The success rate for businesses owned and operated by franchisees is significantly higher than the success rate for other independently owned small businesses. In a recent nationwide Gallup poll of 944 franchise owners, 94 percent of franchisees indicated that they were very or somewhat successful, only 5 percent believed that they were very unsuccessful or somewhat unsuccessful, and 1 percent did not know. Despite these impressive statistics, franchising is not a guarantee of success for either franchisees or franchisors. Too rapid expansion, inadequate capital or management skills, and a host of other problems can cause failure for both franchisee and franchisor. Thus, for example, the Dizzy Dean’s Beef and Burger franchise is no longer in business. Timothy Bates, a Wayne State University economist, warns, “Despite the hype that franchising is the safest way to go when starting a new business, the research just doesn’t bear that out.” Just consider Boston Chicken, which once had more than 1,200 restaurants before declaring bankruptcy in 1998.

5-7b advantages of Franchising Franchising plays a vital role in our economy and soon may become the dominant form of retailing. Why? Because franchising offers advantages to both the franchisor and the franchisee.

to thE FranChISor The franchisor gains fast and well- controlled distribution of its products without incurring the high cost of constructing and operating its own outlets. The franchisor thus has more capital available to expand production and to use for

We Do Lines. When three landscape business owners needed their parking lot striped, they discovered a new business opportunity which quickly became their only business. Their Connecticut based We Do Lines grew quickly along the East Coast. They now have franchisees in Arizona, Ohio, New York, New Jersey, and Florida.

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advertising. At the same time, it can ensure, through the franchise agreement, that outlets are maintained and operated according to its own standards.

The franchisor also benefits from the fact that the franchisee—a sole proprietor in most cases—is likely to be very highly motivated to succeed. The success of the franchise means more sales, which translate into higher royalties for the franchisor.

to thE FranChISEE The franchisee gets the opportunity to start a business with limited capital and to make use of the business experience of others. Moreover, an outlet with a nationally advertised name, such as RadioShack, McDonald’s, or Century 21, has guaranteed customers as soon as it opens.

If business problems arise, the franchisor gives the franchisee guidance and advice. This counseling is primarily responsible for the very high degree of success enjoyed by franchises. In most cases, the franchisee does not pay for such help.

The franchisee also receives materials to use in local advertising and can take part in national promotional campaigns sponsored by the franchisor. McDonald’s and its franchisees, for example, constitute one of the nation’s top 20 purchasers of advertising. Finally, the franchisee may be able to minimize the cost of advertising, supplies, and various business necessities by purchasing them in cooperation with other franchisees.

5-7c Disadvantages of Franchising The main disadvantage of franchising affects the franchisee, and it arises because the franchisor retains a great deal of control. The franchisor’s contract can dictate every aspect of the business: decor, design of employee uniforms, types of signs, and all the details of business operations. All Burger King French fries taste the same because all Burger King franchisees have to make them the same way.

Contract disputes are the cause of many lawsuits. For example, Rekha Gabhawala, a Dunkin’ Donuts franchisee in Milwaukee, alleged that the franchisor was forcing her out of business so that the company could profit by reselling the downtown franchise to someone else; the company, on the other hand, alleged that Gabhawala breached the contract by not running the business according to company standards. In another case, Dunkin’ Donuts sued Chris Romanias, its franchisee in Pennsylvania, alleging that Romanias intentionally underreported gross sales to the company. Romanias, on the other hand, alleged that Dunkin’ Donuts, Inc., breached the contract because it failed to provide assistance in operating the franchise. Other franchisees claim that contracts are unfairly tilted toward the franchisors. Yet others have charged that they lost their franchise and investment because their franchisor would not approve the sale of the business when they found a buyer.

To arbitrate disputes between franchisors and franchisees, the National Franchise Mediation Program was established in 1993 by 30 member firms, including Burger King Corporation, McDonald’s Corporation, and Wendy’s International, Inc. Negotiators have since resolved numerous cases through mediation. Recently, Carl’s

The growth of franchising. Franchising is designed to provide a tested formula for success, along with ongoing advice and training. The franchisor, such as McDonald’s, Chipotle, or Panda Express, supplies a known and advertised business name, management skills, the required training and materials, and a method of doing business. Franchising, however, is not a guarantee of success for either franchisees or franchisors.

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Jr. brought in one of its largest franchisees to help set its system straight, making most franchisees happy for the first time in years. The program also helped PepsiCo settle a long-term contract dispute and renegotiate its franchise agreements.

Because disagreements between franchisors and franchisees have increased in recent years, many franchisees have been demanding government regulation of franchising. In 1997, to avoid government regulation, some of the largest franchisors proposed a new self-policing plan to the Federal Trade Commission.

Franchise holders pay for their security, usually with a one-time franchise fee and continuing royalty and advertising fees, collected as a percentage of sales. For example, a SUBWAY franchisee pays an initial franchise fee of $15,000 and a weekly fee of 12.5 percent of gross sales (8 percent royalty and 4.5 percent advertising fees) In some fields, franchise agreements are not uniform. One franchisee may pay more than another for the same services.

Even success can cause problems. Sometimes a franchise is so successful that the franchisor opens its own outlet nearby, in direct competition—although franchisees may fight back. For example, a court recently ruled that Burger King could not enter into direct competition with the franchisee because the contract was not specific on the issue. A spokesperson for one franchisor contends that the company “gives no geographical protection” to its franchise holders and thus is free to move in on them. Franchise operators work hard. They often put in 10- and 12-hour days, six days a week. The International Franchise Association advises prospective franchise purchasers to investigate before investing and to approach buying a franchise cautiously. Franchises vary widely in approach as well as in products. Some, such as Dunkin’ Donuts and Baskin-Robbins, demand long hours. Others, such as Great Clips and SportClips hair salons, are more appropriate for those who do not want to spend many hours at their stores.

5-7d global perspectives in Small Business The world economy has entered a new phase since the ups and downs of the global financial crisis of 2009. For small American businesses, the world is becoming smaller. National and international economies are growing more and more interdependent as political leadership and national economic directions change and trade barriers diminish or disappear. Globalization and instant worldwide communications are rapidly shrinking distances at the same time that they are expanding business opportunities. According to a recent study, the Internet is increasingly important to small-business strategic thinking, with more than 50 percent of those surveyed indicating that the Internet represented their most favored strategy for growth. This was more than double the next-favored choice, strategic alliances reflecting the opportunity to reach both global and domestic customers. The Internet and online payment systems enable even very small businesses to serve international customers. In fact, technology now gives small businesses the leverage and power to reach markets that were once limited solely to large corporations. According to the U.S. Commercial Service, “More than 70 percent of the world’s purchasing power is outside of the United States and over the next five years, 85 percent of the world’s economic growth will be overseas.”19

The SBA offers help to the nation’s small-business owners who want to enter the world markets. U.S. Export Assistance Centers, staffed by experts from the SBA, Department of Commerce, Export-Import Bank, and other public and private organizations are located in major U.S. metropolitan areas. The SBA’s efforts include counseling small firms on how and where to market overseas, matching U.S.

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small-business executives with potential overseas customers, and helping exporters to secure financing. The agency brings small U.S. firms into direct contact with potential overseas buyers and partners. The SBA International Trade Loan program provides guarantees of up to $5 million in loans to small-business owners. These loans help small firms in expanding or developing new export markets. The U.S. Commercial Service, a Commerce Department division, aids small- and medium-sized businesses in selling overseas. The division’s global network includes more than 100 offices in the United States and 151 others in more than 70 countries around the world.20

Consider Daniel J. Nanigian, president of Nanmac Corporation in Framingham, Massachusetts. This company manufactures temperature sensors used in a wide range of industrial applications. With an export strategy aimed at growing revenues in diverse foreign markets including China, the Nanmac Corporation experienced explosive growth in 2009. The company nearly doubled its sales from $2.7 million in 2008 to $5.1 million in 2009. The company’s international sales, at $300,000 in 2004, reached $700,000 in 2009, and $1.7 million in 2010. Its administrative, sales, and manufacturing employees have increased by 80 percent.

The company has a strong presence in China and is expanding in other markets, as well, including Latin America, Singapore, and Russia. Under Nanigian’s guidance, the company has developed creative solutions and partnerships to help maximize its presence internationally. As part of its China strategy, Nanmac partners with distributors, recruits European and in-country sales representatives, uses a localized Chinese website, and relies for advice on the export assistance programs of the Massachusetts Small Business Development Center Network’s Massachusetts Export Center. The strategy, along with travel to China to conduct technical training seminars and attend trade shows and technical conferences, has helped to grow Nanmac’s Chinese client list from 1 in 2003 to more than 30 accounts today. Mr. Nanigian received SBA’s Small Business Exporter of the Year Award.21

International trade will become more important to small-business owners as they face unique challenges in the new century. Small businesses, which are expected to remain the dominant form of organization in this country, must be prepared to adapt to significant demographic and economic changes in the world marketplace.

This chapter ends our discussion of American business today. From here on, we shall be looking closely at various aspects of business operations. We begin, in the next chapter, with a discussion of management—what management is, what managers do, and how they work to coordinate the basic economic resources within a business organization.

Concept Check ✓✓ What does the franchisor receive in a franchising agreement? What does the franchisee receive? What does each provide?

✓✓ cite one major benefit of franchising for the franchisor. cite one major benefit of franchising for the franchisee.

✓✓ how does the sBa help small business-owners who want to enter the world markets?

✓✓ What are the global perspectives in small business?

Summary

5-1 define what a small business is and recognize the fields in which small businesses are concentrated.

A small business is one that is independently owned and operated for profit and is not dominant in its field. There are about 28.2 million businesses in this country, and 99.7 percent of them are small businesses. Small businesses employ more than half the nation’s workforce. About 69 percent of small businesses survive at least two years and about 50 percent survive at least five years. More than half of all small businesses are in retailing and services.

5-2 identify the people who start small businesses and the reasons why some succeed and many fail.

Such personal characteristics as independence, desire to create a new enterprise, and willingness to accept a challenge may encourage individuals to start small businesses. Various external circumstances, such as special expertise or even the loss of a job, also can supply the motivation to strike out on one’s own. Poor planning and lack of capital and management experience are the major causes of small-business failures.

Chapter 5 Small Business, Entrepreneurship, and Franchises 157

5-3 assess the contributions of small businesses to our economy. Small businesses have been responsible for a wide variety of inventions and innovations, some of which have given rise to new industries. Historically, small businesses have created the bulk of the nation’s new jobs. Further, they have mounted effective competition to larger firms. They provide things that society needs, act as suppliers to larger firms, and serve as customers of other businesses, both large and small.

5-4 describe the advantages and disadvantages of operating a small business.

The advantages of smallness in business include the opportunity to establish personal relationships with customers and employees, the ability to adapt to changes quickly, independence, and simplified record keeping. The major disadvantages are the high risk of failure, the limited potential for growth, and the limited ability to raise capital.

5-5 explain how the Small Business administration helps small businesses.

The Small Business Administration (SBA) was created in 1953 to assist and counsel the nation’s millions of small-business owners. The SBA offers management courses and workshops; managerial help, including one-to-one counseling through SCORE; various publications; and financial assistance through guaranteed loans and SBICs. It places special emphasis

on aid to minority-owned businesses, including those owned by women.

5-6 explain the concept and types of franchising. A franchise is a license to operate an individually owned business as though it were part of a chain. The franchisor provides a known business name, management skills, a method of doing business, and the training and required materials. The franchisee contributes labor and capital, operates the franchised business, and agrees to abide by the provisions of the franchise agreement. There are three major categories of franchise agreements.

5-7 analyze the growth of franchising and its advantages and disadvantages.

Franchising has grown tremendously since the mid-1970s. The franchisor’s major advantage in franchising is fast and well-controlled distribution of products with minimal capital outlay. In return, the franchisee has the opportunity to open a business with limited capital, to make use of the business experience of others, and to sell to an existing clientele. For this, the franchisee usually must pay both an initial franchise fee and a continuing royalty based on sales. He or she also must follow the dictates of the franchise with regard to operation of the business.

Worldwide business opportunities are expanding for small businesses. The SBA assists small-business owners in penetrating foreign markets. The next century will present unique challenges and opportunities for small-business owners.

Key Terms

You should now be able to define and give an example relevant to each of the following terms:

small business (133) business plan (144) Small Business

Administration (SBA) (146)

Service Corps of Retired Executives (SCORE) (147)

small-business institutes (SBIs) (148)

small-business development centers (SBDCs) (148)

venture capital (149) small-business investment

companies (SBICs) (150)

franchise (150) franchising (150) franchisor (150) franchisee (150)

Discussion Questions

1. Most people who start small businesses are aware of the high failure rate and the reasons for it. Why, then, do some take no steps to protect their firms from failure? What steps should they take?

2. Are the so-called advantages of small business really advantages? Wouldn’t every small-business

owner like his or her business to grow into a large firm?

3. Do average citizens benefit from the activities of the SBA, or is the SBA just another way to spend our tax money?

4. Would you rather own your own business independently or become a franchisee? Why?

158 Part 2 Business Ownership and Entrepreneurship

Building Skills for Career Success

1. Social Media Exercise American Express’s “Open Forum” is a website that is designed for small-business owners (www.openforum.com). Do a search using a search engine like Google or Bing and you will also find its presence on Tumblr and Pinterest. Take a look at the Open Forum website and answer the following questions.

1. What questions can Open Forum answer for business owners?

2. Develop a list of five issues or topics that you feel illus- trates how American Express does an effective job of presenting information on this website.

Video Case From two Men and a truck to 220 Franchises and 1,400 trucks

Two Men and a Truck (www.twomenandatruck.com) began in the 1980s as a way for brothers Brig and Jon Sorber to make money while in high school. They started with one old pickup truck, placed a newspaper ad promoting their moving services in and around Lansing, Michigan, and charged $25 per hour to transport household goods. Their mother Mary Ellen Sheets created the hand-drawn logo of stick-figure men inside a truck, which has been part of the company’s business identity since the beginning.

When the brothers left for college, their mother took over to keep the moving business on the move. Demand was so strong, in fact, that Sheets decided to buy a larger used truck for $350, hire two more men, and undertake even larger moving jobs. During school breaks, the brothers came home and earned extra spending money by climbing into one of the trucks and helping homeowners move.

Two Men and a Truck continued to attract so many customers that Sheets finally quit her job to operate the business as a full-time entrepreneur. In 1985, she hired more people, purchased a new truck, and set a tone of superior customer service embodied by the “Grandma Rule”—treat every customer with the same care and respect you would show your own grandmother. Within two years, Two Men and a Truck had earned its first profit, which Sheets donated to community charities. This was only the first of many efforts driven by the entrepreneur’s core value of taking care of people—the community as well as the customers.

One day, Sheets was part of a panel about entrepreneurship and met a woman who had successfully franchised her business. With this woman’s encouragement, Sheets looked into the idea of franchising Two Men and a Truck. She asked her daughter Melanie Bergeron to join the family business as head of the franchising division. Thanks to a grant, Bergeron was able to learn about franchising through weekly consultations with experts at the accounting firm of Deloitte & Touche. Two Men and a Truck started to offer franchises and as its aggressive growth continued, Bergeron’s brothers returned to work in the family business a few years later.

Over time, each family member has found ways to apply his or her own strengths to the challenges and opportunities faced by the company, and to function effectively as business partners when they’re all in the office dealing with a problem. Today, Brig Sorber is the CEO, Jon Sorber is the executive vice president, and Melanie Bergeron serves as chair of Two Men and a Truck. Looking ahead, the company has a structured succession plan in place for an orderly transition if the next generation chooses to become part of the business. Alicia Sorber, Brig’s daughter, is already involved, working for a franchisee and learning from her father’s experiences and ideas.

Two Men and a Truck now has 220 franchisees and 1,400 trucks across the United States and is expanding into Europe. The company’s annual revenue is $275 million and it handles more than 400,000 moves every year. Franchisees have adopted the company’s credo of caring, using their trucks and employees for the benefit of local causes. For example, some have moved boxes of donated food from collection points to food banks for distribution to needy families. Others have delivered cleaning supplies, food, and personal care items to areas hit hard by natural disasters. No matter what cause they support, local franchisees show how Two Men and a Truck cares for its communities as well as its customers.22

Questions 1. Which advantages of small business helped Mary

Ellen Sheets establish and grow Two Men and a Truck?

2. Which disadvantages of small business did Two Men and a Truck have to overcome? If you had been part of the business at the start, what suggestions would you have offered for overcoming these issues?

3. Do you think it’s a good idea for Two Men and a Truck to offer franchises outside of North America? Why or why not? What kinds of questions would international franchi- sees be likely to ask the company?

Chapter 5 Small Business, Entrepreneurship, and Franchises 159

2. Building Team Skills A business plan is a written statement that documents the nature of a business and how that business intends to achieve its goals. Although entrepreneurs should prepare a business plan before starting a business, the plan also serves as an effective guide later on. The plan should concisely describe the business’s mission, the amount of capital it requires, its target market, competition, resources, production plan, marketing plan, organizational plan, assessment of risk, and financial plan.

assignment 1. Working in a team of four students, identify a company in

your community that would benefit from using a business plan, or create a scenario in which a hypothetical entre- preneur wants to start a business.

2. Using the resources of the library or the Internet and/or interviews with business owners, write a business plan incorporating the information in Table 5-3.

3. Present your business plan to the class.

3. Researching Different Careers Many people dream of opening and operating their own businesses. Are you one of them? To be successful, entrepreneurs must have certain characteristics; their profiles

generally differ from those of people who work for someone else. Do you know which personal characteristics make some entrepreneurs succeed and others fail? Do you fit the successful entrepreneur’s profile? What is your potential for opening and operating a successful small business?

assignment 1. Use the resources of the library or the Internet to estab-

lish what a successful entrepreneur’s profile is and to determine whether your personal characteristics fit that profile. Internet addresses that can help you are www.smartbiz.com/sbs/arts/ieb1.html and www.sba. gov (see “Start your Business” and “FAQ”). These sites have quizzes online that can help you to assess your personal characteristics. The SBA also has helpful bro- chures.

2. Interview several small-business owners. Ask them to describe the characteristics they think are necessary for being a successful entrepreneur.

3. Using your findings, write a report that includes the following: a. A profile of a successful small-business owner b. A comparison of your personal characteristics with

the profile of the successful entrepreneur c. A discussion of your potential as a successful small-

business owner

160 Part 2 Business Ownership and Entrepreneurship

1p6

Running a Business Part 2

graeter’s: a Fourth-generation Family Business

Independent and family-owned for more than 140 years, Graeter’s has successfully made the transition from a 19th century mom-and-pop ice cream business to a 21st century corporation with three manufacturing facilities, dozens of ice cream shops, and hundreds of employees. Much of the company’s success over the years has been due to the family’s strong and enduring entrepreneurial spirit.

Small Business, Big Ambitions The road to small-business success started with co-founder Louis Charles Graeter, who developed the startup’s first flavors, insisted on only the finest ingredients, and made all his ice cream by hand in small batches to ensure freshness and quality. After his death, his wife and co-founder Regina maintained the same high level of quality as she led the company through three decades of aggressive growth. Her great-grandson, CEO Richard Graeter II, says that “without her strength, fortitude, and foresight, there would be no Graeter’s ice cream today.”

Richard, Bob, and Chip, great-grandsons of the founders, are the fourth generation to own and operate Graeter’s. They grew up in the business, and now they share responsibility for the firm’s day-to-day management and for determining its future direction. Bob worked his way up to vice president of operations, starting with a management position in one of the Graeter’s ice-cream shops. Chip, currently vice president of retail operations, handled all kinds of jobs in Graeter’s stores as a teenager. He uses this first-hand knowledge of customer relations to fine- tune every store function.

Richard Graeter became the company’s CEO in 2007. “Even though I have the title of CEO, in a family business titles don’t mean a whole lot,” he comments. “The functions that I am doing now as CEO, I was doing as executive vice president for years … It really was and remains a partnership with my two cousins … Our fathers brought us into the business at an early age … I think most important is we saw our fathers and their dedication and the fact that, you know, they came home later, they came home tired, they got up early and went to work before we ever got up to go to school in the morning, and you see that dedication and appreciate that—that is what keeps your business going.”

Graeter continues, “It can be challenging to work with your family. My father and I didn’t always see things the same way. But on the other hand, there is a lot of strength in the family relationship … we certainly had struggles, and

family businesses do struggle, especially with transition … but we found people to help us, including lawyers,

accountants, and a family-business psychologist.”

Growing Beyond Cincinnati To expand beyond Cincinnati without diverting resources from the existing stores and factory, the third generation of Graeter’s family owners decided to license a handful of franchise operators.

One franchise operation was so successful that it even opened its own factory. A few years ago,

however, the fourth generation switched gears on growth and repurchased all the stores of its last remaining franchisee. “When you think about Graeter’s,” says the CEO, “the core of Graeter’s is the quality of the product. You can’t franchise

your core. So by franchising our manufacturing, that created substantial risk for the organization, because

the customer doesn’t know that it is a franchise.… They know it is Graeter’s.… You really have to rely on

the intention and goodwill of the individual franchisees to make the product the way you would make it, and that is

not an easy thing to guarantee.” After working with consultants to carefully analyze the

situation and evaluate alternative paths to future growth, the founder’s great-grandsons decided against further franchising. Instead, they pursued nationwide distribution through a large network of grocery stores and supermarket chains. They also built a new facility to increase production capacity and hired experienced executives to help manage the expanded business.

As a private company, Graeter’s can take actions like these without worrying about the reaction of the stock market. Specifically, Graeter’s is an S corporation, which allows it limited-liability protection coupled with the benefit of not being taxed as a corporation. Instead, the three owners—who are the stockholders—pay only personal income taxes on the corporation’s profits. In the event of significant legal or tax code changes, Graeter’s owners do have the option of choosing a different form of corporate organization.23

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Chapter 5 Small Business, Entrepreneurship, and Franchises 161

Questions 1. Graeter’s current management team bought the business

from their parents, who did not have a formal succes- sion plan in place to indicate who would do what. Do you think the current team should have such a plan specifying who is to step into the business, when, and with what responsibilities? Why or why not?

2. Graeter’s hired management consultants to help improve its training procedures and expand distribution. “I think

my cousins and I all have come to realize we can’t do it alone,” says the CEO. Why do you think the management team made this decision? Does the involvement of out- side consultants move Graeter’s further from its roots as a family business?

3. Do you agree with Graeter’s decision to stop franchising? Explain your answer.

Chapter 5 Small Business, Entrepreneurship, and Franchises 161

162 Part 2 Business Ownership and Entrepreneurship

After reading Part 2, “Business Ownership and Entrepreneurship,” you should be ready to tackle the company and industry component of your business plan. In this section, you will provide information about the background of the company, choice of the legal business form, information on the product or services to be offered, and descriptions of potential customers, current competitors, and the business’s future. This chapter and the previous chapter (Chapter 4) in your textbook, “Choosing a Form of Business Ownership,” and Chapter 5, “Small Business, Entrepreneurship, and Franchises,” can help you to answer some of the questions in this part of the business plan.

The Company and Industry Component The company and industry analysis should include the answers to at least the following questions: 2.1. What is the legal form of your business? Is your

business a sole proprietorship, a partnership, or a corporation?

2.2. What licenses or permits will you need, if any? 2.3. Is your business a new independent business, a take-

over, an expansion, or a franchise?

2.4. If you are dealing with an existing business, how did your company get to the point where it is today?

2.5. What does your business do, and how does it satisfy customers’ needs?

2.6. How did you choose and develop the products or ser- vices to be sold, and how are they different from those currently on the market?

2.7. What industry do you operate in, and what are the industry-wide trends?

2.8. Who are the major competitors in your industry? 2.9. Have any businesses recently entered or exited? Why

did they leave? 2.10. Why will your business be profitable, and what are your

growth opportunities? 2.11. Does any part of your business involve e-business?

Review of Business Plan Activities Make sure to check the information you have collected, make any changes, and correct any weaknesses before beginning Part 3. Reminder: Review the answers to questions in the preceding part to make sure that all your answers are consistent throughout the business plan. Finally, write a summary statement that incorporates all the information for this part of the business plan.

Endnotes

1 Sources: Based on information in Kieron Monks, “Fluffy Millions: Start-Ups Booming in the Pet Business,” CNN, December 9, 2014, www.cnn.com; Darrell Etherington, “BarkCam, BarkBox’s Instagram for Dogs, Is Now Available,” Tech Crunch, July 15, 2014, http:// techcrunch.com; Sarah Perez, “Doggie-Focused Bark & Co. (BarkBox) Raises $15 Million Series B,” Tech Crunch, July 11, 2014, http:// techcrunch.com; Thornton McEnery, “BarkBox Creators Feast on $15 M in New Capital,” Crain’s New York Business, July 14, 2014, www.crainsnewyork.com.

2 U.S. Small Business Administration, Office of Advocacy, Frequently Asked Questions, updated March 2014, www.sba.gov/content/small- business-size-standards (accessed January 14, 2015).

3 Ibid. 4 U.S. Small Business Administration, Office of Advocacy, Small Business

Quarterly Bulletin, Second Quarter 2014, released September 9, 2014, Table 1, https://www.sba.gov/advocacy/small-business-quarterly- bulletins (accessed January 15, 2015).

5 SBA Office of Advocacy, Small Business Facts, June 2012, https://www. sba.gov/sites/default/files/Business-Survival.pdf (accessed January 14, 2015).

6 Thomas A. Garrett, “Entrepreneurs Thrive in America,” Bridges, Federal Reserve Bank of St. Louis, Spring 2005, 2.

7 U.S. Small Business Administration website at https://www.sba.gov/ tools/local-assistance/wbc (accessed January 14, 2015), and SBA

Office of Advocacy website at http://www.sba.gov/sites/default/files/ FAQ_March_2014_0.pdf (accessed January 14, 2015).

8 U.S. Small Business Administration, News Release, Number 05–53, September 13, 2005, www.sba.gov/teens/brian_hendricks.html (accessed February 8, 2013), and the SBA website at https://www.sba. gov/offices/district/dc/washington/success-stories?page=10 (accessed January 15, 2015).

9 U.S. Small Business Administration, Office of Advocacy, Small Business Quarterly Bulletin, 2nd Quarter 2014, released September 9, 2014, accessed at https://www.sba.gov/advocacy/small-business-quarterly- bulletins (accessed January 12, 2015).

10 SBA Press Release, “Computer Simulation Company from Florida Is National Small Business of the Year,” May 25, 2010, www.sba.gov/ news (accessed March 15, 2012), and Orlando Chamber of Commerce website at http://www.orlando.org/index.php?src=news&refno=1887&ca tegory=Headlines (accessed January 15, 2015).

11 U.S. Small Business Administration, Office of Advocacy website at http://www. sba.gov/sites/default/files/FAQ_March_2014_0.pdf (accessed January 14, 2015 and January 15, 2015), and the SBA Blog at https://www.sba.gov/blogs/smallbusinesses-create-2-million-jobs (accessed January 18, 2015).

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Chapter 5 Small Business, Entrepreneurship, and Franchises 163

13 BusinessUSA website at http://www/business.usa.gov/external-site? (accessed January 5, 2015).

14 The SCORE Foundation website at http://scorefoundation.org/about-us/ our-impact/ (accessed January 4, 2015).

15 The SBA Blog website at https://www.sba.gov/blogs/hurricane-sandy- and-small-business (accessed January 15, 2015), and the SBA website at www.sba.gov (accessed February 8. 2013).

16 U.S. Small Business Administration, News Release, Release Number 10–33, May 26, 2010, www.sba.gov/news (accessed March 18, 2012).

17 The SBA website at http://www.sba.gov/content/sbic-program-overview (accessed January 12, 2015).

18 Cindy Elmore, “Putting the Power into the Hands of Small Business Owners,” Marketwise, Federal Reserve Bank of Richmond, Issue II, 2005, 13.

19 U.S. Commercial Service, U.S. Department of Commerce 2011 Annual Report, accessed at http://www.trade.gov/cs/cs_annualreport12.pdf (accessed January 15, 2015).

20 U.S. Department of Commerce, International Trade Administration website at http://www.trade.gov/cs/ (accessed January 15, 2015), and at http://www.trade.gov/cs/factsheet.asp (accessed January 15, 2015).

21 SBA Press Release, “SBA 2010 Small Business Exporter of the Year,” www.sba.gov/news (accessed March 20, 2012); NANMAC Corporation website at http://nanmac.com/press-sba.html (accessed February 9, 2013); and U.S. Small Business Administration website at http:// www.sba.gov/offices/district/dc/washington/success-stories?page=8 (accessed January 16, 2015).

22 Sources: Based on information in Joe Boomgaard, “Mother Knows Best: Mary Ellen Sheets Helps Foster Culture for Two Men and a Truck Moving Company,” MiBiz (Grand Rapids, Michigan), May 13, 2012, www.mibiz.com; “Janelle Dowley Distinction: President and Franchisee of Two Men and a Truck,” Palm Beach Post (Florida), February 20, 2012, p. 2D; “In the Classroom: ABC Academy, Two Men and a Truck Join Forces in Thanksgiving Food Collection,” Michigan Live, November 19, 2012, www.mlive.com; J. Patrick Pepper, “Woodhaven: From Downriver to Sandy’s Downtrodden, a Special Delivery,” News Herald (Downriver, Michigan), November 16, 2012, www.thenewsherald.com; www. twomenandatruck.com.

23 Sources: Based on information from Kimberly L. Jackson, “Graeter’s Premium Chocolate Chip Ice Cream Lands at Stop & Shop,” Newark Star-Ledger (NJ), April 4, 2012, www.nj.com; “Graeter’s Ice Cream Debuts in Bay Area,” Tampa Bay Times (St. Petersburg, FL), January 10, 2012, p. 4B; Jim Carper, “Graeter’s Runs a Hands-on Ice Cream Plant,” Dairy Foods, August 2011, pp. 36+; Jim Carper, “The Greater Good,” Dairy Foods, August 2011, pp. 95+; “Graeter’s Unveils New ‘Mystery Flavor,’” Dayton Daily News, March 29, 2012, www.daytondailynews. com; Bob Driehaus, “A Cincinnati Ice Cream Maker Aims Big,” New York Times, September 11, 2010, www.nytimes.com; Lucy May, “Graeter’s Northern Kentucky Franchisee Puts Stores on the Block,” Business Courier, August 6, 2010, http://cincinnati.bizjournals.com; www.graeters.com; interviews with company staff and Cengage videos about Graeter’s.

Learning Objectives Once you complete this chapter, you will be able to:

6-1 Define what management is.

6-2 Describe the four basic management functions: planning, organizing, leading and motivating, and controlling.

6-3 Distinguish among the various kinds of managers in terms of both level and area of management.

6-4 Identify the key management skills of successful managers.

6-5 Explain the different types of leadership.

6-6 Discuss the steps in the managerial decision-making process. 6-7 Describe how organizations benefit from total quality management.

Understanding the Management Process

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The leadership demonstrated at the Walt Disney Company, which fosters the company’s unique culture, illustrates that management can be one of the most exciting and rewarding professions available today. Depending on its size, a firm may employ a number of specialized managers who are responsible for particular areas of management, such as marketing, finance, and operations. That same organization also includes managers at several levels within the firm.

In this chapter, we define management and describe the four basic management functions of planning, organizing, leading and motivating, and controlling. Then we focus on the types of managers with respect to levels of responsibility and areas of expertise. Next, we focus on the skills of effective managers and the different roles managers must play. We examine several styles of leadership and explore the process by which managers make decisions. We also describe how total quality management can improve customer satisfaction.

6-1 What is ManageMent? Management is the process of coordinating people and other resources to achieve the goals of an organization. As we saw in Chapter 1, most organizations make use of four kinds of resources: material, human, financial, and informational (see Figure 6-1).

Material resources are the tangible, physical resources an organization uses. For example, General Motors uses steel, glass, and fiberglass to produce cars and trucks on complex machine-driven assembly lines. A college or university uses books,

Learning Objective

6-1Define what management is. management the process of coordinating people and other resources to achieve the goals of an organization

Managing Walt Disney for a Second Century of Creativity and Success

Walt Disney was famous for his attention to quality and detail—two elements that have helped the Walt Disney company expand into a $49 billion entertainment empire by continuing the cre- ative, yet careful management of its legendary founder. Through more than nine decades of operation, the company has become a business behemoth with brands known on every continent. beyond charac- ters like buzz Lightyear and ariel and blockbuster movies like Frozen and The Avengers, Walt Disney owns cable television giants esPn and the Disney channel as well as abc Television, Disney World and Disneyland theme parks, and the Penguin club children’s website.

Managing such a diverse group of businesses can be a chal- lenge. under the leadership of ceo bob iger, the managers of each individual business unit handle their own strategic planning and make their own decisions to keep the creativity flowing, yet meet high corporate standards for service and success. This minimizes decision-making bottlenecks and allows each unit to set its own agenda within the framework of Disney’s overall strategy and goals. iger is responsible for corporate-level decisions about acquisitions to

enhance Disney’s strengths (such as bringing Lucasfilm under the Disney umbrella to add Star Wars as a movie brand).

iger aggressively promotes a global viewpoint and invests in advanced technology as a competitive advantage across busi- nesses as customers’ buying and consuming patterns evolve. he also empowers managers in individual units to make decisions and take actions that will improve the customer experience and boost Disney’s long-term growth prospects. if actual results are not pro- ceeding according to plan, Disney managers understand the need for early intervention to get performance back on track. on the other hand, iger allows businesses to delay projects for reasons of creative execution, the way the Pixar unit did when it postponed the animated feature The Good Dinosaur to allow more time for development.1

Did You Know? The Walt Disney Company employs 175,000 people and rings up $49 billion in annual revenue worldwide.

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166 Part 3 Management and Organization

classroom buildings, desks, and computers to educate students. And the Mayo Clinic uses operating room equipment, diagnostic machines, and laboratory tests to provide health care.

Perhaps the most important resources of any organization are its human resources— people. In fact, some firms live by the philosophy that employees are their most important assets. Some managers believe that the way employees are developed and managed has more impact on an organization than other vital components such as marketing, financial decisions, production, or technology. Research supports this belief. It shows that prioritizing human resources and working to ensure that employees are happy can greatly affect productivity and customer relationships.

Financial resources are the funds an organization uses to meet its obligations to investors and creditors. A 7-Eleven convenience store obtains money from customers at the checkout counter and uses a portion to pay its suppliers. Your college obtains money in the form of tuition, income from endowments, and state and federal grants. It uses the money to pay bills, insurance premiums, and salaries.

Increasingly, organizations are finding that they cannot afford to ignore information. External

environmental conditions—the economy, consumer markets, technology, politics, and cultural forces—are all changing so rapidly that a business must adapt to survive. To adapt to change, the business must gather information about competitors and changes to the industry in order to learn from the failures and successes of others.

It is important to realize that the four types of resources described earlier are only general categories. Within each category are hundreds or thousands of more specific resources. It is this complex mix of specific resources—which varies between companies and industries—that managers must coordinate to produce goods and services.

Another way to look at management is in terms of the different functions managers perform, which are planning, organizing, leading and motivating employees, and controlling. We look at each of these management functions in the next section.

Concept Check ✓✓ What is management?

✓✓ What are the four kinds of resources?

Figure 6-1 The Four Main Resources of Management

Managers coordinate an organization’s resources to achieve the organization’s goals.

Material resources

Human resources

Financial resources

Informational resources

Organizational goals

MANAGEMENT

are you already a manager?

Maybe you’ve never thought of yourself as a manager. But if you’ve ever headed a committee or organized a new school club, you’ve actually been involved in management. Understanding more about the way management works can make you more successful in the daily business of your life.

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6-2 BasiC ManageMent FunCtiOns After years of declining profits, Hewlett-Packard’s new CEO Meg Whitman analyzed its situation and developed a five-year plan to turn the company around. Her plan required revamping the firm’s core printer and personal computer business, laying off 45,000 employees, and ultimately, splitting the company into two separate corporations—one for hardware and one for business software.2

Management functions do not occur according to some rigid, preset timetable. Managers do not plan in January, organize in February, lead and motivate in March, and control in April. At any given time, managers may engage in a number of functions simultaneously. However, each function tends to lead naturally to others. Figure 6-2 provides a visual framework for a more detailed discussion of the four basic management functions. How well managers perform these key functions determines whether a business is successful.

6-2a Planning Planning, in its simplest form, is establishing organizational goals and deciding how to accomplish them. It is often referred to as the “first” management function because all other management functions depend on planning. Organizations such as Starbucks, Amazon, and Twitter base the planning process on a mission statement.

An organization’s mission is a statement of the basic purpose that makes that organization different from others. Starbucks’s mission statement, for example, is “to inspire and nurture the human spirit—one person, one cup, and one neighborhood at a time.” Amazon.com’s mission is “to be earth’s most customer-centric company, where people can come to find and discover anything they might want to buy online.” Twitter’s mission statement is “to give everyone the power to create and share ideas and information instantly, without barriers.”3 Once a mission has been stated, the next step is to engage in strategic planning.

StrategiC Planning ProCeSS The strategic planning process involves establishing an organization’s major goals and objectives and allocating resources to achieve them. Top management is responsible for strategic planning, although customers, products, competitors, and company resources all factor into the process.

In today’s rapidly changing business environment, constant internal or external changes may necessitate changes in a company’s goals, mission, or strategy. The timeline for strategic plans is generally one to two years, but can be much longer. Strategic plans should be flexible and include action items, such as outlining how plans will be implemented.

eStabliShing goalS anD objeCtiveS A goal is an end result that an organization is expected to achieve over a one- to ten-year period. An objective is

Learning Objective

6-2 Describe the four basic management functions: planning, organizing, leading and motivating, and controlling.

planning establishing organizational goals and deciding how to accomplish them

mission a statement of the basic purpose that makes an organization different from others

strategic planning process the establishment of an organization’s major goals and objectives and the allocation of resources to achieve them

goal an end result that an organization is expected to achieve over a one- to ten-year period

objective a specific statement detailing what an organization intends to accomplish over a shorter period of time

Figure 6-2 The Management Process

Note that management is not a step-by-step procedure but a process with a feedback loop that represents a flow.

Planning Organizing

Review and modify

Leading and motivating

Controlling

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a specific statement detailing what the organization intends to accomplish over a shorter period of time.

Goals and objectives can involve a variety of factors, such as sales, company growth, costs, customer satisfaction, and employee morale. Whereas a small manufacturer may focus primarily on sales objectives for the next six months, a large firm may be more interested in goals that will drive the firm for several years. While many retailers have scaled back in recent years, Swedish fashion retailer H&M has set ambitious growth targets through opening new stores and online markets that complement its stores. The company aims to open 375 new stores worldwide, especially in the United States and China, as well as eight to ten new online markets around the world.4 Finally, goals are set at every level of an organization. Every member of an organization—the president of the company, the head of a department, and an operating employee at the lowest level—has a set of

goals that he or she hopes to achieve. It is likely that some conflicts will arise

among levels within the organization, but goals must be made consistent across an organization. A production department, for example, may have a goal of minimizing costs. One way to do this is to produce only one type of product and limited customer service. Marketing may have a goal of maximizing sales, which might be achieved by offering a wide range of products and options. As part of goal-setting, the manager responsible for both departments must strike a balance between conflicting goals. This balancing process is called optimization.

The optimization of conflicting goals requires insight and ability. Faced with the marketing-versus- production conflict just described, most managers would find a middle ground through offering a moderately diverse product line featuring only the most popular products. Such a compromise would be best for the whole organization.

Human Resources. Superior human resources management can set a firm apart. Do you have a great business plan or product? A competitor can easily copy both. Great employees, however, are much harder to duplicate. That’s why being able to attract, train, and retain talented workers can give a firm a competitive advantage over its rivals.

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What is your organization’s purpose? How is it different than other organizations? Those are the questions a firm’s mission statement like the one shown here should answer. Mission statements are meant for multiple audiences, including a company’s customers, investors, the general public, and employees. Most firms familiarize their personnel with their mission statements so they know what’s expected of them and what they should strive for.

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SWot analySiS SWOT analysis is the identification and evaluation of a firm’s strengths, weaknesses, opportunities, and threats. Strengths and weaknesses are internal factors that affect a company’s capabilities. Strengths refer to a firm’s favorable characteristics and core competencies. Core competencies are approaches and processes that a company performs well that may give it an advantage over its competitors. These core competencies may help the firm attract financial and human resources that increase the firm’s capacity to produce products that satisfy customers. Weaknesses refer to internal limitations a company faces in developing or implementing plans. At times, managers have difficulty identifying and understanding the negative effects of weaknesses in their organizations.

External opportunities and threats exist independently of the firm. Opportunities refer to favorable conditions in the environment that could benefit the organization if properly exploited. Threats, on the other hand, are conditions or barriers that may prevent the firm from reaching its objectives. Opportunities and threats can stem from many sources within the business environment. Because environmental factors vary between firms and industries, threats for some firms may be opportunities for others. Examples of strengths, weaknesses, opportunities, and threats are shown in Figure 6-3.

tyPeS of PlanS Once goals and objectives have been set for the organization, managers must develop plans for achieving them. A plan is an outline of the actions by which an organization intends to accomplish its goals and objectives. The organization develops several types of plans, as shown in Figure 6-4.

An organization’s strategic plan is its broadest plan, developed as a guide during the strategic planning process for major policy setting and decision making. Strategic plans are set by the board of directors and top management and are generally designed to achieve the organization’s long-term goals. Thus, a firm’s strategic plan defines what business the company is in or wants to be in and the kind of company

SWOT analysis the identification and evaluation of a firm’s strengths, weaknesses, opportunities, and threats

core competencies approaches and processes that a company performs well that may give it an advantage over its competitors

plan an outline of the actions by which an organization intends to accomplish its goals and objectives

strategic plan an organization’s broadest plan, developed as a guide for major policy setting and decision making

Figure 6-3 Elements and Examples of SWOT Analysis

SWOT Analysis

• Ef�cient distribution channels • Employee education and experience • Protected patents • Core competencies • Excellent facilities/equipment • Proven management • Economies of scale • Cost advantages

OPPORTUNITIES • New markets opening up • New technologies • Increased demand for new products • Potential strategic alliances • More favorable trade regulations in desirable foreign markets • Competitor complacency

WEAKNESSES • High turnover, absenteeism • Lack of strategic direction • Obsolete production facilities • Labor grievances • Lack of managerial depth • Negative public image

THREATS • Entry of lower-cost foreign competitors • Unfavorable changes in buyer needs and tastes • Rising sales of substitute products • Slowing market growth • Costly regulatory requirements • Vulnerability to business cycle changes • Sole sourcing

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it is or wants to be. Although it was an early leader in handheld e-mail devices, in recent years BlackBerry suffered in the face of stiff competition from Apple and Android smartphones. Sharply sagging sales prompted the company to revise its strategic plan to slash costs and focus more on business customers, software, and mobile data services. In addition to its BlackBerry Messenger instant messaging service, the company is developing devices and applications for network security and Internet connectivity for all sorts of commercial devices.5

In addition to strategic plans, most organizations also employ several narrower kinds of plans. A tactical plan is a smaller scale plan developed to implement a strategy. Most tactical plans cover a one- to three-year period. If a strategic plan will take five years to complete, the firm may develop five tactical plans, one covering each year. Tactical plans may be updated periodically as dictated by conditions and experience. Their more limited scope permits them to be changed more easily than strategies. As part of its tactical plan to improve revenue, Best Buy’s CEO is fighting slumping sales with a reinvention effort called “Renew Blue.” This plan involves slashing costs, matching Amazon.com’s prices, boosting online sales through bestbuy. com, and improving distribution so that stores do not run out of popular items. The plan has already resulted in cost savings of nearly $1 billion and greater online sales.6

An operational plan is a type of plan designed to implement tactical plans. Operational plans are usually established for one year or less and deal with how to accomplish the organization’s specific objectives.

Regardless of how hard managers try, sometimes business activities do not go as planned. Today, most corporations also develop contingency plans along with strategies, tactical plans, and operational plans. A contingency plan is a plan that outlines alternative courses of action that may be taken if an organization’s other plans are disrupted or become ineffective. Contingency plans may address disruptions

tactical plan a smaller scale plan developed to implement a strategy

operational plan a type of plan designed to implement tactical plans

contingency plan a plan that outlines alternative courses of action that may be taken if an organization’s other plans are disrupted or become ineffective

Figure 6-4 Types of Plans

Managers develop and rely on several types of plans.

Types of Plans

STRATEGIC PLANS

• Broad guide for major policy setting • Designed to achieve long-term goals • Set by board of directors and top management

TACTICAL PLANS

• Smaller-scale plan to implement strategic plan • May be updated periodically • Easier to change than strategic plans

OPERATIONAL PLANS

• Designed to implement tactical plans • Plan is one year or less • Deals with how to accomplish speci�c objectives

CONTINGENCY PLANS

• Outline of alternative courses of action if other plans are disrupted or noneffective • Used in conjunction with strategic, tactical, and operational plans

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caused by natural disasters, criminal or ethical misconduct, political instability, or other unexpected activities. For example, the potential threat of power disruptions caused by lava flows from the Kilauea volcano has led Hawaii Electric Light to draft contingency plans to keep power on throughout the Hawaiian island. The plans include monitoring eruptions and lava flows from the volcano and coordinating with state agencies. The company’s plans also include the development of prototype power poles that can better withstand conditions stemming from lava flows across the island of Hawaii, as well as strategically locating generators to fill in transmission gaps as needed.7

6-2b organizing the enterprise After goal-setting and planning, the manager’s second major function is organization. Organizing is the grouping of resources and activities to accomplish some end result in an efficient and effective manner. Consider the case of an inventor who creates a new product and goes into business to sell it. At first, the inventor will do everything on his or her own—purchase raw materials, make the product, advertise it, sell it, and keep business records. Eventually, as business grows, the inventor will need help. To begin with, he or she might hire a professional sales representative and a part- time bookkeeper. Later, it also might be necessary to hire sales staff, people to assist with production, and an accountant. As the inventor hires new personnel, he or she must decide what each person will do, to whom each person will report, and how each person can best take part in the organization’s activities. We discuss these and other facets of the organizing function in much more detail in Chapter 7.

6-2c leading and Motivating The leading and motivating function is concerned with an organization’s human resources. Specifically, leading is the process of influencing people to work toward a common goal. Motivating is the process of providing reasons for people to work in the best interests of an organization. Together, leading and motivating are often referred to as directing.

Leading and motivating are critical activities because of the importance of an organization’s human resources. Obviously, different people do things for different reasons—that is, they have different motivations. Some are interested primarily in earning as much money as they can. Others may be spurred on by opportunities to get promoted. Part of a manager’s job, then, is to determine what factors motivate workers and to try to provide those incentives to encourage effective performance. Many people choose to work at the Container Store because of its reputation for treating its employees well (it has been on Fortune’s Best Companies to Work For list for 15 years), and they want to be part of a major specialty retailer with strong growth potential. Kip Tindell, CEO and one of the founders of the Container Store, is a top CEO in America and has guided the Container Store to success through his model leadership. The Container Store pays its employees nearly twice the industry average and provides extensive training and development to ensure

organizing the grouping of resources and activities to accomplish some end result in an efficient and effective manner

leading the process of influencing people to work toward a common goal

motivating the process of providing reasons for people to work in the best interests of an organization

directing the combined processes of leading and motivating

Encouraging employees is part of motivating them. Organizations employ numerous motivational messages. There are considerable differences among people regarding the factors and messages that motivate them.

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they can find the right storage products for each customer. The Container Store also provides generous benefits and

strives to create fun workspaces.8 A lot of research has been done on both motivation and leadership.

As you will see in Chapter 10, research on motivation has yielded very useful information. However, research on leadership has been less successful. Despite decades of study, no one has discovered a general set of personal traits or characteristics that makes a good leader.

Later in this chapter, we discuss leadership in more detail.

6-2d Controlling ongoing activities Controlling is the process of evaluating and regulating ongoing activities to ensure that goals

are achieved. The control function includes three steps (see Figure 6-5). The first is setting standards

against which performance can be compared. The second is measuring actual performance and comparing

it with the standard. The third is taking corrective action as necessary. Notice that the control function is circular in nature.

The steps in the control function must be repeated periodically until the goal is achieved. For example, suppose that Southwest Airlines

establishes a goal of increasing profits by 12 percent. Southwest’s management will monitor its profit on a monthly basis to ensure success. After three months, if profit has increased by 3 percent, management may assume that plans are effective. In this case, no action will likely be taken. However, if profit has increased only 1 percent, some corrective action will be needed to get the firm on track. The action that is required depends on the reason for the less-than- expected increase.

controlling the process of evaluating and regulating ongoing activities to ensure that goals are achieved

Concept Check ✓✓ Why is planning sometimes referred to as the “first” management function?

✓✓ What is a plan? Differentiate between the major types of plans.

✓✓ What kind of motivations do different employees have?

✓✓ What are the three steps of controlling?

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Figure 6-5 The Control Function

The control function includes three steps: setting standards, measuring actual performance, and taking corrective action.

Setting standards

Taking corrective action

Measuring actual performance

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6-3 Kinds OF Managers Managers can be classified in two ways: according to their level within an organization and according to their area of management. In this section, we use both perspectives to explore the various types of managers.

6-3a levels of Management For the moment, think of an organization as a three-story structure (as illustrated in Figure 6-6). Each story corresponds to one of the three general levels of management: top managers, middle managers, and first-line managers.

toP ManagerS A top manager is an upper-level executive who guides and controls an organization’s overall fortunes. Top managers represent the smallest of the three groups. In terms of planning, they are generally responsible for developing the organization’s mission. They also determine the firm’s strategy. It takes years of hard work, long hours, and perseverance, talent, and no small share of good luck to reach the ranks of top management in large companies. Common job titles associated with top managers are president, vice president, chief executive officer (CEO), and chief operating officer (COO).

MiDDle ManagerS Middle managers make up the largest group of managers in most organizations. A middle manager is a manager who implements the strategy and major policies developed by top management. Middle managers develop tactical and operational plans, and they coordinate and supervise the activities of first-line managers. Titles at the middle-management level include division manager, department head, plant manager, and operations manager.

Learning Objective

6-3 Distinguish among the various kinds of managers in terms of both level and area of management.

top manager an upper-level executive who guides and controls the overall fortunes of an organization

middle manager a manager who implements the strategy and major policies developed by top management

Figure 6-6 Management Levels Found in Most Companies

The coordinated effort of all three levels of managers is required to implement the goals of any company.

Top management

Middle management

First-line management

A top manager’s out-of-this-world business strategy. At the age of 16, Richard Branson, the CEO and founder of the Virgin Group, started his first business venture: a magazine called The Student. Today, the Virgin Group consists of over 400 companies, including Virgin Telecommunications, Virgin Radio, Virgin Cola, Virgin Wine, Virgin Spa, Virgin Airlines—and the list goes on. In the near future, Virgin Galactic, one of Branson’s newest companies, aims to launch paying customers into space.

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firSt-line ManagerS A first-line manager is a manager who coordinates and supervises the activities of operating employees. First-line managers spend most of their time working with and motivating their employees, answering questions, and solving day-to-day problems. Most first-line managers are former operating employees who were promoted into management. Many of today’s middle and top managers began their careers on this first management level. Common titles for first-line managers include office manager, supervisor, and foreman.

6-3b areas of Management Specialization Organizational structure can also be divided into areas of management specialization (see Figure 6-7). The most common areas are finance, operations, marketing, human resources, and administration. Depending on its mission, goals, and objectives, an organization may include other areas as well—research and development (R&D), for example.

finanCial ManagerS A financial manager is primarily responsible for an organization’s financial resources. Accounting and investment are specialized areas within financial management. Because financing affects the operation of the entire firm, many CEOs and presidents of large companies are people who were first trained as financial managers.

oPerationS ManagerS An operations manager manages the systems that convert resources into goods and services. Traditionally, operations management has been equated with manufacturing—the production of goods. However, in recent years, many of the techniques and procedures of operations management have been applied to the production of services and to a variety of nonbusiness activities. As with financial management, operations management has produced a large percentage of today’s company CEOs and presidents.

first-line manager a manager who coordinates and supervises the activities of operating employees

financial manager a manager who is primarily responsible for an organization’s financial resources

operations manager a manager who manages the systems that convert resources into goods and services

Figure 6-7 Areas of Management Specialization

Other areas may have to be added, depending on the nature of the firm and the industry.

Others (e.g., research and development)

AdministrationMarketingOperationsFinance Human resources

Harnessing the cooperation of an organization’s specialized managers. Imagine the managers of different departments as a team of horses. If they—and their employees—don’t all work together and pull in the same direction, the organization won’t get to the destination it’s trying to reach.

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Marketing ManagerS A marketing manager is responsible for facilitating the exchange of products between an organization and its customers or clients. Specific areas within marketing are marketing research, product management, advertising, promotion, sales, and distribution. A sizable number of today’s company presidents have risen from marketing management.

hUMan reSoUrCeS ManagerS A human resources manager is charged with managing an organization’s human resources programs. He or she engages in human resources planning, designs systems for hiring, training, and evaluating the performance of employees, and ensures that the organization follows government regulations concerning employment practices. There are many technological tools to help human resources managers. For example, Workday, Inc. produces a suite of software and tools for human resources departments, including a program to streamline the recruiting and hiring process and tools that help HR managers collect and process information.

aDMiniStrative ManagerS An administrative manager (also called a general manager) is not associated with any specific functional area, but provides overall administrative guidance and leadership. A hospital administrator is an example of an administrative manager. He or she does not specialize in operations, finance, marketing, or human resources management but instead coordinates the activities of specialized managers in all these areas. In many respects, most top managers are really administrative managers.

Whatever their level and specialization in the organization, successful managers generally exhibit certain key skills and are able to play a variety of managerial roles. However, as we shall see, some skills are likely to be more critical at one level of management than at another.

6-4 Key sKiLLs OF suCCessFuL Managers As shown in Figure 6-8, managers need a variety of skills, including conceptual, analytic, interpersonal, technical, and communication skills.

marketing manager a manager who is responsible for facilitating the exchange of products between an organization and its customers or clients

human resources manager a person charged with managing an organization’s human resources programs

administrative manager a manager who is not associated with any specific functional area but who provides overall administrative guidance and leadership

Concept Check ✓✓ Describe the three levels of management.

