Principles of Management

Transcription

1 Student name/ ID Principles of Management A case-led introduction to the environment, functional areas and interactions involved in everyday business. Professor Karin McDonald Office: Room L513

2 BED01 Professor K.McDonald Contents

3 BED01 Professor K.McDonald Contents Table of Contents Introduction i Unit 1: Business Basics I 1 Unit 2: Business Basics II 11 Unit 3: The Operations Department 23 Unit 4: The Marketing Department 35 Unit 5: Supply Chain and Channel Management, Category Management, etc. 46 Unit 6: Reaching Global Markets 56 Unit 7: Corporate Organization and Planning 68 Unit 8: The Finance Department 80 Unit 9: The Accounting Team and Financial Statements 94 Unit 10: The Human Resources Department 112

4 i Introduction Welcome to POPCO For the purpose of this class, you should now consider yourself an intern at the fictional manufacturing company, POPCO. POPCO is a Korean-based toy company that started in the 1980s. They make a variety of toys and traditional Korean games. Their main products are soft toys (in English language, stuffed animals ). They have recently launched a product called Clucky Chicken. Clucky Chicken is an artificially intelligent chicken soft toy. It relies on basic computer programming via a computer chip inside the stuffed toy to interact with consumers. POPCO launched the Clucky Chicken toy to compete with the wildly successful Zhu Zhu Pets line of toy hamsters. Class discussion and exercises will focus on POPCO to describe theories and principles. Your job as an intern is to participate in helping the company make good decisions, considering the new theories and principles you have learned. Later, you will spend a week or two learning about the way each different area of POPCO s business works, including the types of jobs in each department, and their responsibilities and activities. We will discuss in class how these jobs, responsibilities and activities might be different in different kinds of companies. POPCO Worksheets The purpose of worksheets is to help you check your understanding of the concepts and skills in the reading, so that in class we can demonstrate and practice applying that learning. Worksheet problems and questions are very similar to those on the quizzes, although the quiz problems and questions are a little bit harder. Ethical questions Included in this CP are questions that raise ethical issues. Ethics are a key consideration of the global business environment and interactions within and without a business. Ethics are more than just corporate social responsibility, though. We will discuss ethical issues in business throughout the course as time allows. Ethics-related questions are marked by a Dongguk lotus emblem: Terminology Like any field of study, business has its own jargon, and requires learning a lot of vocabulary. To avoid confusion where the business meaning of a common English term may be different from the definition you know, or where common usage of a business term may lead to confusion, this CP includes common terminology explanations marked with a speech bubble:

5 1 Unit 1 Business Basics I Learning objectives of this unit In this unit you will learn the following concepts: What is the goal of a business? What are the resources it uses? (in class: resource diagram) What is profit, and who receives it? (in class: profit calculation) What is a competitive market, and how does supply and demand work? (in class: graphing supply and demand) How do businesses interact with households and governments (in class: circular flow diagram) with regards to resources? What trends are common to competitive market economies? (in class: productivity calculation) What are economies of scale, and how can a company get them? (in class: economies of scale diagram)

6 2 Unit 1 Vocabulary Factors of production ( 생산요소 ): Things of economic value needed to produce goods and services 제품이나서비스의생산에필요한자본이나노동등의요소 Net Profit ( 순이익 ): The money a business earns when revenues are greater than expenses 총이익에서원가를차감한뒤에남는이익 Revenues ( 수익 ): The money a business earns from activities like selling goods or services 영업활동과정에서상품의매출액과서비스제공을통해얻어지는 경제가치로서자기자본을증가시키는이익 Expenses ( 비용 ): The economic costs that a business incurs through its operations in order to earn revenues 기업이수익을창출하기위해운영을통해부과하는경제적대가 ( 원가 Supply and demand ( 수요와공급 ): Supply is how much quantity that sellers in the market can offer of a specific good or service at each of various prices, and demand is how much quantity of a good or service buyers are willing to buy at each of various prices in that market. 수요 : 경제재또는용역에대한인간의욕망, 청구 / 공급 : 어느제조업자또는 판매업자가판매에제공하는경제재의양, 소모품 Households ( 가구, 가족, 가정 ): The population of an economy that consumes goods and services and also own and contribute other factors of production 가구는개인으로구성되며, 제품및서비스의소비자일뿐만아니라생산요소 일부의소유자 Stockholder ( 주주 ): A person who owns stock in a corporation 주식회사의주식을한주이상소유한법적소유자 Stakeholder ( 이해당사자 ): The different people who are affected by an organization s activities and decisions 기업의활동이나정책에의해서이익또는손실을입게되는모든사람들 Productivity ( 생산성 ): The amount of output produced by a given amount of factors of production input; often measured in quantity per unit of time. 주어진생산요소를투입하여생산해낸결과물의양 Economies of Scale ( 규모의경제 ): The cost advantage that arises with increased output of a product. For many (but not all) firms the greater the quantity of a good produced, the lower the per-unit fixed cost because these costs are shared over a larger number of goods. 생산요소투입량의증대에따른생산비절약또는수익향상의이익 Specialization ( 특화 ): A method of production where a business or area focuses on the production of a limited scope of products or services in order to gain greater degrees of productive efficiency. 최대한의생산효율을얻기위한생산활동의분업 Growth (Globalization) ( 성장 ( 세계화 )): The tendency of investment funds and businesses to move beyond domestic and national markets to other markets around the globe, thereby increasing the interconnectedness of different markets. 다양한시장이상호연결되어투자기금과기업들이세계의다른시장으로움직이는 과정

7 3 What makes a Business There are many ways to define business. One way is to combine the purpose of business in a definition with the resources required by business activities, and the goal of those activities. Below is a common definition of business. Business is an organized effort to combine and manage resources in a profitable way in order to produce products and services that satisfy the needs of customers. Purpose: The definition of the purpose of business has changed over the years with changes in economic and business thought. However, most people today define the purpose of business as satisfying the needs of customers by producing and selling products (also called goods ) and services. Resources: No matter what type of country or political system you are working in, business activity requires the organization and management of resources. Generally, you can categorize resources as material, human, financial, or information resources. What are the specific resources a toy company requires to produce and sell toys? In economics class, you probably learned to