✓✓ identify the various areas of management specialization, and describe the responsibilities of each.

Learning Objective

6-4 Identify the key management skills of successful managers.Figure 6-8 Key Skills of Successful Managers

Key Management

Skills

Interpersonal Skills

Technical SkillsCommunication Skills

Analytic Skills

Conceptual Skills

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6-4a Conceptual Skills Conceptual skills involve the ability to think in abstract terms. Conceptual skills allow a manager to see the “big picture” and understand how the various parts of an organization or idea can fit together. Consider Engineer Jonathan Downey, who founded Airware after recognizing that the proliferation of hobby unmanned aerial vehicles (UAVs), better known as drones, represented a huge opportunity for commercial applications such as photography, agriculture, police work, and public utilities. Airware develops hardware, software, and other services for UAVs that allow them to perform a wide variety of activities. The firm has already provided services for overseas UAV makers and hopes to provide the dominant operating system platform for U.S. makers’ drones as soon as the Federal Aviation Administration allows their commercial use.9 Conceptual skills are useful in a wide range of situations, including the optimization of goals described earlier.

6-4b analytic Skills Employers expect managers to use analytic skills to identify problems correctly, generate reasonable alternatives, and select the “best” alternatives to solve problems. Top-level managers especially need these skills because they must discern the important issues from the less important ones, as well as recognize the underlying reasons for different situations. When Lee Bird became the CEO of At Home Group (formerly known as Garden Ridge), he quickly identified a number of issues that were contributing to stagnating sales of Garden Ridge home décor stores. These issues included disorganized stores, incoherent product offerings, outdated employee policies, and even unused warehouse space—which he converted into new corporate headquarters offices. Within a short time, Bird and his team identified alternatives and solutions to these issues and then set about updating the stores—which are now

conceptual skills the ability to think in abstract terms

analytic skills the ability to identify problems correctly, generate reasonable alternatives, and select the “best” alternatives to solve problems

Collaborate your Way to Success

Do you know how to collaborate? According to recent research, managers at all levels value the ability to collaborate with others, not just give orders. By working together to devise innovative solutions to problems, they benefit individually from the added knowledge and experience—and their teamwork supports the organization’s creativity and performance. Moreover, collaboration is a necessity in situations where you and other managers are expected to achieve shared goals by pooling your efforts.

You’ll be in a better position to collaborate if you sharpen your communication skills—particularly if you’re using e-mail or phone conversations that can’t convey unspoken cues or nuances of body language. Listen carefully, keep an open mind, and ask questions to clarify your understanding of what your collaborator says. Simply being a better communicator can save precious time on the job, whether

you’re working with one person or a group, collaborating across time zones, or joining forces with colleagues across the continent.

Also be aware that effective collaboration depends on your ability to work with people of different backgrounds. Cisco Systems sees this as such an important issue that it has appointed a Chief Inclusion and Collaboration Officer to encourage diversity and collaboration within the company’s workforce. The best managers are respectful of differences, ready to learn from anybody who has a great idea, and willing to share their know-how with others to get the job done.

sources: based on information in Michal Lev-ram, “cisco opens up about its struggle to Diversify its Workforce,” Fortune, november 19, 2014, www.fortune.com; Jack Zenger and Joseph Folkman, “Most Managers Think of Themselves as coaches,” Harvard Business Review, July 25, 2014, http://hbr.org; “businesses Losing 20 Days of Work a year Thanks to outdated communications,” Growth Business, november 18, 2014, http://www.growthbusiness.co.uk.

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called At Home—and employee policies, as well as reorganizing stores and refocusing the products offered.10 Managers who use these skills not only address a situation but also correct the initial event or problem that caused it to occur. Thus, these skills are vital to running a business efficiently and logically.

6-4c interpersonal Skills Interpersonal skills involve the ability to deal effectively with other people, both inside and outside an organization. Examples of interpersonal skills are the ability to relate to people, understand their needs and motives, and show genuine compassion.

6-4d technical Skills Technical skills involve specific skills needed to accomplish a specialized activity. For example, engineers and machinists need technical skills to do their jobs. First-line managers (and, to a lesser extent, middle managers) need to understand the technical skills relevant to the activities they manage in order to train subordinates, answer questions, and provide guidance, even though the managers may not perform the technical tasks themselves. In general, top managers do not rely on technical skills as heavily as managers at other levels. Still, understanding the technical side of a business is an aid to effective management at every level.

6-4e Communication Skills Communication skills, both oral and written, involve the ability to speak, listen, and write effectively. Managers need both oral and written communication skills. Because a large part of a manager’s day is spent conversing with others, the ability to speak and listen is critical. Oral communication skills are used when a manager makes sales presentations, conducts interviews, and holds press conferences. Written communication skills are important because a manager’s ability to prepare letters, e-mails, memos, sales reports, and other written documents may spell the difference between success and failure. Computers, smartphones, and other high-tech devices make communication in today’s businesses easier and faster. To manage an organization effectively and to stay informed, it is very important that managers understand how to use and maximize the potential of digital communication devices.

6-5 LeadershiP Leadership has been defined broadly as the ability to influence others. Leadership is different from management in that a leader strives for voluntary cooperation, whereas a manager may have to depend on coercion to change employee behavior.

6-5a formal and informal leadership Some experts make distinctions between formal leadership and informal leadership. Formal leaders have legitimate power of position. They have authority within an organization to influence others to work toward the organization’s objectives. Informal leaders usually have no such authority and may or may not exert their influence in support of the organization. Both formal and informal leaders make use of several kinds of power, including the ability to grant rewards or impose punishments, the possession of expert knowledge, and personal attraction or charisma. Informal leaders who identify with the organization’s goals are a valuable

interpersonal skills the ability to deal effectively with other people

technical skills specific skills needed to accomplish a specialized activity

Concept Check ✓✓ What are the key skills that successful managers should have?

✓✓ For each skill, provide two reasons why a successful manager should have that skill.

communication skills the ability to speak, listen, and write effectively

Learning Objective

6-5 Explain the different types of leadership.

leadership the ability to influence others

How good are your managerial skills? To be successful, managers must master and simultaneously utilize a number of skills. These include technical skills that aid with specialized work, conceptual skills that foster abstract thinking, and interpersonal skills to help manage and motivate their employees. Which of these skills will you need to work on as you build your career?

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asset to any organization. However, a business can be greatly hampered by informal leaders who turn work groups against management.

6-5b Styles of leadership For many years, finding a consensus on the most important leadership traits was difficult. Leadership was viewed as a combination of personality traits, such as self- confidence, concern for people, intelligence, and dependability. In recent years, the emphasis has been on styles of leadership. Several styles have emerged, including autocratic, participative, and entrepreneurial.

Autocratic leadership is very task-oriented. Decisions are made unilaterally, with little concern for employee opinions. Employees are told exactly what is expected from them and given specific guidelines, rules, and regulations on how to achieve their tasks.

Participative leadership is common in today’s business organizations. Participative leaders consult workers before making decisions. This helps workers understand which goals are important and fosters a sense of ownership and commitment to reach them. Participative leaders can be classified into three groups: consultative, consensus, and democratic. Consultative leaders discuss issues with workers but retain the final authority for decision making. Consensus leaders seek input from almost all workers and make final decisions based on their support. Democratic leaders give final authority to the group. They collect opinions and base their decisions on the vote of the group. New Belgium Brewing frequently appears on lists of best places to work in part because of the company’s “high involvement, ownership culture” and participative leader, CEO Kim Jordan. She encourages employees to own stock and make important business decisions.11 Communication is open up and down the hierarchy. Coaching, collaborating, and negotiating are important skills for participative leaders.

autocratic leadership task- oriented leadership style in which workers are told what to do and how to accomplish it without having a say in the decision- making process

participative leadership leadership style in which all members of a team are involved in identifying essential goals and developing strategies to reach those goals

elon Musk’s far-out ideas are Crazy like a fox

South African-born Elon Musk has been a high-tech entrepreneur since the age of 12, when he developed and sold a videogame for several hundred dollars. He scored his first multimillion-dollar payday in 1999, from the sale of Web-based city guides for newspapers. His next multimillion-dollar payday came from creating an electronic payment system that ultimately merged with PayPal and was purchased by eBay in 2002.

Elon Musk exemplifies entrepreneurial leadership at its best, transforming bold ideas into viable businesses by inspiring employees, investors, and others to work toward his vision of the future. He used some of his fortune to launch SpaceX, now a leading rocket technology company, with an eye toward a new era of space exploration. Next, he invested in Tesla Motors, a fast-growing company developing clean, emission-free electric vehicles. Within a few years, he

took over as CEO and shifted the world of electric vehicles into high gear by giving away Tesla’s patents to rivals in the automotive industry.

Even though he spends just two days a week at Tesla and three days at SpaceX, the CEO’s unflagging enthusiasm, determination, and sense of purpose motivate his employees every day and add to the forward momentum of both enterprises. Under Musk’s entrepreneurial leadership, his businesses are turning the seemingly impossible into reality one day at a time, day after day after day.

sources: based on information in Dana hull, “Timeline: elon Musk’s accomplishments,” San Jose Mercury News, april 11, 2014, www.mercurynews.com; simon Mainwaring, “21st century Leadership: 3 Master strokes by elon Musk,” Forbes, June 24, 2014, www. forbes.com; scott Pelley, “Tesla and spaceX: elon Musk’s industrial empire,” CBS News, March 30, 2014, http://www.cbsnews.com/news/tesla-and-spacex-elon-musks- industrial-empire (accessed July 11, 2015).

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Entrepreneurial leadership is personality dependent. Although each entrepreneur is different, this leadership style is generally task-oriented, driven, charismatic, and enthusiastic.12 The entrepreneurial personality tends to take initiative, be visionary, and be forward-looking. Their enthusiasm energizes and inspires employees. Entrepreneurial leaders tend to be very invested in their businesses, working long hours to ensure success. They may not understand why their employees do not have the same level of passion for their work. Dr. David Hung, President and CEO of drug maker Medivation, was recognized by Ernst & Young as a top entrepreneur. He beat out thousands of others for this distinction through his passion to make a difference, resilience in learning from his company’s failures, and persistence in looking for the key to developing life-saving products.13

6-5c Which leadership Style is the best? Today, most management experts agree that no “best” managerial leadership style exists. Each of the styles described—autocratic, participative, and entrepreneurial—has advantages and disadvantages. For example, participative leadership can motivate employees to work effectively because they have a sense of ownership in decision making. However, the decision- making process in participative leadership takes time that subordinates could be devoting to the work itself.

Although hundreds of research studies have been conducted to prove which leadership style is best, there are no definite conclusions. Each of the leadership styles can be highly effective in the right situation. The most effective style depends on the right balance between interaction among employees, characteristics of the work situation, and the manager’s personality.

6-6 ManageriaL deCisiOn MaKing Decision making is the act of choosing one alternative from a set of alternatives.14 In ordinary situations, decisions are made casually and informally. We encounter a problem, mull it over, settle on a solution, and go on. Managers, however, require a more systematic method for solving complex problems. As shown in Figure 6-9, the managerial decision-making process involves four steps: (1) identifying the

entrepreneurial leadership personality-based leadership style in which the manager seeks to inspire workers with a vision of what can be accomplished to benefit all stakeholders

Concept Check ✓✓ Describe the major leadership styles.

✓✓ Which one is best?

Learning Objective

6-6 Discuss the steps in the managerial decision- making process.

decision making the act of choosing one alternative from a set of alternatives

A CEO who motivates and inspires. Howard Schultz, CEO of Starbucks, has a highly participative leadership style. He gives more power to employees and allows, encourages, and seeks feedback and advice from them. Schultz states that, “when you’re surrounded by people who share a passionate commitment around a common purpose, anything is possible.”

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Figure 6-9 Major Steps in the Managerial Decision-Making Process

Managers require a systematic method for solving problems in a variety of situations.

Identifying the problem or opportunity

Selecting an alternative

Generating alternatives

Implementing and evaluating the solution

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problem or opportunity, (2) generating alternatives, (3) selecting an alternative, and (4) implementing and evaluating the solution.

6-6a identifying the Problem or opportunity

A problem is the discrepancy between an actual condition and a desired condition—the difference between what

is occurring and what one wishes would occur. For example, a marketing manager at Campbell’s Soup Company has a problem if sales revenues for its Pepperidge Farm Goldfish crackers are declining (the actual condition). To solve this problem, the marketing manager must take steps to increase sales revenues (desired condition). Most people consider a problem to be “negative,” but a problem also can be “positive.” Some problems can be viewed

as “opportunities.” Although accurate identification of a problem is essential before it can be solved

or turned into an opportunity, this stage of decision making creates many difficulties for managers. Sometimes managers’ preconceptions of the problem prevent them from seeing the actual situation. They produce an answer before the proper question has been asked, leading them to focus on insignificant issues. Also, managers may mistakenly analyze problems in terms of symptoms rather than underlying causes.

Effective managers learn to look ahead so that they are prepared when decisions must be made. They clarify situations and examine the causes of problems, asking whether the presence or absence of certain variables alters a situation. Finally, they consider how individual behaviors and values affect the way problems or opportunities are defined.

6-6b generating alternatives After a problem has been defined, the next task is to generate alternatives. The more important the decision, the more attention must be devoted to this stage. Managers should be open to fresh, innovative ideas as well as obvious answers.

Certain techniques can aid in the generation of creative alternatives. Brainstorming, commonly used in group discussions, encourages participants to produce many new ideas. During brainstorming, other group members are not permitted to criticize or ridicule. Another approach, developed by the U.S. Navy, is called “Blast! Then Refine.” Group members tackle a recurring problem by erasing all previous solutions and procedures. The group then re-evaluates its original objectives, modifies them if necessary, and devises new solutions. Other techniques— including trial and error—are also useful in this stage of decision making.

6-6c Selecting an alternative Final decisions are influenced by a number of considerations, including financial constraints, human and informational resources, time limits, legal obstacles, and political factors. Managers must select the alternative that will be most effective and practical. When publishing giant Meredith Corporation (Family Circle and Every Day with Rachel Ray) acquired Eating Well magazine, managers had to decide what focus it would have. For example, it could emphasize comfort food or health food. After analyzing the alternatives and the competition, managers decided to focus on healthy meals on a shoestring, a choice that has paid off.15

problem the discrepancy between an actual condition and a desired condition

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At times, two or more alternatives or some combination of alternatives will be equally appropriate. Managers may choose solutions to problems on several levels. The word satisfice describes solutions that are only adequate and not ideal. When lacking time or information, managers often make decisions that “satisfice.” Whenever possible, managers should try to investigate alternatives carefully and select the ideal solution.

6-6d implementing and evaluating the Solution Implementation of a decision requires time, planning, preparation of personnel, and evaluation of results. Managers usually deal with unforeseen consequences even when they have carefully considered the alternatives.

The final step in managerial decision making entails evaluating a decision’s effectiveness. If the alternative that was chosen removes the difference between the actual condition and the desired condition, the decision is considered effective. If the problem still exists, managers may select one of the following choices:

• Decide to give the chosen alternative more time to work. • Adopt a different alternative. • Start the problem identification process all over again.

Managers should be aware that failure to evaluate decisions adequately may have negative consequences.

6-7 Managing tOtaL QuaLity The management of quality is a high priority in many organizations today. Major reasons for a greater focus on quality include foreign competition, more demanding customers who have the ability to comparison shop online, and poor

Concept Check ✓✓ Describe the major steps in the managerial decision-making process.

✓✓ Why does a manager need to evaluate the solution and look for problems after a solution has been implemented?

Learning Objective

6-7 Describe how organizations benefit from total quality management.

CvS backs Words with actions

Should a drug store carry tobacco products? In 2014, CVS’s top management decided that the answer was “no.” CVS rings up nearly $130 billion in annual sales and operates 7,700 U.S. drug stores, many with in-store pharmacy departments. For years, CVS (like many other drug, grocery, and convenience stores) sold cigarettes at the checkout counter. Early in 2014, however, the CEO unexpectedly announced that CVS would halt all tobacco sales before the end of the year: “Cigarettes and tobacco products have no place in a setting where health care is delivered. This is the right thing to do.”

One month after CVS’s announcement, more than two dozen attorneys general from U.S. states and territories wrote competing drug retailers to ask them to follow suit. CVS increased the pressure by dumping tobacco products well in advance of its self-appointed deadline, but at that point, no

other major drug retailer had yet agreed to drop cigarettes. Not only did CVS drop tobacco products—potentially losing up to $2 billion in yearly revenue—it also changed its name to CVS Health, to reflect the mission of “helping people on their path to better health.”

Should drug stores take a stand against tobacco? Walgreens and Rite Aid, which compete with CVS, both offer various plans and products to help people stop smoking. But should retailers that sell products to protect or restore health continue to sell products that are known to be unhealthy?

sources: based on information in sarah kliff, “cVs to stop selling cigarettes by oct. 1,” Washington Post, February 5, 2014, www.washingtonpost.com; kelly Gilblom and Michelle Fay cortez, “cVs’s competitors can’t afford to Quit Tobacco,” Bloomberg News, november 5, 2014, www.bloomberg.com; Jason Millman, “after cutting Tobacco sales, cVs is now Pressuring other Pharmacies to Do the same,” Washington Post, october 20, 2014, www.washingtonpost. com; www.cvs.com.

Ethical Success or Failure

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financial performance resulting from reduced market shares and higher costs. Over the last few years, several U.S. firms have lost the dominant competitive positions they had held for decades.

Total quality management is a much broader concept than just controlling the quality of the product itself (which is discussed in Chapter 8). Total quality management (TQM) is the coordination of efforts directed at improving customer satisfaction, increasing employee participation, strengthening supplier partnerships, and facilitating an organizational atmosphere of continuous quality improvement. For TQM programs to be effective, management must address each of the following components:

• Customer satisfaction. Ways to improve include producing higher- quality products, providing better customer service, and showing customers that the company cares.

• Employee participation. This can be increased by allowing employees to contribute to decisions, develop self-managed work teams, and assume responsibility for improving the quality of their work.

• Strengthening supplier partnerships. Developing good working relationships with suppliers can ensure that the right supplies and materials will be delivered on time at lower costs.

• Continuous quality improvement. A program based on continuous improve- ment has proven to be the most effective long-term approach.

One tool that is used for TQM is called benchmarking. Benchmarking is the process of evaluating the products, processes, or management practices of another organization for the purpose of improving quality. The benchmark should be superior in safety, customer service, productivity, innovation, or in some other way.

For example, competitors’ products might be disassembled and evaluated, or wage and benefit plans might be surveyed to measure compensation packages against the labor market. The four basic steps of benchmarking are identifying objectives, forming a benchmarking team, collecting and analyzing data, and acting on the results. Best practices may be discovered in any industry or organization.

Although many factors influence the effectiveness of a TQM program, two issues are crucial. First, top management must make a strong commitment to a TQM program by treating quality improvement as a top priority and giving it frequent attention. Firms that establish a TQM program but then focus on other priorities will find that their quality-improvement initiatives will fail. Second, management must coordinate the specific elements of a TQM program so that they work in harmony with each other.

Although not all U.S. companies have TQM programs, they provide many benefits. Overall financial benefits include lower operating costs, higher return on sales and on investments, and an improved ability to use premium pricing rather

total quality management (TQM) the coordination of efforts directed at improving customer satisfaction, increasing employee participation, strengthening supplier partnerships, and facilitating an organizational atmosphere of continuous quality improvement

benchmarking a process used to evaluate the products, processes, or management practices of another organization that is superior in some way in order to improve quality

Total Quality Management. Prior to the 1970s, products “Made in Japan” were often considered shoddy. Not anymore. Toyota Motor Company, the maker of Lexus, worked hard to change that image by pioneering the use of total quality management practices. As a part of its total quality management practices, Toyota meticulously inspects its products and continuously strives to improve them.

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than competitive pricing. Firms that do not implement TQM are sometimes afraid that the costs of doing so will be prohibitive. While implementing TQM can be costly initially, the savings from preventing future problems and integrating systems usually make up for the expense. The long-term costs of not implementing TQM can involve damage to a company’s reputation and lost productivity and time spent fixing mistakes after they have happened.16

Concept Check ✓✓ Why does top management need to be strongly committed to TQM programs?

✓✓ Describe the major components of a TQM program.

Summary

6-1 define what management is.Management is the process of coordinating people and other resources to achieve an organization’s goals. Managers are concerned with four types of resources— material, human, financial, and informational.

6-2 describe the four basic management functions: planning, organizing, leading and motivating, and controlling.

Managers perform four basic functions, which do not occur according to a rigid, preset timetable. At any time, managers may engage in a number of functions simultaneously. However, each function tends to lead naturally to the next. Managers engage in planning— determining where the firm should be going and how best to get there. One method of planning that can be used is SWOT analysis, which identifies and evaluates a firm’s strengths, weaknesses, opportunities, and threats. Three types of plans, from the broadest to the most specific, are strategic, tactical, and operational. Managers also organize resources and activities to accomplish results in an efficient and effective manner, and they lead and motivate others to work in the best interests of the organization. In addition, managers control ongoing activities to keep the organization on course. There are three steps in the control function: setting standards, measuring actual performance, and taking corrective action.

6-3 distinguish among the various kinds of managers in terms of both level and area of management.

Managers—or management positions—may be classified from two different perspectives. From the perspective of level within the organization, there are top managers, who control the organization as a whole, middle managers, who implement strategies and major policies, and first-line managers, who supervise the activities of operating employees. From the viewpoint of area of management, managers most often deal with the areas

of finance, operations, marketing, human resources, and administration.

6-4 identify the key management skills of successful managers. Managers need a variety of skills in order to run a successful and efficient business. Conceptual skills are used to think in abstract terms or see the “big picture.” Analytic skills are used to identify problems correctly, generate reasonable alternatives, and select the “best” alternatives to solve problems. Interpersonal skills are used to deal effectively with other people, both inside and outside an organization. Technical skills are needed to accomplish a specialized activity, whether they are used to actually do the task or to train and assist employees. Communication skills are used to speak, listen, and write effectively.

6-5 explain the different types of leadership. Managers’ effectiveness often depends on their styles of leadership—that is, their ability to influence others, either formally or informally. Autocratic leaders are very task oriented; they tell their employees exactly what is expected from them and give them specific instructions on how to do their assigned tasks. Participative leaders consult their employees before making decisions and can be classified into three groups: consultative, consensus, and democratic. Entrepreneurial leaders are different depending on their personalities, but they are generally enthusiastic and passionate about their work and tend to take the initiative.

6-6 discuss the steps in the managerial decision-making process. Decision making, an integral part of a manager’s work, is the process of developing a set of possible alternative solutions to a problem and choosing one alternative from among the set. Managerial decision making involves four steps: Managers must accurately identify problems, generate several possible solutions, choose the solution

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that will be most effective under the circumstances, and implement and evaluate the chosen course of action.

6-7 describe how organizations benefit from total quality management. Total quality management (TQM) is the coordination of efforts directed at improving customer satisfaction, increasing employee participation, strengthening supplier partnerships, and facilitating an organizational atmosphere of continuous quality improvement. Another tool used for TQM is benchmarking, which involves comparing and evaluating the products, processes, or

management practices of another organization that is superior in some way in order to improve quality. The five basic steps in benchmarking are identifying objectives, forming a benchmarking team, collecting data, analyzing data, and acting on the results. To have an effective TQM program, top management must make a strong, sustained commitment to the effort and must be able to coordinate all the program’s elements so that they work in harmony. Benefits of TQM include lower operating costs, higher return on sales and on investment, and an improved ability to use premium pricing rather than competitive pricing.

Key Terms

You should now be able to define and give an example relevant to each of the following terms:

management (165) planning (167) mission (167) strategic planning process

(167) goal (167) objective (167) SWOT analysis (169) core competencies (169) plan (169) strategic plan (169)

tactical plan (170) operational plan (170) contingency plan (170) organizing (171) leading (171) motivating (171) directing (171) controlling (172) top manager (173) middle manager (173) first-line manager (174)

financial manager (174) operations manager (174) marketing manager (175) human resources manager

(175) administrative manager (175) conceptual skills (176) analytic skills (176) interpersonal skills (177) technical skills (177) communication skills (177)

leadership (177) autocratic leadership (178) participative leadership

(178) entrepreneurial leadership

(179) decision making (179) problem (180) total quality management

(TQM) (182) benchmarking (182)

Discussion Questions

1. Define the word manager without using the word man- agement in your definition.

2. Does a healthy firm (one that is doing well) have to worry about effective management? Explain.

3. What might be the mission of a neighborhood restaurant? Of the Salvation Army? What might be reasonable objec- tives for these organizations?

4. What are the major elements of SWOT analysis? 5. How do a strategic plan, a tactical plan, and an

operational plan differ? What do they all have in common?

6. Why are leadership and motivation necessary in a busi- ness in which people are paid for their work?

7. Compare and contrast the major styles of leadership.

8. According to this chapter, the leadership style that is most effective depends on interaction among the employees, characteristics of the work situation, and the manager’s personality. Do you agree or disagree? Explain your answer.

9. What are the major benefits of a total quality manage- ment program?

10. Do you think that people are really as important to an organization as this chapter seems to indicate?

11. Discuss what happens during each of the four steps of the managerial decision-making process.

12. As you learned in this chapter, managers often work long hours at a hectic pace. Would this type of career appeal to you? Explain.

Chapter 6 Understanding the Management Process 185

Building Skills for Career Success

1. Social Media Exercise Crowdsourcing is a set of principles, processes, and platforms to get things done that includes putting out an open call to a group and managing the responses and output. Crowdsourcing can be like outsourcing in a bigger way because instead of contracting to one known entity, you are putting a call out to a bigger group, often a global online community, to either get many to participate or to find the person you need by casting a much wider net.

There are crowdsourcing companies that perform specific types of work such as translations (Gengo, Smartling), transcription (CastingWords), keyword marketing (Trada), even design and marketing work (99Designs, CrowdSpring). Each company operates differently. In the case of transcription or translation, you give work to a company like CastingWords or Gengo, and they in turn put the job out to their “crowd” of workers from around the world. They are like the middleman to helping you get the work done, and their

Video Case Meet heidi ganahl, top Dog at Camp bow Wow

Even the strongest leaders welcome fresh ideas when facing difficult decisions. Heidi Ganahl had already founded and failed with two businesses when she emptied her bank account to fund Camp Bow Wow. Her vision for the business was to provide a healthy, happy, and safe day-care and overnight environment for dogs. She opened her first Camp Bow Wow in 2000 inside a refurbished former Veterans of Foreign Wars hall in Denver, Colorado, followed by a second camp nearby in 2002. At camp, each dog gets a private cabin, and counselors supervise as the “campers” play together, enjoy a swim, or romp through rough terrain. Owners can watch what’s happening by clicking to view live coverage on the web-based Camper Cams installed at each location.

Within three years of founding Camp Bow Wow, Ganahl realized that she needed more money to expand the business and the brand. After exploring various alternatives, she began selling franchises in the United States and Canada. When new franchisees come on board, Ganahl is careful to explain the need for consistency in delivering services the same way at every Camp Bow Wow. She also explains the measurement standards she uses to manage the performance of the business and its franchise operations. Yet within that framework, she encourages franchisees to come forward with fresh ideas, and she seeks the input of franchisees when making important decisions about maintaining Camp Bow Wow’s momentum.

Taking Camp Bow Wow from a cash-guzzling startup to a thriving, profitable franchise company has required all of Ganahl’s skills in leadership and decision making. One complication she faced is that she originally relied on family members to fill management roles in the business. Over time, she found that she was making some decisions with an eye toward how it would affect her family, rather than what was best for a fast-growing business. Although her family did a good job, Ganahl quickly realized she needed to

focus on her business’s priorities and hire professionals with the specialized expertise to support her long-term goal of opening 1,000 Camp Bow Wows worldwide.

Camp Bow Wow operates in 122 locations and rings up $71 million in total revenues, including about $4 million in franchise fees. Recently analyzing the competition and future opportunities, Ganahl knew she would need significant financial backing for Camp Bow Wow to blossom into a major force in the dog day-care market. Thus, she sold her firm to VCA, a large pet health-care company that owns hundreds of animal hospitals and diagnostic centers. Next, applying the enthusiasm and personal touch for which she’s known, Ganahl picked up the phone and called every franchise owner to deliver the news and explain the implications.

As part of the deal with VCA, Ganahl has hired a president to manage Camp Bow Wow’s daily operations. Taking this step frees the founder to spend more time planning for the future and making strategic decisions about innovative new products to satisfy the changing needs of dog owners and their dogs. Ganahl is aiming high as she plans to increase the company’s share of the $5 billion market for pet-related goods and services by attracting many more customers and many more franchisees in the coming years.17

Questions 1. When Heidi Ganahl talks with franchisees about perfor-

mance expectations and measurements, what part of the management process is she describing? Why is this so important in a franchising business?

2. How would you describe Heidi Ganahl’s leadership style? Why is it appropriate for her role at Camp Bow Wow?

3. Managers need five key skills to succeed. Of the five, which do you think will be most valuable to Heidi Ganahl now that she’s been freed from day-to-day management to spend her time focusing on the future?

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distributed workforce can be less costly to them so they pass on their savings to your organization. 1. Check out a few of these crowdsourcing companies.

What are your thoughts? Do you think they are effective? Why or why not?

2. Which type of leadership is most likely to include the use of crowdsourcing?

3. Can you think of other areas in businesses that can ben- efit from the use of crowdsourcing? What are they?

2. Building Team Skills Over the past few years, an increasing number of employees, stockholders, and customers have demanded to know more about their companies. As a result, more companies have been taking the time to analyze their operations and to prepare mission statements that focus on the purpose of the company. The mission statement is becoming a critical planning tool for successful companies. To make effective decisions, employees must understand the purpose of their company.

assignment 1. Divide into teams and write a mission statement for one

of the following types of businesses: Food service, restaurant Banking Airline Auto repair Cabinet manufacturing 2. Discuss your mission statement with other teams. How

did the other teams interpret the purpose of your com- pany? What is the mission statement saying about the company?

3. Write a one-page report on what you learned about developing mission statements.

3. Researching Different Careers A successful career requires planning. Without a plan, or roadmap, you will find it very difficult, if not impossible, to reach your desired career destination. The first step in planning is to establish your career goal. You then must set objectives and develop plans for accomplishing those objectives. This kind of planning takes time, but it will pay off later.

assignment Complete the following statements: 1. My career objective is to •

•

• This statement should encapsulate what you want to

accomplish over the long run. It may include the type of job you want and the type of business or industry you want to work in. Examples include the following: • My career goal is to work as a top manager in the food

industry. • My career goal is to supervise aircraft mechanics. • My career goal is to win the top achievement award in

the advertising industry. 2. My career objectives are to •

•

• Objectives are benchmarks along the route to a career

destination. They are more specific than a career goal. A statement about a career objective should specify what you want to accomplish, when you will complete it, and any other details that will serve as criteria against which you can measure your progress. Examples include the following: • My objective is to enroll in a management course at Main

College in the spring semester 2016. • My objective is to earn an A in the management course

at Main College in the spring semester 2016. • My objective is to be promoted to supervisor by

January 1, 2018. • My objective is to prepare a status report by September

30 covering the last quarter’s activities by asking Charlie in Quality Control to teach me the procedures.

3. Exchange your goal and objectives statements with another class member. Can your partner interpret your objectives correctly? Are the objectives concise and complete? Do they include criteria against which you can measure your progress? If not, discuss the problem and rewrite the objective.

Endnotes

1 Based on information in Brooks Barnes, “Bob Iger, on Success Streak, Gets 2nd Contract Extension at Disney,” New York Times, October 2, 2014, www.nytimes.com; “How Bob Iger Remade the House that Walt Built,” Chief Executive, August 7, 2014, http:// chiefexecutive.net; “Disney Offers HR Lessons, Best Practices,” Benefits Pro, June 23, 2014, www.benefitspro.com; David A. Price, “Managing Creativity: Lessons from Pixar and Disney Animation,” Harvard Business Review, April 9, 2014, http://hbr.org; www. thewaltdisneycompany.com (accessed July 11, 2015).

2 Gregory Wallace and Chris Isidore, “HP to Split into Two Companies,” CNN Money, October 6, 2014, http://money.cnn.com/2014/10/06/ technology/hp-restructuring-split/index.html?hpt=hp_t2 (accessed June 24, 2015).

3 Starbucks website at http://www.starbucks.com/about-us/company- information/mission-statement (accessed February 10, 2015); Amazon. com website at http://phx.corporate-ir.net/phoenix.zhtml?c=176060&p= irol-factSheet (accessed February 10, 2015); Twitter website at https:// about.twitter.com/company (accessed February 10, 2015).

Chapter 6 Understanding the Management Process 187

4 The Associated Press, “Swedish Fashion Retailer H&M Plans More Store Openings,” The Star, September 25, 2014, http://www.thestar. com/business/2014/09/25/swedish_fashion_retailer_hm_plans_more_ store_openings.html (accessed July 11, 2015).

5 Scott Moritz and Christina Pellegrini, “Blackberry Says Growth in Sight as Turnaround Takes Hold,” Bloomberg, June 19, 2014, http://www. bloomberg.com/news/2014-06-19/blackberry-beats-estimates-as-cost- cutting-plan-fuels-turnaround.html (accessed June 24, 2015).

6 Spencer Jakab, “Best Buy Won’t Fade to Blue,” Wall Street Journal, August 25, 2014, http://online.wsj.com/articles/best-buy-wont-fade- to-blue-ahead-of-the-tape-1408994708 (accessed June 24, 2015); Zack’s Equity Research, “Will Best Buy’s Turnaround Efforts Beat Sector Weakness?” Yahoo Finance, September 16, 2014, http://finance. yahoo.com/news/best-buys-turnaround-efforts-beat-155002603.html (accessed June 24, 2015); Ann Zimmerman and Joan E. Solsman, “Best Buy’s Turnaround Plan Models Unlikely Set of Retailers,” Wall Street Journal, November 15, 2012, http://online.wsj.com/article/SB100014241 27887324556304578119321442547426.html (accessed June 24, 2015).

7 “Hawaii Electric Light’s Contingency Plans as Kilauea Lava Approaches,” KHON, October 3, 2014, http://khon2.com/2014/10/03/ hawaii-electric-lights-contingency-plans-as-kilauea-lava-approaches/ (accessed June 24, 2015).

8 Don Schwabel, “Kip Tendell: How He Created an Employee-First Culture at the Container Store,” Forbes, October 7, 2014, http://www.forbes. com/sites/danschawbel/2014/10/07/kip-tindell-how-he-created-an- employee-first-culture-at-the-container-store/ (accessed June 24, 2015); Aaron Taube, “Why the Container Store Pays Its Employees $50,000 a Year,” Business Insider, October 16, 2014, http://www.businessinsider. com/the-container-store-pays-employees-50000-a-year-2014-10 (accessed June 24, 2015).

9 Heather Kelly, “The CNN10 Startups: Airware,” CNN Money, http://www. cnn.com/interactive/2014/10/tech/cnn10-startups/index.html?hpt=hp_ bn5 (accessed February 10, 2015).

10 Maria Halkias, “Garden Ridge Is Evolving into At Home,” Dallas News, June 16, 2014, http://www.dallasnews.com/business/retail/20140616- garden-ridge-is-evolving-into-at-home.ece (accessed June 24, 2015).

11 Dinah Eng, “New Belgium’s Kim Jordan Is Tasting Success in Craft Brewing,” Fortune, June 30, 2014, http://fortune.com/2014/06/12/new- belgium-kim-jordan/ (accessed June 24, 2015); Bryan Simpson, “New Belgium Brewing: How Intangibles Keep Employees Coming Back for More,” Sustainable Brands, July 2012, http://www.sustainablebrands. com/news_and_views/jul2012/new-belgium-brewing-how-intangibles- keep-employees-coming-back-more (accessed June 24, 2015).

12 Andrew J. Dubrin, Leadership: Research Findings, Practice and Skills, 8th ed. (Mason, OH: South-Western/Cengage Learning, 2016).

13 “EY Entrepreneur of the Year Winner Talks Passion, Persistence, and Resilience,” Forbes, November 16, 2014, http://www.forbes.com/ sites/ey/2014/11/16/ey-entrepreneur-of-the-year-winner-talks-passion- persistence-resilience/ (accessed June 24, 2015).

14 Ricky Griffin, Fundamentals of Management, 8th ed. (Mason, OH: South-Western Cengage, 2016), 6.

15 Christine Haughney, “A Sale Gives a Magazine on Healthy Eating a New Lease on Life,” New York Times, October 21, 2012, http://www. nytimes.com/2012/10/22/business/media/eating-well-magazines- new-lease-on-life.html (accessed June 24, 2015).

16 Martin Murray, “Total Quality Management (TQM),” http://logistics.about. com/od/qualityinthesupplychain/a/TQM.htm (accessed February 10, 2015).

17 Based on information in Heidi Ganahl, “My Turn: Changes to Franchise Rules Would Do Much Harm to Small-Business Owners,” Concord (NH) Monitor, February 6, 2015, www.concordmonitor.com (accessed July 7, 2015); Caroline McMillan Portillo, “How Did She Turn a Plane Crash and Two Flops into a $71M Company? Dogs,” BizWomen, August 12, 2014, www.bizjournals.com; Ryan Dezember, “VCA to Acquire Camp Bow Wow Chain,” Wall Street Journal, August 4, 2014, www.wsj.com; Cengage Learning, Camp Bow Wow video.

Learning Objectives Once you complete this chapter, you will be able to:

7-1 Understand what an organization is and identify its characteristics. 7-2 Explain why job specialization is important. 7-3 Identify the various bases for departmentalization. 7-4 Explain how decentralization follows from delegation. 7-5 Understand how the span of management describes an organization.

7-6 Describe the four basic forms of organizational structure. 7-7 Describe the effects of corporate culture. 7-8 Understand how committees and task forces are used. 7-9 Explain the functions of the informal organization and the grapevine in a

business.

Creating a Flexible Organization

Chapter

7 Why Should You Care? To operate a successful business,

those in charge must create

an organization that operates

efficiently and is able to attract

employees.

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To survive and to grow, companies such as McDonald’s must constantly look for ways to improve their methods of doing business. Managers at McDonald’s, like those at many organizations, maintain an organizational structure that best achieves company goals and creates products that foster long-term customer relationships.

When firms are organized, or reorganized, the focus is sometimes on achieving low operating costs. Other firms, such as Nike, emphasize providing high-quality products to ensure customer satisfaction. The issue of a firm’s organizational structure is important because it can influence performance.

We begin this chapter by examining the business organization—what it is and how it functions in today’s business environment. Next, we focus one by one on five characteristics that shape an organization’s structure. We discuss job specialization within a company, the grouping of jobs into manageable units or departments, the delegation of power from management to workers, the span of management, and establishment of a chain of command. Then we step back for an overall view of organizational structure, describe the effects of corporate culture, and focus in on how committees and task forces are used. Finally, we look at the network of social interactions—the informal organization—that operates within the formal business structure.

7-1 What is an OrganizatiOn? We used the term organization throughout Chapter 6 without really defining it, mainly because its everyday meaning is close to its business meaning. Here, however, let us agree that an organization is a group of two or more people working together

Learning Objective

7-1Understand what an organization is and identify its characteristics.

organization a group of two or more people working together to achieve a common set of goals

Can Structural Changes re-Ignite McDonald’s Growth?

although Mcdonald’s leads the world in fast-food restaurant reve-nues, competitors are nibbling away at its U.S. market share and profits. Some rivals are attracting customers with fancier burgers or healthier fare, while others are inviting customers to pick and choose sandwich toppings. Now, facing stagnant U.S. sales after decades of steady growth, Mcdonald’s is getting closer to its customers by changing its organizational structure as well as its menu.

in the past, Mcdonald’s organized its U.S. operations into three regional divisions (east, Central, and West). Managers in those regions provided ideas and input for decisions made at cor- porate headquarters. However, decision making was a slow process because information, analyses, and communications had to move through multiple layers of managers up and down the organization.

To speed things up, and stay in tune with local customers, the fast-food company is eliminating some management layers and switching to a four-zone structure (Northeast, South, Central, and West). States are grouped into zones not just for efficiency but also to reflect regional taste preferences. in this new structure, each zone’s president has the authority to make decisions about products and

promotions based on the needs and buying patterns of local custom- ers. By expediting decision making, Mcdonald’s hopes to respond more quickly to changes in customer buying behavior and—just as important—to more effectively fend off competitive challenges.

Mcdonald’s has also put its menu on a diet. Too many choices was complicating ordering and adding precious seconds to prepara- tion time—which, in turn, slowed service in the drive-through lanes and inside the restaurants. instead, Mcdonald’s is paring the number of menu items, adding a few healthier food choices, and allowing each zone to promote special items that prove popular with local customers. Some zones are testing “create your taste” customized ordering so customers can select the specific sandwich toppings they like. Others are testing service guarantees. Will these organizational changes enable Mcdonald’s to reignite growth in revenues and profits?1

Did You Know? With global annual revenues topping $28 billion, McDonald’s serves 70 million customers each day through more than 35,000 restaurants in 100 nations.

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to achieve a common set of goals. A neighborhood dry cleaner owned and operated by a husband-and-wife team is an organization. IBM and Home Depot, which employ thousands of workers worldwide, are also organizations. Although each corporation’s organizational structure is more complex than the dry-cleaning establishment, all must be organized to achieve their goals.

An inventor who goes into business to produce and market a new invention hires people, decides what each will do, determines who will report to whom, and so on. These activities are the essence of organizing, or creating, the organization. An organization chart helps to illustrate the shape of an organization.

7-1a Developing Organization Charts An organization chart is a diagram that represents the positions and relationships within an organization. An example of an organization chart is shown in Figure 7-1. Each rectangle represents a particular position or person in the organization. At the top is the president, next are the vice presidents, and so on. The solid vertical lines connecting each level of the hierarchy indicate who is in the chain of command. The chain of command is the line of authority that extends from the highest to the lowest levels of the organization. You can see that each vice president reports directly to the president. Similarly, the plant managers, regional sales managers, and accounting department manager report to the vice presidents. An organization’s chain

organization chart a diagram that represents the positions and relationships within an organization

chain of command the line of authority that extends from the highest to the lowest levels of an organization

Figure 7-1 A Typical Corporate Organization Chart

A company’s organization chart depicts the positions and relationships within the organization and shows the managerial chains of command.

District manager

Regional sales manager

Supervisor Supervisor

Accounting department manager

Vice president, marketing

President

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of command can be short or long. A small local restaurant may have a very short chain of command consisting of the owner at the top and employees below. Large multinational corporations, on the other hand, may have very long chains of command. No matter what the length of the chain of command, organizations must ensure that communication along the chain is clear. Not everyone who works for an organization is part of the direct chain of command. In the chart these positions are represented by broken lines, as you can see with the directors of legal services, public affairs, and human resources. Instead, they hold advisory, or staff, positions. This difference will be examined later in the chapter when we discuss line-and-staff positions.

Most smaller organizations find organization charts useful. They clarify positions and relationships for everyone in the organization, and they help managers to track growth and change in the organizational structure. However, many large organizations, such as ExxonMobil, Kellogg’s, and Procter & Gamble, do not maintain complete, detailed charts. There are two reasons for this. First, it is difficult to chart even a few dozen positions accurately, much less the thousands that characterize larger firms. Second, larger organizations are almost always changing parts of their structure. An organization chart would be outdated before it was completed. Increasingly, technology can help even large and complicated organizations implement up-to-date organization charts.

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District manager

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Supervisor Supervisor

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President

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7-1b Major Considerations for Organizing a Business When a firm is started, management must decide how to organize the firm. These decisions focus on job design, departmentalization, delegation, span of management, and chain of command. In the next several sections, we discuss major issues associated with these dimensions.

7-2 JOb Design In Chapter 1, we defined specialization as the separation of a manufacturing process into distinct tasks and the assignment of different tasks to different people. Here we are extending that concept to all the activities performed within an organization.

7-2a Job Specialization Job specialization is the separation of all organizational activities into distinct tasks and the assignment of different tasks to different people. Adam Smith, the 18th century economist whose theories gave rise to capitalism, was the first to emphasize the power of specialization in his book, The Wealth of Nations. According to Smith, the various tasks in a particular pin factory were arranged so that one worker drew the wire for the pins, another straightened the wire, a third cut it, a fourth ground the point, and a fifth attached the head. Smith claimed that 10 men were able to produce 48,000 pins per day. Before specialization, they could produce only 200 pins per day because each worker had to perform all five tasks!

7-2b the rationale for Specialization For a number of reasons, some job specialization is necessary in every organization because the “job” of most organizations is too large for one person to handle. In a firm such as Ford Motor Company, thousands of people are needed to manufacture

automobiles. Others are needed to sell the cars, control the firm’s finances, and so on.

Second, when a worker has to learn one specific, highly specialized task, that individual can learn it quickly and perform it efficiently. Third, a worker repeating the same job does not lose time changing operations, as the pin work- ers did when producing complete pins. Fourth, the more specialized the job, the easier it is to design specialized equipment. And finally, the more specialized the job, the easier the job training.

7-2c alternatives to Job Specialization Unfortunately, specialization can have negative consequences. The most significant drawback is the boredom and dissatisfaction employees may feel when repeating the same job. Bored employees may be absent from work frequently, not put much effort into their work, and even sabotage the company’s efforts to produce quality products.

Concept Check ✓✓ How do large and small organizations use organization charts differently?

✓✓ identify the major considerations when organizing a business.

Learning Objective

7-2 Explain why job specialization is important.

job specialization the separation of all organizational activities into distinct tasks and the assignment of different tasks to different people

Specialization has its drawbacks. This employee has a specialized job that includes stitching a component of leather shoes. Specialization is efficient for the firm, but it can leave employees bored and dissatisfied. What do you think a firm can do to offset these problems?

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To combat these problems, managers often turn to job rotation. Job rotation is the systematic shifting of employees from one job to another. For example, a worker may be assigned a different job every week for a four-week period and then return to the first job in the fifth week. Job rotation provides a variety of tasks so that workers are less likely to become bored and dissatisfied. Intel, for instance, encourages job rotation as a means of sharing ideas, perspectives, and best practices across the company. Job rotation helps workers stay interested in their jobs, develop new skills, and identify new roles where they may want to focus their energies in the future. According to the Society for Human Resource Management, around 38 percent of employers offer some kind of cross-training for their workers.2

Two other approaches—job enlargement and job enrichment—also can provide solutions to the problems caused by job specialization. These topics, along with other methods used to motivate employees, are discussed in Chapter 10.

7-3 DePartmentaLizatiOn After jobs are designed, they must be grouped together into “working units,” or departments. This process is called departmentalization, which is the process of grouping jobs into manageable units. Today, the most common bases for organizing a business into effective departments are by function, by product, by location, and by customer.

7-3a By Function Departmentalization by function groups jobs that relate to the same organizational activity. Under this scheme, all marketing personnel are grouped together in the marketing department, all production personnel in the production department, and so on.

job rotation the systematic shifting of employees from one job to another

Concept Check ✓✓ What are the positive and negative effects of specialization?

✓✓ What are three ways to reduce the negative effects of specialization?

Learning Objective

7-3 Identify the various bases for departmentalization. departmentalization the process of grouping jobs into manageable units

departmentalization by function grouping jobs that relate to the same organizational activity

Flexible Work Space: are You ready to Sit Next to the CeO?

Private offices and permanent desk assignments are so 20th century. The latest trend is temporary seating assignments, in which managers and employees alike occupy desks on a “first-come, first served” basis or as needed. At the Goodman Birtcher real estate firm in California, for example, the CEO begins his day by retrieving desk accessories and files from his private locker. Next, he scouts for an empty chair, plugs his laptop into the monitor on that desk, spreads out his files, and gets to work. Colleagues from every corner of the organization chart do the same, reserving private conference rooms when needed for meetings with clients.

One goal of flexible workspaces is to encourage communication and collaboration among employees at all levels. Another is to save money by having fewer desks and offices, knowing that on any given day, some employees will work from home or travel on business. Citicorp did away with assigned desks in its corporate human resources

department, for example. Now, employees choose an empty desk in a color-coded work “neighborhood,” depending on whether their job relates to compensation, training and development, or another specialty. Employees use headsets for phone conversations, and white noise machines minimize distracting sounds in each neighborhood.

The U.S. General Services Administration recently switched to a system it calls “hoteling,” in which employees reserve a desk day by day, as needed. This means office space is used more efficiently. It also improves productivity, because team members can sit near each other while working on a project, and then move to new seats for new projects.

Sources: Based on information in ellen Galinsky and eve Tahmincioglu, “Why Citi Got rid of assigned desks,” Harvard Business Review, November 12, 2014, http://hbr.org; lana Bortolot, “designing a Better Office Space,” Entrepreneur, July 26, 2014, www.entrepreneur. com; kimberly pierceall, “irvine Firm ditches Cubicles for lockers,” Orange County Register, November 18, 2013, www.ocregister.com; andrew Siddons, “To Cut Costs, Federal Workers Become Nomads,” New York Times, July 7, 2014, www.nytimes.com.

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Most smaller and newer organizations departmentalize by function. Supervision is simplified because everyone is involved in the same activities and coordination is easy. The disadvantages of this method of grouping jobs are that it can lead to slow decision making and it tends to emphasize the department over the organization as a whole.

7-3b By product Departmentalization by product groups activities related to a particular good or service. This approach is used often by older and larger firms that produce and sell a variety of products. Each department handles its own marketing, production, financial management, and human resources activities.

Departmentalization by product makes decision making easier and provides for the integration of all activities associated with each product. However, it causes some duplication of specialized activities— such as finance—between departments. Moreover, the emphasis is placed on the product rather than on the whole organization.

7-3c By Location Departmentalization by location groups activities according to the defined geographic area in which they are performed. Departmental areas may range from whole countries (for international firms) to regions within countries (for national firms) to

areas of several city blocks (for police departments organized into precincts). For example, Ford has divisions for the Americas, Europe, Asia Pacific and Africa, and China. Departmentalization by location allows the organization to respond readily to the unique demands or requirements of different locations. Nevertheless, a large administrative staff and an elaborate control system may be needed to coordinate operations across many locations.

7-3d By Customer Departmentalization by customer groups activities according to the needs of various customer populations. The advantage of this approach is that it allows the firm to deal efficiently with unique customers or customer groups. The biggest drawback is that a larger-than-usual administrative staff is needed.

7-3e Combinations of Bases Many organizations use a combination of departmentalization bases. PepsiCo, for instance, is divided by product and location. It has product divisions such as Americas Beverages and Americas Foods, as well as divisions based on location such as Asia, Europe, the Middle East, and Africa.3

Take a moment to examine Figure 7-2. Notice that departmentalization by customer is used to organize New-Wave Fashions, Inc., into three major divisions: Men’s, Women’s, and Children’s clothing. Then functional departmentalization is used to distinguish the firm’s production and marketing activities. Finally, location is used to organize the firm’s marketing efforts.

departmentalization by product grouping activities related to a particular product or service

departmentalization by location grouping activities according to the defined geographic area in which they are performed

departmentalization by customer grouping activities according to the needs of various customer populations

Concept Check ✓✓ What are the four most common bases for departmentalization?

✓✓ Give an example of each.

How is your school organized? These call center employees are organized by their function. Some organizations are structured in other ways. For example, if your university has more than one campus, they are organized by location but also by function such as by their business, social sciences, and math departments. Your school also might be organized by customer such as by undergraduate, graduate, and continuing education students.

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7-4 DeLegatiOn, DeCentraLizatiOn, anD CentraLizatiOn The third major step in the organizing process is to distribute power in the organization. Delegation assigns work and power to other workers. The degree of centralization or decentralization of authority is determined by the overall pattern of delegation within the organization.

7-4a Delegation of authority Because no manager can do everything, delegation is vital to completion of a manager’s work. Delegation is also important in developing the skills and abilities of subordinates. It allows those who are being groomed for higher-level positions to play increasingly important roles in decision making.

StepS IN DeLeGatION The delegation process generally involves three steps (see Figure 7-3). First, the manager must assign responsibility. Responsibility is the duty to do a job or perform a task. In most job settings, a manager simply gives the worker a job to do. Typical job assignments might range from preparing a report on the status of a new quality control program to being put in charge of a task force. Second, the manager must grant authority. Authority is the power, within the organization, to accomplish an assigned job or task. This might include the power to obtain specific information, order supplies, authorize relevant expenditures, or make certain decisions. Finally, the manager must create accountability. Accountability is the obligation of a worker to accomplish an assigned job or task.

Note that accountability is created but it cannot be delegated. Suppose that you are an operations manager for Target and are responsible for performing a specific task. You, in turn, delegate this task to someone else. You nonetheless remain accountable to your immediate supervisor for getting the task done properly. If the

Learning Objective

7-4 Explain how decentralization follows from delegation.

delegation assigning part of a manager’s work and power to other workers

responsibility the duty to do a job or perform a task

authority the power, within an organization, to accomplish an assigned job or task

accountability the obligation of a worker to accomplish an assigned job or task

Figure 7-2 Multibase Departmentalization for New-Wave Fashions, Inc.

Most firms use more than one basis for departmentalization to improve efficiency and to avoid overlapping positions.

Design Cutting Sewing Western region

Midwestern region

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other person fails to complete the assignment, you—not the person to whom you delegated the task—will be held accountable.

BarrIerS tO DeLeGatION For several reasons, managers may be unwilling to delegate work. This may be because the manager does not trust the employee to complete the task, or because the manager fears the employee will perform exceptionally and attract the notice of higher level managers. Finally, some managers do not delegate because they are disorganized and they are not able to plan and assign work effectively.

7-4b Decentralization of authority The pattern of delegation throughout an organization determines the extent to which that organization is decentralized or centralized. In a decentralized organization, management consciously attempts to spread authority widely across various organization levels. A centralized organization, on the other hand, systematically works to concentrate authority at the upper levels. For example, shipping companies like UPS tend to be centralized, with shipping dispatches coordinated by upper management. After merging with OfficeMax, Office Depot restructured its European operations to reduce costs by centralizing and standardizing processes across all European countries.4 Large organizations may have characteristics of both decentralized and centralized organizations.

A number of factors can influence the extent to which a firm is decentralized. One is the external environment in which the firm operates. The more complex and unpredictable this environment, the more likely it is that top management will let lower- level managers make important decisions because lower-level managers are closer to the problems. Another factor is the nature of the decision itself.

decentralized organization an organization in which management consciously attempts to spread authority widely in the lower levels of the organization

centralized organization an organization that systematically works to concentrate authority at the upper levels of the organization

Delegate, delegate, delegate. The industrialist Andrew Carnegie once said, “No person will make a great business who wants to do it all himself or get all the credit.” Delegating gives employees different tasks to do, which can enrich and enlarge their jobs. It also enables both employees and their superiors to learn new skills required for higher-level positions.

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Figure 7-3 Steps in the Delegation Process

To be successful, a manager must learn how to delegate. No one can do everything alone.

Assign responsibility

Manager

THE DELEGATION PROCESS

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The riskier or more important the decisions that have to be made, the greater the tendency to centralize decision making. A third factor is the abilities of lower-level managers. If these managers do not have strong decision-making skills, top managers will be reluctant to decentralize. Finally, a firm that has practiced centralization or decentralization is likely to maintain that same posture in the future.

In principle, neither decentralization nor centralization is right. What works for one organization may or may not work for another. Every organization must assess its own situation and choose the level of centralization or decentralization that will work best.

7-5 the sPan OF management The fourth major step in organizing a business is establishing the span of management (or span of control), which is the number of workers who report directly to one manager. Hundreds of years of research has shown that there is no perfect ratio of subordinates to managers. More recently, theorists have focused on the width of the span of management. This issue is complicated because the span of management may change by department within the same organization. A highly mechanized factory where all operations are standardized may allow for a wide span of management. An advertising agency, where new problems and opportunities arise every day and where teamwork is a constant necessity, will have a much narrower span of management.

7-5a Wide and Narrow Spans of Management A wide span of management exists when a manager has a larger number of subordinates. A narrow span exists when the manager has only a few subordinates. Several factors determine the span that is best for a particular manager (see Figure 7-4). Generally, the span of management may be wide when (1) the manager and the subordinates are very competent, (2) the organization has a well-established set of standard operating procedures, and (3) few new problems are expected to arise. The span should be narrow when (1) workers are physically located far from one another,

Concept Check ✓✓ identify and describe the three steps in the delegation process.

✓✓ differentiate decentralized organization and centralized organization.

Learning Objective

7-5 Understand how the span of management describes an organization.

Figure 7-4 The Span of Management

Several criteria determine whether a firm uses a wide span of management, in which a number of workers report to one manager, or a narrow span, in which a manager supervises only a few workers.

WIDE SPAN

• High level of competence in managers and workers

• Standard operating procedures • Few new problems

NARROW SPAN

• Physical dispersion of subordinates • Manager has additional tasks • High level of interaction required

between manager and workers • High frequency of new problems

Flat organization

Tall organization

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(2) the manager has much work to do in addition to supervising workers, (3) a great deal of interaction is required between supervisor and workers, and (4) new problems arise frequently.

7-5b Organizational height The span of management has an obvious impact on relations between managers and workers. It has a more subtle, but equally important, impact on the height of the organization. Organizational height is the number of layers, or levels, of management in a firm. The span of management plays a direct role in determining the height of the organization (see Figure 7-4). If the span of management is wide, fewer levels are needed, and the organization is flat. If the span of management is narrow, more levels are needed, and the resulting organization is tall.

In a tall organization, administrative costs are higher because more managers are needed. Communication may become distorted because information has to pass up and down through more levels. When companies

are cutting costs, one option is to decrease organizational height in order to reduce related administrative expenses. For example, in the wake of fallout from the 2008 financial crisis and stricter rules on risky forms of investing, major Swiss bank UBS laid off 10,000 employees (15 percent of staff) and scrapped its risky fixed income business. These steps were meant to simplify the company’s structure and help it return to its roots as a private banker.5 Although flat organizations avoid these problems, their managers may perform more administrative duties simply because there are fewer managers. Wide spans of management also may require managers to spend considerably more time supervising and working with subordinates.

7-6 FOrms OF OrganizatiOnaL struCture Up to this point, we have focused our attention on the major characteristics of organizational structure. In many ways, this is like discussing the parts of a jigsaw puzzle one by one. It is now time to put the puzzle together. We will next discuss four basic forms of organizational structure: line, line-and-staff, matrix, and network.

7-6a the Line Structure The simplest and oldest form of organizational structure is the line structure, in which the chain of command goes directly from person to person throughout the organization. Thus, a straight line could be drawn down through the levels of management, from the chief executive down to the lowest level in the organization. In a small retail store, for example, an hourly employee might report to an assistant manager, who reports to a store manager, who reports to the owner.

Managers within a line structure, called line managers, make decisions and give orders to subordinates to achieve the organization’s goals. A line structure’s simplicity and clear chain of command allow line managers to make decisions quickly with direct accountability because the decision maker only has one supervisor to whom he or she reports.

The downside of a line structure is that line managers are responsible for many activities, and therefore must have a wide range of knowledge about all of them. While this

organizational height the number of layers, or levels, of management in a firm

Concept Check ✓✓ describe the two spans of management.

✓✓ What are problems associated with each one?

Learning Objective

7-6 Describe the four basic forms of organizational structure.

line structure an organizational structure in which the chain of command goes directly from person to person throughout the organization

line managers a position in which a person makes decisions and gives orders to subordinates to achieve the organization’s goals

Narrow versus wide spans of management: Which is better? The manager in the middle of the photo supervises only a handful of employees. Consequently, she has a narrow span of management. Companies are constantly searching for the ideal number of employees their supervisors should manage.

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may not be a problem for small organizations with a lower volume of activities, in a larger organization, activities are more numerous and complex, thus making it more difficult for line managers to fully understand what they are in charge of. Therefore, line managers in a larger organization would have a hard time making an educated decision without expert advice from outside sources. As a result, line structures are not very effective in medium- or large-sized organizations, but are very popular in small organizations.

7-6b the Line-and- Staff Structure A line-and-staff structure not only utilizes the chain of command from a line structure but also provides line managers with specialists, called staff managers. Therefore, this structure works much better for medium- and large-sized organizations than line management alone. Staff managers provide support, advice, and expertise to line managers, thus eliminating the major drawback of line structures. Staff managers are not part of the chain of command like line managers are, but they do have authority over their assistants (see Figure 7-5).

line-and-staff structure an organizational structure that utilizes the chain of command from a line structure in combination with the assistance of staff managers

staff managers a position created to provide support, advice, and expertise within an organization

Do you have a mentor?

Personal App

If you’re looking to move up, try to get some advice from co-workers in both line and staff positions. Not only will this broaden your understanding of the organization, it will also help you bridge the gaps between line and staff and connect with both groups.

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Figure 7-5 Line and Staff Managers

A line manager has direct responsibility for achieving the company’s goals and is in the direct chain of command. A staff manager supports and advises the line managers.

Regional sales manager

Accounting department manager

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President

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Both line and staff managers are needed for effective management, but the two positions differ in important ways. Most importantly, line managers have line

authority, which means that they can make decisions and issue directives relating to the organization’s goals. Staff managers seldom have this kind of authority. Instead, they usually have either advisory authority or functional authority. Advisory authority is the expectation that line managers will consult the appropriate staff manager when making decisions. Functional authority is a stronger form. It is the authority of staff managers to make decisions and issue directives about their areas of expertise. For example, a legal adviser for Nike can decide whether to retain a particular clause in a contract but not product pricing.

Staff managers in a line-and-staff structure tend to have more access to information than line managers. This means that line managers must rely on the staff managers for information. This is usually not an issue, unless the staff manager makes a wrong decision and there is no one else to catch his or her mistake.6 For a variety of reasons, conflict between line managers and staff managers is fairly common in business. Staff managers often have more formal education and sometimes are younger (and perhaps more ambitious) than line managers. Line managers may perceive staff managers as a threat to their own authority and thus may resent them. For their part, staff managers may become annoyed or angry if their expert recommendations are not adopted by line management.

Line-and-staff organization structure. Ronald McDonald occupies a staff position and does not have direct authority over other employees at McDonald’s. Steve Easterbrook, McDonald’s CEO, does have direct authority over other McDonald’s employees and thus occupies a line position.

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If We Get ethics right, Will Compliance Follow?

During the past two decades, hundreds of corporations, as well as many educational institutions, nonprofit groups, and government agencies, have established the chief ethics officer as a staff position. This senior management- level position serves as the central point of organizational contact for formulating ethics guidelines, communicating ethical values, and dealing with reports of potential ethics violations. Often, the chief ethics officer works with the staff executive who is responsible for ensuring compliance with the various local, state, national, and international laws and regulations governing the organization’s products, operations, and facilities.

At L’Oreal, which has been named one of the world’s most ethical companies, the chief ethics officer makes a distinction between enforcing compliance and instilling ethical behavior. “If we get ethics right, compliance will follow,” he says. The company’s core ethics values are respect, integrity, courage, and transparency. Every year, L’Oreal invites all employees to participate in a global ethics day event, during

which they can discuss ethical issues with the chief executive officer. The goal is to encourage the work force to ask questions and to speak up about what’s happening in any division or unit.

Even organizations with a chief ethics officer may discover potentially unethical behavior at some point. Walmart, for example, is investigating allegations of bribery and corruption in Mexico, China, and other countries. The retailer has developed a detailed, multinational compliance plan and is investing $100 million in compliance technology. Both its chief ethics officer and chief compliance officer report to a committee of the board of directors to allow for top-level discussions about possible problems.

Sources: Based on information in Sue reisinger, “Wal-Mart Compliance Chief looking Beyond the Scandals,” Corporate Council, October 21, 2014, www.corpcounsel.com; elizabeth a. Harris, “after Bribery Scandal, High-level departures at Walmart,” New York Times, June 4, 2014, www.nytimes.com; rachel louise ensign, “Q&a: emmanuel lulin, l’Oreal’s Chief ethics Officer,” Wall Street Journal, November 12, 2013, www.wsj.com; http://corporate.walmart.com (accessed January 15, 2015).

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Fortunately, there are several ways to minimize the likelihood of such conflict. One way is to integrate line and staff managers into one team. Another is to ensure that the areas of responsibility of line and staff managers are clearly defined. Finally, line and staff managers both can be held accountable for the results of their activities.

7-6c the Matrix Structure The matrix structure combines vertical and horizontal lines of authority, forming a matrix shape in the organization chart. The matrix structure occurs when product departmentalization is superimposed on a functionally departmentalized organization. In a matrix organization, authority flows both down and across and individuals report to more than one superior at the same time.

To understand the structure of a matrix organization, consider the usual functional arrangement, with people working in departments such as engineering, finance, and marketing. Now suppose that we assign people from these departments to a special group that is working on a new project as a team—a cross-functional team. A cross-functional team consists of individuals with varying specialties, expertise, and skills that are brought together to achieve a common task. Frequently, cross-functional teams are charged with the responsibility of developing new products. The manager in charge of a team is usually called a project manager. Any individual who is working with the team reports to both the project manager and the individual’s superior in the functional department (see Figure 7-6).

Cross-functional team projects may be temporary, in which case the team is disbanded once the mission is accomplished, or they may be permanent. As the world becomes more connected, many companies require managers to have had cross-functional team experience. Major corporations such as GE, Whirlpool,

matrix structure an organizational structure that combines vertical and horizontal lines of authority, usually by superimposing product departmentalization on a functionally departmentalized organization

cross-functional team a team of individuals with varying specialties, expertise, and skills that are brought together to achieve a common task

Figure 7-6 A Matrix Structure

A matrix is usually the result of combining product departmentalization with function departmentalization. It is a complex structure in which employees have more than one supervisor.

Project manager

Vice president, engineering

Project manager

Vice president, production

Vice president, �nance

Vice president, marketing

CEO

Employees

202 Part 3 Management and Organization

and Procter & Gamble all utilize the diverse viewpoints that come out of cross- functional teams.

These teams often are empowered to make major decisions. When a cross- functional team is employed, prospective team members may receive special training because effective teamwork can require different skills. For cross-functional teams to be successful, team members must be given specific information on the job each performs. The team must also develop a sense of cohesiveness and maintain good communications among its members.

Matrix structures offer advantages over other organizational forms, added flex- ibility probably being the most obvious one. The matrix structure also can increase productivity, raise morale, and nurture creativity and innovation. In addition, employees experience personal development through doing a variety of jobs.

The matrix structure also has disadvantages. Having employees report to more than one supervisor can cause confusion about who is in charge. Like committees, teams may take longer to resolve problems and issues than individuals working alone. Other difficulties include personality clashes, poor communication, undefined individual roles, unclear responsibilities, and difficulties in finding ways to reward individual and team performance simultaneously. Because more managers and sup- port staff may be needed, a matrix structure may be more expensive to maintain.

7-6d the Network Structure In a network structure (sometimes called a virtual organization), administration is the primary function performed, and other functions such as engineering, production, marketing, and finance are contracted out to other organizations. Frequently, a network organization does not manufacture the products it sells. This type of organization has a few permanent employees consisting of top management and hourly clerical workers. Leased facilities and equipment, as well as temporary

network structure an organizational structure in which administration is the primary function, and most other functions are contracted out to other firms

entrepreneurs Set the tone of Corporate Culture

Even the smallest business can build a strong and vibrant corporate culture—starting with the entrepreneur’s vision and values. By demonstrating, communicating, celebrating, and reinforcing what’s important, you can, as an entrepreneur, cultivate a strong culture to support long-term growth and success. Here are three tips from entrepreneurs and experts: • Hire employees who share your values and who believe

in the business and its mission. Employees whose values aren’t aligned with yours are likely to be less committed and less productive. A shared belief in specific values and vision “keeps the team focused and moving forward with purpose, against all odds,” explains Elena Bajic, the founder of Ivy Exec, an executive search firm.

• Involve employees in activities that perpetuate the culture. From awards ceremonies to after-work parties, every small business needs rituals built around the entrepreneur’s values. At Stylerunner, a small business

in Sydney, Australia, employees gather for twice-weekly “gratitude sessions” where they talk about the things and people they’re thankful for. This ritual reflects the co-founders’ emphasis on positive thinking and on how people make a difference.

• Live the values by applying them in every business decision and action. Employees will take their cue from what the entrepreneur does, day in and day out, not just what he or she says. “You can delegate everything else, but you must always hold the culture in your hands,” says consultant Sharon Hadary.

Sources: Based on information in Sharon Hadary, “Five Ways entrepreneurs Can keep a Great Corporate Culture,” Wall Street Journal, June 12, 2014, www.wsj.com; eric Thome, “Three Ways to Maintain your Small-Business Culture,” Wall Street Journal, June 12, 2014, www. wsj.com; Sarah kimmorley, “How the Twin Sisters Behind Stylerunner put a Quirky Company Culture at the Heart of Their Strategy,” Business Insider (Australia), december 19, 2014, www. businessinsider.com.au; elena Bajic, “Corporate Culture: Creating and Cultivating Company ‘Charisma,’” Forbes.com, May 7, 2013.

Entrepreneurial Success

Chapter 7 Creating a Flexible Organization 203

workers, are increased or decreased as the organization’s needs change. Thus, there is limited formal structure associated with a network organization.

An obvious strength of a network structure is flexibility that allows the organization to adjust quickly to changes. Network structures consist of a lot of teams working together, rather than relying on one centralized leader. One noteworthy benefit is that firms with a network structure are more likely to survive the loss of an important member. Some of the challenges faced by managers in network-structured organizations include controlling the quality of work performed by other organizations, low morale and high turnover among hourly workers, and a lack of a clear hierarchy.

7-7 COrPOrate CuLture Most managers function within a corporate culture. A corporate culture is generally defined as the inner rites, rituals, heroes, and values of a firm. An organization’s culture has a powerful influence on how employees think and act. It also can determine public perception of the organization.

Corporate culture generally is thought to have a very strong influence on a firm’s performance over time. Hence, it is useful to be able to assess a firm’s corporate culture. Common indicators include the physical setting (building or office layouts), what the company says about its corporate culture (in advertising or news releases), how the company greets guests (formal or informal reception areas), and how employees spend their time (working alone in an office or working with others).

Researchers Rob Goffee and Gareth Jones identified four distinct types of corporate cultures (see Figure 7-7). One is called the networked culture, characterized by a base of trust and friendship among employees, a strong commitment to the organization, and an informal environment. A small nonprofit organization may seek to build a networked culture where employees look out for each other and believe strongly in the organizational mission. Building a networked culture in such an organization is important because employees may have to work long hours for relatively little pay, and a strong sense of community and commitment helps to keep productivity high and turnover low.

Learning Objective

7-7 Describe the effects of corporate culture.

corporate culture the inner rites, rituals, heroes, and values of a firm

Figure 7-7 Types of Corporate Cultures

Which corporate culture would you choose?

• Extrovert energized by relationships • Tolerant of ambiguities and have low needs for

structure • Can spot politics and act to stop “negative” politics • Consider yourself easygoing, affable, and loyal to others

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Networked Culture Communal Culture

• You consider yourself passionate • Strong need to identify with something bigger than yourself • You enjoy being in teams • Prepared to make sacrifices for the greater good

Fragmented Culture

• Have a strong sense of self

• Are a reflective and self-contained introvert • Have a high autonomy drive and strong desire to work independently

Mercenary Culture

• Goal-oriented and have an obsessive desire to complete tasks • Thrive on competitive energy • Keep “relationships” out of work—develop them

Source: “Types of Corporate Culture,” in rob Goffee and Gareth Jones, The Character of a Corporation (New york: HarperCollins, 1998). Copyright © 1998 by rob Goffee and Gareth Jones. permission granted by rob Goffee and Gareth Jones.

Concept Check ✓✓ describe the four forms of organizational structure.

✓✓ Give an example of each form.

204 Part 3 Management and Organization

The phrase mercenary culture may have a negative connotation, but it also involves a high degree of passion, energy, sense of purpose, and excitement for one’s work. Large banks and investment firms often have mercenary cultures because the environment is fast-paced, the stakes are high, and winning is important. This kind of culture can be very stressful for an employee with an incompatible personality. The term mercenary does not imply that employees are motivated to work only for the money, although financial gain does play a role. In this culture, employees are very intense, focused, and determined to win. For example, years after the 2008 economic crisis, Barclays, a major financial company, is still being criticized by U.S. and British regulators for its mercenary culture. Accusations include an excessive risk-taking culture and encouraging employees to win by any means. Although new CEO Antony Jenkins has vowed to restore Barclay’s culture, similar allegations of conduct continue to dog the British firm.7

In the fragmented culture, employees do not become friends, and they work “at” the organization, not “for” it. Employees have a high degree of autonomy, flexibility, and equality.

The communal culture combines the positive traits of the networked culture and the mercenary culture—those of friendship, commitment, high focus on performance, and high energy. People’s lives revolve around the product in this culture, and success by anyone in the organization is celebrated by all.8

Some experts believe that cultural change is needed when a com- pany’s environment changes, such as when the industry becomes more

competitive, the company’s performance is mediocre, or when the company is growing. It is not uncommon that companies feel they must adjust their culture in order to attract top talent. For example, many companies have formally come out in favor of same-sex marriage, including General Mills, Alcoa, and Aetna. Having a nondiscriminatory cul- ture is seen as important for maintaining a strong workforce for many corporations.9

Organizations in the future will look quite different, as technology allows more to be done in small, flexible work groups that are coordinated by computers and held together by strong corporate cultures. Businesses operating in fast-changing industries will require leadership that supports trust and risk taking. Creating a culture of trust in an organization can lead to increases in growth, profit, productivity, and job satisfaction. A culture of trust can help an organization to retain the best people, inspire customer loyalty, develop new markets, and increase creativity.

Another area where corporate culture plays a vital role is the integration of two or more companies. Business leaders often cite the role of corporate cultures in the integration process as one of the primary factors affecting the success of a merger or acquisition. Experts note that corporate culture is a way of conducting business both within the company and externally. If two merging companies do not address differences in corporate culture, they are setting themselves up for missed opportu- nities and possibly failure.

7-8 COmmittees anD task FOrCes Today, business firms use several types of committees that affect organizational structure. An ad hoc committee is created for a specific short-term purpose, such as reviewing the firm’s employee benefits plan. Once its work is finished, the ad hoc committee disbands. A standing committee is a relatively permanent committee charged with performing a recurring task. A firm might establish a budget review committee, for example, to review departmental budget requests on an ongoing basis. Finally, a task force is a committee established to investigate a major problem

Concept Check ✓✓ What is corporate culture?

✓✓ explain the four types of corporate cultures.

Learning Objective

7-8 Understand how committees and task forces are used.

ad hoc committee a committee created for a specific short-term purpose

standing committee a relatively permanent committee charged with performing some recurring task

task force a committee established to investigate a major problem or pending decision

Corporate Culture. Corporate culture can influence an employee’s attitudes toward fitness and health. Some organizations have gyms and complimentary healthy snacks such as fruit.

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Chapter 7 Creating a Flexible Organization 205

or pending decision. A firm contemplating a merger with another company might form a task force to assess the pros and cons of the merger.

Committees offer some advantages over individual action. Their several members are able to bring information and knowledge to the task at hand. Furthermore, committees tend to make more accurate decisions and to transmit their results through the organization more effectively. However, committee deliberations take longer than individual actions. In addition, unnecessary compromise may take place within the committee, or the opposite may occur, as one person dominates (and thus negates) the committee process.

7-9 the inFOrmaL OrganizatiOn anD the graPevine So far, we have discussed the organization as a formal structure consisting of interrelated positions. This is the organization that is shown on an organization chart. There is another kind of organization, however, that does not appear on any chart. We define this informal organization as the pattern of behavior and interaction that stems from personal rather than official relationships. Embedded within every informal organization are informal groups and the notorious grapevine.

An informal group is created by the group members them- selves to accomplish goals that may or may not be relevant to the organization. Workers may create an informal group to go bowling, form a union, get a particular manager fired or transferred, or meet for lunch. The group may last for several years or a few hours.

Informal groups can be powerful forces in organizations. They can restrict output, or they can help managers through tight spots. They can cause disagreement and conflict, or they can help to boost morale and job satisfaction. They have the power to improve or worsen employee performance and productivity. Clearly, managers should be aware of informal groups and determine how to utilize them.

The grapevine is the informal communications network within an organization. It is completely separate from—and sometimes much faster than—the organization’s formal channels of communication. Formal communications usually follow a path that parallels the organizational chain of command. Information can be transmitted through the grapevine in any direction— up, down, diagonally, or horizontally across the organizational structure. Subordinates may pass information to their bosses, an executive may relay something to a maintenance worker, or there may be an exchange of information between people who work in totally unrelated departments. Information gleaned from the grapevine can run the gamut from the latest management decisions to gossip.

How should managers treat the grapevine? Certainly, it would be a mistake to try to eliminate it. People working together, day in and day out, are bound to communicate. A more rational approach is to recognize its existence. For example, managers should respond promptly and aggressively to inaccurate grapevine information to minimize the damage that such misinformation might do. Moreover, the grapevine can come in handy when managers are on the receiving end of important communications from the informal organization.

In the next chapter, we apply these and other management concepts to an extremely important business function: the production of goods and services.

Concept Check ✓✓ What is the difference between a committee and a task force?

✓✓ What are the advantages and disadvantages of using committees?

Learning Objective

7-9 Explain the functions of the informal organization and the grapevine in a business.

There is power in numbers. It’s common for employees to befriend one another and form informal groups within an organization. The groups provide their members with camaraderie and information, but can create both challenges and benefits for the organization.

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Concept Check ✓✓ in what ways can informal groups affect a business?

✓✓ How is the grapevine used in a business organization?

informal organization the pattern of behavior and interaction that stems from personal rather than official relationships

informal group a group created by the members themselves to accomplish goals that may or may not be relevant to an organization

grapevine the informal communications network within an organization

206 Part 3 Management and Organization

Summary

7-1 understand what an organization is and identify its characteristics. An organization is a group of two or more people working together to achieve a common set of goals. The relationships among positions within an organization can be illustrated by means of an organization chart. Five elements—job design, departmentalization, delegation, span of management, and chain of command—help to determine what an organization chart and the organization itself look like.

7-2 explain why job specialization is important. Job specialization is the separation of all the activities within an organization into smaller components and the assignment of those different components to different people. Several factors combine to make specialization a useful technique for designing jobs, but high levels of specialization may cause employee dissatisfaction and boredom. One technique for overcoming these problems is job rotation.

7-3 identify the various bases for departmentalization. Departmentalization is the grouping of jobs into manageable units. Typical bases for departmentalization are by function, product, location, or customer. Because each of these bases provides particular advantages, most firms—especially larger ones—use a combination of different bases to address different organizational situations.

7-4 explain how decentralization follows from delegation. Delegation is giving part of a manager’s work to other workers. It involves the following three steps: (1) assigning responsibility, (2) granting authority, and (3) creating accountability. A decentralized firm is one that delegates as much power as possible to people in the lower management levels. In a centralized firm, on the other hand, power is retained at the upper levels.

7-5 understand how the span of management describes an organization.

The span of management is the number of workers who report directly to a manager. Spans generally are characterized as wide (many workers per manager) or narrow (few workers per manager). Wide spans generally result in flat organizations (few layers of management); narrow spans generally result in tall organizations (many layers of management).

7-6 Describe the four basic forms of organizational structure. There are four basic forms of organizational structure. The line structure is the oldest and simplest structure, in which the chain of command moves in a straight line from person to person down through the levels of man- agement. The line-and-staff structure is similar to the line structure, but adds specialists called staff manag- ers to assist the line managers in decision making. The line structure works most efficiently for smaller orga- nizations, whereas the line-and-staff structure is used by medium- and large-sized organizations. The matrix structure may be depicted as product departmentaliza- tion superimposed on functional departmentalization. With the matrix structure, an employee on a cross-func- tional team reports to both the project manager and the individual’s supervisor in a functional department. In an organization with a network structure, the primary function performed internally is administration, and other functions are contracted out to other firms.

7-7 Describe the effects of corporate culture. Corporate culture has both internal and external effects on an organization. An organization’s culture can influence the way employees think and act, and it can also determine the public’s perception of the organization. Corporate culture can affect a firm’s performance over time, either negatively or positively. Creating a culture of trust, for example, can lead to increased growth, profits, productivity, and job satisfaction, while retaining the best employees, inspiring customer loyalty, developing new markets, and increasing creativity. In addition, when two or more companies undergo the integration process, their different or similar corporate cultures can affect the success of a merger or acquisition.

7-8 understand how committees and task forces are used. Committees and task forces are used to develop organizational structure within an organization. An ad hoc committee is created for a specific short-term purpose, whereas a standing committee is relatively permanent. A task force is created to investigate a major problem or pending decision.

7-9 explain the functions of the informal organization and the grapevine in a business.

Informal groups are created by group members to accomplish goals that may or may not be relevant to the organization, and they can be very powerful

Chapter 7 Creating a Flexible Organization 207

forces. The grapevine—the informal communications network within an organization—can be used to transmit information (important or gossip) through an organization much faster than through the formal

communication network. Information transmitted through the grapevine can go in any direction across the organizational structure, skipping up or down levels of management and even across departments.

Key Terms

You should now be able to define and give an example relevant to each of the following terms:

organization (189) organization chart (190) chain of command (190) job specialization (192) job rotation (193) departmentalization (193) departmentalization by

function (193) departmentalization by

product (194)

departmentalization by location (194)

departmentalization by customer (194)

delegation (195) responsibility (195) authority (195) accountability (195) decentralized organization

(196)

centralized organization (196) span of management (or

span of control) (197) organizational height (198) line structure (198) line manager (198) line-and-staff structure (199) staff manager (199) matrix structure (201) cross-functional team (201)

network structure (202) corporate culture (203) ad hoc committee (204) standing committee (204) task force (204) informal organization (205) informal group (205) grapevine (205)

Discussion Questions

1. In what way do organization charts create a picture of an organization?

2. What determines the degree of specialization within an organization?

3. Describe how job rotation can be used to combat the problems caused by job specialization.

4. Why do most firms employ a combination of departmen- talization bases?

5. What three steps are involved in delegation? Explain each. 6. How does a firm’s top management influence its degree

of centralization?

7. How is organization height related to the span of man- agement?

8. Contrast line-and-staff and matrix forms of organizational structure.

9. How does the corporate culture of a local Best Buy store compare to that of a local McDonald’s?

10. Which kinds of firms probably would operate most effec- tively as centralized firms? As decentralized firms?

11. How do decisions concerning span of management and the use of committees affect organizational structure?

Video Case Zappos Wants to Make Customers (and employees) happy

Zappos (www.zappos.com) doesn’t want to simply satisfy its customers—it wants to make them happy, a major reason for its success as an Internet retailer. Founded in 1999 to sell shoes online, the business soon earned a reputation for delivering personalized, responsive customer service. Top executives didn’t pressure call-center employees (known internally as members of the Customer Loyalty Team) to follow a script or end conversations quickly. In fact, they encouraged employees to stay on the phone as long as needed to answer customers’ questions, discuss merchandise, add a little chit- chat, and provide a “wow” shopping experience. Delighted customers would tell their friends and click or call back for more “wow” the next time they’re in the market for new shoes.

By 2009, when it was purchased by the pioneering web giant Amazon, Las Vegas-based Zappos was beginning to branch out into clothing, handbags, and other merchandise. Today, with annual sales surpassing $2 billion, the website features outerwear, beauty products, sporting goods, and many other items, as well as shoes and clothing for the whole family. In addition, the company has established an Insights division to help other companies understand and adapt the unique corporate culture that has given Zappos a vital competitive edge in the dynamic world of e-commerce.

Zappos is so famous for its upbeat, can-do culture—not to mention the many opportunities for advancement available in a fast-growing firm—that it attracts 55,000 job applications

208 Part 3 Management and Organization

every year. During interviews, managers ask offbeat questions such as, “On a scale of one to ten, how weird are you?” The purpose is to determine whether an applicant has the personality and temperament to fit into a corporate culture where fun, change, teamwork, creativity, transparency, and personal growth are highly valued. All newly hired employees have to sign a statement confirming that they understand these core values and are committed to applying them on the job.

Delivering superior service with a virtual smile requires careful behind-the-scenes coordination. Every Zappos employee is responsible for performing specific tasks, supported by regular training plus optional courses to build new skills. Because so many orders come in by phone, the entire workforce (including the CEO) receives a month of call-center training, along with a week of training in the warehouse, to get a first-hand taste of the challenges of customer contact and order fulfillment.

In line with the corporate culture, Zappos provides the tools and the opportunities for employees to become the best they can be. For example, employees are invited to meet with an on-site life coach for assistance in setting and meeting both personal and professional goals. They can sign up to shadow a manager or employee elsewhere in the organization as a way to explore new career possibilities. Work hard, play hard is the rule at Zappos, where holiday parties, picnics, parades, and other special events bring employees together for a bit of fun. These are only some

of the ways that Zappos makes the workplace a “wow” experience for its workforce.

To keep the organization running smoothly, Zappos holds an “all hands” meeting every three months. Videotaped and available online for repeat viewing, these meetings update everyone on the latest departmental and company news, serve as team-building events, and keep employees excited and inspired about working at Zappos. In addition, the firm monitors key performance statistics and posts them at headquarters to inform employees about what’s happening to the business, day by day.

Now Zappos is taking on a leadership role in Las Vegas, using its new headquarters in the former city hall as the corporate linchpin in an ambitious plan to revitalize the downtown area. Will Zappos succeed in making its community as happy as its employees and customers?10

Questions 1. Do you think Zappos is a decentralized or centralized

organization? Do you think it should change? Explain your answer.

2. Of the four types of corporate culture, which most closely describes the culture of Zappos? What are the implications for the organization and for managers and employees?

3. What effect are quarterly meetings and daily postings of performance statistics likely to have on the grapevine inside Zappos?

Building Skills for Career Success

1. Social Media Exercise Zappos has a reputation for being customer-centered, meaning it embraces the notion that customers come first. One of the ways that it allows employees to communicate with customers is through its blog www.zapposinsights.com/blog. 1. Take a look at this blog. What can you tell about the cor-

porate culture of Zappos? 2. How do they approach customer service? Do you think it

works? Why or why not?

2. Building Team Skills An organization chart is a diagram showing how employees and tasks are grouped and how the lines of communication and authority flow within an organization. These charts can look very different depending on a number of factors, including the nature and size of the business, the way it is departmentalized, its patterns of delegating authority, and its span of management.

assignment 1. Working in a team, use the following information to draw

an organization chart: The KDS Design Center works

closely with two home-construction companies, ACME Homebuilders and Highmass. KDS’s role is to help customers select materials for their new homes and to ensure that their selections are communicated accurately to the builders. The company is also a retailer of wallpa- per, blinds, and drapery. The retail department, the ACME Homebuilders accounts, and the Highmass accounts make up KDS’s three departments. The company has the following positions: president, executive vice president, managers, two appointment coordinators, two ACME Homebuilders coordinators, two Highmass coordinators, two consultants/designers for the Amex and Highmass accounts, 15 retail positions, and four payroll and billing personnel.

2. After your team has drawn the organization chart, dis- cuss the following: a. What type of organizational structure does your chart

depict? Is it a bureaucratic, matrix, cluster, or network structure? Why?

b. How does KDS use departmentalization? c. To what extent is authority in the company centralized

or decentralized?

Chapter 7 Creating a Flexible Organization 209

d. What is the span of management within KDS? e. Which positions are line positions and which are

staff? Why? 3. Prepare a three-page report summarizing what the chart

revealed about relationships and tasks at the KDS Design Center and what your team learned about the value of organization charts. Include your chart in your report.

3. Researching Different Careers In the past, company loyalty and the ability to assume increasing job responsibility usually ensured advancement within an organization. While the reasons for seeking advancement (the desire for a better-paying position, more prestige, and job satisfaction) have not changed, the qualifications for career advancement have. In today’s business environment, climbing the corporate ladder requires packaging and marketing yourself. To be promoted within your company or to be considered for employment with another company, it is wise to improve your skills continually. By taking workshops and seminars or enrolling in community college courses, you can keep up with the changing technology in your industry. Networking with people in your business or community can help you to find a new job. Most jobs are filled through personal contacts, proving that who you know can be important.

A list of your accomplishments on the job can reveal your strengths and weaknesses. Setting goals for improvement helps to increase your self-confidence.

Be sure to recognize the signs of job dissatisfaction. If you are feeling unhappy in your job, it may be time to move to another position or company.

assignment Are you prepared to climb the corporate ladder? Do a self- assessment by analyzing the following areas and summarize the results in a two-page report. 1. Skills

• What are your most valuable skills? • What skills do you lack? • Describe your plan for acquiring new skills and

improving your existing skills. 2. Networking

• How effective are you at using a mentor? • Are you a member of a professional organization? • In which community, civic, or church groups are you

participating? • Whom have you added to your contact list in the last

six weeks? 3. Accomplishments

• What achievements have you reached in your job? • What would you like to accomplish? What will it take

for you to reach your goal? 4. Promotion or new job

• What is your likelihood for getting a promotion? • Are you ready for a change? What are you doing or

willing to do to find another job?

Endnotes 1 Based on information in Tom Huddleston, Jr., “McDonald’s Latest

Recipe to Reverse Declining Sales: More ‘Lovin,’” Fortune, January 2, 2015, www.fortune.com; Julie Jargon, “McDonald’s Plans to Change U.S. Structure,” Wall Street Journal, October 30, 2014, www.wsj.com; Lisa Jennings and Jonathan Maze, “McDonald’s Reorganizes US into Four Regional Divisions,” Nation’s Restaurant News, October 31, 2014, http://nrn.com (accessed June 26, 2015); Julie Jargon, “McDonald’s to Pare Menu, Review Ingredients,” Wall Street Journal, December 10, 2014, www.wsj.com; www.aboutmcdonalds.com (accessed January 15, 2015).

2 Jennifer Alsever, “Job Swaps: Are They for You?” Fortune, October 29, 2012, http://management.fortune.cnn.com/2012/10/24/job-swaps/ (accessed June 26, 2015).

3 PepsiCo Corporate Profile website at http://www.pepsico.com/ Company/Global-Business-Units/ (accessed October 14, 2014).

4 Nick Turner, “Office Depot to Eliminate 1,100 Jobs in European Division,” Bloomberg, October 16, 2014, http://www.bloomberg.com/ news/2014-10-16/office-depot-to-eliminate-about-1-100-jobs-in- european-division.html (accessed June 26, 2015).

5 “Francesco Guerrera, “UBS Tells Why it Cut off a Limb,” Wall Street Journal, November 12, 2012, http://online.wsj.com/article/SB100014241 27887323894704578114863817976002.html (accessed June 26, 2015).

6 Dana Griffin, “Disadvantages of a Line & Staff Organization Structure,” Small Business, http://smallbusiness.chron.com/disadvantages-line- staff-organization-structure-2762.html (accessed January 15, 2015).

7 Chris Dolmetsch and Keri Geiger, “Barclays Hid Traders’ Role After Questions: Schneiderman,” Bloomberg, September 17, 2014, http:// www.bloomberg.com/news/2014-09-16/barclays-hid-traders-role- after-questions-schneiderman.html (accessed June 26, 2015); Matthew Heller, “SEC Fines Barclays $15M for Compliance Omissions,” CFO, September 24, 2014, http://ww2.cfo.com/regulation/2014/09/sec- fines-barclays-15m-compliance-omissions/ (accessed June 26, 2015); Peter J. Henning, “A Triple Whammy for Barclays,” New York Times,

November 5, 2012, http://dealbook.nytimes.com/2012/11/05/a-triple- whammy-for-barclays/ (accessed June 26, 2015).

8 Rob Goffee and Gareth Jones, “The Character of a Corporation: How Your Company’s Culture Can Make or Break Your Business,” Jones Harper Business, December 2003, 182.

9 Leslie Kwoh, “To Snag Top Talent, Companies Come out For Gay Rights,” New York Times, November 13, 2012, http://blogs.wsj.com/ atwork/2012/11/13/to-snag-top-talent-companies-come-out-for-gay- rights/ (accessed June 26, 2015); Jenna McGregor, “Corporate America’s Gay-Rights Revolution,” The Washington Post, February 27, 2014, http://www.washingtonpost.com/blogs/on-leadership/wp/2014/02/27/ corporate-americas-gay-rights-evolution/ (accessed June 26, 2015).

10 Based on information in “Inside Zappos,” https://jobs.zappos.com/ (accessed January 12, 2015); Ryan Mac, “Revenge of the Ripoff: How Zalando Became a $5 Billion Retailing Sensation,” Forbes, August 18, 2014, http://www.forbes.com/sites/ryanmac/2014/07/30/ zalando-europe-zappos-fashion/ (accessed June 26, 2015); “How Zappos’ CEO Turned Las Vegas into a Startup Fantasyland,” Wired, January 21, 2014, http://www.wired.com/2014/01/zappos-tony-hsieh- las-vegas/ (accessed June 26, 2015); Rhymer Rigby, “The Benefits of Workplace Levity,” Financial Times, December 19, 2012, http:// www.ft.com/cms/s/0/3983a83e-492a-11e2-9225-00144feab49a. html#axzz3fcVR33yA (accessed July 11, 2015); Carmine Gallo, “America’s Happiest Employee,” Forbes, December 26, 2012, http:// www.forbes.com/sites/carminegallo/2012/12/26/americas-happiest- employee/ (accessed July 11, 2015); Mig Pascual, “Zappos: 5 Out-of- the-Box Ideas for Keeping Employees Engaged,” U.S. News & World Report, October 30, 2012, http://money.usnews.com (accessed June 26, 2015); Lisa V. Gillespie, “Workplace Culture: Targeting Soft Skills Yields Hard Returns for Employers,” Employee Benefit News, April 15, 2012, p. 18; Priya de Langen, “The Right Fit at Zappos,” HRM Asia, January 5, 2012, www.hrmasia.com (accessed June 26, 2015); Cengage “Zappos” video; www.zappos.com (accessed July 11, 2015).

Learning Objectives Once you complete this chapter, you will be able to:

8-1 Explain the nature of production.

8-2 Outline how the conversion process transforms raw materials, labor, and other resources into finished goods or services.

8-3 Understand the importance of service businesses to consumers, other business firms, and the nation’s economy.

8-4 Describe how research and development leads to new products and services.

8-5 Discuss the components involved in planning the production process. 8-6 Explain how purchasing, inventory control, scheduling, and quality control

affect production.

8-7 Summarize how technology can make American firms more productive and competitive in the global marketplace.

Producing Quality Goods and Services

ChaPter

8 Why Should You Care? Think for a moment about the

products and services you bought

in the past week. Those products

and services could not be produced

if it weren’t for the production

activities described in this chapter

and that means consumers like you

would not be able to purchase the

products and services they need

or want.

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Because more and more people are living in metropolitan areas and either walk or ride a bike to work, Zak Pashak, the founder of Detroit Bikes, felt there was a need for a different kind of bike that was sturdy, easy to understand, and easy to ride. Unfortunately, many of the bikes available today are geared toward performance rather than for a daily commute in a large city. A successful musician, music promoter, and entrepreneur, Pashak started Detroit Bikes with a $2 million investment. In addition to investing money, Pashak recruited a talented group of employees—many with a background in Detroit’s automotive industry—to design and build bikes that are practical, functional, and reliable. In contrast to other bike manufacturers, the products produced by Detroit Bikes are low maintenance because they have three gears and a coaster brake. High performance bikes have as many as 36 gears or more and hand brakes—both components that often require high maintenance over time. And compared to the cost of a Detroit Bike, high performance bikes cost more. Although the business was slow to start, it is now recognized for quality and craftsmanship, and its bikes are now sold around the globe. According to Pashak, the near-term goal is to sell 50,000 bikes per year to shops from Detroit to Japan. With increased global interest and sales steadily climbing, he is well on his way to achieving his dream.

We begin this chapter with an overview of operations management—the activities required to produce goods and services that meet the needs of customers. In this section, we also discuss the role of manufacturing in the U.S. economy, competition in the global marketplace, and careers in operations management. Next, we describe the conversion process that makes production possible and also note

how Detroit Bikes Makes Bikes in Detroit

musician and entrepreneur Zak pashak got the idea for his bicycle manufacturing firm during a taxi ride through down- town Detroit. the cab was weaving around cyclists in the bicycle lanes, which caught pashak’s attention. he realized that more people would try commuting by bicycle if they could ride a sturdy, basic, reasonably-priced bike designed for city streets. Since 99 percent of the bikes sold in the United States are made abroad, he also saw an opportunity to build on Detroit’s manufacturing heritage by mass- producing “made in America” bicycles.

pashak quickly recruited a handful of employees with manufac- turing expertise and purchased a production facility on Detroit’s west side with sufficient space to build 40,000 bikes a year. he invested hundreds of thousands of dollars to equip the factory, develop designs, and build prototypes. however, the entrepreneur soon dis- covered that the high cost of manufacturing every component in Detroit would force him to set too high a price for his bicycles. to keep costs down and prices reasonable, pashak decided to import many parts but make the bicycle frames and chain guards in his factory, where all bicycles would be assembled.

the company’s first product was the A-type, a name remi- niscent of Ford’s “model A” cars made in Detroit a century ago. Although pashak initially set the ambitious goal of selling 10,000 A-types during the first year, only 1,000 were actually sold. When he launched his second product, the b-type, he set a more realis- tic first-year sales goal of 1,000, and concentrated on expanding distribution.

these days, Detroit bikes has a workforce of 31 turning out about a dozen bicycles every business day, with new models on the way. it also faces local competition from Shinola and the Detroit bicycle company. All this entrepreneurial activity means Detroit is gaining new fame as a center of bicycle manufacturing—a plus for a small business named Detroit bikes.1

Did you know? Detroit Bikes’ mission is “to encourage cycling by making an accessible, enjoyable bicycle while continuing Detroit’s legacy of quality manufacturing and design.”

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the growing role of services in our economy. Then we examine more closely three important aspects of operations management: developing ideas for new products, planning for production, and effectively controlling operations after production has begun. We close the chapter with a look at the productivity trends and the ways that manufacturing can be improved through the use of technology.

8-1 What is PrOduCtiOn? Have you ever wondered where a new pair of Levi’s jeans comes from? Or an Apple iPhone, or a Uniroyal tire for your car? Even factory service on a Maytag clothes dryer would be impossible if it weren’t for the activities described in this chapter. In fact, these products and services and millions of others like them would not exist if it weren’t for production activities.

Let’s begin this chapter by reviewing what an operating manager does. In Chapter 6, we described an operations manager as a person who manages the systems that convert resources into goods and services. This area of management is usually referred to as operations management, which consists of all the activities required to produce goods and services.

To produce a product or service successfully, a business must perform a number of specific activities. For example, suppose that Ford Motor Company has an idea for a new version of its popular F-150 truck that includes an aluminum body and costs between $30,000 and $50,000. The driving force behind the idea is that a truck with an aluminum body will be 700 pounds lighter than previous models. And a lighter truck equals better gas mileage and saves fuel. Marketing research must determine not only if customers are willing to pay the price for this product but also what additional features they want, and how Ford’s new truck compares with the competition. Once marketing research is completed, Ford’s operations managers

must turn the idea into reality. Ford’s managers cannot just push the “start button”

and immediately begin producing the new truck. As you will see, planning takes place both before anything is produced and during the production process.

Managers also must concern themselves with the control of operations to ensure that the organization’s goals are achieved. For a product such as the Ford F-150 truck, control of operations involves a number of important issues, including product quality, performance standards, the amount of inventory of both raw materials and finished products, and production costs.

We discuss each of the major activities of operations management later in this chapter. First, however, let’s take a closer look at American manufacturers and how they compete in the global marketplace.

8-1a how american Manufacturers Compete in the Global Marketplace After World War II, the United States became the most productive country in the world. For almost 30 years, until the late 1970s, its leadership was never threatened. By then, however, manufacturers in Japan, Germany, Korea, Singapore, Sweden, and other industrialized nations were offering U.S. firms increasing competition. Now the Chinese are manufacturing everything from

Learning Objective

8-1Explain the nature of production.

operations management all the activities required to produce goods and services

Know what this Hasbro employee is holding? Not sure. Ask a young boy. The product—the KRE-0—is the latest line of transformers. While kids love the product, so does Hasbro because it is one of its most profitable product lines. The KRE-0 transformers also allow Hasbro to compete with the very popular Lego transformers in both the U.S. and the global marketplace.

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sophisticated electronic equipment and automobiles to less expensive everyday items. And yet, in the face of increasing competition, there is both good and bad news for U.S. manufacturers. First the bad news.

the BaD NewS for MaNufaCturerS The number of Americans employed in the manufacturing sector has decreased. Currently, just over 12 million U.S. workers are employed in manufacturing jobs—down from just over 19 million back in 1979.2 While there are many additional factors, three major factors explain why employment in this economic sector has declined.

• Many of the U.S. manufacturing jobs that were lost were outsourced to low- wage workers in nations where there are few labor, safety, and environmental regulations.

• It costs about 20 percent more to manufacture goods in the United States than it does anywhere else in the world.3

• The number of unemployed factory workers increased during the economic crisis that began in 2008 because of decreased consumer demand for manufactured goods. Although the number of jobs in manufacturing has increased during the economic recovery, manufacturing employment is close to all-time lows.

As a result, manufacturing accounts for only about 9 percent of the current U.S. workforce.4 Since 1979, 7 million jobs have been lost, and many of those jobs aren’t coming back. Experts also predict that U.S. employment in the manufacturing sector will continue to decline to about 11 million jobs between now and the year 2022.5

the GooD NewS for MaNufaCturerS The United States remains one of the largest manufacturing countries in the world. While some people would argue that “Made in America” doesn’t mean what it used to mean, consider the following:

• U.S. manufacturers produce approximately 18 percent of total global manufacturing output.6

• Every year, manufacturing contributes about 12 percent of the gross domestic product and almost $2 trillion to the U.S. economy.7

• Manufacturing exports are nearly 60 percent of all U.S. exports.8

• Compared to other economic activities, manufacturing has a huge multiplier effect. For every $1 spent in manufacturing, an additional $1.35 is generated in the nation’s economy because of purchases from suppliers and businesses that support manufacturers.9

As a result, the manufacturing sector is still a very important part of the U.S. economy. Although the number of manufacturing jobs has declined, productivity has increased. At least two very important factors account for increases in productivity: First, innovation—finding a better way to produce products—is the key factor that has enabled American manufacturers to compete in the global marketplace. Second, today’s workers in the manufacturing sector are highly skilled in order to operate sophisticated equipment. Simply put, Americans are making more goods, but with fewer employees.

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social Media: inside Boeing’s Factories Every year, hundreds of jumbo jets roll out of Boeing’s factories in Washington state and South Carolina. Now you can take a peek inside these cavernous facilities and see how Boeing aircrafts are designed, assembled, tested, and delivered. You’ll find dozens of videos on the company’s YouTube Channel (https://www.youtube. com/user/Boeing).

More than 130,000 people subscribe to receive notices of Boeing’s new videos as they’re posted. If you’re interested in high- tech production techniques, you can watch robots painting the wings for a Boeing 777 aircraft. Or take a look at what happens in the interior of a jet as it’s being assembled. Or watch employees talking about their area of manufacturing expertise, such as produc- tion planning. These videos are the next best thing to a guided tour through a Boeing plant.

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Even more good news is that many American manufacturers that outsourced work to factories in foreign nations are once again beginning to manufacture goods in the United States. For our purposes, the term reshoring (sometimes referred to as onshoring or insourcing) describes a situation where U.S. manufacturers bring manufacturing jobs back to the United States. For example, General Electric, Ford, Apple, Caterpillar, Honda, Lenovo, Whirlpool, and many other U.S. firms are involved in reshoring. The primary reasons why U.S. firms are “coming back home” include increasing labor costs in foreign nations, higher shipping costs, significant quality and safety issues, faster product development when goods are produced in the United States, and federal and state subsidies to encourage manufactures to produce products in the United States.

Although there are many challenges facing U.S. manufacturers, experts predict that there could be a significant resurgence for manufacturers that can meet current and future challenges. The bottom line: The global marketplace has never been more competitive and successful U.S. firms will focus on the following:

1. Meeting the needs of customers and improving product quality. 2. Motivating employees to cooperate with management and improve productivity. 3. Reducing costs by selecting suppliers that offer higher quality raw materials and

components at reasonable prices. 4. Using computer-aided and flexible manufacturing systems that allow a higher

degree of customization. 5. Improving control procedures to help ensure lower manufacturing costs. 6. Using green manufacturing to conserve natural resources and sustain the planet.

For most firms, competing in the global marketplace is not only profitable but also an essential activity that requires the cooperation of everyone within the organization.

8-1b Careers in operations Management Although it is hard to provide information about specific career opportunities in operations management, some generalizations do apply to this management area. A basic understanding of mass production and the difference between an analytical process and a synthetic process is essential. Mass production is a manufacturing process that lowers the cost required to produce a large number of identical or similar

products over a long period of time. An analytical process breaks raw materials into different component parts. For example, a barrel of crude oil refined by Marathon Oil Corporation—a Texas-based oil and energy exploration company—can be broken down into gasoline, oil, lubricants, and many other petroleum by-products. A synthetic process is just the opposite of the analytical one; it combines raw materials or components to create a finished product. Black & Decker uses a

synthetic process when it combines plastic, steel, rechargeable batteries, and other components to produce a cordless drill.

Once you understand that operations managers are responsible for producing tangible goods or services that customers want, you must

determine how you fit into the production process. Today’s successful operations managers must:

1. Be able to motivate and lead people. 2. Understand how technology can make a

manufacturer more productive. 3. Appreciate the cost-control processes that help

lower production costs and improve product quality.

reshoring a situation in which U.S. manufacturers bring manufacturing jobs back to the United States

mass production a manufacturing process that lowers the cost required to produce a large number of identical or similar products over a long period of time

analytical process a process in operations management in which raw materials are broken into different component parts

synthetic process a process in operations management in which raw materials or components are combined to create a finished product

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Concept Check ✓✓ List the major activities in operations management.

✓✓ What steps have U.S. firms taken to regain a competitive edge in the global marketplace?

✓✓ What is the difference between an analytical and a synthetic manufacturing process? Give an example of each type of process.

Chapter 8 Producing Quality Goods and Services 215

4. Understand the relationship between the customer, the marketing of a product, and the production of a product.

If operations management seems like an area you might be interested in, why not do more career exploration?

8-2 the COnversiOn PrOCess The purpose of manufacturing or a service business is to provide utility to customers. Utility is the ability of a good or service to satisfy a human need. Although there are four types of utilities—form, place, time, and possession—operations management focuses primarily on form utility. Form utility is created by people converting raw materials, finances, and information into finished products. The other types of utility—place, time, and possession—are discussed in Chapter 11.

But how does the conversion take place? How does Kellogg’s convert corn, sugar, salt, and other ingredients; money from previous sales and stockholders’ investments; production workers and managers; and economic and marketing forecasts into Frosted Flakes cereal products? How does H&R Block employ more than 80,000 tax preparers and convert retail locations, computers and software, and advertising and promotion into tax services for its clients. They do so through the use of a conversion process like the one illustrated in Figure 8-1. As indicated by our H&R Block example, the conversion process can be used to produce services.

8-2a Manufacturing using a Conversion Process The conversion of resources into products and services can be described in several ways. We limit our discussion here to three: the focus or major resource used in the conversion process, its magnitude of change, and the number of production processes employed.

foCuS By the focus of a conversion process, we mean the resource or resources that make up the major or most important input. The resources are financial, material, information, and people—the same resources discussed in Chapters 1 and 6. For a bank such as Citibank, financial resources are the major resource. A chemical and energy company such as Chevron concentrates on material resources. Your college or university is concerned primarily with information. And temporary employment services, such as Manpower, focus on the use of human resources.

MaGNituDe of ChaNGe The magnitude of a conversion process is the degree to which the resources are physically changed. At one extreme lie such processes as the one by which the Glad Products Company produces Glad® ClingWrap. Various chemicals in liquid or powder form are combined to produce long, thin sheets of plastic Glad ClingWrap. Here, the original resources are totally unrecognizable in the finished product. At the other extreme, Southwest Airlines produces no physical change in its original resources. The airline simply provides a service and transports people from one location to another.

NuMBer of ProDuCtioN ProCeSSeS A single firm may employ one production process or many. In general, larger firms that make a variety of products use multiple production processes. For example, GE manufactures some of its own products, buys other merchandise from suppliers, and operates multiple divisions including a finance division, a lighting division, an appliance division, a healthcare division, and other divisions responsible for the products and services that customers

Learning Objective

8-2 Outline how the conversion process transforms raw materials, labor, and other resources into finished goods or services.

utility the ability of a good or service to satisfy a human need

form utility utility created by people converting raw materials, finances, and information into finished products

Figure 8-1 The Conversion Process

The conversion process converts ideas and resources into useful

goods and services.

PRODUCTION INPUTS • Concept or idea for a new good or service • Human, financial, material, and informational resources

• Plan necessary production activities to create a good or service

• Design the good or service

• Completed good or service

OUTPUTS

CONVERSION

• Execute the plan to produce the good or service

• Evaluate the quality of the good or service

• Improve the good or service based on evaluation

• Redesign the good or service if necessary

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associate with the GE name. Smaller firms, by contrast, may use one production process. For example, Texas-based Advanced Cast Stone, Inc., manufactures one basic product: building materials made from concrete.

8-3 the inCreasing iMPOrtanCe OF serviCes The application of the basic principles of operations management to the production of services has coincided with a dramatic growth in the number and diversity of service businesses. In 1900, only 28 percent of American workers were employed in service firms. By 1950, this figure had grown to 40 percent, and by the beginning of 2015, it had risen to 86 percent.10 In fact, the American economy is now characterized as a service economy (see Figure 8-2). A service economy is one in which more effort is devoted to the production of services than to the production of goods.

8-3a Planning Quality Services Today, the managers of restaurants, laundries, real estate agencies, banks, movie theaters, airlines, travel bureaus, and other service firms have realized that they can benefit from the experience of manufacturers. And while service firms are different from manufacturing firms, both types of businesses must complete many of the same activities in order to be successful. For example, as illustrated in the middle section of Figure 8-1, service businesses must plan, design, execute, evaluate, improve, and redesign their services in order to provide the services that their customers want.

For a service firm, planning often begins with determining who the customer is and what needs the customer has. After customer needs are identified, the next step for successful service firms is to develop a plan that will enable the firm to deliver the services that their customers want or need. For example, a swimming pool repair business must develop a business plan that includes a process for hiring and training qualified employees, obtaining necessary parts and supplies, marketing the firm’s

Concept Check ✓✓ explain how utility is related to form utility.

✓✓ in terms of focus, magnitude of change, and number, characterize the production processes used by a local pizza parlor, a dry-cleaning establishment, and an automobile repair shop.

Learning Objective

8-3 Understand the importance of service businesses to consumers, other business firms, and the nation’s economy.

service economy an economy in which more effort is devoted to the production of services than to the production of goods

Towering skyscraper or medieval castle? While we may not be able to answer that question, this future engineer can. Often the conversion process begins with an idea. Then the idea becomes reality when someone takes the next step and begins to focus on the resources needed to develop an idea into a good or service that meets customer needs.

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Chapter 8 Producing Quality Goods and Services 217

services, and creating management and accounting systems to control the firm’s activities. Once the firm provides a service to a customer, successful firms evaluate the way they operate and measure customer satisfaction. And if necessary, redesign their services to improve the customer’s experience.

8-3b evaluating the Quality of a firm’s Services The production of services is very different from the production of manufactured goods in the following five ways:

1. When compared to manufactured goods, customers are much more involved in obtaining the service they want or need.

2. Services are consumed immediately and, unlike manufactured goods, cannot be stored. For example, a hair stylist cannot store completed haircuts.

3. Services are provided when and where the customer desires the service. In many cases, customers will not travel as far to obtain a service.

4. Services are usually labor-intensive because the human resource is often the most important resource used in the production of services.

5. Services are intangible, and it is therefore more difficult to evaluate customer satisfaction.11

Compared with manufacturers, service firms often listen more carefully to customers and respond more quickly to the market’s changing needs. For example, Maggiano’s Little Italy restaurant is a chain of eating establishments owned by Brinker International. In order to continuously improve customer service, the restaurant encourages diners to complete online surveys that prompt diners to evaluate the food, atmosphere, service, and other variables. The information from the surveys is then used to fine-tune the way Maggiano’s meets its customers’ needs. Often, as a reward for completing the survey, diners are given free food the next time they visit a Maggiano’s restaurant.

In addition, many service firms are now using social media to build relationships with their customers. Coldwell Banker, one of the largest real estate companies in the United States sponsors an Internet blog—for both residential and commercial clients—that can be used not only to provide information about the current real

Figure 8-2 Service Industries

The growth of service firms has increased so dramatically that we now live in what is referred to as a service economy.

Percentage of American workers employed by service industries

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2010

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80%

83%

86%

2015 (January)

86%

Source: U.S. bureau of Labor Statistics website, www.bls.gov (accessed January 20, 2015).

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estate market, but also as a method to encourage comments and questions from customers.

Now that we understand something about the production process that is used to transform resources into goods and services, we can consider three major activities involved in operations management: research and development, planning for production, and operations control.

8-4 Where dO neW PrOduCts and serviCes COMe FrOM? Imagine an automobile that can drive itself! Sound like a crazy idea. Think again. At the 2015 Consumer Electronics Show in Las Vegas, Mercedes Benz introduced a concept car that can do just that—drive for you. What’s even more astonishing is that Mercedes is not the only company using research and development to create driverless cars. Toyota, Audi, Ford, General Motors, and even Google are attempting to turn a “big” idea into a marketable product. New products—like a driverless car—start with an idea. In fact, no firm can produce a product or service until it has an idea. Then assuming the idea has potential, a company’s research and development activities turn the idea into a reality.

8-4a research and Development How did we get the Apple iPhone or the MakerBot 3D printer? We got them as a result of people working with new ideas that developed into useful products. These activities generally are referred to as research and development. For our purposes, research and development (R&D) involves a set of activities intended to identify new ideas that have the potential to result in new goods and services.

Today, business firms use three general types of R&D activities. Basic research consists of activities aimed at uncovering new knowledge. The goal of basic research is scientific advancement, without regard for its potential use in the development of goods and services. Applied research, in contrast, consists of activities geared toward discovering new knowledge with some potential use. Development and implementation involves research activities undertaken specifically to put new or existing knowledge to use in producing goods and services. For many companies, R&D is a very important part of their business operations. According to Marc Levinson, a researcher for the Congressional Research Service, “U.S. manufacturers spend far more on research and development (R&D) than those in any other country, but manufacturers’ R&D spending is rising more rapidly in China, Korea, and Taiwan. Much of the R&D in the United States takes place in high technology industries.”12 The 3M company, for example, has always been known for its development and implementation research activities. Currently, 3M employs 8,400 researchers worldwide and has invested almost $8 billion over the last five years to develop new products designed to make people’s lives easier and safer.13

8-4b Product extension and refinement If a firm sells only one product or service, when customers quit buying the product or service, the firm will die. To stay in business, the firm must, at the very least, find ways to refine or extend the want-satisfying capability of its product or service. Consider television sets. Since they were introduced in the late 1930s, television sets have been constantly refined so that they now provide clearer, sharper pictures with less dial adjusting. During the same time, television sets also were extended. There are basic flat-screen televisions without added features, and many others that include

Concept Check ✓✓ how is the production of services similar to the production of manufactured goods?

✓✓ how is the production of services different from the production of manufactured goods?

✓✓ how can service firms measure customer satisfaction?

Learning Objective

8-4 Describe how research and development leads to new products and services.

research and development (R&D) a set of activities intended to identify new ideas that have the potential to result in new goods and services

Chapter 8 Producing Quality Goods and Services 219

DVD or Blu-Ray players and Apps that can be used to access the Internet. The latest development—high-definition television—has already become the standard. Already Samsung, LG, Sony, and other television manufacturers are taking the next step—4K Ultra High-Definition TV. Ultra high definition displays movies, sports, and other shows at four times the resolution of HD and provides incredible detail on your TV screen.

have a New Product idea? think Quirky

Quirky is a rather strange name for a successful business that develops and markets dozens of crowdsourced new products every year. Founded by CEO Ben Kaufman, the New York-based company invites consumers to submit ideas for products to help solve a problem or fill a need. Quirky receives as many as 4,000 ideas every week, but turns away ideas that are too complex, too similar to existing products, or too narrowly focused. After screening, the surviving ideas are posted online and the Quirky community votes on each.

Ideas that do well in the vote count are evaluated by industry experts who examine the market, legal and regulatory concerns, and competitive issues. High-potential ideas then move to Quirky’s weekly evaluation meeting, which is streamed online while staff members, experts, and hundreds of participating viewers decide which merit further research and development. Next, Quirky creates prototypes to polish the design, finalize the features, and get ready for introduction.

Quirky works quickly. It has created as many as five working prototypes in a day, using 3D printers and other high-tech tools. One product, the Pluck egg yolk extractor, was available in stores within a month of being approved. Quirky rings up $100 million in annual revenues from products sold in 35,000 stores worldwide—sharing the profits with those who originate the ideas and community members who help tweak a product and suggest a name. Already, one entrepreneurial inventor has earned more than $1 million from his winning idea for a pivoting power strip.

Sources: based on information in J. J. mccorvey, “What happens When crowdsourcing Stops being polite and Starts Getting real,” Fast Company Design, September 9, 2014, www. fastcodesign.com; Serena Altschul, “today’s Quirky idea may be tomorrow’s must-have consumer item,” CBS Sunday Morning, march 23, 2014, www.cbsnews.com; Steve Lohr, “Quirky to create a Smart-home products company,” New York Times, June 22, 2014, www. nytimes.com; chris raymond, “how Quirky turns ideas into inventions,” Popular Mechanics, January 7, 2014, www.popularmechanics.com.

Entrepreneurial Success

A cure for Ebola! While the world waits, scientists, researchers, and lab technicians are desperately working to find a cure for a disease that kills more than half of the people who contract the disease. Unfortunately, the search for a cure for Ebola and many other diseases is not a perfect science and it takes time, effort, research and development, and money to eventually find a cure for some very serious diseases.

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For most firms, extension and refinement are expected results of their research, development, and implementation activities. Each refinement or extension results in an essentially “new” product whose sales make up for the declining sales of a product that was introduced earlier. When consumers were introduced to the original five varieties of Campbell’s Soup, they discovered that these soups were of the highest quality, as well as inexpensive, and the soups were an instant success. Although one of the most successful companies at the beginning of the 1900s, Campbell’s had to continue to innovate, refine, and extend its product line. For example, many consumers in the United States live in what is called an on-the-go society. To meet this need, Campbell’s Soup has developed ready-to-serve products that can be popped into a microwave at work or school. It also continues to develop new soup flavors including Fiesta Chicken Lime Tortilla Soup, Avengers™ Fun Shaped Pasta Soup, and organic products to meet the needs of its customers.

8-5 hOW dO Managers PLan PrOduCtiOn? Only a few of the many ideas for new products ever reach the production stage. For those ideas that do, however, the next step is planning for production. Once a new idea for a product or service has been identified, planning for production involves three different phases: design planning, facilities planning, and operational planning (see Figure 8-3).

8-5a Design Planning When the R&D staff at Samsung recommended to top management that the firm manufacture and market a “Smart Fridge” with a touch screen, Wi-Fi connectivity, and apps that allow consumers to update their calendars, leave notes to family members, or even provide recipe suggestions, the company could not simply swing into production the next day. Instead, a great deal of time and energy had to be invested in determining what the new refrigerator would look like, where and how

Concept Check ✓✓ Describe how research and development leads to new products.

✓✓ What is the difference between basic research, applied research, and development and implementation?

✓✓ explain why product extension and refinement are important.

Learning Objective

8-5 Discuss the components involved in planning the production process.

Figure 8-3 Planning for Production

Once research and development identifies an idea that meets customer needs, three additional steps are used to convert the idea to an actual good or service.

Research and development identi�es an idea for a new good or service.

Design planning develops a plan to convert the idea into a new good or service.

Facilities planning identi�es a site where the good or service can be produced.

Operational planning decides on the amount of goods or services that will be produced within a speci�c time period.

Chapter 8 Producing Quality Goods and Services 221

it would be produced, and what options would be included. These decisions are a part of design planning. Design planning is the development of a plan for converting an idea into an actual product or service. The major decisions involved in design planning deal with product line, required capacity, and use of technology.

ProDuCt LiNe A product line is a group of similar products that differ only in relatively minor characteristics. During the design-planning stage, a manufacturer like Samsung must determine how many different models to produce and what major options to offer. Likewise, a restaurant chain such as Pizza Hut must decide how many menu items to offer.

An important issue in deciding on the product line is to balance customer preferences and production requirements. Typically, marketing personnel want a “long” product line that offers customers many options. Because a long product line with more options gives customers greater choice, it is easier to sell products that meet the needs of individual customers. On the other hand, operations managers and production personnel generally want a “short” product line with fewer options because products are easier to produce.

Once the product line has been determined, each distinct product within the product line must be designed. Product design is the process of creating a set of specifications from which a product can be produced. For example, product engineers for Samsung must make sure that their new “Smart Fridge” keeps food frozen in the freezer compartment. At the same time, they must make sure that lettuce and tomatoes do not freeze in the crisper section of the refrigerator. The need for a complete product design is fairly obvious; products that work cannot be manufactured without it. But services should be designed carefully as well—and for the same reason.

reQuireD ProDuCtioN CaPaCity Capacity is the amount of products or services that an organization can produce in a given period of time. Remember Detroit Bikes—the company profiled in the Inside Business feature for this chapter. The company’s capacity is up to 40,000 bikes per year in its present facilities. The capacity of a Panasonic assembly plant might be 1.3 million high-definition televisions per year. Operations managers—again working with the firm’s marketing managers—must determine the required capacity. This, in turn, determines the

design planning the development of a plan for converting an idea into an actual product or service

product line a group of similar products that differ only in relatively minor characteristics

product design the process of creating a set of specifications from which a product can be produced

capacity the amount of products or services that an organization can produce in a given time

Who needs a driver? This Mercedes Benz can drive you where you want to go. In addition to Mercedes, Toyota, Audi, Ford, General Motors, and even Google are all developing driverless cars. Of course, one of the most important factors required to turn any idea—like a driverless car— into reality is design planning— the development of a plan for converting an idea into an actual product or service.

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amount of goods and services that will be produced and the size of the production facility. If the facility is built with too much capacity, valuable resources (plant, equipment, and money) will lie idle. If the facility offers insufficient capacity, additional capacity may have to be added later when it is much more expensive than in the initial building stage.

Capacity means about the same thing to service businesses. For example, the capacity of a restaurant such as the Hard Rock Cafe in Nashville, Tennessee, is the number of customers it can serve at one time.

uSe of teChNoLoGy During the design-planning stage, management must determine the degree to which automation and technology will be used to produce a product or service. Here, there is a trade-off between high initial costs and low operating costs (for automation) and low initial costs and high operating costs (for human labor). Ultimately, management must choose between a labor-intensive technology and a capital-intensive technology. A labor-intensive technology is a process in which people must do most of the work. Housecleaning services and the New York Yankees baseball team, for example, are labor-intensive. A capital-intensive technology is a process in which machines and equipment do most of the work. A Sony automated assembly plant is capital intensive because there are fewer workers that operate automated machinery. In many situations, people and technology are combined to create the most efficient and most cost effective method to produce goods or services.

8-5b Site Selection and facilities Planning Generally, a business will choose to produce a new product in an existing factory as long as (1) the existing factory has enough capacity to handle customer demand for both the new product and established products and (2) the cost of refurbishing an existing factory is less than the cost of building a new one.

After exploring the capacity of existing factories, management may decide to build a new production facility. In determining where to locate production facilities, management must consider a number of variables, including the following:

• Locations of major customers and suppliers. • Availability and cost of skilled and unskilled labor. • Quality of life for employees and management in the proposed location. • The cost of land and building costs. • Local and state taxes, environmental regulations, and zoning laws. • The amount of financial support and subsidies, if any, offered by local and state

governments. • Special requirements, such as great amounts of energy or water used in the

production process.

Before making a final decision about where a proposed plant will be located and how it will be organized, two other factors—human resources and plant layout— should be examined.

huMaN reSourCeS Several issues involved in site selection and facilities planning fall within the province of human resources managers. When Nestlé built its new 900,000-square-foot production facility to make liquid Nesquik® and Coffee- Mate® products in Anderson, Indiana, human resources managers were involved to make sure the necessary employees needed to staff and operate the plant were available. And when a company decides to build a new facility in a foreign country, again human resources managers are involved. For example, suppose that a U.S. firm like General Motors wants to lower labor costs by importing component parts from China. It has two choices. It can build its own manufacturing facility in a foreign country or it can outsource production to local firms. In either case, human resources

labor-intensive technology a process in which people must do most of the work

capital-intensive technology a process in which machines and equipment do most of the work

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become involved in the decision. If the decision is made to build its own plant, human resources managers will have to recruit employees with the appropriate skills who are willing to relocate to a foreign country, develop training programs for local Chinese workers, or both. On the other hand, if the decision is made to outsource production to local suppliers, human resources managers must make sure that local suppliers are complying with the U.S. company’s human rights policies and with all applicable national and local wage and hour laws. For General Motors, selecting suppliers in foreign countries is an important consideration when determining where to buy component parts. At a recent awards ceremony, General Motors recognized 76 companies representing 16 different countries with its Supplier of the Year award.

PLaNt Layout Plant layout is the arrangement of machinery, equipment, and personnel within a production facility. Three general types of plant layout are used (see Figure 8-4).

The process layout is used when different operations are required for creating small batches of different products or working on different parts of a product. The plant is arranged so that each operation is performed in its own particular area.

plant layout the arrangement of machinery, equipment, and personnel within a production facility

Figure 8-4 Facilities Planning

The process layout is used when small batches of different products are created or when working on different parts of a product. The product layout (assembly line) is used when all products undergo the same operations

in the same sequence. The fixed-position layout is used in producing a product too large to move.

Workstation Workstation

Workstation

Ship yard for a large naval vessel

Maxim Integrated Products assembly line

Lincoln repair shop

Safety inspection

Car in need of repairs

Electronic components

Repaired car

Resources and

components

Finished circuit boards

PROCESS LAYOUT

PRODUCT LAYOUT

FIXED-POSITION LAYOUT

Engine repair

Wheel alignment

Body work

Workstation Workstation Workstation

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An auto repair facility at a local automobile dealership provides an example of a process layout. The various operations may be engine repair, bodywork, wheel alignment, and safety inspection. If you take your Lincoln Navigator for a wheel alignment, your car “visits” only the area where alignments are performed.

A product layout (sometimes referred to as an assembly line) is used when all products undergo the same operations in the same sequence. Workstations are arranged to match the sequence of operations, and work flows from station to station. An assembly line is the best example of a product layout. For example, California-based Maxim Integrated Products, Inc., uses a product layout to manufacture integrated circuits and components for consumer and business electronic products. A fixed-position layout is used when a very large product is produced. Boeing, for instance, uses a fixed layout plant arrangement because of the size of its products—commercial airliners. Shipbuilders also use this type of layout because of the difficulty of moving a large product such as an ocean liner. In both examples, the product remains stationary, and people and machines are moved as needed to assemble the product.

8-5c operational Planning The objective of operational planning is to decide on the amount of products or services each facility will produce during a specific period of time. Four steps are required.

SteP 1: SeLeCtiNG a PLaNNiNG horizoN A planning horizon is simply the time period during which an operational plan will be in effect. A common planning horizon for production plans is one year. Then, before each year is up, management must plan for the next. A planning horizon of one year generally is long enough to average out seasonal increases and decreases in sales. At the same time, it is short enough for planners to adjust production to accommodate long- range sales trends.

SteP 2: eStiMatiNG Market DeMaND The market demand for a product is the quantity that customers will purchase at the going price. This quantity must be estimated for the time period covered by the planning horizon. Sales projections

planning horizon the period during which an operational plan will be in effect

A “BIG” parking jam. At this Boeing assembly plant, space is at a premium because the finished product—a 757 jetliner—is so big. To see how large each airliner is, compare its size with the people in the photo. When a product is this large, it is easier to move people, machinery, and parts to where they are needed instead of moving the plane.

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developed by marketing managers are the basis for market-demand estimates.

SteP 3: CoMPariNG Market DeMaND with CaPaCity The third step in operational planning is to compare the estimated market demand with the facility’s capacity to satisfy that demand. (Remember that capacity is the amount of products or services that an organization can produce in a given time period.) One of three outcomes may result: Demand may exceed capacity, capacity may exceed demand, or capacity and demand may be equal. If they are equal, the facility should be operated at full capacity. However, if market demand and capacity are not equal, adjustments may be necessary.

SteP 4: aDjuStiNG ProDuCtS or ServiCeS to Meet DeMaND The biggest reason for changes to a firm’s production schedule is changes in the amount of products or services that a company sells to its customers. For example, Indiana-based Berry Plastics produces all kinds of plastic products. One particularly successful product line for Berry Plastics is drink cups that can be

A Marie Callender pie that tastes as good as it looks. For just a moment, assume you are the production manager responsible for making thousands of pies like this one. What would your factory look like? How could plant layout improve productivity? How would you manage human resources, purchasing, and quality control? All good questions that should be answered before a single pie is produced.

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how would you Plan for Peak holiday Deliveries?

Imagine you work for an express package delivery service. You must prepare to deliver more than 20 million packages in a single December day, regardless of the weather. You don’t know how many packages you’ll handle on any given day, nor do you know where these packages are headed. You do know that if even a small fraction of these deliveries are late, a lot of recipients will be disappointed—and the shippers will be unhappy, as well.

These are challenges that FedEx and UPS face every year in planning capacity to meet peak demand for on-time deliveries during the holidays—creating career opportunities in many fields. Consider FedEx’s Memphis hub, which unloads cargo from 160 jets every evening. Before sunrise, 1.8 million packages will ride 42 miles of conveyor belts to be loaded on outbound jets for delivery. That means jobs inside the sorting facility, transportation and maintenance jobs on the ground and in the air, plus engineers to plan the physical plant and data analysts to identify efficiencies.

Both UPS and FedEx employ meteorologists, so they can be ready to reroute planes and trucks around storms. They have logistics experts to devise creative ways of increasing temporary capacity—such as mobile sorting centers that can be shifted from place to place as demand fluctuates. And they have human resources planning experts to project how many extra employees will be needed for the peak season. During one recent holiday season, UPS hired 95,000 seasonal employees for its sorting and delivery operations, based on what its experts projected.

Sources: based on information in hiroko tabuchi, “crunch time for Fedex and UpS as Last- minute Shipping ramps Up,” New York Times, December 21, 2014, www.nytimes.com; nick carey, “UpS, Fedex Seek Ways to manage massive peak Season package bulge,” Reuters. com, october 23, 2014; mae Anderson, “retailers and package Deliverers take on peak Shipping volume Days before christmas,” Minneapolis Star-Tribune, December 22, 2014, www. startribune.com; Aamer madhani, “UpS hopes for a merrier christmas in 2014,” USA Today, December 14, 2014, www.usatoday.com.

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screen-printed to promote a company or its products or services.14 If Berry Plastics obtains a large contract to provide promotional cups to a large fast-food chain such as Sonic, Whataburger, or McDonald’s, the company may need to work three shifts a day, seven days a week, until the contract is fulfilled. Unfortunately, the reverse is also true. If the company’s sales force does not generate new sales, there may be only enough work for the employees on one shift.

When market demand exceeds capacity, several options are available to a firm. Production of products or services may be increased by operating the facility overtime with existing personnel or by starting a second or third work shift. For manufacturers, another response is to subcontract or outsource a portion of the work to other manufacturers. If the excess demand is likely to be permanent, the firm may expand the current facility or build another facility.

What happens when capacity exceeds market demand? Again, there are several options. To reduce output temporarily, workers may be laid off or the facility may be operated on a shorter-than-normal workweek. To adjust to a permanently decreased demand, management may shift the excess capacity of a manufacturing facility to the production of other goods or services. The most radical adjustment is to eliminate the excess capacity by selling unused manufacturing facilities.

8-6 OPeratiOns COntrOL We have discussed the development of an idea for a product or service and the planning that translates that idea into the reality. Now we are ready to begin the production process. In this section, we examine four important areas of operations control: purchasing, inventory control, scheduling, and quality control (see Figure 8-5).

8-6a Purchasing Purchasing consists of all the activities involved in obtaining required materials, supplies, components (or subassemblies), and parts from other firms. Levi Strauss, for example, must purchase denim cloth, thread, and zippers before it can produce a single pair of jeans.

The objective of purchasing is to ensure that required materials are available when they are needed, in the proper amounts, and at minimum cost. Generally, the company with purchasing needs and suppliers must develop a working relationship built on trust. In addition, many companies believe that purchasing is one area where they can promote diversity. For example, AT&T developed a Supplier Diversity Program in 1968. Today, goals for the AT&T program include purchasing a total of 21.5 percent of all products and services from minorities, women, and disabled

Concept Check ✓✓ What are the major elements of design planning?

✓✓ Define capacity. Why is it important for a manufacturing business or a service business?

✓✓ What factors should be considered when selecting a site for a new manufacturing facility?

✓✓ What is the objective of operational planning? What four steps are used to accomplish this objective?

Learning Objective

8-6 Explain how purchasing, inventory control, scheduling, and quality control affect production.

Figure 8-5 Four Aspects of Operations Control

Implementing the operations control system in any business requires the effective use of purchasing, inventory control, scheduling, and quality control.

Inventory control

OPERATIONS CONTROL

Purchasing Scheduling Quality controlpurchasing all the activities

involved in obtaining required materials, supplies, components, and parts from other firms

Chapter 8 Producing Quality Goods and Services 227

veteran business enterprises. In recent years, it has exceeded the goal of 21.5 percent and purchases more than $15 billion in merchandise and supplies from diverse businesses that obtain AT&T supplier certification. In recognition of its efforts to promote diverse and minority businesses, AT&T has received awards from the Women’s Business Enterprise National Council, Diversity, Inc., DiversityBusiness. com and other national organizations.15

Purchasing personnel should constantly be on the lookout for new or backup suppliers, even when their needs are being met by their present suppliers, because problems such as strikes and equipment breakdowns can cut off the flow of purchased materials from a primary supplier at any time.

The choice of suppliers should result from careful analysis of a number of factors. The following are especially critical:

• Price. Comparing prices offered by different suppliers is always an essential part of selecting a supplier.

• Quality. Purchasing specialists always try to buy materials at a level of quality in keeping with the type of product being manufactured. The lowest acceptable quality is usually specified by product designers.

• Reliability. An agreement to purchase high-quality materials at a low price is the purchaser’s dream. However, the dream becomes a nightmare if the supplier does not deliver.

• Credit terms. Purchasing specialists should determine if the supplier demands immediate payment or will extend credit.

• Shipping costs. The question of who pays the shipping costs should be answered before any supplier is chosen.

8-6b inventory Control Can you imagine what would happen if a Coca-Cola manufacturing plant ran out of the company’s familiar red-and-white aluminum cans? It would be impossible to complete the manufacturing process and ship soft drinks to retailers. Management would be forced to shut the assembly line down until the next shipment of cans arrived from a supplier. The simple fact is that shutdowns are expensive because costs such as wages, rent, utilities, insurance, and other expenses still must be paid.

Operations managers are concerned with three types of inventories. A raw- materials inventory consists of materials that will become part of the product during the production process. The work-in-process inventory consists of partially completed products. The finished-goods inventory consists of completed goods. Each type of inventory also has a holding cost, or storage cost, and a stock-out cost, the cost of running out of inventory. Inventory control is the process of managing inventories in such a way as to minimize inventory costs, including both holding costs and potential stock-out costs.

Today, computer systems are being used to track inventory levels and alert managers to impending stock-outs. One of the most sophisticated methods of inventory control used today is materials requirements planning. Materials requirements planning (MRP) is a computerized system that integrates production planning and inventory control. One of the great advantages of an MRP system is its ability to juggle delivery schedules and lead times effectively. For a complex product such as an automobile with 4,000 or more individual parts, it is virtually impossible for individual managers to oversee the hundreds of parts that go into the finished product. However, a manager using an MRP system can arrange both order and delivery schedules so that materials, parts, and supplies arrive when they are needed.

Because large firms can incur huge inventory costs, much attention has been devoted to inventory control. The just-in-time system being used by some businesses

inventory control the process of managing inventories in such a way as to minimize inventory costs, including both holding costs and potential stock-out costs

materials requirements planning (MRP) a computerized system that integrates production planning and inventory control

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is one result of all this attention. A just-in-time inventory (JIT) system is designed to ensure that materials or supplies arrive at a facility just when they are needed so that storage and holding costs are minimized. For example, managers using a just-in-time inventory system at a Harley Davidson assembly plant determine the number of motorcycles that will be assembled in a specified time period. Then Harley Davidson purchasing personnel order just the parts needed to produce those motorcycles. In turn, suppliers deliver the parts in time or when they are needed on the assembly line. The benefits for Harley Davidson are enormous and include decreased inventory levels and a much more efficient manufacturing process that reduces costs and increases profits. While stories of large firms like Harley Davidson, Dell, and Toyota are common, smaller firms can also use JIT to reduce costs and improve profitability. For example, fast-food restaurants, florists, and print-on- demand publishing can all use the same JIT principles that larger firms use—and for the same reasons.

Without proper inventory control, it is impossible for operations managers to schedule the work required to produce goods and services that can be sold to customers.

8-6c Scheduling Scheduling is the process of ensuring that materials and other resources are at the right place at the right time. As our definition implies, both place and time are important to scheduling. The routing of materials is the sequence of workstations that the materials will follow. Assume that Hickory White—a furniture company based in North Carolina—is scheduling production of an oval coffee table made from cherry wood. Operations managers route the needed materials (wood, screws, packaging materials, etc.) through a series of individual workstations along an assembly line. At each workstation, a specific task is performed, and then the partially finished coffee table moves to the next workstation. When routing materials, operations managers are especially concerned with the sequence of each step of the production process. For the coffee table, the top and legs must be cut before the wood is finished. (If the wood were finished before being cut, the finish would be ruined, and the coffee table would have to be stained again.)

When scheduling production, managers also are concerned with timing. The timing function specifies when the materials will arrive at each station and how long they will remain there. For the cherry coffee table, it may take workers 30 minutes to cut the table top and legs and another 30 minutes to drill the holes and assemble the table. Before packaging the coffee table for shipment, it must be finished with cherry stain and allowed to dry. This last step may take as long as three days depending on weather conditions and humidity.

Regardless of whether the finished product requires a simple or complex production process, operations managers are responsible for monitoring schedules— called follow-up—to ensure that the work flows according to the schedule.

8-6d Quality Control Over the years, more and more managers have realized that quality is an essential “ingredient” of the good or service being produced. This view of quality provides several benefits. The number of defects decreases, which causes profits to increase.

just-in-time inventory (JIT) system a system designed to ensure that materials or supplies arrive at a facility just when they are needed so that storage and holding costs are minimized

scheduling the process of ensuring that materials and other resources are at the right place at the right time

Consider what happens when a firm doesn’t have any inventory. In a manufacturing plant, everything shuts down until the raw materials, component parts, or subassemblies are delivered. Inventory is also a problem for retailers that sell finished goods because many customers won’t wait, but simply purchase alternate goods from another business. That’s why these two employees are pouring over inventory levels and making important decisions that determine when it’s time to reorder inventory.

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Furthermore, making products or completing services right the first time reduces many of the rejects and much of the rework.

As mentioned earlier in this chapter, American business firms that compete in the very competitive global marketplace have taken another look at the importance of improving quality. Today, there is even a national quality award. The Malcolm Baldrige National Quality Award is given by the President of the United States to organizations judged to be outstanding in specific managerial tasks that lead to improved quality for both products and services. Past winners include PricewaterhouseCoopers, Nestlé Purina Petcare, Boeing Aerospace, and Ritz-Carlton Hotels, among many others. All Baldrige winners have one factor in common: They use quality control to improve their firm’s products or services.

Quality control is the process of ensuring that goods and services are produced in accordance with design specifications. The major objective of quality control is to see that the organization lives up to the standards it has set for itself on quality. Some firms, such as Mercedes-Benz, have built their reputations on quality. Other firms adopt a strategy of emphasizing lower prices along with reasonable (but not particularly high) quality. Today, many firms use the techniques described in Table 8-1 to gather information and statistics that can be used to improve the quality of a firm’s products or services.

Although the techniques described in Table 8-1 can provide information and statistics, it is people who must act on the information and make changes to improve the production process. And the firm’s employees are often the most important component needed to improve quality.

iMProviNG QuaLity throuGh eMPLoyee PartiCiPatioN One of the first steps needed to improve quality is employee participation. Simply put:

Malcolm Baldrige National Quality Award an award given by the President of the United States to organizations judged to be outstanding in specific managerial tasks that lead to improved quality for both products and services

quality control the process of ensuring that goods and services are produced in accordance with design specifications

taBLe 8-1 Four Widely Used Techniques to Improve the Quality of a Firm’s Products.

Technique Description

Benchmarking A process of comparing the way a firm produces products or services to the methods used by organizations known to be leaders in an industry in order to determine the “best practices” that can be used to improve quality.

Continuous Improvement

Continuous improvement is a never-ending effort to eliminate problems and improve quality. Often this method involves many small changes or steps designed to improve the production process on an ongoing basis.

Statistical Process Control (SPC)

Sampling to obtain data that are plotted on control charts and graphs to see if the production process is operating as it should and to pinpoint problem areas.

Statistical Quality Control (SQC)

A detailed set of specific statistical techniques used to monitor all aspects of the production process to ensure that both work-in-process and finished products meet the firm’s quality standards.

Nobody likes complaints!

Personal App

You don’t want to buy a shoddy product, and a company doesn’t want to gain a reputation for poor quality. In addition to just complaining about your problem, you can actually help by providing feedback to companies to pinpoint problems and identify areas where quality improvement is needed.

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Successful firms encourage employees to accept full responsibility for the quality of their work. When Toyota, once the role model for world-class manufacturing, faced a quality crisis, the company announced a quality-improvement plan based on its famous “Toyota Way.” One tenet of the Toyota Way is the need to solve problems at their source, which allows factory workers to stop the production line if necessary to address a problem. Another tenet that enabled Toyota to resolve quality problems was the use of quality circles designated to deal with difficulties as they arise. A quality circle is a team of employees who meet on company time to solve problems of product quality. Quality circles have also been used successfully in companies such as IBM, Northrop Grumman Corporation, Lockheed Martin, and GE.

Increased effort is also being devoted to inspection, which is the examination of the quality of work-in-process. Employees perform inspections at various times during production. Purchased materials may be inspected when they arrive at the production facility. Component parts may be inspected before they become part of a finished product. In addition, finished goods may be inspected before they are shipped to customers. Items that are within design specifications continue on their way. Those that are not within design specifications are removed from production.

Total quality management (TQM) can also be used to improve quality of a firm’s products or services. As noted in Chapter 6, a TQM program coordinates the efforts directed at improving customer satisfaction, increasing employee participation, strengthening supplier partnerships, and facilitating an organizational atmosphere of continuous quality improvement. Firms such as American Express, AT&T, Motorola, and Hewlett-Packard all have used TQM to improve product quality and, ultimately, customer satisfaction.

Another technique that businesses may use to improve not only quality but also overall performance is Six Sigma. Six Sigma is a disciplined approach that relies on statistical data and improved methods to eliminate defects for a firm’s products and services. Although many experts agree that Six Sigma is similar to TQM, Six Sigma often has more top-level support, much more teamwork, and a new corporate attitude or culture.16 The companies that developed, refined, and have the most experience with Six Sigma are Motorola, GE, Ford, and Honeywell. Although each of these companies is a corporate giant, the underlying principles of Six Sigma can

be used by any firm, regardless of size.

worLD QuaLity StaNDarDS: iSo 9000 aND iSo 14000 Without a common standard of quality,

customers may be at the mercy of manufacturers and vendors. As the number of companies competing

in the global marketplace has increased, so has the seriousness of this problem. To deal with the problem of standardization, the International Organization for Standardization, a nongovernmental organization with headquarters in Geneva, Switzerland, was created. The International Organization for Standardization (ISO) is a network of national standards institutes and similar organizations

from over 160 different countries that is charged with developing standards for quality products

and services that are traded throughout the globe.17

Standardization is achieved through consensus agreements between national delegations representing

all the economic stakeholders—suppliers, customers, and

quality circle a team of employees who meet on company time to solve problems of product quality

inspection the examination of the quality of work-in-process

Six Sigma a disciplined approach that relies on statistical data and improved methods to eliminate defects for a firm’s products and services

International Organization for Standardization (ISO) a network of national standards institutes and similar organizations from over 160 different countries that is charged with developing standards for quality products and services that are traded throughout the globe

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often governments. The member organization for the United States is the American National Standards Institute located in Washington, D.C.

Although certification is not a legal requirement to conduct business globally, ISO standards are so prevalent around the globe that many customers refuse to do business with noncertified companies. As an added bonus, companies completing the certification process often discover new, cost-efficient ways to improve their existing quality-control programs.

In 1987, the panel published ISO 9000 (iso is Greek for “equal”), which sets the guidelines for quality management procedures that manufacturers and service providers must use to receive certification. Certification by independent auditors and laboratory testing services serves as evidence that a company meets the standards for quality control procedures in design, production processes, and product testing.

As a continuation of this standardization process, the ISO has developed many different standards for businesses that provide goods and services to customers around the globe. For example, the ISO 14000 is a family of international standards for incorporating environmental concerns into operations and product standards. ISO standards are also updated periodically.

8-6e Production Planning: a Summary In this chapter, the activities that firms use to produce products and services have been described. Now, toward the end of the chapter, it may help to look at a table to see how all of the “pieces of the puzzle” fit together. At the top of Table 8-2, planning for production begins with research and development, design planning, site selection and facilities planning, and operational planning—all topics described in this chapter. In the middle of Table 8-2, activities that were described in the Operations Control section (purchasing, inventory control, scheduling, and quality control) are summarized. The goal of all the planning activities in the top section and operations control activities in the middle section is to create and produce a successful product or service. Of course, the steps for planning production and operations control should always be evaluated to determine if the firm’s activities can be improved.

Concept Check ✓✓ Why is selecting a supplier important? What factors should be considered when selecting a supplier?

✓✓ What costs must be balanced and minimized through inventory control?

✓✓ explain in what sense scheduling is a control function of operations managers.

✓✓ how can a business firm improve the quality of its products or services?

taBLe 8-2 Production Planning: A Summary

Both planning for production and operations control are necessary if a firm is to produce a successful product or service.

The Process Begins with Planning for Production

1. Research and Development identifies ideas for a product or service.

2. Design Planning develops a plan for producing a product or service.

3. Site Selection and Facilities Planning identifies a production site, a plant layout, and if human resources are available.

4. Operational Planning decides on the amount of products or services that will be produced.

Then Four Operations Control Steps Are Used to Produce a Product or Service

1. Purchasing obtains required materials, supplies, and parts from other firms.

2. Inventory Control ensures that materials, supplies, and parts are available when needed.

3. Scheduling ensures that materials and other resources are at the right place and at the right time in the production process.

4. Quality Control determines if the firm has lived up to the standards it has set for itself on the quality of its products or services.

The End Result: A Successful Product or Service

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8-7 iMPrOving PrOduCtivity With teChnOLOgy No coverage of operations management would be complete without a discussion of productivity and technology. Productivity concerns all managers, but it is especially important to operations managers, the people who must oversee the creation of a firm’s goods or services. In Chapter 1, productivity was defined as the average level of output per worker per hour. Hence, if each worker at plant A produces 75 units per day and each worker at plant B produces only 70 units per day, the workers at plant A are more productive. If one fast-food employee serves 25 customers per hour and another serves 28 per hour, the second employee is more productive.

8-7a Productivity trends For U.S. businesses, overall manufacturing productivity growth for output per hour averaged 2.1 percent for the period 2004–2014.18 More specifically, the U.S. productivity growth rate for the first three quarters of 2014 was 3.2 percent.19 (Note: At the time of publication, 2014 was the last year that actual statistics were available.) While the 3.2 percent increase in productivity for 2014 was slightly higher when compared with average productivity growth over the 2004–2014 period, economists, business leaders, and government officials point to the need for even larger increases in the future. In reality, there are many factors that account for increases or decreases in productivity growth rates for any country. For example, as illustrated in Figure 8-6, U.S. productivity growth was zero in 2008—the beginning of a global economic crisis. To make matters worse, it actually declined to a negative 0.3 percent in 2009.20 Fortunately, as the economy began to improve, so did U.S. productivity growth rates. Many other nations in the world experienced the same pattern of growth and decline in productivity during this same time period. And for some nations including Finland, the United Kingdom, Singapore, and Australia low

Learning Objective

8-7 Summarize how technology can make American firms more productive and competitive in the global marketplace.

Figure 8-6 U.S. Productivity Growth Rates

This chart describes manufacturing productivity growth rates for U.S. businesses for the period 2004 to 2014—the latest statistics available prior to publication.

2005

2009

2010

2006

2011

0 2 31 4 5 6 7

2008

2013

(First 3 Quarters) 2014

2007

2012

4.2

–0.3 6.2

0.4

0.8

2.0

3.4

3.2

1.0

2.42004

Source: based on information in “productivity Growth and costs—manufacturing 2014,” the bureau of Labor Statistics website at www.bls. gov (accessed January 22, 2015).

Chapter 8 Producing Quality Goods and Services 233

productivity growth or negative growth rates continued even as other nations were in economic recovery.21

8-7b improving Productivity Growth Many U.S. firms are using a number of techniques to improve productivity. For example, a large number of business firms are adopting lean manufacturing to improve productivity. Lean manufacturing is a concept built on the idea of eliminating waste from all of the activities required to produce a good or service. Benefits of lean manufacturing include a reduction in the amount of resources required to produce a product or service, more efficient use of employee time, improved quality, and increased profits. In addition to lean manufacturing, several other factors must be considered if U.S. firms are going to increase productivity and their ability to compete in the global marketplace. For example:

• The United States must stabilize its economy so that firms will invest more money in new facilities, equipment, technology, and employee training.

• Managers and executives must cooperate with employees to increase employee motivation and participation in the workplace.

• All government policies must be examined to ensure that unreasonable regulations that may be hindering productivity growth are eliminated.

• Successful techniques that have been used in manufacturing firms must be used to increase productivity in the service industry.

• Increased use of automation, robotics, and computer manufacturing systems must be used to lower production costs.

• There must be more emphasis on satisfying the customer’s needs with quality goods and services.

Finally, innovation and research and development efforts to create new products and services must be increased in order for U.S. firms to compete in the global marketplace. As pointed out earlier in this chapter, U.S. manufacturers spend more on innovation and research and development than firms in other nations, but foreign firms are beginning to innovate and realize the importance of research and development.

8-7c the impact of automation, robotics, and Computers on Productivity Automation is the total or near-total use of machines to do work. The rapid increase in automated procedures has been made possible by computer technology—the same technology that led to the production of desktop computers for businesses, homes, and schools. In factories, computer technology is used in robotics and in sophisticated manufacturing systems.

roBotiCS Robotics is the use of programmable machines to perform a variety of tasks by manipulating materials and tools. Robots work quickly, accurately, and steadily. For example, the iRobot Ava 500, distributed by Cisco Systems, is a robot that takes teleconferencing to the next level and allows workers to meet with other employees in an office setting or tour remote facilities that would be impossible without traveling to the physical site. The AVA 500 robot can also be used to inspect manufacturing facilities, laboratories, customer experience centers, and other remote facilities. And when the robot’s work is finished, it will return to its docking station for charging.22

Robots are especially effective in tedious, repetitive assembly-line jobs, as well as in handling hazardous materials. Lincoln Electric, for example, provides robotic arc welders that eliminate the hot, dirty job of welding, which is key to many

lean manufacturing a concept built on the idea of eliminating waste from all of the activities required to produce a product or service

automation the total or near-total use of machines to do work

robotics the use of programmable machines to perform a variety of tasks by manipulating materials and tools

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manufacturing tasks. As an added bonus, robotic arc welders are often quicker and are more precise than old-fashioned welding machines.

Robots are also useful as artificial “eyes” that can check the quality of products as they are being processed on assembly lines. To date, the automotive industry has made the most extensive use of robotics, but robots also have been used to mine coal, inspect the inner surfaces of pipes, assemble computer components, provide certain kinds of patient care in hospitals, and clean and guard buildings at night.

CoMPuter MaNufaCturiNG SySteMS People are quick to point out how computers have changed their everyday lives, but most people do not realize the impact computers have had on manufacturing. In simple terms, the factory of the future has already arrived. For most manufacturers, the changeover began with the use of computer-aided design and computer-aided manufacturing. Computer-aided design (CAD) is the use of computers to aid in the development of products. Ford speeds up car design, Canon designs new photocopiers, and American Greetings creates new birthday cards by using CAD.

Computer-aided manufacturing (CAM) is the use of computers to plan and control manufacturing processes. A well-designed CAM system allows manufacturers to become much more productive. Not only are a greater number of products produced, but speed and quality also increase. Using CAM systems, Toyota produces automobiles, Hasbro manufactures toys, and Apple Computer creates electronic products.

If you are thinking that the next logical step is to combine the CAD and CAM computer systems, you are right. Today, the most successful manufacturers use CAD and CAM together to form a computer-integrated manufacturing system. Specifically, computer-integrated manufacturing (CIM) is a computer system that not only helps to design products but also controls the machinery needed to produce the finished product. For example, manufacturers for Juicy Couture use CIM to design clothing, to establish patterns for new fashions, and then to cut the cloth needed to produce finished products that are sold in Juicy Couture Stores and select department stores in North America, Europe, Asia, Latin America, Africa, and the Middle East.23 Other advantages of using CIM include improved flexibility, more efficient scheduling, and higher product quality—all factors that make a production facility more competitive in today’s global economy.

computer-aided design (CAD) the use of computers to aid in the development of products

computer-aided manufacturing (CAM) the use of computers to plan and control manufacturing processes

computer-integrated manufacturing (CIM) a computer system that not only helps to design products but also controls the machinery needed to produce the finished product

The factory of the future is already here! Thanks to automation, robotics, and computer manufacturing, manufacturing is much more efficient and employees are more productive. Because of increased efficiency and improved productivity, U.S. firms are able to compete with manufacturers both at home and in the global marketplace.

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fLexiBLe MaNufaCturiNG SySteMS Manufacturers have known for a number of years that the mass-production and traditional assembly lines used to manufacture products present a number of problems. For example, although traditional assembly lines at General Motors, Ford, Nissan, and other automobile manufacturers turn out extremely large numbers of products economically, the system requires expensive, time-consuming retooling of equipment whenever a new product is to be manufactured. This type of manufacturing is often referred to as a continuous process. Continuous process is a manufacturing process in which a firm produces the same product(s) over a long period of time. Now it is possible to use flexible manufacturing systems to solve such problems. A flexible manufacturing system (FMS) combines electronic machines and CIM in a single production system. Instead of having to spend large amounts of time and effort to retool the traditional mechanical equipment on an assembly line for each new product, an FMS is rearranged simply by reprogramming electronic machines. Because FMSs require less time and expense to reprogram than traditional systems, manufacturers can produce smaller batches of a variety of products without raising the production cost. Flexible manufacturing is sometimes referred to as an intermittent process. An intermittent process is a manufacturing process in which a firm’s manufacturing machines and equipment are changed to produce different products.

For most manufacturers, the driving force behind FMSs is the customer. In fact, the term customer-driven production is often used to describe a manufacturing system that is driven by customer needs and what customers want to buy. For example, advanced software and a flexible manufacturing system have enabled Dell Computer to change to a more customer-driven manufacturing process. Although the costs of designing and installing an FMS such as this are high, the electronic equipment is used more frequently and efficiently than the machinery on a traditional assembly line.

8-7d Sustainability and technological Displacement In Chapter 1, sustainability was defined as creating and maintaining the conditions under which humans and nature can exist in productive harmony that permit fulfilling the social, economic, and other requirements of present and future generations. While sustainability affects all aspects of a nation, its people, and the economy, the concept is especially important for manufacturers and service providers. Because of the amount of resources required to produce goods and services, these businesses must conserve resources whenever possible. As an added bonus, efforts to reduce waste and sustain the planet can often improve a firm’s bottom-line profit amount.

Today, many countries around the globe produce goods and services and compete with U.S. manufacturers. And yet, U.S. producers are known for quality and innovation—especially for products that are more expensive or more complicated to manufacture. As a result, most experts agree that, because U.S. manufacturers will continue to innovate, workers who have manufacturing jobs will be highly skilled and will be able to work with automated and computer- aided manufacturing systems. Those that don’t possess high-tech skills will be unemployed. Many workers will be faced with the choice of retraining for new jobs or seeking jobs in other sectors of the economy. Government, business, and education will have to cooperate to prepare workers for new roles in an automated workplace.

The next chapter discusses many of the issues caused by technological displacement. In addition, a number of major components of human resources management are described, and we see how managers use various reward systems to boost motivation, productivity, and morale.

continuous process a manufacturing process in which a firm produces the same product(s) over a long period of time

flexible manufacturing system (FMS) a single production system that combines electronic machines and CIM

intermittent process a manufacturing process in which a firm’s manufacturing machines and equipment are changed to produce different products

Concept Check ✓✓ how might productivity be measured in a dry cleaners? in a department store? in a public school system?

✓✓ how can robotics, computer manufacturing systems, and flexible manufacturing systems help a manufacturer to produce products?

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Summary

8-1 explain the nature of production.Operations management consists of all the activities that managers engage in to create goods and services. Today, U.S. companies are forced to compete in an ever-smaller world to meet the needs of more- demanding customers. As a result, U.S. manufacturers have used innovation to improve productivity. Because of innovation, fewer workers are needed, but those workers who are needed possess the skills to use automation and technology. In an attempt to regain a competitive edge, manufacturers have taken another look at the importance of improving quality and meeting the needs of their customers. They also have used new techniques to motivate employees, reduced costs, used computer-aided and flexible manufacturing systems, improved control procedures, and used green manufacturing. Competing in the global economy is not only profitable but also an essential activity that requires the cooperation of everyone within an organization. A number of career options are available for employees in operations management.

8-2 Outline how the conversion process transforms raw materials, labor, and other resources into finished goods or services.

A business transforms resources into goods and services in order to provide utility to customers. Utility is the ability of a good or service to satisfy a human need. Form utility is created by people converting raw materials, finances, and information into finished products. Conversion processes vary in terms of the major resources used to produce goods and services (focus), the degree to which resources are changed (magnitude of change), and the number of production processes that a business uses.

8-3 understand the importance of service businesses to consumers, other business firms, and the nation’s economy.

The application of the basic principles of operations management to the production of services has coincided with the growth and importance of service businesses in the United States. Today 86 percent of American workers are employed in the service industry. In fact, the American economy is now characterized as a service economy. For a service firm, planning often begins with determining who the customer is and what needs the customer has. After customer needs are identified the next step is to develop a plan that will enable the firm to deliver the services that their customers want or need.

Although it is often more difficult to measure customer satisfaction, today’s successful service firms work hard at providing the services customers want. For example, compared with manufacturers, service firms often listen more carefully to customers and respond more quickly to the market’s changing needs.

8-4 describe how research and development leads to new products and services.

Operations management often begins with product research and development and often referred to as R&D. The results of R&D may be entirely new products or services or extensions and refinements of existing products or services. R&D activities are classified as basic research (aimed at uncovering new knowledge), applied research (discovering new knowledge with some potential use), and development and implementation (using new or existing knowledge to produce goods and services). If a firm sells only one product or provides only one service, when customers quit buying the product or service, the firm will die. To stay in business, the firm must, at the very least, find ways to refine or extend the want-satisfying capability of its product or service.

8-5 discuss the components involved in planning the production process. Planning for production involves three major phases: design planning, site selection and facilities planning, and operational planning. First, design planning is undertaken to address questions related to the product line, required production capacity, and the use of technology. Then production facilities, human resources, and plant layout must be considered. Operational planning focuses on the use of production facilities and resources. The steps for operational planning include (1) selecting a planning horizon, (2) estimating market demand, (3) comparing market demand with capacity, and (4) adjusting production of products or services to meet demand.

8-6 explain how purchasing, inventory control, scheduling, and quality control affect production.

The major areas of operations control are purchasing, inventory control, scheduling, and quality control. Purchasing involves selecting suppliers. The choice of suppliers should result from careful analysis of a number of factors, including price, quality, reliability, credit terms, and shipping costs. Inventory control is the management of stocks of raw materials, work- in-process, and finished goods to minimize the total inventory cost. Scheduling ensures that materials and

Chapter 8 Producing Quality Goods and Services 237

other resources are at the right place at the right time. Quality control guarantees that products and services are produced in accordance with design specifications. The major objective of quality control is to see that the organization lives up to the standards it has set for itself on quality. A number of different activities including quality circles, inspection, total quality management, and six sigma can be used to encourage employee participation and to improve quality.

8-7 summarize how technology can make american firms more productive and competitive in the global marketplace.

Productivity is the average level of output per worker per hour. From 2004 to 2014, U.S. productivity growth averaged a 2.1 percent increase. More specifically, productivity for the first three quarters of 2014 increased 3.2 percent. Although a 3.2 percent increase was higher when compared to our average productivity growth over the 2004 to 2014 time period, economists,

business leaders, and government officials point to the need for even larger increases in the future. Several factors must be considered if U.S. firms are going to increase productivity and their ability to compete in the global marketplace.

Automation, the total or near-total use of machines to do work, has for some years been changing the way work is done in factories. A growing number of industries are using programmable machines called robots. Computer-aided design, computer-aided manufacturing, and computer-integrated manufacturing use computers to help design and manufacture products. A flexible manufacturing system (FMS) combines electronic machines and CIM to produce smaller batches of products more efficiently than on the traditional assembly line. Instead of having to spend vast amounts of time and effort to retool the traditional mechanical equipment on an assembly line for each new product, an FMS is rearranged simply by reprogramming electronic machines. An FMS is sometimes referred to as an intermittent process.

Key Terms

You should now be able to define and give an example relevant to each of the following terms:

operations management (212) reshoring (214) mass production (214) analytical process (214) synthetic process (214) utility (215) form utility (215) service economy (216) research and development

(R&D) (218) design planning (221) product line (221)

product design (221) capacity (221) labor-intensive technology

(222) capital-intensive technology

(222) plant layout (223) planning horizon (224) purchasing (226) inventory control (227) materials requirements

planning (MRP) (227)

just-in-time inventory (JIT) system (228)

scheduling (228) Malcolm Baldrige National

Quality Award (229) quality control (229) quality circle (230) inspection (230) Six Sigma (230) International Organization for

Standardization (ISO) (230) lean manufacturing (233)

automation (233) robotics (233) computer-aided design (CAD)

(234) computer-aided manufacturing

(CAM) (234) computer-integrated

manufacturing (CIM) (234) continuous process (235) flexible manufacturing system

(FMS) (235) intermittent process (235)

Discussion Questions

1. Why would Rubbermaid—a successful U.S. company— need to expand and sell its products to customers in foreign countries?

2. What steps have U.S. firms taken to regain a competitive edge in the global marketplace?

3. Do certain kinds of firms need to stress particular areas of operations management? Explain.

4. Is it really necessary for service firms to engage in research and development? In planning for production and operations control?

5. How are the four areas of operations control interrelated? 6. Is operations management relevant to nonbusiness

organizations such as colleges and hospitals? Why or why not?

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Video Case Chobani Gives the world a taste for Greek yogurt

Entrepreneur Hamdi Ulukaya, founder and CEO of fast- growing Chobani, needed less than ten years to transform a defunct yogurt factory in rural South Edmeston, New York into the U.S. capitol of Greek yogurt production. He came up with the idea of making Greek yogurt in the United States in 2005, when he bought the factory with the help of a Small Business Administration loan from its former owner, Kraft Foods. Ulukaya spent the next 18 months experimenting with recipes while upgrading the factory, arranging a steady supply of milk and other fresh ingredients, and working out the details of what the yogurt cup would look like.

By 2007, Ulukaya had perfected his recipe and was churning out the first cases of Chobani yogurt for an ever-larger list of supermarket customers. His Greek yogurt, thicker and tangier than traditional yogurts, took the industry by storm. Ulukaya originally projected that Chobani would break even if it produced 20,000 cases of yogurt every week. By 2009, the company was getting weekly orders for 200,000 cases—ten times the founder’s estimate.

Suddenly, Chobani’s Greek yogurt wasn’t a tiny, niche product that multinational competitors like Dannon and Yoplait could ignore. Although Ulukaya considered enlarging the factory to accommodate weekly production capacity of 400,000 cases, he decided on the much more ambitious strategy of planning for weekly production capacity of 1 million cases. This huge expansion required new equipment and an around-the-clock production schedule. At the newly enlarged plant, employees would operate machines for 10 hours, followed by a cleaning period of 4 hours to ensure product purity.

By 2012, Chobani was ringing up $1 billion in annual sales throughout North America, and the South Edmeston factory was operating at near capacity every day. According to Ulukaya, “milk is a gift from nature” and along with the freshest fruits available is what makes Chobani different from its competitors. However, Chobani was having difficulty obtaining sufficient quantities of fresh milk to further boost production in the New York plant. Whereas one cup of regular yogurt is made from one cup of milk, one cup of Greek yogurt requires three cups of milk. Ulukaya’s $450 million solution to the challenge of milk availability: Build a cavernous new production facility in Twin Falls, Idaho, where Chobani can draw on an abundant local supply of milk. This plant opened in December, 2012, with a weekly production

capacity of more than 2 million cases of yogurt. It serves Western states, while the original New York plant ships to Eastern states.

Even as Chobani gears up for higher production and higher market share in North America, it’s also getting ready for growth halfway around the world. Ulukaya purchased a dairy near Melbourne, Australia, and invested millions of dollars to upgrade and expand yogurt production at the site. From this facility, Chobani will serve Australia and export its popular Greek yogurt to new markets in Asia. In addition, it maintains a sales office in Europe to support expansion on the continent.

Today, Chobani—a company that was started with an SBA loan in 2005—dominates the U.S. market for Greek yogurt and is the number one Greek yogurt brand in the U.S. It has expanded its product line to include Greek yogurt for children and various sizes and flavors of Greek yogurt for adults. Not long ago, Ulukaya opened a specialty yogurt shop in a trendy part of New York City. New flavor combinations that prove especially popular there may soon be transferred to the production lines in New York, Idaho, and beyond.

While a product recall in 2013 caused Chobani’s market share to take a one percent drop and a corresponding drop in revenues, the company moved quickly to correct the problems that led to the recall. Today, the company is constantly looking for new ways to improve its manufacturing efficiency and increase sales revenues and profits while staying true to its mission. According to Ulukaya, “If we can’t do it better, we don’t do it at all.”24

Questions 1. Do you agree with Ulukaya’s decision to open a produc-

tion facility in Idaho instead of buying milk and trucking it to Chobani’s New York plant? In addition to the cost of transporting the milk, are there other factors that might have influenced Ulukaya’s decision to build a second plant?

2. What can Chobani do to gauge market demand for Greek yogurt and for particular flavors and products in its own product line? Identify at least three specific ideas.

3. Chobani’s equipment runs for 10 hours and must be idle for four hours while being cleaned. Its plants operate day and night, all week long. What are the implications for the company’s purchasing, inventory control, scheduling, and quality control functions?

Chapter 8 Producing Quality Goods and Services 239

Building Skills for Career Success

1. Social Media Exercise Starbucks has taken an innovative approach to improving their products and the customer experience in their stores. Their entire purpose is to create a “third place” beyond home and work where people can congregate and socialize (while having a nice cup of coffee). To engage customers, they created a website called My Starbucks Idea (http://mystarbucksidea.com) that allows customers to post their ideas and then allows customers to also vote on them. 1. Visit the http://mystarbucksidea.com site. Do you have an

idea for Starbucks? If so, post it. Do you have an opinion about one of the current ideas? If so, then vote for it.

2. Do you think this is an effective way to gain customer ideas for new products? Why or why not?

3. Can you think of other ways that corporate executives at Starbucks can gauge customer interest in their products and in-store experience using social media?

2. Building Team Skills Suppose that you are planning to build a house in the country. It will be a brick, one-story structure of approximately 2,000 square feet, centrally heated and cooled. It will have three bedrooms, two bathrooms, a family room, a dining room, a kitchen with a breakfast nook, a study, a utility room, an entry foyer, a two-car garage, a covered patio, and a fireplace. Appliances will operate on electricity and propane fuel. You have received approval and can be connected to the cooperative water system at any time. Public sewerage services are not available; therefore, you must rely on a septic

system. You want to know how long it will take to build the house.

assignment 1. In a group, identify the major activities involved in the

project and sequence them in the proper order. 2. Estimate the time required for each activity. 3. Present your list of activities to the class and ask for

comments and suggestions.

3. Researching Different Careers Because service businesses are now such a dominant part of our economy, job seekers sometimes overlook the employment opportunities available in production. Two positions often found in manufacturing and production are quality-control inspector and purchasing agent.

assignment 1. Using the Occupational Outlook Handbook at your local

library or on the Internet (http://www.bls.gov/ooh), find the following information for the jobs of quality-control inspector and purchasing agent: a. Nature of work, including main activities and respon-

sibilities b. Job outlook c. Earnings d. Training, qualifications, and advancement.

2. Look for other production jobs that may interest you and compile the same sort of information about them.

3. Summarize in a two-page report the key things you learned about jobs in production.

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1p6

Running a Business Part 3

Graeter’s Grows through Good Management, organization, and Quality

Graeter’s began as a tiny Cincinnati business and now enjoys a national reputation for the quality of its premium ice cream. Even though the $30 million company recently opened a new factory to support its expansion plans, it still clings fiercely to its original small-batch production method for making creamy ice cream from fresh ingredients. CEO Richard Graeter emphasizes that profits are important, but “staying true to who you are and investing in your business is what makes sure that your business is going to be here tomorrow.” That’s why Graeter’s still makes all of its ice cream by hand, ensuring that the texture and taste meet its high standards batch after batch, year after year.

More than a Family Affair Graeter’s top-management team includes the CEO and his two cousins, Bob and Chip Graeter. As vice president of operations, Bob is responsible for manufacturing, as well as for developing new products and finding suppliers to provide ingredients such as fresh fruits, cream, eggs, and chocolates. His brother Chip oversees all of the company’s ice cream shops. Rounding out the management team is a vice president of manufacturing, a controller, a vice president of sales and marketing, and a candy production manager.

“Every major decision, we make on a consensus basis,” Richard says, describing the equal partnership among the three family members. “That doesn’t mean we don’t have a different point of view from time to time, but . . . we learn to see each other’s view and discuss, debate, and get down to a decision that all of us support. The other thing that we have learned to do, something that is a little different than our parents’ generation [did], is bring in outside people into the . . . executive level of the management team. . . . We now work with a couple of consultants to help us plan our strategy to look for a new vision, to develop training programs . . . all those systems that big companies have.” Managers stay in close contact with employees at all levels and don’t hesitate to ask for their input when solving problems and making decisions.

Inside the Org Chart Graeter’s formalized its organization structure over the years as it opened more stores and expanded beyond

Cincinnati. Today, the store managers report to a group manager, who in turn reports to the vice president of retail operations. At the company’s recently opened 28,000

square foot production facility, employees in each of three shifts are supervised by a shift manager, who reports to the vice president of operations. The first and third shifts are responsible for ice

cream production, while the second shift is in charge of cleaning and sanitizing the facility.

Because so many Graeter’s stores are located miles from headquarters, two managers “shop” each store every

month, checking on quality and service. These management visits are supplemented by two

monthly visits from “mystery shoppers” who buy ice cream and other products on different days, observing what employees are doing and taking note of what else is happening in the store. Their

written reports give Graeter’s top managers another view of the business, this time from the customer’s

perspective.

What’s the Plan? Change has come quickly to Graeter’s, not all of it

anticipated. The company was constructing its second factory to support the drive for nationwide distribution

when an unexpected opportunity arose: to buy out the last franchise company operating Graeter’s retail stores and take over its factory as well. The management team jumped at the chance. “A few months ago our strategy was just operate one plant,” says Richard. “Now our strategy is, adapt to the opportunity that came along . . . we are operating three plants. The goal is to keep all of your assets deployed productively, so if we have these three plants, what is the most we can do out of those plants to be generating product and profit? One example would be supplying restaurants in other cities, which we really weren’t considering originally because our new plant was really geared for pints, but if we have this excess capacity, the smart thing to do is figure out what we can do with that.”

The newest Graeter’s facility, on Regina Graeter Way in Cincinnati, was built with the capacity to produce as much as 1 million gallons of ice cream per year, although the current annual output is about 625,000 gallons. Many steps, such as

240 Part 3 Management and Organization

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Chapter 8 Producing Quality Goods and Services 241

putting lids on packages and moving them into refrigerated storage, are handled by automated equipment. Yet all of the ice cream is still made in small batches and by hand. Experienced technicians wield a paddle to gradually mix in ingredients such as molten chocolate, which have been pasteurized on the premises to comply with government regulations. Once the ice cream reaches the right temperature and texture, another employee hand-packs it into individual packages, which are then automatically capped, stamped with a date code, sealed, and whisked away to be kept cold until being loaded onto trucks for delivery to supermarket customers. Ice cream samples from every shift’s output are tested to ensure purity and quality.

Graeter’s sets weekly and monthly sales goals for its stores, based on each unit’s location and other factors that affect demand. If a store doesn’t meet its goals, the group manager acts quickly to find out why and help the store get back on track. As the company explores the possibility of opening Graeter’s stores as far away as Los Angeles and

New York, the management team is planning carefully and assessing the potential challenges and advantages of coast- to-coast operations.25

Questions 1. Based on this case and the two previous Graeter’s cases,

what are the company’s most important strengths? Can you identify any weaknesses that might affect its ability to grow?

2. How would you describe the departmentalization and the organizational structure at Graeter’s? Do you think Graeter’s is centralized or decentralized, and what are the implications for its plans for growth?

3. The newest Graeter’s plant can produce far more ice cream than is needed today. The company also makes ice cream cakes, pies, toppings, and other products at its original plant and at the plant formerly owned by a fran- chisee. What are the implications for Graeter’s strategy and for its operational planning?

Chapter 8 Producing Quality Goods and Services 241

242 Part 3 Management and Organization

Now you should be ready to provide evidence that you have a management team with the necessary skills and experience to execute your business plan successfully. Only a competent management team can transform your vision into a successful business. You also should be able to describe your manufacturing and operations plans. The three chapters in Part 3 of your textbook, “Understanding the Management Process,” “Creating a Flexible Organization,” and “Producing Quality Goods and Services,” should help you in answering some of the questions in this part of the business plan.

The Management Team Component The management team component should include the answers to at least the following questions: 3.1. How is your team balanced in technical, conceptual,

interpersonal, and other special skills needed in your business?

3.2. What will be your style of leadership? 3.3. How will your company be structured? Include a state-

ment of the philosophy of management and company culture.

3.4. What are the key management positions, compensation, and key policies?

3.5. Include a job description for each management position and specify who will fill that position. Note: Prepare an organization chart and provide the résumé of each key manager for the appendix.

3.6. What other professionals, such as a lawyer, an insurance agent, a banker, and a certified public accountant, will you need for assistance?

The Manufacturing and Operations Plan Component If you are in a manufacturing business, now is a good time to describe your manufacturing and operations plans, space

requirements, equipment, labor force, inventory control, and purchasing requirements. Even if you are in a service-oriented business, many of these questions still may apply.

The manufacturing and operations plan component should include the answers to at least the following questions: 3.7. What are the advantages and disadvantages of your

planned location in terms of

• Wage rates

• Unionization

• Labor pool

• Proximity to customers and suppliers

• Types of transportation available

• Tax rates

• Utility costs

• Zoning requirements

3.8. What facilities does your business require? Will you rent, lease, or purchase the facilities? Prepare a floor plan for the appendix.

3.9. Will you make or buy component parts to be assem- bled into the finished product? Make sure to justify your “make-or-buy” decision.

3.10. Who are your potential subcontractors and suppliers? 3.11. How will you control quality, inventory, and production?

How will you measure your progress? 3.12. Is there a sufficient quantity of adequately skilled peo-

ple in the local labor force to meet your needs?

Review of Business Plan Activities Be sure to go over the information you have gathered. Check for any weaknesses and resolve them before beginning Part 4. Also, review all the answers to the questions in Parts 1, 2, and 3 to be certain that they are consistent throughout the entire business plan. Finally, write a brief statement that summarizes all the information for this part of the business plan.

Endnotes

1 Sources: Based on information in Gary Anglebrandt, “Detroit Bikes Rolls Out Second Model, Sets Sales Goal of 1,000 by Year’s End,” Crain’s Detroit Business, August 24, 2014, www.crainsdetroit.com; Jen Weiczner, “Motor-less City? Bankrupt Detroit’s Booming Bike Industry,” Fortune, October 9, 2014, www.fortune.com; Jason McBride, “Cycling in Motor City,” Canadian Business, February 19, 2014, www. canadianbusiness.com; http://detroitbikes.com.

2 The Bureau of Labor Statistics website at www.bls.gov (accessed January 20, 2015).

3 Tom Raum, “Obama Call for Manufacturing Revival a Tough Goal,” the Yahoo! Finance website at http://finance.yahoo.com (accessed February 10, 2012).

4 The Bureau of Labor Statistics website at www.bls.gov (accessed January 20, 2015).

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Chapter 8 Producing Quality Goods and Services 243

5 “Industry Employment and Output Projections to 2022,” The Bureau of Labor Statistics website at www.bls.gov (accessed January 20, 2015).

6 Marc Levinson, “U.S. Manufacturing in International Perspective,” Congressional Research Service website at http://fas.org/sgp/crs/misc/ R42135.pdf (accessed February 20, 2014).

7 “U.S. Manufacturing in Context,” The Advanced Manufacturing Portal website at www.manufacturing.gov (accessed January 20, 2015).

8 Ibid. 9 Ibid. 10 The Bureau of Labor Statistics website at www.bls.gov (accessed

January 21, 2015). 11 Robert Kreitner and Carlene Cassidy, Management, 12th ed. (Mason,

OH: Cengage Learning, 2013). 12 Marc Levinson, “U.S. Manufacturing in International Perspective,”

Congressional Research Service website at http://fas.org/sgp/crs/misc/ R42135.pdf (accessed February 20, 2014).

13 The 3M Corporation website at www.3m.com (accessed January 21, 2015).

14 The Berry Plastics Corporation website at www.berryplastics.com (accessed January 22, 2015).

15 The AT&T Supplier website at www.attsuppliers.com (accessed January 22, 2015).

16 “What Makes Six Sigma Work,” The iSixSigma website at www. isixsigma.com (accessed January 22, 2015).

17 The International Organization of Standardization (ISO) website at www. iso.org (accessed February 15, 2013).

18 The Bureau of Labor Statistics website at www.bls.gov (accessed January 22, 2015).

19 Ibid. 20 Ibid. 21 “International Labor Comparisons,” The Conference Board website at

www.conference-board.org (accessed January 20, 2015). 22 The KBZ Communications website at www.kbz.com (accessed January

23, 2015).

23 The Juicy Couture website at www.juicycouture.com (accessed January 23, 2015).

24 Sources: Based on information from the Chobani website at www. chobani.com (accessed January 27, 2015); Eric Goodell, “Chobani Defends Company, Twin Falls Plant Operations,” the MagicValley. com website at www.magicvalley.com (accessed January 8, 2015); Bryan Gruley, “How a Turkish Immigrant Made a Billion Dollars in Eight Years Selling … Yogurt,” Bloomberg Businessweek, February 4, 2013, pp. 60–64; Andrew Grossman, “Yogurt Boom Leaves Dairy Farmers Behind,” Wall Street Journal, June 26, 2012, www.wsj. com; Bill Roberts, “Twin Falls Welcomes New Chobani Yogurt Plant,” Idaho Statesman, December 17, 2012, www.idahostatesman.com; Mark Astley, “What to Expect in 2013,” Dairy Reporter, January 9, 2013, www.dairyreporter.com; Meghan Walsh, “Chobani Takes Gold in the Yogurt Aisle,” Bloomberg Businessweek, July 31, 2012, www. businessweek.com.

25 Sources: Based on information from the Graeter’s website at www. graeters.com (accessed January 26, 2015); Kimberly L. Jackson, “Graeter’s Premium Chocolate Chip Ice Cream Lands at Stop & Shop,” Newark Star-Ledger (NJ), April 4, 2012, www.nj.com; “Graeter’s Ice Cream Debuts in Bay Area,” Tampa Bay Times (St. Petersburg, FL), January 10, 2012, p. 4B; “Graeter’s to Make All Ice Cream at new Cincinnati Plant,” the Cincinnati Business Courier website at http://www. bizjournals.com/cincinnati/news/2011/08/12/graeters-to-make-all-ice- cream-at-new.html (accessed August 12, 2011); Jim Carper, “Graeter’s Runs a Hands-on Ice Cream Plant,” Dairy Foods, August 2011, pp. 36+; Jim Carper, “The Greater Good,” Dairy Foods, August 2011, pp. 95+; “Graeter’s Unveils New ‘Mystery Flavor,’” Dayton Daily News, March 29, 2012, www.daytondailynews.com; Bob Driehaus, “A Cincinnati Ice Cream Maker Aims Big,” New York Times, September 11, 2010, www. nytimes.com; Lucy May, “Graeter’s Northern Kentucky Franchisee Puts Stores on the Block,” Business Courier, August 6, 2010, http:// cincinnati.bizjournals.com; interviews with company staff and Cengage videos about Graeter’s.

Learning Objectives Once you complete this chapter, you will be able to:

9-1 Describe the major components of human resources management. 9-2 Identify the steps in human resources planning. 9-3 Describe cultural diversity and understand some of the challenges and

opportunities associated with it.

9-4 Explain the objectives and uses of job analysis. 9-5 Describe the processes of recruiting, employee selection, and orientation.

9-6 Discuss the primary elements of employee compensation and benefits. 9-7 Explain the purposes and techniques of employee training and development. 9-8 Discuss performance appraisal techniques and performance feedback. 9-9 Outline the major legislation affecting human resources management.

Attracting and Retaining the Best Employees

ChAptER

9 Why Should You Care? Being able to understand how

to attract and keep the right

people is crucial. Also, you can

better understand about your own

interactions with your co-workers.

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Netflix recruits some of the most skilled people in the tech industry and retains and keeps them satisfied by offering good compensation and trusting them to do right by the company. We begin our study of human resources management (HRM) with an overview of how businesses acquire, maintain, and develop human resources. After listing the steps by which firms match their human resources needs with the supply available, we explore several dimensions of cultural diversity. Then we examine the concept of job analysis. Next, we focus on how a firm’s recruiting, selection, and orientation procedures impact a firm’s success in acquiring employees. We describe forms of employee compensation, which can impact employee loyalty and productivity. Then we discuss methods of employee training, management development, and performance appraisal. Finally, we consider legislation that affects HRM practices.

9-1 Human ResOuRCes management: an OveRview Human resources, the people who work within an organization, are the most important and valuable resource for a business. Without them, a firm would cease to function. Organizations will expend a great deal of effort to acquire and utilize human resources fully. This effort is known as human resources management, or staffing and personnel management.

Human resources management (HRM) consists of all the activities involved in acquiring, maintaining, and developing an organization’s human resources. HRM begins with acquisition—getting people to work for the organization. The acquisition

Learning Objective

9-1Describe the major components of human resources management.

human resources management (HRM) all the activities involved in acquiring, maintaining, and developing an organization’s human resources

Netflix Stands Ready to Change

Founded in 1997 to rent dvds by mail, netflix was a fledgling business challenging the competitive dominance of mighty blockbuster, which operated an extensive network of video and dvd rental stores. these days, the video format is obsolete and blockbuster is bankrupt, but netflix is thriving worldwide because it was smart enough and nimble enough to shift focus from renting dvds to streaming entertainment as the technology evolved. the california-based company now streams two billion hours of movies and television every month to 53 million subscribers in 50 countries.

credit netflix’s culture of excellence for the company’s success. it hires the best managers and employees, and gives them the free- dom and responsibility to do whatever it takes to move the company forward. in fact, co-founder and ceo reed hastings prides himself on making as few decisions as possible. he rejects the idea of rigidly controlling the workforce because “if you dummy-proof the process, you only get dummies to work there.”

instead, netflix seeks out highly skilled, high-performance individu- als and trusts them to do what’s best for the company. For example, instead of having to comply with a lengthy, detailed policy for business

travel and expenses, employees are told only to: “act in netflix’s best interests.” the firm’s vacation policy for salaried employees is similarly informal, depending on common sense and the rhythm of the business to set the tone. salaried employees can arrange time off as needed, as long as they consult with their managers and colleagues, and ensure proper staffing levels during busy periods.

rather than requiring the kind of formal yearly performance reviews that are typical at other organizations, managers and employees at netflix have spontaneous performance-appraisal con- versations as occasions arise, day by day. and to keep work teams running smoothly, the company asks employees to provide feedback about what their managers and colleagues should stop doing, start doing, or keep doing.1

Did You Know? Netflix, which began as a DVD-rental-by-mail business, currently rings up more than $4.4 billion in annual revenues and serves 53 million customers in 50 countries.

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process can be very competitive, particularly for skilled employees and in fields where demand for workers exceed supply. Next, steps must be taken to retain these valuable resources. (After all, they are the only business resources that can voluntarily leave an organization.) Finally, human resources should be developed to their full capacity.

9-1a hRM Activities Each of the three phases of HRM—acquiring, maintaining, and developing human resources— consists of related actions. Acquisition, for exam- ple, includes planning, and the various activities that lead to hiring new personnel. Altogether this phase of HRM includes five separate activities:

• Human resources planning—determining the firm’s future human resources needs

• Job analysis—determining the exact nature of the positions

• Recruiting—attracting people to apply for positions

• Selection—choosing and hiring the most qualified applicants

• Orientation—acquainting new employees with the firm

Maintaining human resources consists primarily of encouraging employees to remain with the firm and to work effectively by using a variety of HRM programs, including the following:

• Employee relations—increasing employee job satisfaction through satisfaction surveys, employee communication programs, exit interviews, and fair treatment

• Compensation—rewarding employee effort through monetary payments

• Benefits—providing rewards to ensure employee well-being

The development phase of HRM is concerned with improving employees’ skills and expanding their capabilities. The two important activities of this phase are:

• Training and development—teaching employees new skills and new jobs, and more effective ways of performing their present jobs

• Performance appraisal—assessing employ- ees’ current and potential performance levels

We will discuss each of these activities in more detail later in the chapter.

how many skills do you have?

The more skills you develop, the more valuable you are to any employer. Do your own personal skills inventory before you write a résumé or interview for a job. Then you’ll be prepared to explain the special skills you can bring to an employer.

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The power of people. Many firms believe their employees are their most important assets. However, unlike other assets such as machinery, capital, and products, employees can choose to leave an organization. Carefully designing compensation and reward packages can help a firm attract and retain valuable employees.

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9-1b Responsibility for hRM In general, HRM is a shared responsibility of line managers and staff HRM specialists. In very small organizations, the owner handles all or most HRM activities. As a firm grows in size, an owner may employ an outside party to handle some HRM functions, such as payroll and taxes, or hire a human resources manager to take over some staff responsibilities. In very large firms such as Disney, HRM activities tend to be highly specialized, with separate groups for compensation, benefits, training and development, and other staff activities. GE, for example, has divisions and offices all over the world. Because of the size and complexity of the organization, GE has hundreds of HR managers to cover different geographic areas and departments within the firm.

Specific HRM activities are assigned to those in the best position to perform them. Human resources planning and job analysis are usually carried out by staff specialists with input from line managers. Similarly, staff experts handle recruiting and selection, although line managers are involved in hiring decisions. Staff specialists devise orientation programs that are carried out by both staff specialists and line managers. Compensation systems (including benefits) most often are developed and administered by the HRM staff. However, line managers recommend pay increases and promotions. Training and development activities are the joint responsibility of staff and line managers. Performance appraisal is the job of the line manager, although HRM personnel design the firm’s appraisal system in many organizations.

9-2 Human ResOuRCes PLanning Human resources planning is the development of strategies to meet a firm’s future human resources needs. The organization’s overall strategic plan is the starting point of the process. From this, human resource planners can forecast future demand for human resources. Next, the planners must determine whether the needed human resources will be available. Finally, they have to take steps to match supply with demand.

9-2a Forecasting human Resources Demand Planners should base human resource demand forecasts on all relevant information available. The firm’s overall strategic plan will provide information about future business ventures, new products, and projected expansions or contractions of specific product lines. Information on past staffing levels, evolving technologies, industry staffing practices, and projected economic trends also can be helpful. Technological advances are creating new opportunities in forecasting and planning for human resources demand. Increasingly, companies are using specialized software to analyze data about their employees’ demographics, performance, training, and internal movements in order to make better HR decisions. Insights gained from such technology can help managers develop more cost-effective recruiting and selection strategies, as well as recognize threats and opportunities. For example, at Black Hills, Corp., computer modeling exposed the fact that an anticipated loss of 24 percent of employees over the next five years, due to retirement, would actually result in the loss of 34 percent of the firm’s total employee experience—a significant loss. Recognizing that threat, executives looked for ways to capture those employees’ knowledge and experience before they retired.2

HRM managers use forecasting information to determine both the number of employees required and their qualifications. Planners use a wide range of methods

Concept Check ✓✓ What are the three phases of human resources management?

✓✓ identify the activities associated with each phase.

✓✓ how does the responsibility of hrm change with the size of a firm?

Learning Objective

9-2 Identify the steps in human resources planning.

human resources planning the development of strategies to meet a firm’s future human resources needs

248 Part 4 Human Resources

to predict specific personnel needs. For example, a simple method projects personnel requirements to increase or decrease in the same proportion as sales revenue. Thus, a 30 percent increase in projected sales volume over the next two years results in a forecasted personnel increase of 30 percent for the same period. (This method can be applied to specific positions and to the workforce in general. It is not, however, a very precise forecasting method.) At the other end of the spectrum are complex computer programs that perform HRM activities, such as forecasting future human resources requirements, using algorithms and demographic data.

9-2b Forecasting human Resources Supply A forecast of human resources supply must take into account both the present workforce and any changes that may occur within it. For example, suppose that planners project that in five years a firm that currently employs 100 engineers will need to employ 200 engineers. Forecasting is not as simple as planning to hire 100 additional engineers. Some of the firm’s current engineers will leave, move to other jobs within the firm, or be promoted. Thus, planners may project the supply of current engineers in five years at 87, which means that the firm will have to hire a total of 113 new engineers. When forecasting supply, planners should also account for the organization’s existing employees to determine who can be retrained to perform required tasks.

Two useful techniques for forecasting human resources supply are the replacement chart and the skills inventory. A replacement chart is a list of key personnel and their possible replacements within a firm. It is important to maintain this chart to ensure that top-management positions can be filled quickly in the event of an unexpected death, resignation, or retirement. Some firms provide additional training for employees who might eventually replace top managers.

A skills inventory is a searchable database containing information on the skills and experience of all present employees, which can be mined to find

replacement chart a list of key personnel and their possible replacements within a firm

skills inventory a computerized data bank containing information on the skills and experience of all present employees

hiring Your First Employee: Key Questions to Consider

Put yourself in the shoes of an entrepreneur whose startup is gaining momentum. When is the right time to hire your first employee? Here are some key questions to ask before you recruit. • Do you have enough work for two people (or more)?

If so, what part of the business needs the most help? Think about what skills are required to complement your own skills. Also think about how to spread the workload so that you, as the owner, will have more time to work on strategic challenges and future planning.

• Do you have enough money? Your budget will have to cover not only compensation and benefits, but also payroll taxes and other mandatory payments. Remember to budget for a desk and a computer or other equipment for the new employee, not to mention the cost of complying with the laws and regulations that apply to employers. Yet cost is only part of the equation:

Consider whether hiring someone will help the business increase revenue, attract larger clients, or prepare for imminent expansion.

• Can you find qualified candidates who are accustomed to life in a startup? Not everyone is suited to the fast pace and pressure of a small business—and to working closely with an entrepreneurial boss. Although you’ll have to invest time to train and supervise your first employee, this investment will pay off if the employee understands how to function in an entrepreneurial situation.

sources: based on information in eric siu, “5 things you need to know before hiring your First employee,” Entrepreneur.com (accessed july 10, 2015), november 4, 2014; jeffrey hayzlett, “6 tips to keep in mind When hiring your First employees,” Entrepreneur.com, september 16, 2014; jessica stillman, “3 signs you’re ready to hire your First employee,” Inc., august 27, 2014, www.inc.com (accessed july 10, 2015); nellie akalp, “4 Questions to ask before hiring your First employee,” mashable, october 30, 2014, http://mashable.com/2014/10/30/questions- before-hiring/ (accessed july 27, 2015).

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Chapter 9 Attracting and Retaining the Best Employees 249

candidates to fill available positions. For a special project, a manager may be seeking a current employee with specific information technology skills, at least six years of experience, and fluency in French. The skills inventory can quickly identify qualified employees. Skill-assessment tests, which provide the information in a skills inventory, can be administered internally or by outside vendors. Some companies, such as Halogen Software, offer customizable skills assessment and training software that allows firms to examine skills more expertly without contracting with an outside provider.

9-2c Matching Supply with Demand Once they have forecasted the supply and demand for personnel, HR planners can devise a course of action for matching one with the other. When demand is predicted to be greater than supply, they must make plans to recruit new employees. The timing of recruitment efforts depends on the types of positions to be filled. Suppose that we expect to open another plant in five years that will need a plant manager and 25 maintenance workers, along with additional support staff. We can wait to recruit maintenance personnel. However, because the job of a plant manager is so critical, we may begin the process to fill that position immediately.

When the supply of employees is predicted to be greater than demand, the firm must take steps to reduce the size of its workforce. When the oversupply is expected to be temporary, companies may implement a hiring freeze, cut back employees’ hours and/or benefits, or lay off some employees—dismiss them from the workforce until they are needed again. In the case of layoffs, it is the positions that are eliminated rather than the employees holding those positions.

Perhaps the most humane method for making personnel cutbacks is through attrition. Attrition is the normal reduction in the workforce that occurs when employees leave a firm due to retirement or finding a new job.

Early retirement is another option for reducing workforce size. Under early retirement, people who are within a few years of retirement are permitted to retire ahead of schedule with full benefits. To streamline operations, Microsoft used a combination of attrition, layoffs, early retirements, and firings to reduce the size of its workforce by 18,000 people, most of them from recently acquired Nokia.3

Buyouts are similar to early retirement in that employees are offered a severance package in order to leave their jobs. Buyouts typically offer a number of weeks of pay for every year an employee has worked plus a specified period of extension of benefits after the employee leaves.

As a last resort, unnecessary employees are sometimes simply fired if cause can be found, such as failure to measure up to a specified performance standard. In such cases, companies must take care to document employees’ performance and should give them warning that their performance is subpar long before a pink slip is handed out. However, because of its negative impact, this method generally is used only when absolutely necessary.

Concept Check ✓✓ how do firms forecast the demand for human resources?

✓✓ What are the techniques used to forecast human resources supply?

✓✓ to match human resources supply and demand, how is attrition used?

The demand for labor versus its supply: A balancing act. The supply and demand for employees with different skills is constantly shifting. In some industries, qualified workers are plentiful. In others, they are hard to find, even when the nation’s unemployment rate is high.

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9-3 CuLtuRaL DiveRsity in Human ResOuRCes Today’s workforce is highly diverse, with employees bringing a wide variety of beliefs, expectations, and behavioral norms to the workplace. Managers must be sensitive to and aware of these differences. For instance, European businesspeople may offer a kiss on the cheek as a greeting. Latin Americans tend to stand closer to people with whom they are talking than North Americans prefer. Without cultural sensitivity, a job applicant who will not make eye contact during an interview may be rejected for being unapproachable, when, according to his or her culture, he or she was just being polite.

A large number of women, minorities, and immigrants have entered the U.S. workforce in recent decades. It is estimated that women make up about 47 percent of the U.S. workforce; African Americans and Hispanics each make up about 12 and 16 percent of U.S. workers, respectively.4 Women now account for the majority of workers in the financial, education, and health services industries. They make up 52 percent of management positions in the United States.5

Cultural (or workplace) diversity refers to the differences among people in a workforce owing to race, ethnicity, and gender. Increasing cultural diversity is forcing managers to learn to supervise and motivate people who have a broad range of value systems. In addition to cultural diversity, other changes have taken place as well. The high proportion of women in the workforce, combined with a new emphasis on participative parenting by men, has brought many family-related issues to the workplace. Today’s more educated employees also want greater independence and flexibility, leading to improved quality of life.

Although cultural diversity presents a challenge, managers should view it as an opportunity rather than a limitation. When managed properly, cultural diversity can result in a stronger organization. Table 9-1 shows several benefits that creative management of cultural diversity can offer, such as cost and human resource advantages. A culturally diverse organization may gain a marketing edge because it understands different cultures and languages. Proper guidance and management of diversity in an organization also can improve creativity. People who embrace

cultural diversity frequently are more flexible in the types of positions they will accept and are more comfortable working with diverse co-workers.

Because cultural diversity creates chal- lenges along with advantages, it is important for an organization’s employees to under- stand it. To accomplish this goal, numerous U.S. firms have trained their managers to respect and manage diversity. Diversity train- ing programs may include recruiting minori- ties, training minorities to be managers, training managers to view diversity positively, teaching English as a second language, and facilitating support groups for immigrants. Many companies recognize the importance of in-depth diversity training programs. International companies are continuously expanding their business and therefore need to meld a cohesive workforce from a labor pool with ever more diverse demographics.

A diversity program will be successful only if it is systematic, is ongoing, and has a

Learning Objective

9-3 Describe cultural diversity and understand some of the challenges and opportunities associated with it.

cultural (or workplace) diversity differences among people in a workforce owing to race, ethnicity, and gender

Why hiring a diverse group of employees can benefit your business. Organizations that hire diverse types of employees benefit from their different skills and life experiences. The different points of view of these workers can help a firm find new opportunities and ways of doing things. In addition, diverse employees often have a greater understanding of diverse customers and the goods and services they prefer.

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strong, sustained commitment from top leadership. Diversity training can improve workplace attitudes and behaviors, especially when it focuses on the group most resistant to diversity training, which is white male managers. Even though there may be resistance in certain situations, cultural diversity is here to stay. Its impact on organizations is widespread and will continue to grow. Management must learn to overcome the obstacles and capitalize on the advantages associated with culturally diverse human resources.

9-4 JOb anaLysis A manager needs to understand the nature of a job before he or she can find the right person to do it. It would make no sense to hire new people without knowing why. Job analysis is a systematic procedure for studying positions to determine their various elements and requirements. Consider a clerk—in a large corporation, there may be 50 kinds of clerk positions, which may all differ in terms of activities performed, the level of proficiency required for each activity, and the set of qualifications demanded. These distinctions are the focus of job analysis.

The job analysis for a particular position typically consists of two parts—a job description and a job specification. A job description is a list of the elements that make up a particular job. It includes the duties to be performed, the working conditions, the responsibilities, and the tools and equipment that must be used on the job (see Figure 9-1).

A job specification is a list of the qualifications required to perform a particular job, such as certain skills, abilities, education, and experience. In addition to

Concept Check ✓✓ What is cultural diversity in an organization?

✓✓ What are some of the benefits and challenges of cultural diversity in an organization?

Learning Objective

9-4 Explain the objectives and uses of job analysis. job analysis a systematic procedure for studying jobs to determine their various elements and requirements

job description a list of the elements that make up a particular job

job specification a list of the qualifications required to perform a particular job

tabLe 9-1 Advantages of Cultural Diversity

Economic Measure

Description

Cost The cost of poorly integrating workers increases with diversity. However, companies that handle diversity well can create cost advantages over those that do a poor job. Companies can also reduce costs by hiring culturally sensitive and trained workers.

Resource acquisition

Companies develop reputations as being favorable or unfavorable employers for women and ethnic minorities. Those with the best reputations will attract and retain the best personnel.

Marketing edge

For multinational organizations, the insight and cultural sensitivity that comes from an international perspective should improve marketing efforts. The same rationale applies to marketing subpopulations domestically.

Flexibility Culturally diverse employees often are open to a wider array of positions within a company and are more likely to move up the corporate ladder rapidly.

Creativity Diversity of perspectives and less emphasis on conformity to norms of the past should improve the level of creativity.

Problem solving

Differences within decision making and problem-solving groups potentially produce better decisions through a wider range of perspectives and more thorough critical analysis of issues.

Bilingual skills

Cultural diversity in the workplace is valuable in the global marketplace. Employees with knowledge about another country who can communicate in that language can prevent embarrassing mistakes due to a lack of cultural sophistication. Thus, many companies seek job applicants with a background in cultures in which the company does business.

sources: adapted from taylor h. cox and stacy blake, “managing cultural diversity: implications for organizational competitiveness,” Academy of Management Executive 5(3):46, 1991; ricky griffin, Fundamentals of Management, 8th ed. (mason, oh: south-Western/ cengage Learning, 2016), 244–245; and richard L. daft and dororthy marcic, Understanding Management, 9th ed. (mason, oh: south- Western/cengage Learning, 2015), 388–389.

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requiring certain experience, some companies also list personality characteristics in job specifications.

The job analysis is not only the basis for recruiting and selecting new employees, it is also used in other areas of HRM, including evaluation and the determination of equitable compensation levels.

9-5 ReCRuiting, seLeCtiOn, anD ORientatiOn In an organization with jobs waiting to be filled, HRM personnel need to (1) find candidates and (2) match the right candidate with each position. Three activities are involved: recruiting, selection, and new employee orientation.

9-5a Recruiting Recruiting is the process of attracting qualified job applicants. Because it is a vital link in a costly process (the cost of hiring an employee can be several thousand dollars), recruiting needs to be systematic. One goal of recruiters is to attract the “right number” of applicants, which is enough to allow a good match between applicants and open positions but not so many that matching requires a lot of time and effort.

Concept Check ✓✓ What is job analysis?

✓✓ What is job specification?

✓✓ how can it be used to hire the right person for the job?

Learning Objective

9-5 Describe the processes of recruiting, employee selection, and orientation.

recruiting the process of attracting qualified job applicants

FiguRe 9-1 Job Description and Job Specification

This job description explains the job of sales coordinator and lists the responsibilities of the position. The job specification is contained in the last paragraph.

SOUTH-WESTERN JOB DESCRIPTION

TITLE: Georgia Sales Coordinator DATE: 3/26/15 DEPARTMENT: College, Sales GRADE: 12 REPORTS TO: Regional Manager EXEMPT/NONEXEMPT: Exempt

BRIEF SUMMARY: Supervise one other Georgia-based sales representative to gain supervisory experience. Captain the four members of the outside sales rep team that are assigned to territories consisting of colleges and universities in Georgia. Oversee, coordinate, advise, and make decisions regarding Georgia sales activities. Based upon broad contact with customers across the state and communication with administrators of schools, the person will make recommendations regarding issues specific to the needs of higher education in the state of Georgia such as distance learning, conversion to the semester system, potential statewide adoptions, and faculty training.

PRINCIPAL ACCOUNTABILITIES: 1. Supervises/manages/trains one other Atlanta-based sales rep. 2. Advises two other sales reps regarding the Georgia schools in their territories. 3. Increases overall sales in Georgia as well as his or her individual sales territory. 4. Assists regional manager in planning and coordinating regional meetings and Atlanta conferences. 5. Initiates a dialogue with campus administrators, particularly in the areas of the semester conversion, distance learning, and faculty development.

DIMENSIONS: This position will have one direct report in addition to the leadership role played within the region. Revenue most directly impacted will be within the individually assigned territory, the supervised territory, and the overall sales for the state of Georgia.

KNOWLEDGE AND SKILLS: Must have displayed a history of consistently outstanding sales in personal territory. Must demonstrate clear teamwork and leadership skills and be willing to extend beyond the individual territory goals. Should have a clear understanding of the company’s systems and product offerings in order to train and lead other sales representatives. Must have the communication skills and presence to communicate articulately with higher education administrators and to serve as a bridge between the company and higher education in the state.

Chapter 9 Attracting and Retaining the Best Employees 253

For example, if there are five open positions and five applicants, the firm has no choice. It must hire all five applicants (qualified or not). At the other extreme, if several hundred job seekers apply for the five positions, HRM personnel will spend weeks processing applications.

Recruiters may seek applicants outside the firm, within the firm, or both. The source used depends on the nature of the position, the situation within the firm, and sometimes the firm’s established or traditional recruitment policies.

ExtERNAl RECRuitiNg External recruiting is the attempt to attract job applicants from outside an organization. External recruiting may include activities on college campuses and open houses, soliciting recommendations from present employees, posting in newspapers, employment agencies, and online. The Internet is a popular medium for searching and recruiting for positions. Social networking sites like LinkedIn and even Twitter match employers with potential employees. Online job sites such as Monster.com, Indeed.com, and SimplyHired. com help potential employees search for positions by criteria such as location, industry, or pay.

Clearly, it is best to match the recruiting means with the kind of applicant being sought. Technology is helping organizations with this matching process. A survey by the Society for Human Resource Management found that 77 percent of employers look at social media sites— most notably LinkedIn, Facebook, Twitter, and Google+—for recruiting purposes. The survey also found that 69 percent of companies employ social networking tools to identify and recruit applicants with specific skills, and 67 percent use social networking to raise their brand recognition.6

External recruiting has advantages and disadvantages. A primary advantage is that it brings people into a firm who have new perspectives and varied business backgrounds. Some firms prefer to hire recruits directly out of college because they believe that these candidates will be easier to train to fit with the corporate culture and the needs of the company. An additional benefit of hiring younger talent is that they tend to be more technologically savvy than their older counterparts, a characteristic that is highly desirable in today’s workplace. A disadvantage of external recruiting is that it is often expensive, especially if private employment agencies must be used. External recruiting also may provoke resentment among present employees who wish to advance within the company.

iNtERNAl RECRuitiNg Internal recruiting involves considering current employees as applicants for available positions. Generally, current employees are considered for promotion to higher-level positions. However, employees may be considered for transfer from one position to another at the same level.

external recruiting the attempt to attract job applicants from outside an organization

internal recruiting considering present employees as applicants for available positions

social media: Recruiting via social media Social media is a vital tool in recruiting today, used by 93 percent of recruiting professionals polled in a recent survey. Companies don’t just look for talented people with particular skills—they also want to check the fit with their corporate culture by seeing what potential employees value and how they spend their time. In addition, using social media can help firms attract the attention of managers and employees who aren’t actively looking for a change, but who might be interested if they see a tweet or a Facebook post about an open position. A growing number of firms have their own mobile apps or use recruiting apps, from LinkedIn and other networking sites, to reach prospective candidates on the go.

Beyond LinkedIn, one of the most popular networking sites for recruiters and applicants, many businesses are using Twitter to announce job fairs and open positions, including temporary and sea- sonal employment. Crate & Barrel tweets about job fairs for seasonal employees every Fall. The Container Store posts notices of open positions on its Facebook page, reasoning that its customers might want to apply or know someone who might be looking for a new job.

Maersk Drilling, based in Denmark, has been successful in recruiting employees from around the world through its Facebook page. In addition to posting photos of everyday working conditions on an oil rig, the firm asks current employees to comment about what they do, adding a personal touch to the recruiting process.

sources: based on information in sharon Florentine, “3 Ways to use social media to recruit better tech talent,” CIO.com, december 4, 2014, http://www.cio.com/article/2855173/careers-staffing/3-ways-to- use-social-media-to-recruit-better-tech-talent.html (accessed july 27, 2015); clare bettelley, “executives aren’t always right: Why social media recruiting has a place in every industry,” Forbes.com, october 6, 2014 http://www.forbes.com/sites/clarebettelley/2014/10/06/executives-arent-always-right-why- social-media-recruiting-has-a-place-in-every-industry/ (accessed july 27, 2015); sharon Florentine, “the next ‘sea change’ in recruiting: mobile,” CIO.com, december 5, 2014; eric morath, “to Fill holiday jobs, retailers reach out through social media,” Wall Street Journal, october 26, 2014, www.wsj.com (accessed july 27, 2015).

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Promoting from within provides strong motivation for current employees and helps the firm to retain quality personnel, along with their experience. The practice of job posting, or informing current employees of upcoming openings, is practiced by many different firms. It may be a company policy or required by union contract. The primary disadvantage of internal recruiting is that promoting a current employee leaves another position open. Not only does the firm still incur recruiting and selection costs, but it also must train two employees instead of one.

In many situations it may be impossible to recruit internally. For example, no current employee may be qualified to fill a new position, or the firm may be growing so rapidly that there is no time to reassign positions that open as a result of promotion or transfer.

9-5b Selection Selection is the process of gathering information about applicants for a position and using that information to choose the most appropriate applicant. Note the use of the word appropriate. In selection, the idea is not to hire the person with the most qualifications but rather the applicant who is most appropriate. Line managers responsible for the position select applicants. However, HRM personnel usually help by developing a pool of applicants and by expediting their assessment. Common means of obtaining information about applicants’ qualifications are employment applications, interviews, references, assessment centers, and online on social networking sites like LinkedIn and Facebook.

EMploYMENt AppliCAtioNS An employment application is useful for collecting factual information on a candidate’s education, work experience,

and personal history (see Figure 9-2). The data from applications are used for two purposes: to identify applicants who are worthy of further scrutiny and to familiarize interviewers with applicant backgrounds. Online applications are common, which help to streamline the process and improve data gathering capabilities for the firm. In fact, paper applications are becoming rare.

Many job candidates submit résumés, and some firms require them. A résumé is a one- or two-page summary of the candidate’s background and qualifications. It may include a description of the type of job the applicant is seeking. A résumé may be sent to a firm to request consideration for available jobs, or it may be submitted along with an employment application.

To improve the usefulness of information, HRM specialists ask current employees about experiences and characteristics that relate to their current jobs. These factors are included on the applications and may be weighted more heavily when evaluating new applicants’ qualifications.

EMploYMENt tEStS Tests administered to job candidates usually focus on aptitudes, skills, abilities, or knowledge relevant to the job. Such tests (basic computer skills tests, for example) help an employer gauge how well the applicant will perform the job. Companies may use general intelligence or personality tests, but these are seldom helpful in predicting performance. Many organizations of all sizes use predictive behavior tests, which have become more affordable with improved technology.

selection the process of gathering information about applicants for a position and then using that information to choose the most appropriate applicant

Don’t just search the classified ads to find a job. Potential employees are recruited in a variety of ways. Companies often keep statistics on their recruiting sources so they can determine which methods are the most effective for finding good employees.

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iNtERviEwS The interview is perhaps the most widely used selection technique because it provides an opportunity for applicants and the firm to learn more about one another. Job candidates are interviewed by at least one member of the HRM staff and by the person for whom they will be working. Candidates for higher-level jobs may meet with a department head or vice president over several interviews.

Interviewers may pose problems to test the candidate’s abilities, probe employ- ment history, and learn something about the candidate’s attitudes and motiva- tion. The candidate has a chance to find out more about the job and potential co-workers. They also provide an opportunity to test the personality fit of a candi- date with the organizational culture. Many organizations now conduct interviews remotely using services such as Skype or gotomeeting.com, only flying in the most promising candidates for face-to-face meetings.

Unfortunately, interviewing may be the stage at which discrimination begins. For example, suppose that a female applicant mentions that she is the mother of small children. Her interviewer may assume that she will be resistant to job- related travel. In addition, interviewers may be unduly influenced by such factors as appearance. They may also ask different questions of different applicants so that it becomes impossible to compare candidates’ qualifications objectively. Some of these problems can be solved through better interviewer training and using structured interviews. In a structured interview, the interviewer asks only a prepared set of job- related questions. The firm also may consider using several different interviewers for each applicant, but this can be costly.

FiguRe 9-2 Typical Employment Application

Employers use applications to collect factual information on a candidate’s education, work experience, and personal history.

source: courtesy of 3m.

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REFERENCES A job candidate generally is asked to furnish the names of references— people who can verify background information and provide personal evaluations. Naturally, applicants tend to list only references who are likely to say good things. Thus, personal evaluations obtained from references may not be of much value. However, references are often contacted to verify such information as previous job responsibilities and the reason an applicant left a former job. In many cases, social networking has changed the order in which employers receive information. Employers can peruse LinkedIn accounts, for example, to see reviews and recommendations before even interviewing a candidate.

ASSESSMENt CENtERS An assess- ment center is used primarily to select cur- rent employees for promotion to higher-level positions. Typically, a group of employees is

sent to the center for a few days. While there, they participate in activities designed to simulate the management environment and to predict managerial effectiveness. Trained observers make recommendations regarding promotion possibilities. The expense of this technique limits its use.

9-5c orientation Once all information about job candidates has been collected and analyzed, the company extends a job offer. If it is accepted, the candidate becomes an employee. Soon after a candidate joins a firm, he or she goes through the firm’s orientation program. Orientation is the process of acquainting new employees with an organization. Orientation topics range from the location of the company cafeteria to career paths within the firm. The orientation itself may range widely from a half- hour informal presentation to an elaborate program involving dozens of people and lasting several days or weeks.

9-6 COmPensatiOn anD beneFits An effective employee reward system must (1) enable employees to satisfy basic needs, (2) provide rewards comparable with those offered by other firms, (3) be distributed fairly within the organization, and (4) recognize that different people have different needs. A firm’s compensation system can be structured to meet the first three of these requirements. The fourth is more difficult because it must account for many variables. Most firms offer a number of benefits that, taken together, generally help to provide for employees’ varying needs.

9-6a Compensation Decisions Compensation is the payment employees receive in return for their labor. Its importance to employees is obvious. Because compensation can account for a significant percentage of a firm’s operating costs, it is also an important consideration

Concept Check ✓✓ What are the differences between internal and external recruiting?

✓✓ under what conditions are each one of them used?

✓✓ identify and briefly describe the types of practices and tools that are used in the selection process.

orientation the process of acquainting new employees with an organization

Learning Objective

9-6 Discuss the primary elements of employee compensation and benefits.

compensation the payment employees receive in return for their labor

A job interview is similar to a first date. Like a date, interviews can occur in a variety of locations and through several formats. The purpose is to give the candidate and the company the opportunity to find out about each other. Can you think of any other selection methods that benefit both parties in the recruiting process?

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Chapter 9 Attracting and Retaining the Best Employees 257

for management. Therefore, the firm’s compensation system, the policies and strategies that determine employee compensation, must be designed carefully to provide for employees’ needs while keeping labor costs within reasonable limits. For most firms, designing an effective compensation system requires three separate management decisions—wage level, wage structure, and individual wages.

wAgE lEvEl Management first must position the firm’s general pay level relative to pay levels of comparable firms. Most firms choose a level near the industry average. However, a firm that is not in good financial shape may pay less than average, and large, prosperous organizations may pay more than average. To determine the average pay for a job, the firm may use wage surveys. A wage survey is a collection of data on prevailing wage rates within an industry or a geographic area. Such surveys are compiled by industry associations, local governments, personnel associations, and (occasionally) individual firms.

wAgE StRuCtuRE Next, management must decide on relative pay levels for all the positions within the firm. The result of this set of decisions is called the firm’s wage structure. The wage structure almost always is developed on the basis of a job evaluation. Job evaluation is the process of determining the relative worth of the various jobs within a firm. Most observers probably would agree that a secretary/ administrative assistant should make more money than a custodian, but how much more?

A number of techniques may be used to evaluate jobs. The simplest is to rank all the jobs within the firm according to value. A more frequently used method is based on the job analysis. Points are allocated to each element and job requirement. For example, “college degree required” might be worth 50 points, whereas a job requiring only a high school diploma would only receive 25 points. The more points allocated, the more important the job is presumed to be (and the higher its level in the firm’s wage structure).

iNDiviDuAl wAgES Finally, the company must determine the specific payments individual employees will receive. Consider the case of two secretaries. Job evaluation was used to determine the level of secretarial pay, but suppose that one secretary has 15 years of experience, can type 80 words per minute accurately, and can work in several computer programs, while the other has two years of experience, can type only 55 words per minute, and knows only one computer program. In most firms, a wage range would be established (maybe $10.00 to $15.00 per hour) to reflect the range of experience and abilities, with the more qualified secretary receiving the higher wage.

Two wage decisions come into play here. First, the employee’s initial rate must be established. It is based on experience, other qualifications, and expected performance. Later, the employee may be given pay increases based on seniority and performance.

9-6b Comparable worth It is an established fact that women in the workforce are paid less than men, in spite of measures and legislation to counter this phenomenon. Comparable worth is a concept that seeks equal compensation for jobs that require equivalent levels of education, training, and skill. In recent decades, many states have taken steps to ensure that all workers have equal pay for comparable worth, but the issue is contentious. Critics argue that inflating salaries artificially for female-dominated occupations encourages women to keep these jobs rather than seek out higher-paying jobs. Addressing pay inequality is complicated. Studies have shown that, even after controlling for educational attainment and profession, wage gaps persist between men and women. Research suggests that factors behind the continuing wage disparity may include the

compensation system the policies and strategies that determine employee compensation

wage survey a collection of data on prevailing wage rates within an industry or a geographic area

job evaluation the process of determining the relative worth of the various jobs within a firm

comparable worth a concept that seeks equal compensation for jobs requiring about the same level of education, training, and skills

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idea that women are less inclined to ask for raises and that working mothers are less likely to work long hours or at specific times. Some companies have revealed that closing the gap is proving more challenging than expected, even with strong support. Companies, such as Raytheon and Kimberly-Clark, are applying more formal approaches to addressing the issue, such as implementing special teams

dedicated to pay equity analyses that identify areas with pay disparities, as well as where women are

experiencing a “glass ceiling” that keeps them from moving up within a firm. A side effect of such efforts is more women

and minorities moving into management positions.7

9-6c types of Compensation Compensation can take a variety of forms. Most forms fall into the following categories: hourly wage, weekly or monthly salary, commissions, incentive payments, lump-sum salary increases, and profit sharing.

houRlY wAgE An hourly wage is a specific amount of money paid for each hour worked. People who earn wages are paid their hourly wage for the first 40 hours worked in any week. Anything in excess of 40 hours is overtime, for which they are paid one-and-one-half times their hourly wage. Workers in retail and fast- food chains, on assembly lines, and in clerical positions usually are paid an hourly wage.

wEEKlY oR MoNthlY SAlARY A salary is a specific amount of money paid for an employee’s work during a set calendar period, regardless of the actual number of hours worked. Salaried employees receive no overtime pay, but they do not lose pay when they work less than 40 hours per week. Most professional and managerial positions are salaried.

CoMMiSSioNS A commission is a payment that is a percentage of sales revenue. Sales representatives and sales managers often are paid entirely through commissions or a combination of commissions and salary.

iNCENtivE pAYMENtS An incentive payment is in addition to wages, salary, or commissions. Incentive payments are rewards for outstanding job performance. They may be distributed to all or only select employees. Some firms distribute incentive payments to all employees annually. The size of the payment depends on the firm’s earnings and, at times, on the particular employee’s length of service with the firm. Firms sometimes offer incentives to employees who exceed specific sales or production goals, a practice called gainsharing. For example, 12 New Jersey hospitals used a pilot gainsharing program to award financial incentives to physicians for achieving quality and efficiency goals. The three-year program, which paid out nearly $19 million to doctors, reduced costs per admission by 8.5 percent, saving the hospitals $113 million.8 Some organizations reward outstanding workers individually through merit pay. This pay-for-performance approach allows management to control labor costs while encouraging employees to work more efficiently.

luMp-SuM SAlARY iNCREASES In traditional reward systems, an annual pay increase is spread evenly across each paycheck that year. However, some companies offer a lump-sum salary increase. This gives the employee the option of taking the

hourly wage a specific amount of money paid for each hour of work

salary a specific amount of money paid for an employee’s work during a set calendar period, regardless of the actual number of hours worked

commission a payment that is a percentage of sales revenue

incentive payment a payment in addition to wages, salary, or commissions

lump-sum salary increase an entire pay raise taken in one lump sum

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entire pay raise in one lump sum. The employee then draws his or her “regular” pay for the rest of the year. The lump-sum payment typically is treated as an interest-free loan that must be repaid if the employee leaves the firm during the year.

pRoFit-ShARiNg Profit-sharing is the distribution of a percentage of a firm’s profit among its employees. The idea is to motivate employees to work effectively by giving them a stake in the company’s financial success. For example, every year since 1938 Hormel Foods Corporation has distributed its profits to employees in the form of dividends at the beginning of the winter holiday season. The higher the profits, the higher the dividends employees earn.9

9-6d Employee Benefits An employee benefit is a reward in addition to regular compensation that is provided indirectly to employees. Employee benefits consist mainly of services (such as health and life insurance) that are paid for partially or totally by employers, and employee expenses (such as college tuition) that employers reimburse. Currently, the average cost of these benefits is 30 percent of an employee’s total compensation.10 Thus, a person who receives a salary of $35,000 really receives total compensation of $50,000, once $15,000 in benefits (30 percent of $50,000) is factored in.

tYpES oF BENEFitS Employee benefits take a variety of forms. Pay for time not worked covers such absences as vacation, holidays, and sick leave. Insurance packages may include health, life, and dental insurance for employees and their families. Some firms pay the entire cost of the insurance package, and others share the cost with the employee. The costs of pension and retirement programs also may be borne entirely by the firm or shared with the employee.

Some benefits are required by law. For example, employers must maintain workers’ compensation insurance, which pays medical bills for injuries that occur on the job and provides income for employees who are disabled by job-related injuries. Employers must also pay for unemployment insurance and contribute to each employee’s federal Social Security account.

Other benefits employers may provide include tuition-reimbursement plans, credit unions, child-care services, company cafeterias, exercise rooms, and broad employee stock-option plans. Some companies offer special benefits to U.S. military reservists who are called up for active duty.

profit-sharing the distribution of a percentage of a firm’s profit among its employees

employee benefit a reward in addition to regular compensation that is provided indirectly to employees

What job benefits are crucial to you? The benefits companies provide vary widely. Large companies are often able to offer employees more benefits than small ones. However, in small firms, employees are more likely to do a broader range of tasks and advance to higher positions more quickly.

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Increasingly, companies offer more varied benefits to attract and retain the best employees. In the high-tech industry, competition for talented employees is so intense that many firms have adopted more unusual perks, such as on-site bowling alleys, arcades, bike-repair services, and barber services, as well as free food, nap pods, free exercise classes, and concierge services that run errands for employees so they can stay at work and focus on their jobs.11

FlExiBlE BENEFit plANS Through a flexible benefit plan, an employee receives a predetermined amount of benefit dollars and may allocate those dollars to various categories of benefits in the way that best fits his or her needs. Some flexible benefit plans offer a broad array of benefit options, including health care, dental care, life insurance, accidental death and dismemberment coverage for the worker and dependents, long-term disability coverage, vacation benefits, retirement savings, and dependent-care benefits. Other firms offer limited options, primarily in health and life insurance and retirement plans.

Although the cost of administering flexible plans is high, a number of organizations, including Phillips Corporation and Coca-Cola, have implemented this option. Because employees’ needs are so diverse, flexible plans help firms to offer benefit packages that more specifically meet their employees’ needs. Flexible plans can, in the long run, help a company to contain costs because a specified amount is allocated to cover the benefits of each employee. Furthermore, organizations that offer flexible plans with many choices may be perceived as being employee-friendly. Thus, they are in a better position to attract and retain qualified employees.

9-7 tRaining anD DeveLOPment Training and development are extremely important at Verizon, as evidenced by its recent induction into Training magazine’s “Hall of Fame” list. Verizon has made

flexible benefit plan compensation plan whereby an employee receives a predetermined amount of benefit dollars to spend on a package of benefits he or she has selected to meet individual needs

Concept Check ✓✓ identify the major compensation decisions that hrm managers make.

✓✓ What are the different forms of compensation?

✓✓ What are the major types of employee benefits?

✓✓ how do flexible benefit plans work?

Learning Objective

9-7 Explain the purposes and techniques of employee training and development.

what Are the Job perks at Apple?

Apple—famed for its iconic “i” products, including the iPhone, the iPad, and iTunes—employs 98,000 people worldwide in all kinds of positions. Thanks to its ongoing growth and success, the company often has openings for talented employees in functions such as product design and development, engineering, information technology, sales, customer service, finance, human resources, retailing, and administrative support.

Denise Young Smith, the head of human resources, is casting a wide recruiting net and offering a wide range of benefits to encourage diversity in Apple’s workforce. For example, the company will now reimburse employees for the cost of educational courses, help them refinance student loans at subsidized rates, and offer extended new-parent leave. It also matches employees’ charitable donations and donates money to non-profit groups based on the number of volunteer hours put in by Apple employees at each organization. On-site fitness and wellness centers help

employees get into shape and stay healthy. Smith explains that “for the first time, we’ve probably got four generations in the workplace at the same time, and we need a plethora of programs” to attract and retain the best employees.

Apple employees have the option of taking courses at Apple University, either online or in person. Some courses analyze key decisions in the company’s history, illuminating Apple’s corporate culture and business priorities by exploring the background, potential solutions, and actual results. Others focus on the inspirations for product design and on effective communications. Attendance is voluntary—but new hires, in particular, find the courses valuable at the start of their Apple careers.

sources: based on information in michal Lev-ram, “apple unveils new perks to attract talent,” Fortune, october 2, 2014, www.fortune.com (accessed july 27, 2015); brian x. chen, “simplifying the bull: how picasso helps to teach apple’s style,” New York Times, august 10, 2014, www.nytimes.com (accessed july 27, 2015); michal Lev-ram, “apple’s new voice,” Fortune, october 6, 2014, pp. 134–5.

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Chapter 9 Attracting and Retaining the Best Employees 261

Training’s “Top 125” list for 12 consecutive years, distinguishing itself through its effectiveness and efficiency, number of training hours logged by employees, and survey results. Employees log nearly 8 million training hours annually, using a range of technologies, including mobile and online learning. The company offers over 11,000 courses to employees to ensure that they continue their professional development.12 Many top managers believe that the financial and human resources invested in training and development are well worth it. Employees at all levels of a company need training and/or development about its products, specific computer programs and protocols, customer needs, company policies and codes of conduct, applicable regulations, competitors’ products, and more.

Both training and development are aimed at improving employees’ skills and abilities. However, the two are usually differentiated as employee training or management development. Employee training is the process of teaching operations and technical employees how to do their present jobs more effectively and efficiently. Management development is the process of preparing managers and other professionals to assume increased responsibility in both present and future positions. Thus, training and development differ in who is being taught and the purpose of the teaching. However, both are necessary for personal and organizational growth. Companies that hope to stay competitive typically make huge commitments to employee training and development. Indeed, training accounts for about $70 billion of business spending in the U.S. and $130 billion worldwide.13 Developing an effective training program involves analyzing needs, determining the best methods, and developing an evaluation system to gauge effectiveness. Some employers require workers to attain certifications targeted to their field to help them gain and maintain the specific skills they need. There are many different employee training methods, including Internet-based training. Internet training is growing in popularity as it can result in significant cost, travel, and time savings.

9-7a Analysis of training Needs When thinking about developing a training program, managers first must determine if training is actually needed and, if so, what types of training needs exist. Training needs can vary considerably. For example, some employees may need to improve their technical skills, while others need training on organizational procedures. Training also may focus on business ethics, product information, or customer service. Because training is expensive, it is critical that the correct training needs be identified. Employers may find that sometimes employees need motivation more than they need training.

9-7b training and Development Methods A number of methods are available for employee training and management development. Most of these methods can be applied to both training and management development.

• On-the-job methods. The trainee learns by doing the work under the supervision of an experienced employee.

• Simulations. The work situation is simulated in a separate area so that learning takes place away from the day-to-day pressures of work.

employee training the process of teaching operations and technical employees how to do their present jobs more effectively and efficiently

management development the process of preparing managers and other professionals to assume increased responsibility in both present and future positions

What job training methods have you experienced, and how effective were they? Organizations train employees using a variety of methods and locations. Depending on the type of business, the training may take just a few hours or more than a year.

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• Classroom teaching and lectures. Instructors present concepts and illustrations through a variety of techniques.

• Conferences and seminars. Experts and learners come together to discuss problems and exchange ideas.

• Role-playing. Participants act out others’ roles in order to better understand them (primarily a management development tool).

• e-Learning. Participants train by watching videos of lectures or how-to guides, playing “games” that simulate work situations, or taking online quizzes to demonstrate their proficiency in a topic.

9-7c Evaluation of training and Development Training and development are expensive because the training itself can be costly and employees are not working at full productivity while they are receiving training, costing the firm further revenue. To ensure that training and development are as cost-effective as possible, the managers responsible should evaluate the company’s efforts periodically.

In order to set benchmarks and gauge program effectiveness, managers should develop measurable objectives before the training starts. For example, a measurable object would be that, after receiving training, a new employee will be able to produce a report using a specified format and be able to correctly identify 20 critical terms related to the field. The results of training evaluations should be made known to all those involved in the program—including trainees and upper management. For trainees, the results of evaluations can enhance motivation and learning. For upper management, the results may be the basis for making decisions about the training program itself.

9-8 PeRFORmanCe aPPRaisaL Performance appraisal is the evaluation of employees’ current and potential levels of performance to allow managers to make unbiased human resources decisions. The process has three main objectives. First, managers use performance appraisals to let workers know how well they are doing and how they can improve in the future. Second, a performance appraisal provides an effective basis for distributing rewards, such as pay raises and promotions. Third, performance appraisal helps the organization monitor its employee selection, training, and development activities. If large numbers of employees continually perform below expectations, the firm may need to revise its selection process or strengthen its training and development activities. Most performance appraisal processes include a written document. An example appears in Figure 9-3.

9-8a Common Evaluation techniques The techniques and methods for appraising employee performance are either objective or judgmental in nature.

oBJECtivE MEthoDS Objective appraisal methods use some measurable quantity as the basis for assessing performance. Units of output, dollar volume of sales, number of defective products, and number of insurance claims processed are all objective, measurable quantities. Thus, an employee who processes an average of 26 insurance claims per week is given a higher evaluation than one whose average is 19 claims per week.

Such objective measures may require adjustment depending on the work environment. Suppose that the first of our insurance claims processors works in New York City and the second works in rural Iowa. Both must visit each client because they are processing homeowners’ insurance claims. The difference in their

Concept Check ✓✓ What is the difference between employee training and management development?

✓✓ What are the primary training and development methods used by firms?

Learning Objective

9-8 Discuss performance appraisal techniques and performance feedback.

performance appraisal the evaluation of employees’ current and potential levels of performance to allow managers to make objective human resources decisions

Chapter 9 Attracting and Retaining the Best Employees 263

average weekly output may be entirely because of the long distances the Iowan must travel to visit clients. In this case, the two workers may very well be equally competent and motivated. Thus, a manager must take into account circumstances that may be hidden by a purely statistical measurement.

JuDgMENtAl MEthoDS Judgmental appraisal methods are used much more frequently than objective methods. They require that the manager judge or estimate the employee’s performance level. These methods are based on employee ranking or rating scales. When ranking is used, the manager ranks subordinates from best to worst. This approach has drawbacks, including the lack of an absolute standard. Use of rating scales is the most popular judgmental appraisal technique. A rating scale consists of a number of statements, on which each employee is rated based on the degree to which the statement applies. For example, one statement might be, “This employee always does high-quality work.” The supervisor would give the employee a rating, from 5 down to 1, corresponding to gradations ranging from “strongly agree” to “strongly disagree.” The ratings on all the statements are added to obtain the employee’s total evaluation.

AvoiDiNg AppRAiSAl ERRoRS Managers must be cautious if they are to avoid making mistakes when appraising employees. It is common to overuse one portion of an evaluation instrument, thus risking overemphasizing or underempha- sizing issues. A manager must guard against allowing an employee’s poor perfor- mance on one activity to influence his or her judgment of that subordinate’s work

FiguRe 9-3 Performance Appraisal

source: courtesy of 3m.

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on other activities. Similarly, putting too much weight on recent performance can distort an employee’s eval- uation. For example, if the employee is being rated on performance over the last year, a manager should not permit last month’s disappointing performance to overshadow the quality of the work done in the first 11 months of the year. Finally, a manager must guard against discrimination on the basis of race, age, gen- der, religion, national origin, or sexual orientation.

9-8b performance Feedback No matter which appraisal technique is used, managers should discuss the results with the employee soon after completion. The manager should explain the basis for present rewards and should let the employee know what he or she can do to improve. The information provided to an employee in such discussions is called performance feedback, and the process is known as a performance feedback interview.

There are three major approaches to performance feedback interviews: tell-and-sell, tell-and-listen, and problem solving. In a tell-and-sell feedback interview, the superior tells the employee how good or bad the employee’s performance has been and attempts to

persuade the employee to accept the evaluation. Because the employee has no input into the evaluation, the tell-and-sell interview can lead to defensiveness, resentment, and frustration on the part of the subordinate.

With the tell-and-listen approach, the supervisor tells the employee what the employee has done right and wrong and then gives him or her a chance to respond. The subordinate may simply be given an opportunity to react to the supervisor’s statements or may be permitted to offer a full self-appraisal.

In the problem-solving approach, employees evaluate their own performance and set their own goals for future performance. The supervisor is more a colleague than a judge and offers comments and advice in a noncritical manner while mutually agreeing with the employee on goals for improvement. This is the method most likely to result in employee commitment to the established goals.

To avoid some of the problems associated with the tell-and-sell interview, supervisors sometimes use a mixed approach. The mixed interview uses the tell- and-sell approach to communicate administrative decisions and the problem-solving approach to discuss employee-development issues and future performance goals.

Another approach that has become popular is called a 360-degree evaluation. A 360-degree evaluation collects anonymous reviews about an employee from his or her peers, subordinates, and supervisors and compiles them into a feedback report for the employee. Companies that invest significant resources in employee-development efforts are especially likely to use 360-degree evaluations. An employee should not be given a feedback report without first having a one-on-one meeting with his or her supervisor. To ensure effective implementation, upper-level management should adopt this approach first and coach managers on how to use the feedback to achieve positive performance and behavioral outcomes.

Many managers find it difficult to discuss negative appraisals, leading them to ignore performance feedback. However, it is important for employees to be informed of how they can improve. Employers should emphasize employee strengths when delivering a negative appraisal. Without feedback, an employee may be unaware of his or her weaknesses and they will never be addressed. Only through tactful, honest communication can the results of an appraisal be fully used.

Concept Check ✓✓ What are the main objectives of performance appraisal?

✓✓ What methods are used?

✓✓ describe the three approaches to performance feedback interviews.

Performance feedback can help employees progress within an organization. A business usually evaluates its employees on an annual basis, but sometimes it does so quarterly and even monthly, especially when they are newly hired. Performance reviews that gather feedback about an employee from his or her peers, subordinates, and supervisors can help the person get a realistic view of his or her strengths and weaknesses.

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9-9 tHe LegaL enviROnment OF HRm Legislation regarding HRM practices has been passed mainly to protect the rights of employees, to promote job safety, and to eliminate discrimination in the workplace. The major federal laws affecting HRM are summarized in Table 9-2.

9-9a National labor Relations Act and labor–Management Relations Act These laws are concerned with dealings between business firms and labor unions. This general area is, in concept, a part of HRM. However, because of its importance, it is often treated as a separate set of activities.

9-9b Fair labor Standards Act This act, passed in 1938 and amended many times since, applies primarily to wages. It established minimum wages and overtime pay rates. Many managers and other professionals, however, are exempt from this law. Salaried employees seldom get overtime when they work more than 40 hours a week.

Learning Objective

9-9 Outline the major legislation affecting human resources management.

tabLe 9-2 Federal Legislation Affecting Human Resources Management

Law Purpose

National Labor Relations Act (1935) Established a collective-bargaining process in labor–management relations and the National Labor Relations Board (NLRB).

Fair Labor Standards Act (1938) Established a minimum wage and an overtime pay rate for employees working more than 40 hours per week.

Labor–Management Relations Act (1947)

Provides a balance between union power and management power, also known as the Taft– Hartley Act.

Equal Pay Act (1963) Specifies that men and women who do equal jobs must be paid the same wage.

Title VII of the Civil Rights Act (1964) Prohibits discrimination in employment practices based on sex, race, color, religion, or national origin.

Age Discrimination in Employment Act (1967–1986)

Prohibits personnel practices that discriminate against people aged 40 years and older. The 1986 amendment eliminated a mandatory retirement age.

Occupational Safety and Health Act (1970)

Regulates the degree to which employees can be exposed to hazardous substances and specifies the safety equipment that the employer must provide.

Employment Retirement Income Security Act (1974)

Regulates company retirement programs and provides a federal insurance program for retirement plans that go bankrupt.

Worker Adjustment and Retraining Notification (WARN) Act (1988)

Requires employers to give employees 60 days notice regarding plant closure or layoff of 50 or more employees.

Americans with Disabilities Act (1990) Prohibits discrimination against qualified individuals with disabilities in all employment practices, including job-application procedures, hiring, firing, advancement, compensation, training, and other terms, conditions, and privileges of employment.

Civil Rights Act (1991) Empowers employees to sue employers for sexual discrimination and collect punitive damages.

Family and Medical Leave Act (1993) Requires an organization with 50 or more employees to provide up to 12 weeks of leave without pay on the birth (or adoption) of an employee’s child or if an employee or his or her spouse, child, or parent is seriously ill.

Affordable Care Act (2010) Requires an organization with 50 or more employees to make health insurance available to employees or pay an assessment and gives employees the right to buy health insurance from another provider if an organization’s health insurance is too expensive.

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9-9c Equal pay Act Passed in 1963, this law overlaps somewhat with Title VII of the Civil Rights Act (see next section). The Equal Pay Act specifies that men and women who are doing equal jobs must be paid the same wage. Equal jobs are ones that demand equivalent effort, skill, and responsibility and are performed under the same conditions. Discrepancies in pay are legal if they can be attributed to differences in seniority, qualifications, or performance. In spite of having this law on the books for more than half a century, women and men are not treated equally in the workplace. For example, there are only 24 female CEOs of Fortune 500 companies—less than 5 percent—and women still earn 18 percent less than men.14

9-9d Civil Rights Acts Title VII of the Civil Rights Act of 1964 forbids organizations with 15 or more employees to discriminate in employee selection and retention on the basis of sex, race, color, religion, or national origin. The purpose of Title VII is to ensure that employers make personnel decisions on the basis of employee qualifications only. As a result of this act, discrimination in employment (especially against African Americans) has been reduced in this country.

A person who believes that he or she has been discriminated against can file a complaint with the Equal Employment Opportunity Commission (EEOC), which oversees federal laws and regulations regarding discrimination in employment. If it finds that the person has, in fact, been the victim of discrimination, the commission can take legal action on his or her behalf.

The Civil Rights Act of 1991 facilitates an employee’s suing and collecting punitive damages for sexual discrimination. Discriminatory promotion and termination decisions as well as on-the-job issues, such as sexual harassment, are covered by this act.

9-9e Age Discrimination in Employment Act The general purpose of this act, which was passed in 1967 and amended in 1986, is the same as that of Title VII—to eliminate discrimination. However, as the name implies, the Age Discrimination in Employment Act is concerned with discrimination based on age. It outlaws personnel practices that discriminate against people aged 40 years or older in companies with 20 or more employees. Also outlawed are company policies that specify a mandatory retirement age. Employers must base employment decisions on ability, not on a number. For example, Dallas-based HiLine Electric Co. settled EEOC charges over the use of age-based criterion in its recruiting and hiring process. The agency identified eight job seekers, who failed to gain employment because of the company’s discrimination against potential employees over the age of 50. HiLine agreed not to engage in such practices in the future and to pay $210,000 in penalties.15

9-9f occupational Safety and health Act Passed in 1970, this act is concerned with issues of employee health and safety. For example, the act regulates the degree to which employees can be exposed to hazardous substances. It also specifies the safety equipment that the employer must provide. The Occupational Safety and Health Administration (OSHA) was created to enforce this act. Inspectors from OSHA investigate employee complaints regarding unsafe working conditions. They also make spot checks on companies operating in particularly hazardous industries, such as chemicals and mining, to ensure compliance with the law. A firm found to be in violation of federal standards can be heavily fined or shut down. Nonetheless, many people feel that issuing OSHA violations is not enough to protect workers from harm.

Chapter 9 Attracting and Retaining the Best Employees 267

9-9g Employee Retirement income Security Act This act was passed in 1974 to protect the retirement benefits of employees. It does not require that firms provide a retirement plan. However, it does specify that if a retirement plan is provided, it must be managed in such a way that the interests of employees are protected. It also provides federal insurance for retirement plans that go bankrupt.

9-9h Affirmative Action Affirmative action is not one act, but a series of executive orders issued by the President of the United States. It applies to all employers with 50 or more employees holding federal contracts in excess of $50,000. It prescribes that such employers (1) actively encourage job applications from members of minority groups and (2) hire qualified employees from minority groups who are not fully represented in their organizations. Many firms that do not hold government contracts voluntarily take part in affirmative action.

9-9i Americans with Disabilities Act The Americans with Disabilities Act (ADA) prohibits discrimination against qualified individuals with disabilities in all employment practices—including job-application procedures, hiring, firing, advancement, compensation, training, and other terms and conditions of employment. All private employers and government agencies with 15 or more employees are covered by the ADA. Defining who is a qualified individual with a disability is, of course, difficult. Depending on how qualified individual with a disability is interpreted, more than 57 million Americans can be included under this law.16 Although pregnancy is not a disability, the ADA also requires employers to provide reasonable accommodation to pregnant employees. It also mandates that all businesses that serve the public must make their facilities accessible to people with disabilities.

The ADA not only protects individuals with obvious physical disabilities, but also safeguards those with less visible conditions such as heart disease, diabetes, epilepsy, cancer, AIDS, and mental illnesses. Because of this law, many organizations no longer require job applicants to pass physical examinations as a condition of employment.

Employers are required to provide disabled employees with reasonable accommodation. Reasonable accommodation is any modification or adjustment to a job or work environment that will enable a qualified employee with a disability to perform a central job function, such as making existing facilities accessible to and usable by wheelchair-bound individuals. Reasonable accommodation also might mean restructuring a job, modifying work schedules, acquiring or modifying equipment, providing qualified readers or interpreters, or changing training programs.

Concept Check ✓✓ how is the national Labor relations act different from the Fair Labor standards act?

✓✓ how does the civil rights act influence the selection and promotion of employees?

✓✓ What is the occupational safety and health act?

✓✓ What is the purpose of the americans with disabilities act?

Focus on what employees and job candidates can do—not what they can’t. The American Disabilities Act (ADA) requires businesses to make reasonable accommodations for applicants and employees with disabilities. The law is not the only reason why firms should hire and retain the disabled. Studies have shown that firms that do so experience positive business outcomes. Many manual and electronic devices are available today that can help the disabled work safely and productively. Something as small as slightly redesigning workstations can make it possible for people of all abilities to work in many jobs.

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Summary

9-1 Describe the major components of human resources management. Human resources management (HRM) is the set of activities involved in acquiring, maintaining, and developing an organization’s human resources. Responsibility for HRM is shared by specialized staff and line managers. HRM activities include human resources planning, job analysis, recruitment, selection, orientation, compensation, benefits, training and development, and performance appraisal.

9-2 identify the steps in human resources planning. Human resources planning consists of forecasting the human resources that a firm will need and planning a course of action to match supply with demand. Layoffs, attrition, early retirement, and (as a last resort) firing are ways to reduce the size of the workforce when needed. Supply is increased through hiring.

9-3 Describe cultural diversity and understand some of the challenges and opportunities associated with it.

Cultural diversity refers to the differences among people in a workforce owing to race, ethnicity, and gender. With an increasing number of women, minorities, and immigrants in the U.S. workforce, management is faced with challenges and competitive advantages. Some organizations have implemented diversity-related training programs to make the most of cultural diversity. With proper guidance and management, a culturally diverse organization can prove beneficial to all involved.

9-4 explain the objectives and uses of job analysis. Job analysis provides a job description and a job specifi- cation for each position within a firm. A job description is a list of the elements that make up a particular job. A job specification is a list of qualifications required to perform a job. Job analysis is used in evaluation and in the determination of compensation levels and serves as the basis for recruiting and selecting new employees.

9-5 Describe the processes of recruiting, employee selection, and orientation.

Recruiting is the process of attracting qualified job applicants. Candidates for open positions may be recruited from within or outside a firm. In the selection process, information about candidates is obtained from

applications, résumés, tests, interviews, references, assessment centers, even online social networking sites. This information is used to select the most appropriate candidate for the job. Newly hired employees will then go through an orientation program to learn about the firm and the specifics of the job.

9-6 Discuss the primary elements of employee compensation and benefits.

Compensation is the payment employees receive in return for their labor. In developing a system for pay- ing employees, management must decide on the firm’s general wage level (relative to other firms), the wage structure within the firm, and individual wages. Wage surveys and job analyses are useful in making these deci- sions. Employees may be paid hourly wages, salaries, or commissions. They also may receive incentive pay- ments, lump-sum salary increases, and profit-sharing payments. Employee benefits, which are nonmonetary rewards to employees, add about 30 percent to the cost of compensation.

9-7 explain the purposes and techniques of employee training and development.

Employee-training and management-development programs enhance the ability of employees to contribute to a firm. When developing a training program, the company should analyze training needs and then select training methods. Because training is expensive, an organization should periodically evaluate the effectiveness of its training programs.

9-8 Discuss performance appraisal techniques and performance feedback.

Performance appraisal, or evaluation, is used to provide employees with performance feedback, to serve as a basis for distributing rewards, and to monitor selection and training activities. Both objective and judgmental appraisal techniques are used. Their results are communicated to employees through three performance feedback approaches: tell-and-sell, tell-and-listen, and problem solving.

9-9 Outline the major legislation affecting human resources management.

A number of laws have been passed that affect HRM prac- tices and that protect the rights and safety of employees.

Chapter 9 Attracting and Retaining the Best Employees 269

Some of these are the National Labor Relations Act of 1935, the Labor–Management Relations Act of 1947, the Fair Labor Standards Act of 1938, the Equal Pay Act of 1963, Title VII of the Civil Rights Act of 1964, the Age Discrimination in Employment Acts of 1967 and 1986, the Occupational Safety and Health Act of 1970, the

Employment Retirement Income Security Act of 1974, the Worker Adjustment and Retraining Notification Act of 1988, the Americans with Disabilities Act of 1990, the Civil Rights Act of 1991, and the Family and Medical Leave Act of 1993.

Key Terms

You should now be able to define and give an example relevant to each of the following terms:

human resources management (HRM) (245)

human resources planning (247)

replacement chart (248) skills inventory (248) cultural (or workplace)

diversity (250) job analysis (251)

job description (251) job specification (251) recruiting (252) external recruiting (253) internal recruiting (253) selection (254) orientation (256) compensation (256) compensation system (257)

wage survey (257) job evaluation (257) comparable worth (257) hourly wage (258) salary (258) commission (258) incentive payment (258) lump-sum salary increase

(258)

profit-sharing (259) employee benefit (259) flexible benefit plan (260) employee training (261) management development

(261) performance appraisal (262)

Discussion Questions

1. In general, on what basis is responsibility for HRM divided between line and staff managers?

2. How is a forecast of human resources demand related to a firm’s organizational planning?

3. How do human resources managers go about matching a firm’s supply of workers with demand?

4. What are the major challenges and benefits associated with a culturally diverse workforce?

5. What are the advantages and disadvantages of external recruiting? Of internal recruiting?

6. How is a job analysis used in the process of job evaluation?

7. Suppose that you have just opened a new Ford sales showroom and repair shop. Which of your employees

would be paid wages, which would receive salaries, and which would receive commissions?

8. Why is it so important to provide feedback after a perfor- mance appraisal?

9. How accurately can managers plan for future human resources needs?

10. Are employee benefits really necessary? Why? 11. As a manager, what actions would you take if an opera-

tions employee with six years of experience on the job refused ongoing training and ignored performance feed- back?

12. Why are there so many laws relating to HRM practices? 13. Of the laws discussed in the text, which are the most

important, in your opinion?

Video Case the Container Store hires great Employees to Sell Empty Boxes

Empty boxes are big business for the Container Store (www. containerstore.com), headquartered just outside Dallas in Coppell, Texas. Founded in 1978, the company has grown to 67 stores nationwide and $800 million in annual revenue by specializing in storage products for home and office. From stacking bins and spice racks to trash cans and toy caddies, the Container Store sells a variety of functional, stylish storage solutions for every situation.

Kip Tindell, co-founder and CEO, attributes the company’s decades-long success to the high caliber of its employees. “When you’re selling empty boxes, you’d better have great people,” he explains. Tindell’s philosophy that “one great person equals three good people” has become the cornerstone of the Container Store’s approach to recruiting, hiring, training, and retaining employees. To attract and keep enthusiastic people who enjoy working

270 Part 4 Human Resources

with customers, the company pays above-average wages— the average Container Store retail salesperson brings in $50,000—nearly twice that of the typical retailer. It also offers numerous benefits, including medical coverage, generous discounts on store merchandise, paid vacation time, and even pet insurance.

Not surprisingly, hundreds of people apply for every job opening. The Container Store requires as many as nine interviews before managers make a decision about which “great” candidate to select. Only 3 percent of the people who apply to work for the company end up being hired. Once they’re hired, new employees enter a training program to gain the skills they need for on-the-job success. All full-time employees receive more than 260 hours of intensive training during their first 12 months. Part-time workers receive 150 hours of training during the first year. The purpose is to improve employees’ product knowledge, teach them how to assess customers’ storage needs, and provide the techniques and tools they need to suggest creative solutions for each individual’s needs. The training also covers professional development topics to prepare employees for future career advancement.

Although retailers usually experience high turnover, the Container Store’s turnover is exceptionally low, because it is so selective in hiring, rewards its employees well for performance, and provides a satisfying work environment. During the recent recession, when many employers were forced to cut costs through layoffs, the CEO reassured his employees that they didn’t have to worry about being laid off. Rather than reduce its workforce, the company cut back

slightly on some benefits and found other ways to lower expenses during the financial crunch. When the economy turned around and profits began to rise, the Container Store restored employee benefits to their former levels. It also embarked on its most aggressive expansion ever, opening six new stores in a single year and hiring hundreds of employees to fill the newly created sales positions.

The Container Store’s no-layoff policy is only one way it proves how much it values its employees. Following the principle “communication is leadership,” the retailer practices transparency, allowing employees access to most types of information except specific details about what individuals are paid. Not only do employees have the information they need to do their jobs, they can get a big picture overview of the company and its challenges and accomplishments. Thanks to its reputation for putting employees first, the Container Store has been named many times to Fortune magazine’s annual list of 100 best companies to work for in America.17

Questions 1. What effect does low turnover have on the Container

Store’s ability to forecast human resources supply and match supply with demand?

2. Do you agree with the Container Store’s decision to allow employees access to all kinds of company information except individual compensation? Explain your answer.

3. If you were interviewing applicants for a sales position at the Container Store, what questions would you ask, and why?

Building Skills for Career Success

1. Social Media Exercise LinkedIn (www.linkedin.com) is the largest and best-known social network for professionals. Many of you are probably already familiar with it. 1. Do you have a profile? If not, you might want to consider

developing one because many companies recruit from LinkedIn and it can be a great tool for professional networking.

2. If you already have a profile, think about how you might improve it. Do you participate in discussion groups? Have you reached out and connected to people in industries where you want to work?

2. Building Team Skills The New Therapy Company is soliciting a contract to provide five nursing homes with physical, occupational, speech, and respiratory therapists. The therapists will rotate among the five nursing homes. The therapists have not yet been hired,

but the nursing homes expect them to be fully trained and ready to go to work in three months. The previous therapy company lost its contract because of high staff turnover owing to employee “burnout” (a common problem in this field), high costs, and low-quality care. The nursing homes want a plan specifying how the New Therapy Company will meet staffing needs, keep costs low, and provide high- quality care.

Assignment 1. Working in a group, discuss how the New Therapy

Company can meet the deadline and still ensure a high quality of care. Also discuss the following: a. How many of each type of therapist will the company

need? b. How will it prevent therapists from burning out? c. How can it retain experienced staff and still limit costs? d. Are promotions available for staff? What does the

career ladder look like?

Chapter 9 Attracting and Retaining the Best Employees 271

e. How will the company manage therapists at five dif- ferent locations? How will it keep in touch with them (computer, voice mail, or monthly meetings)? Would it make more sense to have therapists work per- manently at each location rather than rotate among them?

f. How will the company justify the travel costs? What other expenses might it expect?

2. Prepare a plan for the New Therapy Company to present to the nursing homes.

3. Researching Different Careers A résumé provides a summary of your skills, abilities, and achievements. It also may include a description of the type of job you want. An effective résumé clearly communicates your career objectives, your experience and qualifications,

and shows that you have given serious thought to your career.

Assignment 1. Prepare a résumé for a job that you want using the infor-

mation in Appendix A (see text website). a. Determine your skills and decide which are important

for this particular job. b. Decide which format—chronological or functional—

will be most effective in presenting your skills and experience.

c. Keep the résumé to one page, if possible (no more than two pages). Note that portfolio items may be attached for certain jobs, such as artwork.

2. Have several people review the résumé for accuracy. 3. Ask your instructor to comment on your résumé.

Endnotes

1 Based on information in Patty McCord, “How Netflix Reinvented HR,” Harvard Business Review, January–February 2014, pp. 70–76; Drake Baer, “Netflix’s Major HR Innovation: Treating Humans Like People,” Fast Company, March 13, 2014, www.fastcompany.com (accessed July 1, 2015); Bill Snyder, “Netflix Founder Reed Hastings: Make as Few Decisions as Possible,” Insights by Stanford (Stanford Graduate School of Business), November 3, 2014, www.gsb.stanford. edu/insights (accessed July 1, 2015); www.netflix.com (accessed January 15, 2015).

2 Dave Zielinski, “Get Analytical,” HRMagazine, November 2014, pp. 61–62.

3 Ellen Meyers, “Microsoft Will Cut 18,000 Jobs by June 2015,” Christian Science Monitor, July 17, 2014, http://www.csmonitor.com/ Business/2014/0717/Microsoft-will-cut-18-000-jobs-by-June-2015 (accessed July 1, 2015).

4 Labor Force Characteristics by Race and Ethnicity, 2013, U.S. Department of Labor, Bureau of Labor Statistics, May 2014, http:// www.bls.gov/cps/wlf-databook-2013.pdf (accessed July 1, 2015), p. 2; Women in the Labor Force: A Data Book, U.S. Department of Labor, Bureau of Labor Statistics, May 2014, http://www.bls.gov/cps/wlf- databook-2013.pdf (accessed July 1, 2015), p. 2.

5 Women in the Labor Force: A Data Book, p. 2. 6 Miriam Salpeter, “How to Use Social Media to Land a Job,” U.S. News

& World Report, April 16, 2014, http://money.usnews.com/money/ blogs/outside-voices-careers/2014/04/16/how-to-use-social-media-to- land-a-job (accessed July 1, 2015).

7 Tara Siegel Bernard, “Vigilant Eye on Gender Pay Gap,” New York Times, November 15, 2014, p. B1.

8 Beth Fitzgerald, “Hospitals Saved $113M in Gainsharing Pilot; Second Program Underway,” NJBiz, July 24, 2014, http://www.njbiz.com/ article/20140724/NJBIZ01/140729835/Hospitals-saved-$113M-in- gainsharing-pilot;-second-program-underway (accessed July 1, 2015).

9 Hormel Foods, “Hormel Foods Distributes Annual Profit-Sharing,” Press Release, November 26, 2014, http://www.hormelfoods.com/Newsroom/ Press-Releases/2014/11/20141126 (accessed July 1, 2015).

10 “Employment Cost Index,” U.S. Department of Labor, Bureau of Labor Statistics, Press Release, October 31, 2014, http://www.bls.gov/news. release/eci.toc.htm (accessed July 1, 2015).

11 Victor Luckerson, “10 Most Lavish Job Perks in Silicon Valley,” Time, October 14, 2014, http://time.com/3506815/10-best-job-perks/ (accessed July 1, 2015).

12 “Training Top 10 Hall of Fame: Farmers Insurance and Verizon Inducted into Top 10 Hall of Fame,” Training, http://www.trainingmag.com/ trgmag-article/farmers-insurance-and-verizon-inducted-top-10-hall-fame (accessed January 15, 2015).

13 Josh Bersin, “Spending on Corporate Training Soars: Employee Capabilities Now a Priority,” Forbes, February 4, 2014, http://www. forbes.com/sites/joshbersin/2014/02/04/the-recovery-arrives-corporate- training-spend-skyrockets/ (accessed July 1, 2015).

14 Caroline Fairchild, “Number of Fortune 500 Women CEOs Reaches Historic High,” Fortune, June 3, 2014, http://fortune.com/2014/06/03/ number-of-fortune-500-women-ceos-reaches-historic-high/ (accessed July 1, 2015); Lawrence H. Leith, “Why Do Women Still Earn Less than Men?” Monthly Labor Review, Bureau of Labor Statistics, June 2014, http://www.bls.gov/opub/mlr/2014/beyond-bls/why-do-women-still- earn-less-than-men.htm (accessed July 1, 2015).

15 Equal Employment Opportunity Commission, “HiLine Electric to Pay $210,000 to Settle EEOC Age Discrimination Suit,” Press Release, October 6, 2014, http://www.eeoc.gov/eeoc/newsroom/release/ 10-6-14c.cfm (accessed July 1, 2015).

16 U.S. Department of Commerce, “Census Bureau Releases Disability Facts and Figures in Recognition of ADA Anniversary,” July 22, 2014, http://www.commerce.gov/blog/2014/07/22/census-bureau-releases- disability-facts-and-figures-recognition-ada-anniversary (accessed July 1, 2015).

17 Based on information in Aaron Taube, “Why The Container Store Pays Its Retail Employees $50,000 a Year,” Business Insider, October 16, 2014, http://www.businessinsider.com/the-container-store-pays-employees- 50000-a-year-2014-10 (accessed July 1, 2015); Jason Heid, “Breakfast with Kip Tindell of The Container Store,” D Magazine, November 2012, http://www.dmagazine.com/publications/d-ceo/2012/november/ breakfast-with-kip-tindell-of-the-container-store (accessed July 8, 2015); Steven R. Thompson, “Container Store Uses Personal Approach in New Strategy,” Dallas Business Journal, April 27, 2012, http://www. bizjournals.com/dallas/print-edition/2012/04/27/container-store-uses- personal-approach.html (accessed July 8, 2015); Brooke Baker, “No. 1, Small Companies: The Container Store,” Indianapolis Star, April 7, 2012, www.indystar.com; Caitlin Keating, “No Layoffs—Ever!” Fortune, January 20, 2012, http://archive.fortune.com/galleries/2012/pf/jobs/1201/gallery. best-companies-no-layoffs.fortune/2.html (accessed July 8, 2015); Cengage “Container Store” video; www.containerstore.com (accessed July 8, 2015).

Learning Objectives Once you complete this chapter, you will be able to:

10-1 Explain what motivation is.

10-2 Understand some major historical perspectives on motivation. 10-3 Describe three contemporary views of motivation: equity theory, expectancy

theory, and goal-setting theory.

10-4 Explain several techniques for increasing employee motivation. 10-5 Understand the types, development, and uses of teams.

Motivating and Satisfying Employees and Teams

ChapTEr

10 Why Should You Care? As you move up into management

positions or operate your own

business, you will need to

understand what motivates others

in an organization.

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272

Chapter 10 Motivating and Satisfying Employees and Teams 273

To achieve its goals, any organization—be it Salesforce.com, Google, or a local convenience store—must be sure that its employees have more than the right raw materials, adequate facilities, and equipment that works. The organization also must ensure that its employees are motivated. A high level of employee motivation derives from effective management practices.

In this chapter, after first explaining what motivation is, we present several studies and views of motivation that have influenced management practices over the years: Taylor’s ideas of scientific management, Mayo’s Hawthorne Studies, Maslow’s hierarchy of needs, Herzberg’s motivation–hygiene theory, McGregor’s Theory X and Theory Y, Ouchi’s Theory Z, and reinforcement theory. Then, turning our attention to contemporary theory, we examine equity, expectancy, and goal- setting theories. Finally, we discuss specific techniques managers can use to foster employee motivation and satisfaction.

10-1 What is MOtivatiOn? A motive is something that causes a person to act. A successful athlete is said to be “highly motivated.” A student who avoids work is said to be “unmotivated.” We define motivation as the individual internal process that energizes, directs, and sus- tains behavior. It is the personal “force” that causes you or me to act in a particular way. For example, although job rotation may increase your job satisfaction and

Learning Objective

10-1 Explain what motivation is.

motivation the individual internal process that energizes, directs, and sustains behavior; the personal “force” that causes you or me to behave in a particular way

What Makes a “Best Company to Work For”?

salesforce.com has appeared six times on Fortune magazine’s annual list of “Best companies to Work For.” The san Francisco- based firm markets technology to help businesses maintain strong customer relationships. As an employer, salesforce.com is in the spotlight because it invests heavily in recognizing and rewarding employee performance. For instance, its top salespeople enjoy lavish vacations in addition to companywide honors—and they take pride in their hard-earned professional achievements.

salesforce.com recruits talented employees who have a drive to succeed and pays close attention to the basics employees need for their well-being. For example, employees have access to health insurance, dental and vision coverage, and fitness programs. company offices are well stocked with free snacks and beverages. To make life easier for those who are out on medical leave or paren- tal leave, salesforce.com offers an allowance for take-out meals. Beyond the basics, employees are invited to bring their dogs to work, mingle at company-sponsored concerts and outings, and play friendly games of ping-pong to break up the office routine.

With an eye toward helping employees achieve their profes- sional goals, salesforce.com provides extensive training to build skills, plus mentoring and career coaching. Both managers and

employees can attend internal job fairs, and switch to other proj- ects or teams, to round out their skills and take on new challenges. employees can also earn virtual merit badges for completing key work tasks or assisting co-workers. Visible in online trophy cases, these badges are particularly effective for motivating Millennials who are accustomed to the immediate rewards of winning points or advancing levels in digital games.

salesforce.com encourages community involvement by giving employees six paid days each year for volunteer work. it matches charitable donations made by employees (up to $5,000 per year) and uses its philanthropic contributions to support not-for-profit groups in which employees are actively involved. employees feel good when they have the opportunity to do good for others, and they appreciate the backing of salesforce.com at work and in the community.1

Did You Know? Founded in 1999, Salesforce.com now employs 15,000 people worldwide and rings up nearly $5 billion in annual sales of technology for customer relationship management.

InsIde BusIness

274 Part 4 Human Resources

your enthusiasm for your work so that you devote more energy to it, it may not have the same impact on someone else.

Morale is an employee’s attitude or feelings about the job, about superiors, and about the firm itself. To achieve organizational goals effectively, employees need more than the right raw materials, adequate facilities, and efficient equipment. High morale results mainly from the satisfaction of needs on the job or as a result of doing the job. One need that might be satisfied on the job is the need to be recognized as an impor- tant contributor to the organization. A need satisfied as a result of the job is the need for financial security. High morale leads to dedication, loyalty, and a desire to do the job well. Low morale, however, can lead to shoddy work, absenteeism, and high turnover rates as employees leave to seek more satisfying jobs with other firms. Turnover can be very costly. To minimize it, companies may try to create work envi- ronments that increase employee satisfaction. One obvious indicator of satisfaction at a specific organization is whether employees report that they like working there and whether other people want to work there. In a recent list of Fortune magazine’s “Top 100 Companies to Work For,” the top ten best companies to work for were Google, SAS, the Boston Consulting Group, Edward Jones, Quicken Loans, Genentech, Salesforce.com, Intuit, Robert W. Baird & Co., and DPR Construction.2 Motivation, morale, and the satisfaction of employees’ needs are highly intertwined consider- ations. Their relationships to business success and productivity have been the subject of much study since the end of the 19th century. We continue our discussion of moti- vation by outlining some landmarks of the early research.

10-2 histOriCaL PersPeCtives On MOtivatiOn Researchers often begin a study with a fairly narrow goal in mind, usually to test a specific hypothesis. After they develop an understanding of their subject, how- ever, they realize that their research has broader applications. This is exactly what happened when early research into productivity grew into the study of employee motivation.

10-2a Scientific Management Toward the end of the 19th century, Frederick W. Taylor, an American mechanical engineer, became interested in improving the efficiency of individual workers. This interest, which stemmed from his own experiences in manufacturing plants, eventu- ally led to the development of scientific management, the application of scientific principles to management of work and workers.

One of Taylor’s first jobs was with the Midvale Steel Company in Philadelphia, where he developed a strong distaste for waste and inefficiency. While there, he observed a practice he dubbed “soldiering.” Workers “soldiered,” or worked slowly, because they feared that if they worked faster, they would run out of work and lose their jobs. Taylor realized that workers could get away with this because managers had no idea what productivity levels should be.

After Midvale, Taylor spent several years at Bethlehem Steel. While there, he made his most significant contribution to the field of motivation. He suggested that each job be broken down into separate tasks. Then management should determine (1) the best way to perform each task and (2) the job output to expect when employ- ees performed the tasks properly. Next, management should choose the best person for each job and train that person in doing the job properly. Finally, management should monitor workers to ensure that jobs were performed as planned.

Taylor also developed the idea that most people work only to earn money. He therefore reasoned that pay should be tied directly to output. The more a person produces, the more he or she should be paid. This gave rise to the piece-rate system,

Concept Check ✓✓ What is motivation?

✓✓ Why is understanding motivation important?

morale an employee’s feelings about the job, about superiors, and about the firm itself

Learning Objective

10-2 Understand some major historical perspectives on motivation.

scientific management the application of scientific principles to management of work and workers

piece-rate system a compensation system under which employees are paid a certain amount for each unit of output they produce

Chapter 10 Motivating and Satisfying Employees and Teams 275

under which employees are paid a certain amount for each unit of output they pro- duce. Under Taylor’s piece-rate system, each employee is assigned an output quota. If they exceed the quota, they receive a higher per unit rate for all work produced (see Figure 10-1).

When Taylor’s system was put into practice at Bethlehem Steel, the results were dramatic. Average earnings per day for steel handlers rose from $1.15 to $1.88. (Do not let the low wages obscure the fact that this was an increase of more than 61 percent!) The average amount of steel handled per day increased from 16 to 57 tons. Today, the piece-rate system is still used by some manufacturers and by farmers who grow crops that are harvested by farm laborers.

Taylor’s revolutionary ideas had a profound impact on management practice. However, his view of motivation was soon recognized as overly simplistic and nar- row. It is true that most people expect to be paid for their work, but it is also true that people work for a variety of reasons other than pay. Therefore, simply increas- ing a person’s pay may not increase that person’s motivation or productivity.

10-2b The hawthorne Studies Between 1927 and 1932, Elton Mayo, an Australian sociologist and organizational theorist, conducted two experiments at the Hawthorne plant of the Western Electric Company in Chicago. The original objective of these studies, now referred to as

Is anyone happy? A century ago, most businesses in the United States weren’t overly concerned about employee satisfaction. This is not the case today. Why do you think attitudes about employee motivation and satisfaction have changed?

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Figure 10-1 Taylor’s Piece-Rate System

Workers who exceeded their quotas were rewarded with a higher rate per piece for all the pieces they produced.

Output

WORKER B

Pay: 12¢ each

$10.20 per hour

Output

Quota 60 pieces per hour

Quota

WORKER A

Pay: 10¢ each

60 pieces

$6.00 per hour

276 Part 4 Human Resources

the Hawthorne Studies, was to determine the effects of the work environment on employee productivity.

The first set of experiments tested the effect of lighting levels on productivity. One group of workers was subjected to varying lighting, while a second was not. To the amazement of the researchers, productivity increased for both groups. For the group whose lighting was varied, productivity remained high until the light was reduced to the level of moonlight!

The second set of experiments focused on the effectiveness of the piece-rate sys- tem in increasing the output of groups of workers. Researchers expected that output would increase because faster workers would put pressure on slower workers to produce more. Again, the results were not as expected. Output remained constant irrespective of the “standard” rates management set.

When faced with unexpected outcomes, the researchers concluded that human factors were responsible for the results. In the lighting experiments, researchers had given both groups of workers a sense of involvement in their jobs merely by asking them to participate in the research. These workers—perhaps for the first time—felt as though they were an important part of the organization. The level of light did not matter. In the piece-rate experiments, each group of workers informally set the acceptable rate of output for the group. To gain or retain the social acceptance of the group, each worker felt pressure to produce at the same rate as the group pace.

The Hawthorne Studies showed that such human factors are at least as impor- tant to motivation as pay rates. From these and other studies, the human relations movement in management was born. Its premise was simple: Employees who are happy and satisfied with their work are motivated to perform better. Hence, man- agement is best served by providing a work environment that maximizes employee satisfaction.

10-2c Maslow’s hierarchy of Needs Abraham Maslow, an American psychologist whose best-known works were pub- lished in the 1960s and 1970s, developed a theory of motivation based on a hier- archy of needs. A need is a personal requirement. Maslow assumed that humans are “wanting” beings who seek to fulfill a variety of needs, which he argued can be arranged from most basic to most complex in a sequence now known as Maslow’s hierarchy of needs (see Figure 10-2).

At the bottom of the pyramid are physiological needs, the things we require to survive. They include food and water, clothing, shelter, and sleep. In the employment context, these needs usually are satisfied through adequate wages.

need a personal requirement

Maslow’s hierarchy of needs a sequence of human needs in the order of their importance

physiological needs the things we require for survival

Figure 10-2 Maslow’s Hierarchy of Needs

Psychologist Abraham Maslow believed that people act to fulfill five categories of needs.

Self-actualization needs

Esteem needs

Social needs

Safety needs

Physiological needs

Chapter 10 Motivating and Satisfying Employees and Teams 277

At the next level are safety needs, the things we require for physical and emotional security. Safety needs may be satisfied through job stability, health insurance, pension plans, and safe working conditions. The escalating costs of health care in today’s work environment threaten some workers’ sense of safety. Many firms are switching to more part-time workers for low-wage positions in order to avoid health insurance costs and fees. Under new law, large employers must provide health insurance to those who work more than 30 hours per week, or risk paying a fine.3 The move might backfire as employees seek to satisfy their safety needs at more secure jobs.

Next are the social needs, the human requirements for love and affection and a sense of belonging. These needs are fulfilled in the workplace through the work environment and the informal organization and outside of the workplace by family and friends. Employers are increasingly offering their workers flexible scheduling options in order to improve their quality of lives, which includes time for family and friends. Employees who have flexible work schedules are more likely to be able to attend family events or care for children or ailing relatives. Employers can help workers satisfy social needs by providing useful feedback and fostering workplace cooperation and communication through a variety of media.

At the level of esteem needs, we require respect and recognition from others and a sense of our own accomplishment and worth (self-esteem). These needs may be satisfied through personal accomplishment, promotion to positions with greater responsibility, various honors and awards, and other forms of recognition.

At the top of the hierarchy are the self-actualization needs, which are the needs to grow, develop, and become all that we are capable of being. These are the most difficult needs to satisfy, and the means of satisfying them tend to vary with the individual. For some people, learning a new skill, starting a new career after retire- ment, or trying to become the best at some endeavor may be the way to realize self-actualization. Some companies reimburse employees for continuing education expenses—even another college degree—knowing they get the benefit of employees with more knowledge, as well as more satisfied employees who feel supported in their efforts to improve themselves.

Maslow suggested that people work up the hierarchy, satisfying their physi- ological needs before safety needs, for example. However, needs at one level do not have to be satisfied completely before needs at the next higher level come into play. People can also move up and down the hierarchy. For example, if a person loses a good job, he may find himself trying to satisfy safety needs when he only recently had focused on social needs.

Maslow’s hierarchy of needs provides a guide for management and a useful way of viewing employee motivation. By and large, American business has been able to satisfy workers’ basic needs, but the higher-order needs present more of a challenge. The means of satisfying these needs varies from one employee to another.

10-2d herzberg’s Motivation–hygiene Theory Frederick Herzberg, an American psycholo- gist, interviewed approximately 200 accoun- tants and engineers in Pittsburgh in the 1950s to develop his theory of motivation. He asked them to think of a time when they had felt especially good about their jobs and

safety needs the things we require for physical and emotional security

social needs the human requirements for love and affection and a sense of belonging

esteem needs our need for respect, recognition, and a sense of our own accomplishment and worth

self-actualization needs the need to grow and develop and to become all that we are capable of being

What satisfies employees? Companies sometimes use travel awards as incentives for better employee performance. According to the motivation–hygiene theory, when an incentive for higher performance is not provided, is that a dissatisfier?

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278 Part 4 Human Resources

their work and to describe the factor or factors that had caused them to feel that way. Next, he asked them about a time when they had felt especially bad about their work. He was surprised to find that feeling good and feeling bad resulted from entirely different factors. That is, low pay may make a particular person feel bad, but high pay does not necessarily make that same person feel good.

SaTiSFaCTioN aNd diSSaTiSFaCTioN Before Herzberg’s interviews, the general assumption was that employee satisfaction and dissatisfaction lay at oppo- site ends of the same scale. However, Herzberg’s interviews convinced him that sat- isfaction and dissatisfaction are different dimensions altogether. In other words, the opposite of satisfaction is not dissatisfaction. The idea that satisfaction and dissatis- faction are separate and distinct dimensions is referred to as the motivation–hygiene theory (see Figure 10-3).

The job factors that Herzberg found most frequently associated with satisfac- tion were achievement, recognition, responsibility, advancement, growth, and the work itself. These factors generally are referred to as motivation factors because their presence increases motivation. However, their absence does not necessarily result in dissatisfaction. When motivation factors are present, they act as satisfiers.

Dissatisfaction, on the other hand, is caused by job factors such as supervision, working conditions, interpersonal relationships, pay, job security, company policies, and administration. These factors, called hygiene factors, reduce dissatisfaction when they are present to an acceptable degree. However, they do not necessarily result in high levels of motivation. When hygiene factors are absent, they act as dissatisfiers.

USiNg hErzBErg’S MoTivaTioN–hygiENE ThEory Herzberg provides explicit guidelines for using the motivation–hygiene theory of employee motivation. He suggests that the hygiene factors must be present to ensure

that a worker can function comfortably. He warns, however, that a state of no dissatisfaction cannot exist. In any

situation, people always will be dissatisfied with something.

According to Herzberg, managers should uti- lize hygiene factors to make the work environment as

positive as possible, but should expect only short-term improvements in motivation. Managers must focus instead on providing those satisfiers that will enhance motivation and long-term effort.

motivation–hygiene theory the idea that satisfaction and dissatisfaction are separate and distinct dimensions

motivation factors job factors that increase motivation, although their absence does not necessarily result in dissatisfaction

hygiene factors job factors that reduce dissatisfaction when present to an acceptable degree but that do not necessarily result in high levels of motivation

Figure 10-3 Herzberg’s Motivation–Hygiene Theory

Herzberg’s theory takes into account that there are different dimensions to job satisfaction and dissatisfaction and that these factors do not overlap.

MOTIVATION FACTORS

Satisfaction No satisfaction

• Achievement

• Recognition

• Responsibility

• Advancement

• Growth

• The work itself

HYGIENE FACTORS

• Supervision

• Working conditions

• Interpersonal relationships

• Pay

• Job security

• Company policies and

administration

Dissatisfaction No dissatisfaction

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/A ld

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Chapter 10 Motivating and Satisfying Employees and Teams 279

We should note that employee pay has proven to have more effect than Herzberg’s theory indicates. He suggests that pay provides only short-term, not true, motivation. Yet, in many organizations, pay is a form of recognition and reward for achievement—and recognition and achievement are both motivation factors. The effect of pay may depend on how it is distributed. If a pay increase does not depend on performance (as in across-the-board or cost-of-living raises), it may not motivate people. However, if pay is increased as a form of recognition (as in bonuses or incen- tives), it can play a role in motivating employees to higher performance.

10-2e Theory X and Theory y The concepts of Theory X and Theory Y were advanced by Douglas McGregor, an American business professor, in his book, The Human Side of Enterprise, in 1967. They represent opposing sets of assumptions that underlie management’s attitudes and beliefs regarding workers’ behavior.

Theory X is a concept of employee motivation generally consistent with Taylor’s ideas about scientific management. Theory X is based on the following assumptions:

1. People dislike work and try to avoid it. 2. Because people dislike work, managers must coerce, control, and frequently

threaten employees to achieve organizational goals. 3. People generally must be led because they have little ambition and will not seek

responsibility; they are concerned mainly about security.

The logical outcome of such assumptions will be a highly controlled, autocratic work environment—one in which managers make all the decisions and employees take all the orders.

On the other hand, Theory Y is a concept of employee motivation generally consistent with the ideas of the human relations movement. Theory Y is based on the following assumptions:

1. People do not naturally dislike work. In fact, work is an important part of all of our lives.

2. People will work toward goals to which they are committed. 3. People become committed to goals when it is clear that accomplishing the goals

will bring personal rewards. 4. People often seek out and willingly accept responsibility. 5. Employees have the potential to help accomplish organizational goals. 6. Organizations generally do not make full use of their human resources.

Obviously, Theory Y is much more positive than Theory X. McGregor argued that most managers behave in accordance with Theory X, but he maintained that Theory Y is more appropriate and effective as a guide for managerial action (see Table 10-1). Theory X a concept of

employee motivation generally consistent with Taylor’s scientific management; assumes that employees dislike work and will function only in a highly controlled work environment

Theory Y a concept of employee motivation generally consistent with the ideas of the human relations movement; assumes responsibility and work toward organizational goals, and by doing so they also achieve personal rewards

tabLe 10-1 Theory X and Theory Y Contrasted

Area Theory X Theory Y

Attitude toward work Dislike Involvement

Control systems External Internal

Supervision Direct Indirect

Level of commitment Low High

Employee potential Ignored Identified

Use of human resources Limited Not limited

280 Part 4 Human Resources

The human relations movement and Theories X and Y increased managers’ awareness of the importance of social factors in the workplace during the second half of the 20th century. However, human motivation is a complex and dynamic process to which there is no simple key. It is clear from decades of research that neither money nor social factors alone can provide the answer.

10-2f Theory z William Ouchi, currently a management professor at UCLA, studied business practices in American and Japanese firms as discussed in his book, Theory Z: How American Management Can Meet the Japanese Challenge. He concluded that different types of management systems dominate in these two countries. In Japan, Ouchi found what he calls type J firms. They are characterized by life- time employment, collective (or group) decision making, collective responsibility for the outcomes of decisions, slow evaluation and promotion, implied control mechanisms, nonspecialized career paths, and a holistic concern for employees as people.

American industry is dominated by what Ouchi calls type A firms, which fol- low a different pattern. They emphasize short-term employment, individual decision making, individual responsibility for the outcomes of decisions, rapid evaluation and promotion, explicit control mechanisms, specialized career paths, and a seg- mented concern for employees only as employees.

A few very successful American firms represent a blend of the type J and type A patterns. These firms, called type Z organizations, emphasize long-term employ- ment, collective decision making, individual responsibility for the outcomes of decisions, slow evaluation and promotion, informal control along with some for- malized measures, moderately specialized career paths, and a holistic concern for employees.

Ouchi’s Theory Z posits that some middle ground between his type A and type J practices is best for American business (see Figure 10-4). A major part of Theory Z emphasizes participative decision making. The focus is on “we” rather than on “us versus them.” Theory Z employees and managers view the organization as a family. This participative spirit fosters cooperation and encourages the dissemination of information and organizational values.

Theory Z the belief that some middle ground between type A and type J practices is best for American business

Figure 10-4 The Features of Theory Z

The best aspects of Japanese and American management theories combine to form the nucleus of Theory Z.

TYPE J FIRMS (Japanese)

• Lifetime employment

• Collective decision making

• Collective responsibility

• Slow promotion

• Implied control mechanisms

• Nonspecialized career paths

• Holistic concern for employees

TYPE A FIRMS (American)

• Short-term employment • Individual decision making • Individual responsibility • Rapid promotion • Explicit control mechanisms • Specialized career paths • Segmented concern for employees

TYPE Z FIRMS (Best choice for American firms)

• Long-term employment

• Collective decision making

• Individual responsibility

• Slow promotion

• Informal control

• Moderately specialized

career paths

• Holistic concern for employees

Chapter 10 Motivating and Satisfying Employees and Teams 281

10-2g reinforcement Theory Reinforcement theory is based on the premise that people will repeat behavior that is rewarded and will cease behavior that is punished. A reinforcement is an action that follows directly from a particular behavior. It may be a pay raise after a particu- larly large sale to a new customer or a reprimand for coming late to work.

Reinforcements can take a variety of forms and can be used in a number of ways. A positive reinforcement is one that strengthens desired behavior by providing a reward, such as praise or recognition from supervisors for a job done well. A reward increases (strengthens) their willingness to perform well in the future. A negative reinforcement strengthens desired behavior by elimi- nating an undesirable task or situation. Suppose that a machine shop must be cleaned thoroughly every month—a dirty, miserable task. During a month when the workers do a less-than-satisfactory job, the boss requires them to clean the factory themselves, rather than bringing in the usual private maintenance service. The employees will be motivated to work harder the next month to avoid the unpleasant cleanup duty.

Punishment is a consequence of undesirable behavior. Common forms of pun- ishment used in organizations include reprimands, reduced pay, disciplinary layoffs, and termination (firing). Punishment often does more harm than good by creating a negative work environment, fostering worker hostility, and encouraging employees to engage in undesirable behaviors behind the backs of supervisors.

Managers who rely on extinction hope to eliminate undesirable behavior by not responding to it with the hope that the behavior will eventually go “extinct.” Suppose, for example, that an employee writes memo after memo to his or her manager about insignificant events. If the manager does not respond to any of these memos, the employee probably will stop writing them, and the behavior will stop.

The effectiveness of reinforcement depends on which type is used and how it is timed. Some situations lend themselves to the use of more than one approach. Generally, positive reinforcement is considered the most effective with most employ- ees, and it is recommended when the manager has a choice.

Continual reinforcement can become tedious for both managers and employees, especially when the same behavior is being reinforced over and over again in the same way. At the start, it may be necessary to reinforce a desired behavior every time it occurs. Generally, once a desirable behavior has been more or less established, only occasional reinforcement will be needed.

10-3 COnteMPOrary vieWs On MOtivatiOn Maslow’s hierarchy of needs and Herzberg’s motivation–hygiene theory are popular and widely known theories of motivation. Each takes a broader view than the nar- row focus of scientific management and Theories X and Y. However, they do have a weakness: each attempts to specify what motivates people, but neither explains why or how motivation develops or is sustained over time. More recently, managers have explored three other models that take a more dynamic view of motivation. These are equity theory, expectancy theory, and goal-setting theory.

10-3a Equity Theory The equity theory of motivation is based on the premise that people are motivated to obtain and preserve equitable treatment for themselves. As used here, equity is the distribution of rewards in direct proportion to each employee’s contribution to the organization. Everyone need not receive the same rewards, but the rewards should be in accordance with individual contributions.

reinforcement theory a theory of motivation based on the premise that rewarded behavior is likely to be repeated, whereas punished behavior is less likely to recur

Learning Objective

10-3 Describe three contemporary views of motivation: equity theory, expectancy theory, and goal- setting theory.

equity theory a theory of motivation based on the premise that people are motivated to obtain and preserve equitable treatment for themselves

Concept Check ✓✓ What are the major elements of Taylor’s “scientific management”?

✓✓ What were elton Mayo’s conclusions from the hawthorne studies?

✓✓ What are the different levels in Maslow’s hierarchy of needs?

✓✓ What are the major elements of herzberg’s motivation–hygiene theory?

✓✓ What are the underlying assumptions of Theory X and Theory Y?

282 Part 4 Human Resources

According to this theory, we conceive of equity in the following way. First, we develop our own input-to-out- come ratio. Inputs are the time, effort, skills, education, experience, and so on that we contribute to the organiza- tion. Outcomes are the rewards we get from the organiza- tion, such as pay, benefits, recognition, and promotions. Next, we compare this ratio to what we perceive as the input-to-outcome ratio for some other person. It might be a co-worker, a friend who works for another firm, or even an average of all the people in our organization. This per- son is called the comparison other. Note that the impor- tant consideration is that we believe our perception to be correct, whether or not it is.

If the two ratios are roughly the same, we feel that the organization is treating us equitably. In this case, we are motivated to leave things as they are. However, if our ratio is the higher of the two, we feel under-rewarded and are motivated to make changes. We may (1) decrease our own inputs by not working as hard, (2) try to increase our out- come by asking for a raise in pay, (3) try to get the com- parison other to increase some inputs or receive decreased outcomes, (4) leave the work situation, or (5) conduct a new comparison with a different comparison other.

Equity theory is most relevant to pay as an out- come. Because pay is a very real measure of a person’s worth to an organization, comparisons involving pay are a natural part of organizational life. Managers can try to avoid problems arising from inequity by making sure

that rewards are distributed on the basis of performance and that everyone clearly understands the basis for his or her own pay.

10-3b Expectancy Theory Expectancy theory, developed by Victor Vroom, a Canadian business professor, is a very complex model of motivation based on a simple assumption. According to expectancy theory, motivation depends on how much we want something and on how likely we think we are to get it (see Figure 10-5). Consider, for example, the case of three sales representatives who are candidates for promotion to one sales manager’s job. Bill has had a very good sales year and always gets positive perfor- mance evaluations. However, he is not sure that he wants the job because it involves

expectancy theory a model of motivation based on the assumption that motivation depends on how much we want something and on how likely we think we are to get it

Employees want to be treated fairly. Employees compare the amount of effort they put into their jobs and the outcomes they get to that of their co-workers. This is the idea behind equity theory. At sweatshops such as this one, though, all employees are treated unfairly. Does equity theory come into play in this instance?

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Figure 10-5 Expectancy Theory

Vroom’s theory is based on the idea that motivation depends on how much people want something and on how likely they think they are to get it.

Yes Yes

N o

MOTIVATED

NOT MOTIVATED NOT MOTIVATED

Does the person think the outcome is likely?

Does the person want the outcome?

Chapter 10 Motivating and Satisfying Employees and Teams 283

travel, long working hours, and stress and pressure. Paul wants the job badly, but does not think he has much chance of getting it. He has had a terrible sales year and gets only mediocre performance evaluations from his present boss. Susan wants the job as much as Paul, and she thinks that she has a pretty good shot. Her sales have improved this past year, and her evaluations are the best in the company.

Expectancy theory would predict that Bill and Paul are not very motivated to seek the promotion. Bill does not really want it, and Paul does not think that he has much of a chance of getting it. Susan, however, is very motivated to seek the promo- tion because she wants it and thinks that she can get it.

Expectancy theory is complex because each action we take is likely to lead to several outcomes, some of which we want and others we do not. For example, a person who works hard and puts in many extra hours may get a pay raise, be pro- moted, and gain valuable new job skills. However, that person also may be forced to spend less time with his or her family and to cut back on social activities.

For one person, the promotion may be paramount, the pay raise and new skills fairly important, and the loss of family and social life of negligible importance. For someone else, the family and social life may be most important, the pay raise of moderate importance, the new skills unimportant, and the promotion undesirable because of the additional hours it would require. The first person would be motivated to work hard and put in the extra hours, whereas the second person would not be motivated at all to do so. In other words, it is the bundle of outcomes combined with the individual’s perception of each outcome’s importance that determines motivation.

Expectancy theory is difficult to apply, but it does provide several useful guide- lines for managers. It suggests that managers must recognize that (1) employees work for a variety of reasons, (2) these reasons, or expected outcomes, may change over time, and (3) it is necessary to show employees how they can attain the out- comes they desire.

10-3c goal-Setting Theory Goal-setting theory states that employees are motivated to achieve goals that they and their managers establish together. The goal should be very specific, moderately difficult, and one that the employee will be committed to achieve.4 Rewards should be tied directly to goal achievement. Using goal-setting theory, a manager can design

Concept Check ✓✓ What is equity theory?

✓✓ how do managers use it in order to decide the pay structure of employees?

✓✓ What is expectancy theory and how is it different from goal- setting theory?

goal-setting theory a theory of motivation suggesting that employees are motivated to achieve goals that they and their managers establish together

What do employees want? That’s what their managers need to determine. Different employees are motivated by different rewards. Figuring out which rewards motivate each employee is a key step in goal setting.

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rewards that fit employee needs, clarify expectations, maintain equity, and provide reinforcement. For example, a manager might discover that one of her employees is very motivated by the occasional day off. Therefore, the manager and the employee may work out a plan that involves a free day as a reward after he completes a proj- ect satisfactorily and ahead of schedule, as long as he is up-to-date in his other work. This theory takes into account the goal the employee has to achieve and the rewards that will accrue if the goal is accomplished.

10-4 Key MOtivatiOn teChniques Today, it takes more than a generous salary to motivate employees. Increasingly, companies are trying to provide motivation by satisfying employees’ less-tangi- ble needs. Businesses may use simple, low- or no-cost, or complex and expensive approaches to motivation. In this section, we discuss several specific techniques that help managers to boost employee motivation and job satisfaction.

10-4a Management by objectives Management by objectives (MBO) is a motivation technique in which managers and employees collaborate in setting goals. The primary purpose of MBO is to clarify the roles employees are expected to play in reaching the organization’s goals.

MBO increases employee motivation by empowering them with an active role in goal-setting and performance evaluation. Most MBO programs consist of a series of five steps. The first step in setting up an MBO program is to secure the acceptance of top management. It is essential that top managers endorse and participate in the program if others in the firm are to accept it. This also provides a natural starting point for educating employees about the purposes and mechanics of MBO.

In the second step, top management and other parties must establish prelimi- nary goals that reflect a firm’s mission and strategy. The intent of an MBO program is to have these goals filter down through the organization.

The third step is the heart of MBO. It consists of three smaller steps:

1. The manager explains to each employee that he or she has accepted certain goals for the organization, or a group within the organization, and asks the individual to think about how he or she can help to achieve these goals.

2. The manager later meets with each employee individually. Together they establish individual goals for the employee. Whenever possible, the goals should be measurable and should specify the time frame for completion (usually one year).

3. The manager and the employee decide what resources the employee will need to accomplish his or her goals.

As the fourth step, the manager and employees meet periodically to review each employee’s progress. They may agree to modify certain goals during these meet- ings if circumstances have changed. For example, a sales representative accepted a goal of increasing sales by 20 percent. However, an aggressive competitor has since entered the marketplace, making this goal unattainable. In light of this circumstance, the goal is revised down to 10 or 15 percent.

The fifth step in the MBO process is evaluation. At the end of the designated time period, the manager and each employee meet again to determine which of the individual’s goals were met and which were not, and why. The employee’s reward (in the form of a pay raise, praise, or promotion) is based primarily on the degree of goal attainment.

As with every other management method, MBO has advantages and disadvan- tages. MBO can motivate employees by involving them actively in the life of the firm. The collaboration on goal setting and performance appraisal improves communication

Learning Objective

10-4 Explain several techniques for increasing employee motivation.

management by objectives (MBO) a motivation technique in which managers and employees collaborate in setting goals

Chapter 10 Motivating and Satisfying Employees and Teams 285

and makes employees feel that they are an important part of the organization. Periodic progress reviews also enhance quality con- trol within an organization. Shortcomings of MBO are that it must have the support of top management, it can result in a lot of paper- work, and managers may not like to work out goals with subordinates.

10-4b Job Enrichment Job enrichment is a method of motivating employees by providing them with variety in their tasks while giving them some responsi- bility for, and control over, their jobs. At the same time, employees gain new skills and acquire a broader perspective about how their individual work contributes to the goals of the organization. Earlier in this chapter, we noted that Herzberg’s motivation–hygiene theory is one rationale for the use of job enrichment. That is, the added responsibility and control that job enrichment confers on employees increases their satisfaction and motivation. For example, some employees at 3M and Google get to spend a fraction of their time at work on projects of their choosing.5 This type of enrichment can motivate employ- ees and result in benefits for the company. At times, job enlargement, expanding a worker’s assignments to include additional but similar tasks, can lead to job enrich- ment. Job enlargement might mean that a worker on an assembly line who used to connect three wires to components moving down the line now connects five wires. Unfortunately, the added tasks often are just as routine as those the worker per- formed before the change and may not be an effective motivator over the long term.

Whereas job enlargement does not really change the routine and monotonous nature of jobs, job enrichment does. Job enrichment results in an increased sense of employee responsibility, increased control over how the job is performed, and new tasks. Job enrichment gives workers more authority and assigns tasks in complete, natural units (rather than breaking it down into the smallest possible task). Employees frequently are given fresh and challenging job assignments. By blending more planning and decision making into jobs, enrichment gives work more depth and complexity.

Job redesign is a type of job enrichment in which work is restructured in ways that cultivate the worker–job match. Job redesign can be achieved by combining tasks, forming work groups, or establishing closer customer relationships. Employees often are more motivated when jobs are combined because the increased variety of tasks presents a more rewarding challenge. Depending on the form it takes, job redesign can give employees a stronger sense of belonging to a team, a clearer image of how their work contributes to the organization as a whole, and a more personal investment in the satisfaction of clients. Furthermore, a job redesign that carefully matches worker to job can prevent stress-related injuries. Employees may play an active role in redesigning their jobs to their liking. If an employee recognizes an opportunity at work to rework his or her job in such a way as to improve efficiency or productivity, he or she may want to approach a superior with the idea.

Job enrichment works best with employees who want more challenging work. Employees must desire personal growth and have the skills and knowledge to per- form more complex tasks. Lack of self-confidence, fear of failure, and distrust of management’s intentions are likely to lead to ineffective performance on enriched jobs. Some workers prefer routine jobs because they find them satisfying. Job enrichment would not be appealing for these individuals. Companies that use job

job enrichment a motivation technique that provides employees with more variety and responsibility in their jobs

job enlargement expanding a worker’s assignments to include additional but similar tasks

job redesign a type of job enrichment in which work is restructured to cultivate the worker–job match

Job enlargement versus job enrichment. It’s no secret. Doing the same task over and over at your job is boring. Being able to do a variety of tasks helps. Having more responsibility over how you do your job is even better.

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enrichment as an alternative to specialization also face extra expenses, such as the cost of retraining.

10-4c Behavior Modification Behavior modification is a systematic program of reinforcement to encourage desir- able behavior. Behavior modification involves both rewards to encourage desirable actions and punishments to discourage undesirable actions. Rewards, such as com- pliments and expressions of appreciation, tend to be much more effective behavior modifiers than punishments, such as reprimands and scorn.

When applied to management, behavior modification strives to encourage desir- able organizational behavior. This technique begins with identifying and measuring a target behavior—the behavior that is to be changed (e.g., low production levels or a high rate of absenteeism). Next, managers provide positive reinforcement in the form of a reward when employees exhibit the desired behavior (e.g., increased pro- duction or less absenteeism). The reward might be praise or a more tangible form of recognition, such as a gift, meal, or trip. For example, Apple offers Corporate Gifts and Rewards Program to give companies the ability to reward their staff or very loyal customers with iPods, iPhones, iPads, Mac computers, or iTunes gift cards. Finally, the levels of the target behavior are measured again to determine whether the desired changes have been achieved. If the target behavior has not changed sig- nificantly in the desired direction, the reward system must be changed to one that is likely to be more effective. The key is to devise effective rewards that will not only modify employees’ behavior in desired ways, but also motivate them. To this end, experts suggest that management should reward quality, loyalty, and productivity.

10-4d Flextime The needs and lifestyles of today’s workforce are changing. Dual-income families make up a much larger share of the workforce than ever before, and women are one of its fastest-growing sectors. In addition to child-rearing duties, a growing number of employees are responsible for the care of elderly relatives. A study by Pew Research found that 40 million Americans are assisting at least one elderly parent with the daily living activities, and that 70 percent of these caretakers must come in late, leave early, or make other adjustments to do so.6 Recognizing that these changes increase the demand for flexibility during the normal work day, many employers are offering flexible work schedules to help employees to manage their time better and increase employee motivation and job satisfaction.

Flextime is a system in which employees set their own work hours within cer- tain limits determined by employers. Typically, the firm establishes two bands of time: the core time, when all employees must be at work, and the flexible time, when employees may choose whether to be at work. The only condition is that every employee must work a total of eight hours each day. For example, the hours between 9 and 11 a.m. and 1 and 3 p.m. might be core times, and the hours between 6 and 9 a.m., 11 a.m. and 1 p.m., and 3 and 6 p.m. might be flexible times. This would give employees the option of coming in early and getting off early, coming in later and leaving later, or taking a long lunch break. But flextime also ensures that everyone is present at certain times, when conferences with supervisors and depart- ment meetings can be scheduled. Another type of flextime allows employees to work a 40-hour work week in four days instead of five.

A study by National Work/Life Measurement Project found that 70 percent of managers and 87 percent of employees said that flexible work measures have a positive or very positive effect on productivity and significantly enhanced the quality of work.7 However, two common problems associated with using flextime are (1) supervisors sometimes find their jobs complicated by having employees who come and go at differ- ent times and (2) employees without flextime sometimes resent co-workers who have it.

behavior modification a systematic program of reinforcement to encourage desirable behavior

flextime a system in which employees set their own work hours within employer-determined limits

Chapter 10 Motivating and Satisfying Employees and Teams 287

While most people still work standard 40-hour weeks, flexible schedules are becoming much more common and easier to manage as improvements in technology allow people to stay connected, no matter where they are or what time it is. Medical and health, education and training, administrative jobs, and accounting are all likely to offer flexible schedule options. For example, the accounting firm Ernst & Young offers flextime as a reward for working in an intense industry that requires long hours during busy times. In order to offset the 60- or 70-hour workweeks during tax sea- son, it allows their employees to work three-day weeks or take extended breaks during the sum- mer. Its flexible work policies have landed Ernst & Young on Working Mother magazine’s “100 Best Companies” list for 18 years in a row.8 Flex policies like this help to reduce employee burnout and keep turnover low in what can be a stressful industry.

10-4e part-Time Work and Job Sharing Part-time work is permanent employment in which individuals work less than a standard work week. The specific number of hours worked var- ies, but part-time jobs are structured so that all responsibilities can be completed in the number of hours an employee works. Part-time work is of special interest to parents who need more time with their children. While some firms are famous for offering part-time workers benefits, such as Starbucks, REI, and Barnes & Noble, most do

part-time work permanent employment in which individuals work less than a standard work week

is Flextime for you?

Would you enjoy a flextime schedule, with the leeway to start work late or leave early and make up the time on other days? Or would you prefer the predictability of a fixed schedule? When it comes to work schedules, one size doesn’t fit all as people seek to balance their personal and professional obligations. And that’s why a growing number of companies, nonprofit organizations, and government agencies are offering flextime.

Parents of young children and employees who care for sick relatives especially appreciate the flexibility. Although more women use flextime than men, the proportion of men who choose flextime has increased to 77 percent. What’s more, 86 percent of men using flextime report higher job satisfaction— and 82 percent say it makes them more loyal to the employer.

However, some managers resist flextime, in part because it’s a challenge to manage workflow when employees are on a variety of schedules. For their part, employees

sometimes fear they’ll be seen as less dedicated or experience a backlash if they request flextime. Now state agencies in almost a dozen states are required to allow flextime, and Vermont has laws preventing private employers from retaliating against those who request flextime or fixed schedules. Flextime is also in schools: One Idaho high school allows a flexible 15 minutes in each school day for underperforming students to work with teachers (while other students have free time).

sources: Based on information in kelly Wallace, “Report: Majority of Men using Flex Time and loving it,” CNN.com (accessed July 11, 2015), december 12, 2014; Jennifer ludden, “if You Want Flextime But Are Afraid to Ask, consider Moving,” National Public Radio, April 29, 2014, www.npr.org (accessed July 11, 2015); Teresa Wiltz, “Flextime Grows, helping Working Families,” Detroit News, october 19, 2014, www.detroitnews.com (accessed July 11, 2015); kristen Johnson, “idaho high school uses Flex Time to help students,” Associated Press, november 22, 2014, www.washingtontimes.com (accessed July 11, 2015); susan Adams, “Workers have More Flextime, less Real Flexibility, study shows,” Forbes.com (accessed July 11, 2015), May 2, 2014.

Career Success

Part-time pay, full-time benefits. Many employees want to work part-time but can’t afford not to have benefits such as health insurance. Companies known for hiring part-time employees with full benefits include Starbucks, REI, Land’s End, UPS, and Barnes & Noble.

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not offer this perk. In fact, more companies are switching to part-time workers in order to cut back on the rising cost of offering ben- efits, especially the health insurance benefits now required of all companies with more than 50 full-time employees. Some companies even use high-tech “workforce optimization” software that models demand so that employ- ers can predict exactly how many workers are needed at any given time, further reducing the length of shifts and numbers of workers needed. Such “just-in-time scheduling” can yield signifi- cant cost savings for businesses; however, it can result in unpredictable schedules for employees, which may create dissatisfaction and thus higher turnover.9

Job sharing (sometimes referred to as work sharing) is an arrangement whereby two people share one full-time position. One job sharer may work from 8 a.m. to noon, and the other from 1 to 5 p.m., or they may alternate workdays. Job shar- ing is different than part-time work because two people share one single position, which is generally more skilled than a part-time position would be. Job sharing can be difficult to orchestrate at the begin- ning, but may contribute to greater job satisfaction and ease in creating work–life balance. Job sharing can actually lead people to be more productive, as they know that their time at work is limited and that someone else is directly depending on the quality of

their work. Job sharing combines the security of a full- time position with the flexibility of a part-time one, which may be especially valu- able for working parents. For firms, job sharing provides a unique opportunity to attract highly skilled employees who are not available on a full-time basis. In addition, companies can save on benefits expenses and avoid the disruptions of employee turnover. For employees, opting for the flexibility of job sharing may mean giving up some of the benefits, such as health insurance, received for full-time work. Job sharing is difficult if tasks are not easily divisible or if two people do not work or communicate well with one another.

10-4f Telecommuting A growing number of companies allow telecommuting, working at home all the time or for a portion of the work week. Technology such as e-mail, cloud computing, smart phones, laptops, tablets, video conferencing, and overnight couriers all make working at home easier and more convenient than ever before. Working at home means that indi- viduals can set their own hours and have more time with their families. Telecommuting has boomed 79 percent since 2005, and now comprises 2.6 percent of the U.S. work- force, excluding the self-employed. Telecommuting can be especially beneficial to the disabled, working parents, and employees taking care of elderly or disabled family members, though in fact, telecommuters include all demographic groups.10

A growing body of research indicates that telecommuters are actually more effective than their in-office counterparts. This is because remote workers feel pres- sured to counter any perception that they do not work as hard. Remote workers try harder to connect, use technology more effectively, use time more efficiently, and

job sharing an arrangement whereby two people share one full-time position

telecommuting working at home all the time or for a portion of the work week

Can you work from home?

Depending on your career and your employer, telecommuting may be in your future. Would you like to have the option of working from home, occasionally or regularly? Do you think you’ll be able to complete your work projects on schedule if you telecommute? Or would you prefer to work in an office or other workplace, where you have access to central records and can consult with colleagues and supervisors?

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generally experience fewer distractions than those working in a conventional office.11

In addition to increased productivity, com- panies that allow occasional telecommuting have lower real estate and travel expenses, improved morale, and the flexibility to access larger labor pools. Telecommuting also reduces fossil fuel emissions from putting fewer cars on the road. When Chinese travel website Ctrip allowed half of its employees to telecommute, the company saved $1,900 per employee in furniture and space costs over nine months. Moreover, the telecommuting employees were so efficient that they effectively netted the company an extra day of work per week. The telecommuters used fewer sick days, quit at a much lower rate, and reported much higher job satisfaction.12

Among the disadvantages of telecommut- ing are feelings of isolation, putting in long hours, and being distracted by family or house- hold responsibilities. The stigma also remains, in spite of evidence to the contrary, that tele- commuters are less productive than office- based staff. In addition, some supervisors have difficulty monitoring productivity of remote workers.

10-4g Employee Empowerment Many companies are increasing employee motivation and satisfaction through the use of empowerment. Empowerment means making employees more involved in their jobs and in the operations of the organization by increasing their participation in decision making. With empowerment, control no longer flows exclusively from the top level of the organization downward. Empowered employees have a voice in what they do and how and when they do it. In some organizations, employees’ input is restricted to individual choices, such as when to take breaks. In other companies, their responsibilities may encompass more far-reaching issues. Successful companies treat their employees like assets, empowering them to fully utilize their talents and shift responsibilities with the firm’s needs. Technology clearly plays a role in empow- ering employees, but so does creating an open and safe workplace where employees feel like they can speak up and are heard. Allowing employees access to information, such as reports, performance data, and communications, can empower them and make them feel more satisfied with their jobs.

For empowerment to work effectively, management must be involved. Managers should set expectations, communicate standards, institute periodic evaluations, and guarantee follow-up. If effectively implemented, empowerment can lead to increased job satisfaction, improved job performance, higher self-esteem, and increased orga- nizational commitment. Obstacles to empowerment include resistance on the part of management, distrust of management on the part of workers, inadequate training of employees, and poor communication between levels of the organization.

10-4h Employee ownership Some organizations have discovered that an effective technique for motivating employees is employee ownership—that is, employees own the company they work for by virtue of being stockholders. Employee-owned businesses directly reward employees for success. When the company enjoys increased sales or lower costs,

empowerment making employees more involved in their jobs by increasing their participation in decision making

employee ownership a situation in which employees own the company they work for by virtue of being stockholders

Office space—at home. Many companies are finding it cost-effective to allow employees to work at home. Working at home means that parents can spend more time with their children. Telecommuting arrangements such as this can be a win-win situation for both employees and their firms.

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employees benefit directly. The National Center for Employee Ownership, an orga- nization that studies employee-owned American businesses, reports that employee stock ownership plans (ESOPs) provide considerable employee incentive and increase employee involvement and commitment. In the United States today, an esti- mated 14.7 million employees participate in 8,926 ESOPs and stock bonus plans.13 Employees in an ESOP may own all or part of a company’s stock. In the United States, employee-owned companies include Publix Super Markets, New Belgium Brewing Company, Harpoon Brewery, and Davey Tree Expert Company. ESOPs have also become more popular in Europe.

As a means to motivate executives and managers to feel invested in the company as they work long days, some firms provide stock options as part of the employee compensation package. An option is simply the right to buy shares of the firm within a prescribed time at a set price. If the firm does well and its stock price rises past the set price (presumably because of all the work being done by the employee), the employee can exercise the option and sell the stock to cash in on the company’s success. However, not all companies choose to engage in ESOPs because they can be complex and expensive for the firm. This is particularly true of smaller organiza- tions that may not have the means to manage such a program.

10-5 teaMs and teaMWOrK The concepts of teams and teamwork may be most commonly associated with sports, but they are also integral parts of business organizations. This organizational struc- ture is popular because it encourages employees to participate more fully in busi- ness decisions. The growing number of companies organizing their workforces into teams reflects an effort to increase employee productivity and creativity because team members are working on specific goals and are given greater autonomy. This leads to greater job satisfaction as employees feel more involved in the management process.14

Concept Check ✓✓ What are the five steps of most MBo programs?

✓✓ how can companies use job enrichment as a method for motivating employees?

✓✓ What is behavior modification and how is it used in organizations?

✓✓ What benefits does a company receive when using flextime, job sharing, and telecommuting?

✓✓ how do employee ownership and employee empowerment help in increasing employee motivation and satisfaction?

Learning Objective

10-5 Understand the types, development, and uses of teams.

a Time to Micromanage

Entrepreneurs are accustomed to being in charge and doing what it takes to help their businesses prosper. Yet even the most competent entrepreneurs may be tempted to cross the line from managing to micromanaging—by dictating exactly what their employees should do, when they should do it, and how to do it, for example. Unfortunately, micromanaged employees can easily become demoralized, which in turn may lead to lower performance, the opposite of what owners intended by exerting such tight control.

Does micromanaging ever make sense? According to experts, a hands-on approach can be helpful when the business is implementing a new but critical process for the first time. Entrepreneurs are aware of the big picture, so they’re in an ideal position to clarify details, offer suggestions, and make decisions on the spot, if problems or questions arise. Just as important, entrepreneurs can encourage

employees as work progresses and congratulate them on successfully tackling a difficult challenge.

In general, empowered employees feel more motivated than micromanaged employees. Therefore, entrepreneurs should establish clear goals, responsibilities, and deadlines; describe how performance will be measured; and hold employees accountable for results. Finally, take the time to explain the context of complicated work assignments, says entrepreneur- turned-author Kevin Daum, and provide opportunities for employees to experience what works and what doesn’t work.

sources: Based on information in Muriel Maignan Wilkins, “signs That You’re a Micromanager,” Harvard Business Review, november 11, 2014, http://hbr.org (accessed July 11, 2015); doug and Polly White, “The 3-step cure for Micromanagement,” Entrepreneur, June 19, 2014, www.entrepreneur.com (accessed July 11, 2015); lindsay Broder, “When it’s Appropriate to Micromanage,” Entrepreneur, March 20, 2014, www.entrepreneur.com; kevin daum, “8 Tips for empowering employees,” inc., september 30, 2013, http://www.inc.com/kevin-daum/8-tips-for- empowering-employees.html (accessed July 27, 2015).

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10-5a What is a Team? In a business organization, a team is two or more workers operating as a coordinated unit to accomplish a specific task or goal.15 A team may be assigned any number of tasks or goals, from development of a new prod- uct to selling that product. A team can also be created to identify or solve a problem that an organization is experiencing. Teamwork may seem like a simple concept, but teams are a microcosm of the organization and any complications in the work environment will affect the team. It is impor- tant to take into account the different work and communication styles and personalities of team members in order to create a productive team.16

10-5b Types of Teams Businesses may have several types of teams to achieve different purposes, including problem-solving teams, self-managed teams, cross-functional teams, and virtual teams.

proBlEM-SolviNg TEaMS The most common type of team in business organizations is the problem-solving team. It is generally used tem- porarily in order to bring knowledgeable employees together to tackle a spe- cific problem. Once the problem is solved, the team typically is disbanded.

SElF-MaNagEd Work TEaMS Self-managed teams are groups of employees with the authority and skills to manage themselves. Experts suggest that workers on self-managed teams are more motivated and sat- isfied because they have greater task variety and job control. On many work teams, members are cross-trained to perform everyone else’s jobs and rotate through all the jobs for which the team is responsible. In a tra- ditional business structure, management is responsible for hiring and firing employees, establishing budgets, purchasing supplies, conducting perfor- mance reviews, and taking corrective action. When self-managed teams are in place, they take over some or all of these management functions. The major advantages and disadvantages of self-managed teams are mentioned in Figure 10-6.

CroSS-FUNCTioNal TEaMS Traditionally, businesses have organized employees into departments based on a common function or specialty. However, increasingly, business organizations are faced with projects that require a diver- sity of skills from multiple departments. A cross-functional team consists of indi- viduals with varying specialties, expertise, and skills that are brought together to achieve a common task. For example, a purchasing agent might create a cross- functional team to gain insight into useful purchases for the company. This struc- ture avoids departmental separation and allows greater efficiency when there is a single goal. Although cross-functional teams are not necessarily self-managed,

team two or more workers operating as a coordinated unit to accomplish a specific task or goal

problem-solving team a team of knowledgeable employees brought together to tackle a specific problem

self-managed teams groups of employees with the authority and skills to manage themselves

cross-functional team a team of individuals with varying specialties, expertise, and skills that are brought together to achieve a common task

Figure 10-6 Advantages and Disadvantages of Self-Managed Teams

While self-managed teams provide advantages, managers must recognize their disadvantages.

ADVANTAGES • Boosts employee morale • Increases productivity • Aids innovation • Reduces employee boredom

DISADVANTAGES • Additional training costs • Teams may be disorganized • Conflicts may arise • Leadership role may be unclear

Using technology to close time and space and get more done. Skype, e-mail, and other electronic methods are allowing employees, continents away from one another, to work together effectively. Being able to hire the best employees from all around the globe to work virtually with one another can give a firm a competitive advantage. Virtual teams located in different time zones and on different continents can also enable a company to work on important projects 24/7.

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most self-managed teams are cross-functional. Cross-functional teams can also be cross-divisional. Ideally, a cross-functional team consists of a group of people with complementary skill sets and perspectives to enable the group to solve problems effectively and efficiently. The Internet and digital tools have helped strengthen the communication abilities of cross-functional teams. Increasingly, the ability to work in cross-functional teams is an important skill as the world becomes more interconnected and businesses must adapt quickly to change.

virTUal TEaMS Teams do not even have to be geographically close, thanks to sophisticated communications technology. A virtual team consists of members who are geographically dispersed but communicate electronically. In fact, team members may never meet in person but rely solely on e-mail, video conferences, voice mail, and other technological interactions. In the global business environment, virtual or remote teams connect employees located anywhere in the world on a common task. However, distance and the lack of face-to-face interactions can make working on virtual teams difficult. Clear communication is very important, especially among team members who have never met in person. E-mail communications, for example, are easily misinterpreted. Team members must be respectful and tolerant of cultural and language differences and quirks, and focus instead on the process.17

10-5c developing and Using Effective Teams It takes time for team members to establish individual roles, relationships, and duties in order to become an effective team. As a team matures, it passes through five stages of development, as shown in Figure 10-7.

ForMiNg In the first stage, forming, team members are introduced to one another and begin to develop a social dynamic. The members of the team are unsure about how to relate to one another, what behaviors are acceptable, and what the ground rules are for the team. Through group member interaction over time, team members become more comfortable and a group dynamic emerges.

STorMiNg During the storming stage, the interaction may be volatile and the team may lack unity. This is the stage at which goals and objectives begin to develop. Team members will brainstorm to develop ideas and plans and establish a broad-ranging agenda. It is important for team members to grow comfortable with each other so that they can contribute openly. It is unlikely that a team leader has come forth by this stage, although an informal leader may emerge. The success or failure of the ideas in the storming stage determines how long the team will take to reach the next stage.

NorMiNg After storming and the first burst of activity, the team begins to stabi- lize during the norming stage. Each person’s role within the group begins to solidify, and members recognize the roles of others. A sense of unity grows during this stage. If it has not occurred already, an identified leader will emerge. The group may remain somewhat in flux during norming, and may even regress back to the storm- ing stage if any conflict, especially over the leadership role, occurs.

pErForMiNg The fourth stage, performing, is when the team achieves its full potential, finally focusing on the assigned task. This stage may take a long time to develop, as team development issues can be complicated. The members of the team finally work in harmony under the established roles to accomplish the necessary goals.

adJoUrNiNg In the final stage, adjourning, the team is disbanded because the project is complete. Team members may be reassigned to other teams or tasks. This stage will not occur if the team is placed together for a task with no specific date of completion. For example, a marketing team may continue to develop promotional efforts for a store even after a specific promotional task has been accomplished.

virtual team a team consisting of members who are geographically dispersed but communicate electronically

Figure 10-7 Stages of Team Development

When attempting to develop teams, managers

must understand that multiple stages are generally required.

FORMING

The team is new. Members get to know each other.

STORMING

The team may be volatile. Goals and objectives are developed.

NORMING

The team stabilizes. Roles and duties are accepted and recognized.

PERFORMING

The team is dynamic. Everyone makes a focused effort to accomplish goals.

ADJOURNING

The team is �nished. The goals have been accomplished and the team is disbanded.

Chapter 10 Motivating and Satisfying Employees and Teams 293

10-5d roles Within a Team Within any team, each member has a role to play in helping the team attain its objectives. Each of these roles adds important dimensions to team member interac- tions. The group member who pushes the team toward achieving goals and objec- tives plays the task-specialist role by concentrating fully on the assigned task. In a cross-functional team, this might be the person with the most expertise relating to the current task. The socioemotional role is played by the individual who supports and encourages the emotional needs of the other members, placing the team mem- bers’ personal needs above the task at hand. Although this may sound like an unim- portant role, the socioemotional member’s dedication to team cohesiveness leads to greater unity and higher productivity. Some team members play a dual role, which is a combination of the socioemotional and task-specialist roles. The team leader might not always play this dual role, but the team is likely to be most successful when he or she does. Sometimes an individual assumes the nonparticipant role. This role behavior is characterized by a person who does not contribute to accomplish- ing the task and does not provide favorable input with respect to team members’ socioemotional needs. He or she is obviously not a desirable team member to have.

10-5e Team Cohesiveness Developing a unit from a diverse group of personalities, specialties, backgrounds, and work styles can be challenging and complicated. In a cohesive team, the mem- bers get along and are able to accomplish their tasks effectively. Team cohesiveness is affected by different factors, internal and external to the team. To assure cohe- siveness, the ideal team size is generally five to 12. Anything larger and relationship development becomes too complicated. Anything smaller and the group may be excessively burdened and tasks may not get completed. Jeff Bezos, CEO of Amazon,

When Teamwork doesn’t Work

Have you ever seen one team member take credit for a suggestion that actually came from another member? Or been part of a team with a member who dodged his or her responsibilities? What about a team that made a poor decision because members were reluctant to state opposing views? These are grey areas in teamwork, which can give rise to resentment and dysfunction rather than satisfaction and productivity.

Janine Popick, who runs a marketing services firm, says leaders should speak up when a team member tries to take credit for someone else’s idea. Otherwise, employees may hold back—and some promising new product or program will never happen.

In the case of “social loafing,” a member “loafs” while others carry the workload. To prevent such situations—and to highlight individual accomplishments—firms can require periodic progress reports from each team member. Team members at Skype and eBay, for example, submit a weekly Progress, Plans, and Problems report. Managers can then

see what individuals have achieved, what they expect to achieve, and what challenges they face.

“Groupthink” occurs when a group makes a decision without encouraging diverse viewpoints and alternatives. Because members feel pressure to conform and avoid dissension, decisions are made without the benefit of constructive debate. Google Ventures avoids Groupthink by having team members note their ideas individually and share the best one or two with everyone. Members then vote on ideas from this pool of the best ideas and, after some group discussion, the team leader makes the final decision.

sources: Based on information in, “Benjamin Voyer on the Psychology of Teamwork,” Economist, January 2, 2015, www.economist.com (accessed July 11, 2015); Jake knapp, “note and Vote: how Google Ventures Avoids Groupthink in Meetings,” Fast Company Design, August 26, 2014, www.fastcodesign.com (accessed July 11, 2015); Janine Popick, “someone is Taking credit for Your idea! now What?” Inc.com, January 25, 2013; kulli koort, “5 Techniques to Make Teamwork More Manageable,” Fast Company, october 27, 2014, www.fastcompany.com (accessed July 11, 2015).

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famously believes that a team is too large if it takes more than two small pizzas to feed everyone on it.18 One of the most reliable ways to build cohesiveness within a team is through competition with other teams. When two teams are competing for a single prize or recognition, they are forced to become more goal-oriented and to put aside conflict. A favorable appraisal from an outsider may strengthen team cohesiveness. Because the team is being praised as a group, team members recognize their contribution as a unit. Teams are also more successful when goals have been agreed upon beforehand. A team that is clear about its objective will be able to focus on accomplishing it. Frequent interaction also builds team cohesiveness through increasing familiarity.

10-5f Team Conflict and how to resolve it Conflict occurs when a disagreement arises between two or more team members. Conflict traditionally has been viewed as negative, but it is unavoidable. If handled properly conflict can improve a team. For example, if two team members disagree about a proposition, both will spend extra time analyzing the situation closely to determine the best decision. As long as conflict is handled in a respectful and pro- fessional manner, it can improve the quality of work produced. However, if conflict turns hostile and affects the work environment, then steps must be taken to arrive at a compromise. Compromises can be difficult because neither party ends up get- ting everything he or she wants. The best solution is a middle-ground alternative in which each party is satisfied to some degree. Conflict must be acknowledged before it can be dealt with or used in a constructive manner. Ignoring conflict may cause it to simmer or grow, disrupting team progress.

10-5g Benefits and limitations of Teams Teamwork can be key to reducing turnover and costs and increasing productivity, customer service, and product quality. There is also evidence that working in teams leads to higher levels of job satisfaction among employees and a harmonious work environment. Thus, an increasingly large number of companies use teams as a valu- able element of their organizational structures. However, the process of organizing teams can be stressful and time consuming, and there is no guarantee that the team will develop effectively. If a team lacks cohesiveness and is unable to resolve conflict, the company may experience lower productivity.

Concept Check ✓✓ What are the major types of teams?

✓✓ highlight some differences between cross-functional teams and virtual teams.

✓✓ identify and describe the stages of team development.

✓✓ how can team conflict be reduced?

✓✓ What are some of the benefits and limitations of a team?

Go team, go! More companies today are using team-building exercises to help their employees figure out how to work better with one another. Sprint uses team-building exercises, such as whitewater rafting, for this purpose as well as to raise money for charities.

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Summary

10-1 explain what motivation is.Motivation is the individual internal process that energizes, directs, and sustains behavior. Motivation is affected by employee morale—that is, the employee’s feel- ings about the job, superiors, and the firm itself. Motivation, morale, and job satisfaction are closely related.

10-2 understand some major historical perspectives on motivation. One of the first approaches to employee motivation was Frederick Taylor’s scientific management, the application of scientific principles to the management of work and workers. Taylor believed that employees work only for money and that they must be closely supervised. This thinking led to the piece-rate system, under which employ- ees are paid a certain amount for each unit they produce.

The Hawthorne Studies attempted to determine the effects of the work environment on productivity. Results of these studies indicated that human factors affect pro- ductivity more than physical aspects of the workplace do.

Maslow’s hierarchy of needs suggests that people are motivated by five sets of needs. In ascending order of complexity, these motivators are physiological, safety, social, esteem, and self-actualization needs. People are motivated by the most basic set of needs that remains unfulfilled. As needs at one level are satisfied, people try to satisfy needs at the next level.

Frederick Herzberg found that job satisfaction and dissatisfaction are influenced by two distinct sets of factors. Motivation factors, including recognition and responsibility, affect an employee’s degree of satisfac- tion, but their absence does not necessarily cause dissat- isfaction. Hygiene factors, including pay and working conditions, affect an employee’s degree of dissatisfac- tion but do not affect satisfaction.

Theory X is a concept of motivation that assumes that employees dislike work and will function effec- tively only in a highly controlled environment. Thus, to achieve an organization’s goals, managers must coerce, control, and threaten employees. This theory generally is consistent with Taylor’s ideas of scientific manage- ment. Theory Y is more in keeping with the results of the Hawthorne Studies and the human relations move- ment. It suggests that employees can be motivated to behave as responsible members of the organization.

Theory Z emphasizes long-term employment, col- lective decision making, and individual responsibility for the outcomes of decisions, informal control, and a holistic concern for employees.

Reinforcement theory is based on the idea that peo- ple will repeat behavior that is rewarded and will avoid behavior that is punished.

10-3 describe three contemporary views of motivation: equity theory, expectancy theory, and goal-setting theory.

Equity theory maintains that people are motivated to obtain and preserve equitable treatment for themselves. Expectancy theory suggests that our motivation depends on how much we want something and how likely we think we are to get it. Goal-setting theory suggests that employees are motivated to achieve a goal that they and their managers establish together.

10-4 explain several techniques for increasing employee motivation. Management by objectives (MBO) is a motivation tech- nique in which managers and employees collaborate in setting goals. MBO motivates employees by involving them directly in their jobs and in the organization as a whole. Job enrichment seeks to motivate employees by varying their tasks and giving them more responsi- bility for and control over their jobs. Job enlargement, expanding a worker’s assignments to include additional tasks, is one aspect of job enrichment. Job redesign is a type of job enrichment in which work is restructured to improve the worker–job match.

Behavior modification uses reinforcement to encourage desirable behavior. Rewards for productiv- ity, quality, and loyalty change employees’ behavior in desirable ways and increase motivation.

Allowing employees to work flexible hours is another way to build motivation and job satisfaction. Flextime is a system of work scheduling that allows workers to set their own schedules, as long as they fall within the limits established by employers. Part-time work is permanent employment in which individuals work less than a standard work week. Job sharing is an arrangement whereby two people share one full-time position. Telecommuting allows employees to work at home for all or part of the work week. All of these work arrangements give employees more time outside the workplace to deal with family responsibilities or to enjoy free time.

Employee empowerment, self-managed work teams, and employee ownership are also techniques that boost employee motivation. Empowerment increases employees’ involvement in their jobs by increasing their decision-making authority. Self-managed work teams are groups of employees with the authority and skills to manage themselves. When employees participate in ownership programs, such as employee stock ownership plans (ESOPs), they have more incentive to make the company succeed and therefore work more effectively.

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10-5 understand the types, development, and uses of teams. A large number of companies use teams to increase their employees’ productivity. In a business organization, a team is a group of workers functioning together as a unit to complete a common goal or purpose.

There are several types of teams that function in specific ways to achieve different purposes. A problem- solving team is a team of knowledgeable employees brought together to tackle a specific problem. Self- managed work teams involve groups of employees with the authority and skills to manage themselves. A cross- functional team is a team of individuals with varying

specialties, expertise, and skills. A virtual team is a team consisting of members who are geographically dispersed and communicate electronically.

The five stages of team development are forming, storming, norming, performing, and adjourning. As a team develops, it becomes more productive and unified in order to achieve its assigned objective and goals. The four roles within teams are task specialist, socioemo- tional, dual, and nonparticipative. Each of these roles plays a specific part in the team’s interaction. For a team to be successful, members must learn how to resolve and manage conflict so that the team can work cohe- sively to accomplish goals.

Key Terms

You should now be able to define and give an example relevant to each of the following terms:

motivation (273) morale (274) scientific management (274) piece-rate system (274) need (276) Maslow’s hierarchy of

needs (276) physiological needs (276) safety needs (277) social needs (277)

esteem needs (277) self-actualization needs (277) motivation–hygiene theory

(278) motivation factors (278) hygiene factors (278) Theory X (279) Theory Y (279) Theory Z (280) reinforcement theory (281)

equity theory (281) expectancy theory (282) goal-setting theory (283) management by objectives

(MBO) (284) job enrichment (285) job enlargement (285) job redesign (285) behavior modification (286) flextime (286)

part-time work (287) job sharing (288) telecommuting (288) empowerment (289) employee ownership (289) team (291) problem-solving team (291) self-managed teams (291) cross-functional team (291) virtual team (292)

Discussion Questions

1. How did the results of the Hawthorne Studies influence researchers’ thinking about employee motivation?

2. What are the five levels of needs in Maslow’s hierarchy? How are a person’s needs related to motivation?

3. What are the two dimensions in Herzberg’s theory? What kinds of elements affect each dimension?

4. According to equity theory, how does an employee deter- mine whether he or she is being treated equitably?

5. According to expectancy theory, what two variables determine motivation?

6. Describe the steps involved in the MBO process. 7. What are the objectives of the MBO? What do you think

might be its disadvantage?

8. How does employee participation increase motivation? 9. Identify and describe the major types of teams. 10. What are the major benefits and limitations associated

with the use of self-managed teams? 11. Explain the major stages of team development. 12. What combination of motivational techniques do you

think would result in the best overall motivation and reward system?

13. In what ways are team cohesiveness and team conflict related?

Chapter 10 Motivating and Satisfying Employees and Teams 297

Building Skills for Career Success

1. Social Media Exercise Infosys is a successful software company with nearly 150,000 employees. Social media is integral to its strategy and communications approach. The company uses social media to engage younger employees in these processes and to empower them. In order to do this, the company created STRAP Surround as a social platform to engage employees and allow executives to teach. It contains blogs, discussion

forums, an in-house version of YouTube for video sharing, and a range of physical activities and games. The system has provided a mountain of data on its workforce for executives to process.

Here is one example. Employees participated in a series of live events related to a strategy execution topic. These events resulted in tens of thousands of ideas shared via social media. Through these events, management discovered

Video Case putting the Focus on people at the Fruit guys

People are as important as profits to Chris Mittelstaedt, founder and CEO of the Fruit Guys (http://fruitguys.com). Remembering the downside of some earlier on-the-job experiences, such as not being asked to help solve problems, Mittelstaedt resolved to make employee empowerment and collaborative teamwork top priorities when he started his own business. Today, his Fruit Guys business rings up $20 million in annual sales and employs dozens of people in the San Francisco area and beyond.

Mittelstaedt’s path to entrepreneurial success grew out of a need to make a change in his professional life when his wife was expecting their first child. He was unhappy at a temporary job and thinking about possible ideas for a new business of his own. In speaking with friends and family, Mittelstaedt realized that many office workers who snack on junk food might prefer something healthier if it was conveniently at hand. This led to the concept of selling weekly deliveries of fresh, ripe fruit to companies so their employees would have healthy snacks at work. Mittelstaedt named his new company the Fruit Guys and began making the rounds of corporate headquarters to sign up customers. He also connected with local growers who could provide a steady supply of apples, oranges, and other fruits in season.

As the business grew, Mittelstaedt had to hire employees to sort, package, and deliver fruits to his expanding customer base, as well as hiring employees to handle billing, human resources, and other functions. This is where his background working for other firms came into play: As the head of a small business, he wanted to motivate his employees the way he wished his managers had motivated him, by treating them fairly, showing respect for their capabilities as individuals and team members, and inviting their input as valued members of the organization. “People like to be part of something bigger than themselves,”

he says. The same is true for suppliers, which is why he pays growers fair prices and offers support to help them profit from what they produce.

Although the company has had its ups and downs over the years, Mittelstaedt has remained true to his principles of building positive relationships with customers, employees, and suppliers. Rather than setting one employee against each other in a race for advancement, the entrepreneur looks for win-win ways to develop the talents of everyone on the team. He emphasizes each employee’s vital role in the company’s overall success, expecting them to reach out to colleagues for coordination purposes as well as to take responsibility for completing their assigned tasks. Recognizing that employees have their own goals and dreams, Mittelstaedt encourages everyone to make the most of opportunities for participation, learning, communication, and expanded responsibilities at the Fruit Guys.

These days, Mittelstaedt’s company has a healthy roster of regular customers that includes high-tech firms, law firms, accounting firms, manufacturers, and even public schools. But no matter how big the Fruit Guys gets, the founder is determined to maintain the healthy corporate culture that shows respect for the individual, fosters involvement, and fuels committed teamwork.19

Questions 1. When Chris Mittelstaedt says, “People like to be part of

something bigger than themselves,” what are the implica- tions for employee motivation?

2. Why would an accounting firm spend money week after week for deliveries of fresh fruit for its employees? Explain your answer in terms of the motivation concepts in this chapter.

3. What other techniques would you suggest Mittelstaedt use to motivate his employees, and why?

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some new things about the effectiveness of different communications media. For example, social media was most effective for structured questions, such as those asking about technologies for future growth, digital consumer behavior, and health care. Moderators made sure to thank participants, and the information gathered was passed along to managers. Some employees who provided particularly useful answers were chosen to become team members.20

1. Do you think social media is an effective way to engage employees who are in large organizations? Why or why not?

2. Do you think social media would work well in smaller companies? Why or why not?

3. Do you think that using social media changes the corpo- rate culture and the way in which teams communicate for the better or worse? Explain your answer.

2. Building Team Skills Empowerment makes workers feel more involved in their jobs and the operations of the organization by involving them in decision making. However, empowerment is a tool that is used inconsistently in different workplaces. If you worked in a position that did not empower you, would you want it? How do you envision empowerment looking in the workplace?

assignment Form small groups of three or four. Each member of the group should think about the last time you had a complaint that you brought to a company’s attention. Perhaps you purchased an item that quickly malfunctioned, you wanted to exchange a pair of pants for a larger size, or you were not happy with the service you received at an auto body shop. 1. Who helped you address the problem? Was the salesper-

son empowered to give you a refund or an exchange? Or did the employee have to call in a manager?

2. Every group member should share their experiences with one another.

3. Discuss the following among your group: a. From the perspective of upper management, what

are the pros and cons of empowering workers to take care of problems?

b. What about from the perspective of the employees? c. How did your experiences as customers change,

depending on how empowered the workers were? Did you prefer dealing with the employee or the man- ager?

3. Researching Different Careers Because a manager’s job varies from department to department within firms, as well as among firms, it is virtually impossible to write a generic description of a manager’s job. If you are contemplating becoming a manager, you may find it helpful to shadow several managers to learn firsthand what they do.

assignment 1. Make an appointment with managers in three firms,

preferably firms of different sizes. When you make the appointments, request a tour of the facilities.

2. Ask the managers the following questions: a. What do you do in your job? b. What do you like most and least about your job?

Why? c. What skills do you need in your job? d. How much education does your job require? e. What advice do you have for someone thinking about

pursuing a career in management? 3. Summarize your findings in a two-page report. Include

answers to these questions: a. Is management a realistic field of study for you?

Why? b. What might be a better career choice? Why?

Chapter 10 Motivating and Satisfying Employees and Teams 299

1p6

Running a Business Part 4

at graeter’s, Tenure is “a proud Number”

Although you might think working for an ice-cream company would be motivating under almost any circumstances, Graeter’s doesn’t take its employees’ commitment for granted. Including full-time and part-time seasonal workers, the company employs about 800 people in three production facilities and dozens of ice-cream shops. Teenagers who take a summer job at a Graeter’s shop often return to help out during the winter holidays and then come back to work the following summer, and the summer after that. Production employees tend to remain with the company for long periods as well, and Graeter’s is relying on their experience and expertise as it expands its national distribution and opens new stores far from the Cincinnati base.

Professional Procedures with Personal Touches Over the last few years, Graeter’s has benefitted from tightening up some of its long-standing human resources management (HRM) procedures, including those for hiring and evaluating employees. David Blink, the company’s controller, explains: “We hire based on potential. . . . We are looking for people who are conscientious about their work, who do a good job, who show up every day. We are a fun place to work. . . . We have turnover based on seasonal work only because we hire a lot of college kids [and] high school kids” to work during the summer months. Managers begin recruiting during the spring so that each store is fully staffed in advance of the peak ice-cream buying season. The company also accepts job applications through its website.

When filling job openings at its three factories, Graeter’s looks for people with baking industry skills. On the job, employees and managers alike wear name badges that show the number of years they have worked for the firm, “and that is a proud number,” says Blink. Graeter’s adds a personal touch by celebrating employees’ birthdays and milestones such as 25 years of service with the firm.

According to a consultant who works with top management, goals and measurement systems weren’t strongly emphasized in the company’s early days. “If [employees] came in and they made ice cream, if they made enough for the week, for the day, that was enough,” he says.

These days, however, Graeter’s sets specific production and store goals so that all employees know what is expected of them. It also has measurement systems in place to track progress toward those goals. “We have defined the behaviors that are acceptable and not acceptable within the

company,” the consultant continues, “We communicate that. We teach and educate people.” At the retail level, Graeter’s training focuses on how employees can

make the in-store experience engaging, fun, and memorable for customers.

In the factory, higher production goals have given newly empowered employees achievements to boast about on the slogan T-shirts they wear. The workforce is eager to

submit suggestions for improvement, and morale is high. The company also offers advancement

opportunities for employees who are ready to take on more responsibility. Graeter’s low rate of turnover indicates that employees feel involved with the firm and the work they do. In fact, some employees spend their entire working careers with Graeter’s and eventually retire

from the firm.

Benefits That Pay The benefits package for managers and full-time employees

is competitive. Graeter’s offers profit sharing, and it has made a profit year after year. It also has a 401(k) retirement plan that matches employees’ contributions, plus a rolling allowance for paid time-off that is separate from paid vacations and holidays, and is based on the employee’s tenure with the firm. Other benefits include medical, life, and disability insurance. Store employees wear uniforms (paid for by the company) and receive a 25 percent discount when they buy Graeter’s products. All managers and employees receive the training they need to be effective in their positions and to develop their professional skills.

“You Can’t Do It Alone” The management team has grown as the company moves forward with its aggressive nationwide expansion plans. CEO Richard Graeter, a great-grandson of the company’s founders, believes in recruiting outstanding people, compensating them well, and giving them the autonomy they need to get things done. “In the last few months,” he notes, “I have hired a vice president of sales and marketing . . . [and] we hired a vice president of finance, basically a CFO [chief financial officer] because we are big enough to support

Chapter 10 Motivating and Satisfying Employees and Teams 299

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that . . . Identifying the gaps in your executive team and your talent pool, and going out and finding people to fill those gaps, is probably one of my most critical functions in addition to looking out to define the strategic direction of the company. I’ve got some wonderful people on the team now, and they are really helping us make the jump from a small business to a medium-sized business . . . People at that level, you’ve got to pay them well. It’s worth it, though . . . They can command the kind of salary they do because they bring the talent you need to navigate the waters.”

“You can’t do it alone,” Richard concludes. “That is the other thing that I think my cousins and I all have come to realize; we can’t do it alone. Our fathers and aunt and the folks that came before them . . . they did it all, from figuring out where to build the next store to hanging up the laundry at the end of the day.” Now, to achieve the fast-growing

company’s ambitious goals, he’s found that “you need to rely on talent that is beyond just you.”21

Questions 1. Imagine that you’re a human resources manager for

Graeter’s. If you were writing the job specification for an entry-level, part-time employee who will serve customers in one of the scoop shops, what qualifications would you include, and why?

2. Food production facilities like the three Graeter’s factories must comply with strict regulations to ensure purity and safety. What kinds of teams might Graeter’s use in these facilities, and for what specific purposes?

3. Graeter’s is currently a non-union company. How might the experience of working there change if a union were to be introduced?

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Chapter 10 Motivating and Satisfying Employees and Teams 301

In this section of your business plan, you will expand on the type and quantity of employees that will be required to operate the business. Your human resources requirements are determined by the type of business and by the size and scale of your operation. From the preceding section, you should have a good idea of how many people you will need. Part 4 of your textbook, “Human Resources,” especially Chapters 9 and 10, should help you in answering some of the questions in this part of the business plan.

The Human Resources Component To ensure successful performance by employees, you must inform workers of their specific job requirements. Employees must know what is expected of the job, and they are entitled to expect regular feedback on their work. It is vital to have a formal job description and job specification for every position in your business. Also, you should establish procedures for evaluating performance.

The labor force component should include the answers to at least the following questions: 4.1. How many employees will you require, and what quali-

fications should they have—including skills, experience, and knowledge? How many jobs will be full-time? Part-time?

4.2. Will you have written job descriptions for each position? 4.3. Have you prepared a job application form? Do you

know what can legally be included in it? 4.4. What criteria will you use in selecting employees? 4.5. Have you made plans for the orientation process? 4.6. Who will do the training? 4.7. What can you afford to pay in wages and salaries? Is

this in line with the going rate in your region and indus- try?

4.8. Who will evaluate your employees? 4.9. Will you delegate any authority to employees?

4.10. Have you developed a set of disciplinary rules? 4.11. Do you plan to interview employees when they resign?

Review of Business Plan Activities Remember that your employees are the company’s most valuable and important resource. Therefore, make sure that you expend a great deal of effort to acquire and make full use of this resource. Check and resolve any issues in this component of your business plan before beginning Part 5. Again, make sure that your answers to the questions in each part are consistent with the entire business plan. Finally, write a brief statement that summarizes all the information for this part of the business plan.

Endnotes

1 Based on information in Patrick Hoge, “Newsmaker 2014: Salesforce CEO Marc Benioff Becomes a Bigger S.F. Powerhouse,” San Francisco Business Times, December 24, 2014, www.bizjournals.com/ sanfrancisco (accessed July 1, 2015); Kathleen Pender, “Rewarding Workers with Virtual Merit Badges,” San Francisco Chronicle, September 25, 2014, www.sfgate.com (accessed July 1, 2015); Milton Moskowitz and Robert Levering, “Best Companies to Work For 2014: #7, Salesforce.com (accessed July 1, 2015),” Fortune, February 3, 2014, p. 110; Alex Konrad, “Salesforce Innovation Secrets: How Marc Benioff’s Team Stays on Top,” Forbes, August 20, 2014, www.forbes. com; www.salesforce.com.

2 “2014 Top 100 Best Companies to Work For,” Fortune, http://fortune. com/best-companies/ (accessed January 26, 2015).

3 Sandhya Somashekhar, “As Health-Care Law’s Mandate Nears, Firms Cut Worker Hours, Struggle with Logistics,” Washington Post, June 23, 2014, http://www.washingtonpost.com/national/ health-science/as-health-care-laws-employer-mandate-nears-firms- cut-worker-hours-struggle-with-logistics/2014/06/23/720e197c- f249-11e3-914c-1fbd0614e2d4_story.html (accessed July 1, 2015).

4 Ricky W. Griffin, Fundamentals of Management, 8th ed. (Mason, OH: South-Western/Cengage Learning, 2016), 302–304.

5 Michael Schein, “Why You Should Let Your Employees Do Whatever They Want,” Inc., February 18, 2014, http://www.inc.com/

michael-schein-let-employees-do-whatever-they-want.html (accessed July 1, 2015).

6 Anne Fisher, “Can You Care for an Elderly Parent and Still Succeed at Work,” Fortune, July 24, 2014, http://fortune.com/2014/07/24/elderly- parents-work-life-balance/ (accessed July 1, 2015).

7 Sara Sutton Fell, “5 Ways Telecommuting and Flex Time Help You Recruit the Best Workers,” Entrepreneur, October 1, 2014, http://www. entrepreneur.com/article/237960 (accessed July 1, 2015).

8 “2014 100 Best Companies,” Working Mother, http://www. workingmother.com/best-company-list/156592 (accessed January 26, 2015); Ernst & Young, “Ernst & Young, LLP, Marks Ninth Year Among the Top 10 on Working Mothers Best Companies List,” Press Release, September 16, 2014, http://www.ey.com/US/en/Newsroom/News- releases/news-ey-marks-ninth-straight-year-among-top-10-on-working- mother-best-companies-list (accessed July 1, 2015).

9 Seth Freed Wessler, “Shift Change: ‘Just-in-Time’ Scheduling Creates Chaos for Workers,” NBC News, May 2, 2014, http://www.nbcnews. com/feature/in-plain-sight/shift-change-just-time-scheduling- creates-chaos-workers-n95881 (accessed July 1, 2015).

10 Alina Tugend, “It’s Clear Undefined, but Telecommuting Is Fast on the Rise,” New York Times, March 7, 2014, http://www.nytimes. com/2014/03/08/your-money/when-working-in-your-pajamas-is-more- productive.html?_r=0 (accessed July 1, 2015).

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11 Nicholas Bloom, “To Raise Productivity, Let More Employees Work at Home,” Harvard Business Review, 92 (January–February 2014), pp. 28–29; Scott Edinger, “Why Remote Workers Are More (Yes, More) Engaged,” Harvard Business Review Blog, August 24, 2012, http:// blogs.hbr.org/cs/2012/08/are_you_taking_your_people_for.html?a wid=6449339475255159080-3271 (accessed July 1, 2015).

12 Bloom, “To Raise Productivity, Let More Employees Work at Home.” 13 National Center for Employee Ownership, “A Brief Overview of

Employee Ownership,” http://www.nceo.org/articles/employee- ownership-esop-united-states (accessed January 26, 2015).

14 Ricky W. Griffin, Fundamentals of Management, 8th ed. (Mason, OH: South-Western/Cengage Learning, 2016), 397.

15 Richard L. Daft and Dorothy Marcic, Understanding Management, 9th ed. (Mason, OH: South-Western/Cengage Learning, 2015), 588.

16 Chana R. Shoenberger, “How to Get People to Work Together,” Wall Street Journal, September 7, 2012, http://blogs.wsj.com/ atwork/2012/09/07/how-to-get-people-to-work-together (accessed July 1, 2015).

17 Paul Berry, “Communication Tips for Global Virtual Teams,” Harvard Business Review, October 30, 2014, https://hbr.org/2014/10/ communication-tips-for-global-virtual-teams/ (accessed July 1, 2015).

18 Drake Baer, “5 Brilliant Strategies Jeff Bezos Used to Build the Amazon Empire,” Business Insider, March 17, 2014, http://www.businessinsider. com/the-strategies-jeff-bezos-used-to-build-the-amazon-empire-2014-3 (accessed July 1, 2015).

19 Based on information in Teresa Novellino, “How the Fruit Guys Made It Through the Dot-Com Bust,” Upstart Business Journal, August 4, 2014, http://upstart.bizjournals.com/entrepreneurs/hot-shots/2014/08/04/ how-the-fruitguys-made-it-through-dot-com-bust.html?page=all

(accessed July 1, 2015); Chris Mittelstaedt, “5 Employee Morale Killers,” Inc., March 16, 2012, www.inc.com; Chris Mittelstaedt, “Is This Your Employees’ Idea of Service?” Inc., June 19, 2012, www.inc.com (accessed July 1, 2015); Stacy Finz, “Fruit Guys Thrives on Adaptability, Realistic Goals,” San Francisco Chronicle, February 12, 2012, www. sfgate.com (accessed July 1, 2015); Cengage “Fruit Guys” video; http:// fruitguys.com (accessed January 26, 2015).

20 Vanessa DiMauro and Adam Zawel, “Social Media for Strategy- Focused Organizations,” Leader Networks, June 19, 2014, http:// www.leadernetworks.com/2014/06/social-media-for-strategy-focused- organizations.html (accessed July 1, 2015).

21 Based on information from Alexander Coolidge, “Graeter’s Pitches Its Products Nationwide,” Cincinnati Enquirer, June 20, 2014, http://www. cincinnati.com/story/money/2014/06/18/graeters-pitches-product- nationwide/10820875/ (accessed July 1, 2015); Kimberly L. Jackson, “Graeter’s Premium Chocolate Chip Ice Cream Lands at Stop & Shop,” Newark Star-Ledger (NJ), April 4, 2012, www.nj.com (accessed July 1, 2015); “Graeter’s Ice Cream Debuts in Bay Area,” Tampa Bay Times (St. Petersburg, FL), January 10, 2012, p. 4B; Jim Carper, “Graeter’s Runs a Hands-on Ice Cream Plant,” Dairy Foods, August 2011, pp. 36+; Jim Carper, “The Greater Good,” Dairy Foods, August 2011, pp. 95+; “Graeter’s Unveils New ‘Mystery Flavor,’” Dayton Daily News, March 29, 2012, www.daytondailynews.com (accessed July 1, 2015); Bob Driehaus, “A Cincinnati Ice Cream Maker Aims Big,” New York Times, September 11, 2010, www.nytimes.com (accessed July 27, 2015); Lucy May, “Graeter’s Northern Kentucky Franchisee Puts Stores on the Block,” Business Courier, August 6, 2010, http://cincinnati.bizjournals.com (accessed July 1, 2015); www.graeters.com (accessed January 26, 2015); interviews with company staff and Cengage videos about Graeter’s.

Learning Objectives Once you complete this chapter, you will be able to:

11-1 Understand the meaning of marketing and the importance of managing customer relationships.

11-2 Explain how marketing adds value by creating several forms of utility. 11-3 Trace the development of the marketing concept and understand

how it is implemented.

11-4 Understand what markets are and how they are classified. 11-5 Understand the two major components of a marketing strategy—target market

and marketing mix.

11-6 Explain how the marketing environment affects strategic market planning. 11-7 Understand the major components of a marketing plan. 11-8 Describe how market measurement and sales forecasting are used. 11-9 Distinguish between a marketing information system and marketing

research.

11-10 Identify the major steps in the consumer buying decision process and the sets of factors that may influence this process.

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building long-term customer

relationships. To develop

competitive product offerings,

business people must identify

acceptable target customer groups

and understand their behaviors.

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Numerous organizations, like Starbucks, use marketing efforts to inform customers about their range of products that seek to satisfy customer demand and create value. Understanding customers’ needs and wants are crucial to providing the products that satisfy them. Although marketing encompasses a diverse set of decisions and activities, it always begins and ends with the customer. The American Marketing Association defines marketing as “[t]he activity, set of institutions, and processes for creating, communicat- ing, delivering, and exchanging offerings that have value for customers, clients, partners, and society at large.”2 The marketing process involves eight major functions and numer- ous related activities, all of which are essential to the marketing process (see Table 11-1).

In this chapter, we examine how marketing activities add value to products. We trace the evolution of the marketing concept and describe how organizations practice it. Next, our focus shifts to market classifications and marketing strategy. We analyze the four elements of a marketing mix and discuss uncontrollable factors in the mar- keting environment. Then we examine the major components of a marketing plan. We consider tools for strategic market planning, including market measurement, sales forecasts, marketing information systems, and marketing research. Finally, we look at the forces that influence consumer and organizational buying behavior.

11-1 Managing CustOMer reLatiOnshiPs Without marketing relationships with customers, businesses would not be success- ful. Therefore, maintaining positive relationships with customers is an important goal for marketers. The term relationship marketing refers to marketing decisions

marketing the activity, set of institutions, and processes for creating, communicating, delivering, and exchanging offerings that have value for customers, clients, partners, and society at large

Learning Objective

11-1Understand the meaning of marketing and the importance of managing customer relationships.

relationship marketing establishing long-term, mutually satisfying buyer–seller relationships

Starbucks: What’s Not to Love

Starbucks doesn’t just sell lattes and espressos—it markets a cof-fee-culture experience, one fresh-brewed cup at a time. Whether customers sit and sip at one of the company’s 22,000 shops worldwide or use the Starbucks app to order and pay for coffee picked up at a drive-thru location, the strategy is to provide high-quality food and bev- erage products with convenient service in comfortable surroundings.

With the acquisition of Tazo teas and the addition of sandwiches and bakery items, Starbucks can offer variety to satisfy repeat customers while attracting new customers for breakfast, lunch, and early evening. The company also reinforces its premium positioning by introducing new specialty beverages and opening new “reserve” stores where enthusi- asts can taste and buy high-end coffees. In the coming months, it will open hundreds of small express stores for city-dwellers who get coffee to go. It is also increasing the number of drive-thrus to accommodate time-pressured suburban commuters. To reach students and faculty members on college campuses, Starbucks is testing mobile trucks that park in different locations and remain open when dining halls are closed.

Starbucks has a growing presence in grocery stores, with bagged coffees, instant coffee packets, single-serve coffee pods,

and ready-to-drink products like bottled Frappuccino. Its single- serve coffee maker, the Verismo, targets coffee-lovers who want to quickly brew high-quality coffee and tea at home or at work. Beyond coffee and related products, the company builds on its brand cachet and market coverage to promote gift cards for all occasions and budgets. During one recent christmas season, more than 45 million americans received a Starbucks gift card.

research shows that many Starbucks customers are tech- savvy. as a result, the company engages these customers online, via mobile marketing, and through social media, where it has more than 35 million Facebook likes and 7 million Twitter followers. These customers are among the first to learn about new products, new locations, and new promotions—and they can post comments to let Starbucks know what they think.1

Did You Know? Starbucks rings up $16 billion in annual revenues through 12,000 U.S. locations and 10,000 locations in 65 other countries.

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and activities focused on achieving long-term, satisfying relationships with custom- ers. Relationship marketing deepens and reinforces the buyer’s trust in the company, which, as the customer’s loyalty grows, increases a company’s understanding of the customer’s needs and desires. Successful marketers respond to customers’ needs and strive to increase value to buyers continually over time. Eventually, this interaction becomes a solid relationship that fosters cooperation and mutual trust. The Internet has expanded and improved relationship marketing options for many firms by mak- ing targeted communication faster, cheaper, and easier. Digital technologies allow firms to connect to consumers and have a dialogue with them in real time. This not only improves the speed at which firms can innovate, but consumers are satisfied because they feel the firm is listening to them.

To build long-term customer relationships, marketers are increasingly turning to marketing research and information technology. Customer relationship management (CRM) focuses on using information about customers to create marketing strategies that develop and sustain desirable cus- tomer relationships. By increasing customer value over time, organizations try to retain and increase long-term profitability through customer loyalty. Kroger, for example, tracks the purchases of its 55 million loyalty-card holders and documents what customers buy at its 2,600 stores. After analyz- ing the data, the supermarket firm sells informa- tion about the trends it identifies to vendors like Procter & Gamble and Nestlé, who are willing to pay for the insights because it helps them more precisely target their products and messages to customer desires.3 Because CRM is such an impor- tant part of creating and building customer loyalty, many companies offer high-tech products aimed at helping firms to identify good customers and to manage relations with them over the long-term. The accessibility of technology has contributed to a more even playing field for firms of all sizes.

customer relationship management (CRM) using information about customers to create marketing strategies that develop and sustain desirable customer relationships

tabLe 11-1 Eight Major Marketing Functions

Exchange functions: All companies—manufacturers, wholesalers, and retailers—buy and sell to market their merchandise.

1. Buying includes obtaining raw materials to make products, knowing how much merchandise to keep on hand, and selecting suppliers.

2. Selling creates possession utility by transferring the title of a product from seller to customer.

Physical distribution functions: These functions involve the flow of goods from producers to customers.

3. Transporting involves selecting a mode of transport that provides an acceptable delivery schedule at an acceptable price.

4. Storing goods is often necessary to sell them at the best selling time.

Facilitating functions: These functions help the other functions to take place.

5. Financing helps at all stages of marketing. To buy raw materials, manufacturers often borrow from banks or receive credit from suppliers. Wholesalers may be financed by manufacturers, and retailers may receive financing from the wholesaler or manufacturer. Finally, retailers often provide financing to customers.

6. Standardization sets uniform specifications for products or services. Grading classifies products by size and quality, usually through a sorting process. Together, standardization and grading facilitate production, transportation, storage, and selling.

7. Risk taking—even though competent management and insurance can minimize risks—is a constant reality of marketing because of such losses as bad-debt expense, obsolescence of products, theft by employees, and product-liability lawsuits.

8. Gathering market information is necessary for making all marketing decisions.

Developing long-term customer relationships. Many companies spend a considerable amount of money on marketing programs to develop and maintain long-term relationships with their customers—especially the valuable ones. Often it’s more profitable to retain these customers by offering them big rewards than attracting new customers who may never develop the same loyalty.

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Managing customer relationships requires identifying patterns of buying behav- ior and using this information to focus on the most promising and profitable cus- tomers. Companies must be sensitive to customers’ requirements and desires and establish communication to build customers’ trust and loyalty. In some instances, it may be more profitable for a company to focus on satisfying a valuable existing customer than to attempt to attract a new one who may never develop the same level of loyalty. This involves determining how much the customer will spend over his or her lifetime. The customer lifetime value (CLV) is a measure of a customer’s worth (sales minus costs) to a business during one’s lifetime.4 CLV also includes the intangible benefits of retaining lifetime-value customers, such as their ability to provide feedback to a company and refer new customers of similar value, but these are important considerations as well. The amount of money a company is will- ing to spend to retain such customers is also a factor. In general, when marketers focus on customers chosen for their lifetime value, they earn higher profits in future periods than when they focus on customers selected for other reasons.5 Thanks to technological innovations and improved research, it is a fairly straightforward task to calculate CLV. In fact, businesses can utilize reliable free online tools to calculate CLV, including one created by the Harvard Business School.6 Because the loss of a potential lifetime customer can result in lower profits, managing customer relation- ships has become a major focus of marketers.

11-2 utiLity: the VaLue added by Marketing Utility is the ability of a good or service to satisfy a human need. The latest iPad, Nike Zoom running shoes, or Mercedes Benz luxury car all satisfy human needs. Thus, each possesses utility. There are four kinds of utility (see Figure 11-1).

Form utility is created by converting production inputs into finished products. Marketing efforts may influence form utility indirectly because the data gathered as part of marketing research are frequently used to determine the size, shape, and features of a product.

The three kinds of utility that are created directly by marketing are place, time, and possession utility. Place utility is created by making a product available at a

Concept Check ✓✓ how can technology help to build long-term customer relationships?

✓✓ What are the benefits of retaining customers?

customer lifetime value (CLV) a measure of a customer’s worth (sales minus costs) to a business over one’s lifetime

Learning Objective

11-2 Explain how marketing adds value by creating several forms of utility.

utility the ability of a good or service to satisfy a human need

form utility utility created by converting production inputs into finished products

place utility utility created by making a product available at a location where customers wish to purchase it

Figure 11-1 Types of Utility

Form utility is created by the production process, but marketing creates place, time, and possession utility.

Form utility

Place utility

Time utility

Possession utility

Size 8 shoes in Duluth available now for $50

Size 8 shoes in Duluth available now

Size 8 shoes in Duluth

Size 8 shoes

CAN SATISFY THE NEED WITH:

Size 8 shoes in Duluth available now for $80

Size 8 shoes in Duluth available next month

Size 8 shoes in Los Angeles

Wanted: One pair of size 8 shoes in Duluth, immediately. Will pay $50.

Size 10 shoes

BUT CANNOT SATISFY THE NEED WITH:

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location where customers wish to purchase it. A pair of shoes is given place utility when it is shipped from a factory to a department store.

Time utility is created by making a product available when customers wish to purchase it. For example, Halloween costumes may be manufac- tured in April but not displayed until September, when consumers start buying them. By storing the costumes until there is a demand, the manu- facturer or retailer provides time utility.

Possession utility is created by transferring title (or ownership) of a product to a buyer. For a product as simple as a pair of shoes, ownership usually is transferred by means of a sales slip or receipt. For such prod- ucts as automobiles and homes, the transfer of title is a more complex process. Along with the title to products, the seller transfers the right to use that product.

Place, time, and possession utility have real value in terms of both money and convenience. This value is created and added to goods and services through a wide variety of marketing activities—from research indicating what customers want to product warranties ensuring that cus- tomers get what they pay for. Overall, these marketing activities account for about half of every dollar spent by consumers. When they are part of an integrated marketing program that delivers maximum utility to the customer, many would agree that they are worth the cost.

Place, time, and possession utility are only the most fundamental applications of marketing activities. In recent years, marketing activi- ties have been influenced by a broad business philosophy known as the marketing concept.

11-3 the Marketing COnCePt The marketing concept is a business philosophy that a firm should provide goods and services that satisfy customers’ needs through a coordinated set of activities that allow the firm to achieve its objectives. Initially, the firm communicates with potential customers to assess their product needs. Then, the firm develops a good or service to satisfy those needs. Finally, the firm continues to seek ways to provide customer satisfaction. This process is an application of the marketing concept or marketing ori- entation. For example, in order to satisfy the demands of an increasingly young and tech-savvy target market, T-Mobile, the fourth largest wireless carrier, has upgraded and expanded its infrastructure at significant expense, eliminated contracts, dropped international roaming charges, offered unlimited data plans that cover music stream- ing, and even offered to pay rivals’ customers to switch to T-Mobile wireless service. Calling itself the “Un-carrier,” T-Mobile has sought to attract market share away from rivals by focusing on what customers really want. The company’s efforts have unsettled the wireless industry and gained it millions of new subscribers.7

11-3a Evolution of the Marketing Concept From the start of the Industrial Revolution until the early 20th century, business effort was directed mainly toward the production of goods. Consumer demand for manufactured products was so great that manufacturers could almost bank on sell- ing everything they produced. Business had a strong production orientation, which placed a strong emphasis on increased output and production efficiency. Marketing was limited to taking orders and distributing finished goods.

In the 1920s, production caught up with and began to exceed demand. Producers had to direct their efforts toward selling goods rather than just producing them. This new sales orientation was characterized by increased advertising, enlarged sales forces, and, occasionally, high-pressure selling techniques. Manufacturers produced

time utility utility created by making a product available when customers wish to purchase it

possession utility utility created by transferring title (or ownership) of a product to a buyer

Concept Check ✓✓ explain the four kinds of utility.

✓✓ Provide an example of each.

Learning Objective

11-3 Trace the development of the marketing concept and understand how it is implemented.

marketing concept a business philosophy that a firm should provide goods and services that satisfy customers’ needs through a coordinated set of activities that allow the firm to achieve its objectives

Putting products at the customer’s fingertips. Firms try to provide customers with products whenever and wherever they need them.

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the goods they expected consumers to want, and marketing consisted primarily of promoting products through personal selling and advertising, taking orders, and delivering goods.

During the 1950s, however, businesspeople started to realize that even enor- mous advertising expenditures and proven sales techniques were not sufficient to gain a competitive edge. It was then that business managers recognized that they were not primarily producers or sellers, but were in the business of satisfying cus- tomers’ needs. Marketers realized that the best approach was to adopt a customer orientation—in other words, the organization had to first determine what customers need and then develop goods and services to fill those par- ticular needs (see Table 11-2).

All functional areas—research and develop- ment, production, finance, human resources, and, of course, marketing—play a role in providing customer satisfaction.

11-3b Implementing the Marketing Concept To implement the marketing concept, a firm first must obtain information about its present and potential customers. The firm must determine not only what customers’ needs are, but also how well these needs are satisfied by products currently in the market—both its own products and those of competitors. It must ascertain how its products might be improved and what opinions customers have about the firm and its marketing efforts.

The firm then must use this information to pinpoint the specific needs and potential cus- tomers toward which it will direct its marketing activities and resources. Next, the firm must mobilize its marketing resources to (1) provide a product that will satisfy its customers, (2) price the product at a level that is acceptable to buyers and will yield a profit, (3) promote the product so that poten- tial customers will be aware of its existence and its ability to satisfy their needs, and (4) ensure that the product is distributed so that it is available to customers where and when it is needed.

Finally, the firm must again obtain marketing information—this time regarding the effectiveness of its efforts. Can the product be improved? Is it being promoted effectively? Is it being distributed efficiently? Is the price too high or too low? The firm must be ready to modify any or all of its marketing activities based on infor- mation about its customers and competitors. For example, West Elm modified its marketing activities at one new furniture store in Durham, North Carolina, after analyzing both in-store and online sales data from customers living in the area.

Concept Check ✓✓ Identify the major components of the marketing concept.

✓✓ how did the customer orientation evolve?

✓✓ What steps are involved when implementing the marketing concept?

tabLe 11-2 Evolution of Customer Orientation

Business managers recognized that they were not primarily producers or sellers, but were in the business of satisfying customers’ wants.

Production Orientation Sales Orientation Customer Orientation

Take orders Increase advertising Determine customer needs

Distribute goods Enlarge sales force Develop products to fill these needs

Intensify sales techniques Achieve the organization’s goals

Tell us what you really think. Customer satisfaction is a major element of the marketing concept. Many businesses attempt to measure customer satisfaction through surveys. Surveys can be conducted in a variety of ways: in-person, by mail or fax, or online. Online surveys have made it very inexpensive for firms to gather customer feedback.

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Although the retailer had expected younger shoppers looking for a contemporary look and stocked the store accordingly, Durham shoppers buying from the firm’s website were actually buying more traditional furniture. Sales at the Durham store rallied quickly, after the store manager adjusted the store’s products to better match what local shoppers were actually buying.8

11-4 Markets and their CLassiFiCatiOn A market is a group of individuals or organizations, or both, that need products in a given category and that have the ability, willingness, and authority to purchase them. Markets are broadly classified as consumer or business-to-business, and mar- keting efforts vary depending on the intended market. Marketers should understand the general characteristics of these two groups.

Consumer markets consist of purchasers and/or household members who intend to consume or benefit from the purchased products and who do not buy products to make profits. Business-to-business markets, also called industrial markets, are grouped broadly into producer, reseller, governmental, and institutional categories. These markets purchase specific kinds of products for use in making other products for resale or for day-to-day operations. Producer markets consist of individuals and business organizations that buy certain products to use in the manufacture of other products. Reseller markets consist of intermediaries, such as wholesalers and retail- ers, who buy finished products and sell them for a profit. Governmental markets consist of federal, state, county, and local governments. They buy goods and services to maintain internal operations and to provide citizens with such products as high- ways, education, water, energy, and national defense. Governmental purchases total billions of dollars each year. Institutional markets include churches, not-for-profit private schools and hospitals, civic clubs, fraternities and sororities, charitable orga- nizations, and foundations. Their goals are different from the typical business goals of profit, market share, or return on investment.

11-5 deVeLOPing Marketing strategies A marketing strategy is a plan that will enable an organization to make the best use of its resources and advantages to meet its objectives. A marketing strategy consists of (1) the selection and analysis of a target market and (2) the creation and main- tenance of an appropriate marketing mix, a combination of product, price, distribu- tion, and promotion developed to satisfy a particular target market.

11-5a Target Market Selection and Evaluation A target market is a group of individuals or organizations, or both, for which a firm develops and maintains a marketing mix suitable for the specific needs and preferences of that group. In selecting a target market, marketing managers exam- ine potential markets for their possible effects on the firm’s sales, costs, and profits. The managers attempt to determine whether the organization has the resources to produce a marketing mix that meets the needs of a particular target market and whether satisfying these needs is consistent with the firm’s overall objectives. They also analyze the strengths and number of competitors already marketing to the target market. A target market can range in size from millions of people to only a few, depending on the product and the marketer’s objectives. Zipcar is a car- sharing company that targets people who either live in cities and do not want to own a car, or those who cannot afford a car or only need one occasionally. Its target

Learning Objective

11-4 Understand what markets are and how they are classified.

market a group of individuals or organizations, or both, that need products in a given category and that have the ability, willingness, and authority to purchase them

Concept Check ✓✓ What is a market?

✓✓ Identify and describe the major types of markets.

Learning Objective

11-5 Understand the two major components of a marketing strategy—target market and marketing mix.

marketing strategy a plan that will enable an organization to make the best use of its resources and advantages to meet its objectives

marketing mix a combination of product, price, distribution, and promotion developed to satisfy a particular target market

target market a group of individuals or organizations, or both, for which a firm develops and maintains a marketing mix suitable for the specific needs and preferences of that group

Chapter 11 Building Customer Relationships Through Effective Marketing 311

market treats cars as something that are needed to get around, not as a status symbol.9 On the other hand, Rolls-Royce targets its automobiles toward a small, very exclusive market: wealthy people who want the ultimate in prestige in an automo- bile. Some companies target multiple markets with different products, prices, distribution systems, and promotion for each one. For example, some high-end clothing designers target multiple markets through developing affordable lines distributed at mass market retail outlets, such as Target, Kmart, and Walmart. This strategy allows designers to reach customers with varying needs and levels of disposable income. For example, Target has part- nered with such high-end designers as Jason Wu, Missoni, and Joseph Altuzarra, and website NET- A-PORTER.COM to offer affordable versions of high-end products.10 The strategy has introduced the normally elite brands to a much larger market, enhancing Target’s stylish image.

UNdIffERENTIaTEd appRoaCh A com- pany that designs a single marketing mix and directs it at the entire market for a particular product is using an undifferentiated approach (see Figure 11-2). This approach assumes that individual customers in the target market for a specific kind of product have similar needs and that the organization can satisfy most custom- ers with a single marketing mix, which consists of one type of product with little or no variation, one price, one promotional program aimed at everyone, and one distribution system to reach all customers in the total market. Products that can be marketed successfully with the undifferentiated approach include staple food items, such as sugar and salt, and some produce. An undifferentiated approach is useful in only a limited number of situations because buyers have varying needs for most product categories, which requires the market segmentation approach.

MaRkET SEgMENTaTIoN appRoaCh Market segmentation is required because different consumers have different needs. A firm that markets 40-foot yachts would not direct its marketing effort toward every person in the total boat market, for instance, because not all boat buyers have the same needs. Marketing efforts directed at the wrong target market are wasted.

Instead, the firm should direct its attention toward a particular portion, or seg- ment, of the total market for boats. A market segment is a group of individuals or organizations within a market that shares one or more common characteristics. The process of dividing a market into segments is called market segmentation. As shown in Figure 11-2, there are two market segmentation approaches: concentrated and dif- ferentiated. When an organization uses concentrated market segmentation, a single marketing mix is directed at a single market segment. If differentiated market segmen- tation is used, multiple marketing mixes are focused on multiple market segments.

In our boat example, one common characteristic, or basis, for segmentation might be end use of a boat. The firm would be interested primarily in the market segment whose uses for a boat could lead to the purchase of a 40-foot yacht. Other bases for segmentation might be income or geographic location. Variables can affect the type of boat an individual might purchase. When choosing a basis for segmenta- tion, it is important to select a characteristic that relates to differences in customers’ needs for a product. The yacht producer, for example, would not use religion to seg- ment the boat market because people’s needs for boats do not vary based on religion.

undifferentiated approach directing a single marketing mix at the entire market for a particular product

market segment a group of individuals or organizations within a market that share one or more common characteristics

market segmentation the process of dividing a market into segments and directing a marketing mix at a particular segment or segments rather than at the total market

Reaching the right market segments. The market for fragrances is segmented based on gender. Some fragrances are aimed at men, while others, such as the perfume featured in this photo, are aimed at women.

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Figure 11-2 General Approaches for Selecting Target Markets

The undifferentiated approach assumes that individual customers have similar needs and that most customers can be satisfied with a single marketing mix. When customers’ needs vary, the market segmentation approach—either concentrated or differentiated—should be used.

UNDIFFERENTIATED APPROACH

Organization Single marketing mix

Product

Promotion

Price Distribution

Target market

A A A AA

A A A A A

CONCENTRATED MARKET SEGMENTATION APPROACH

Single marketing mix

Product

Promotion

Price Distribution

Organization Target market

A A A AA A A A A A

A A A A A B B B B B

B B B B B B B B B B

C C C CC C C C C C

C C C C C

DIFFERENTIATED MARKET SEGMENTATION APPROACH

Marketing mix I

Product

Promotion

Price Distribution

Marketing mix II

Product

NOTE: The letters in each target market represent potential customers. Customers that have the same letters have similar characteristics and similar product needs.

Promotion

Price Distribution Organization Target markets

A A A AA A A A A A

A A A A A B B B B B

B B B B B B B B B B

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Source: William m. Pride and o. c. Ferrell, Marketing, 18th ed. (mason, oh: South-Western/cengage learning, 2016). adapted with permission.

Chapter 11 Building Customer Relationships Through Effective Marketing 313

Marketers use a wide variety of segmentation bases. Those most commonly applied to consumer markets are shown in Table 11-3. Each may be used as a single basis for market segmentation or in combination with other bases. Top-Toy, a Toys “R” Us licensee in Sweden, has turned traditional toy market segmentation on its head by choosing to segment toys by age only. It releases gender-neutral catalogs that market dolls and toy cars, for example, to girls and boys equally in Finland, Norway, Germany, Denmark, and France. Marketers are responding to the cultural trend toward total gender equality in Sweden.11

11-5b Creating a Marketing Mix A business firm controls four important elements of marketing that it combines in a way that reaches the firm’s target market. These are the product itself, the

tabLe 11-3 Common Bases of Market Segmentation

Demographic Psychographic Geographic Behavioristic

Age Personality attributes Region Volume usage

Gender Motives Urban, suburban, rural End use

Race Lifestyles Market density Benefit expectations

Ethnicity Climate Brand loyalty

Income Terrain Price sensitivity

Education City size

Occupation County size

Family size State size

Family life cycle

Religion

Social class

Source: William M. Pride and O. C. Ferrell, Marketing, 18th ed. (Mason, OH: South-Western/Cengage Learning, 2016). Adapted with permission.

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Two types of vitamins, two different differentiated targeting strategies. Both Bayer Flintstones Gummies and Alive! Women’s multivitamins are using a differentiated targeting strategy to aim at a different, single market segment. Although both products are vitamins, they are not competing for the same customers.

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Figure 11-3 The Marketing Mix and the Marketing Environment

The marketing mix consists of elements that the firm controls—product, price, distribution, and promotion. The firm generally has no control over forces in the

marketing environment.

Price Distribution

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Technological forces

Competitive forces

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forces

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Source: William m. Pride and o. c. Ferrell, Marketing, 18th ed. (mason, oh: South-Western/cengage learning, 2016). adapted with permission.

price of the product, the means chosen for its distribution, and the promotion of the product. When combined, these four elements form a marketing mix (see Figure 11-3).

A firm can vary its marketing mix by changing any one or more of the ingredi- ents. Thus, a firm may use one marketing mix to reach one target market and another marketing mix to reach a different target market. For example, most automakers produce several different types and models of vehicles and aim them at different market segments based on the potential customers’ age, income, and other factors.

Developing the right marketing mix. Firms have little control over the marketing environment. However, they can control the marketing mixes for their products—that is, the nature of the products themselves and how they are priced, distributed, and promoted. Marketers at Coca- Cola have developed a specific marketing mix for Coca-Cola Classic.

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The product ingredient of the marketing mix includes decisions about the prod- uct’s design, brand name, packaging, and warranties. When McDonald’s decides on brand names, package designs, sizes of orders, flavors of sauces, and recipes, these choices are all part of the product ingredient.

The pricing ingredient is concerned with both base prices and discounts. Pricing decisions are intended to achieve particular goals, such as to maximize profit or to make room for new models. The rebates offered by automo- bile manufacturers are a pricing strategy developed to boost low auto sales.

The distribution ingredient involves not only trans- portation and storage, but also selecting intermediar- ies. How many levels of intermediaries is ideal in the distribution of a product? Should the product be dis- tributed as widely as possible or should distribution be restricted to specialized outlets? Companies will likely have to alter the distribution ingredient over time. For example, as customers’ consumption habits shift, retailers must adapt their distribution to include online sales—but they must do so carefully or risk cannibalizing sales at their brick-and-mortar stores. At West Elm, the furniture retailer, online sales have grown to 51 percent of its revenues. The company helps its retail store managers embrace its retail website by including online sales that come from households within their zip

Small Businesses Create Big Buzz

Unusual marketing can help small businesses with big goals but tiny budgets make a big impression. For example, the San Francisco-based Headsets.com, which sells high-quality telephone headsets to business customers, promotes certain products with “pay what you want” pricing. The company limits this offer to customers that have made a previous purchase, and allows one such purchase per customer. Although most customers choose to pay close to full price, three have opted to pay just $1. Still, Headsets.com has attracted dozens of new customers since implementing this pricing policy, and the founder is pleased with the financial return on this marketing investment.

Rock Candy Media, a marketing agency in Austin, Texas, showcased its services by shooting an inexpensive, tongue- in-cheek video about searching for additional office space in fast-growing Austin. Called “Workin’ at Ikea,” the video shows the founder and several employees testing out desk space at a local Ikea and taking lunch breaks in the store’s

restaurant. In reality, the firm was eventually able to expand into an office hub for startup businesses. By posting this and other videos on YouTube, Rock Candy demonstrated its creativity and its knowledge of digital media to prospective customers.

The CEO of Silicon Valley startup Zapier promotes his firm’s software expertise by writing articles for well-known publications and websites. The idea is to communicate with decision makers who seek software for improving business processes. Not only does this catch the eye of potential customers, it also adds credibility because the publications and websites are known for authoritative content.

Sources: Based on information in John hall, “Brands lost Big with content marketing in 2014— here’s how to recover This year,” Forbes, January 11, 2015, www.forbes.com (accessed July 18, 2015); chris gay, “Four marketing Strategies That Paid off for Small companies,” Wall Street Journal, november 3, 2014, www.wsj.com (accessed July 1, 2015); chad Swiatecki, “Want to office out of Ikea? austin agency gives It a Try with guerrilla Video,” Austin Business Journal, october 20, 2014, www.bizjournals.com/austin (accessed July 1, 2015).

Entrepreneurial Success

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codes as part of their stores’ performance measures.12 CVS Health has seen traffic at its CVS.com site and through its mobile app grow by 250 percent, and more than 1 million customers a month visit CVS.com through a mobile device. The company has enhanced its online marketing by including tools such as a “Drug Interaction Checker” and a “Family Vitamin Center” that can offer personalized recommendations for vitamins and supplements.13

The promotion ingredient focuses on providing information to target markets. The major forms of promotion are advertising, personal selling, sales promotion, and public relations. Careful planning and implementation of promotional tools is crucial to ensure their effectiveness. Distribution and promotion are discussed in more detail in Chapter 13.

These ingredients of the marketing mix are controllable elements. A firm can vary each of them to suit its organizational and marketing goals and target market needs. As we extend our discussion of marketing strategy, we will see that the mar- keting environment includes a number of uncontrollable elements as well.

11-6 Marketing strategy and the Marketing enVirOnMent The marketing mix consists of elements that a firm controls and uses to reach its target market. The firm also has control of organizational resources, such as finances and data, which can be utilized to accomplish marketing goals and refine the marketing mix. All of a firm’s marketing activities can be affected by external forces, which are generally uncontrollable. As Figure 11-3 illustrates, the following forces make up the external marketing environment:

• Economic forces—the effects of economic conditions on customers’ ability and willingness to buy

• Sociocultural forces—influences in a society and its culture that result in changes in attitudes, beliefs, norms, customs, and lifestyles

• Political forces—influences that arise through the actions of political figures

• Competitive forces—the actions of competitors, who are in the process of implementing their own marketing plans

• Legal and regulatory forces—laws that protect consumers and competition and government regulations that affect marketing

• Technological forces—technological changes that can create new marketing opportunities or cause products to become obsolete rapidly

These forces influence decisions about mar- keting mix ingredients. Changes in the environ- ment can affect existing marketing strategies. For example, Starbucks, recognizing that consumers are spending more time shopping online and less in conventional shopping areas where its coffee shops are found, tweaked its marketing strategy to keep customers coming in by adding beer, wine, and evening snacks to broaden its product line, as well mobile ordering to reduce time wait- ing in line.14 In addition, changes in environmen- tal forces may lead to abrupt shifts in customers’

Concept Check ✓✓ What are the major components of a marketing strategy?

✓✓ Describe the major approaches used in target market selection.

✓✓ Identify the four elements of the marketing mix.

Learning Objective

11-6 Explain how the marketing environment affects strategic market planning.

Concept Check ✓✓ Describe the environmental forces that affect a firm’s marketing decision and activities.

✓✓ how are marketing decisions affected by environmental forces?

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social Media: Warby Parker: social Media star Warby Parker markets fashionable prescription eyeglasses online at prices that undercut traditional eyewear outlets. Its social media strategy focuses on style, value, and social responsibility. For instance, its blog (http://blog.warbyparker.com) chronicles the com- pany’s donations of eyeglasses to people in need and offers sneak peeks of new products and new retail connections.

With 408,000 likes, the firm’s Facebook page (http://www.face- book.com/warbyparker) is filled with posts about fashion frames, special events, and company updates. Some of this content is also featured on Warby Parker’s Twitter account (http://twitter.com/ warbyparker) and its Tumblr account (http://warbyparker.tumblr. com). Warby Parker’s popular Instagram account (http://instagram. com/warbyparker) has attracted more than 173,000 followers who enjoy browsing photos of eyeglass frames and behind-the-scenes photos of employees at work. Finally, fans are invited to pin photos of themselves in Warby Parker glasses on the firm’s Pinterest board (http://www.pinterest.com/warbyparker).

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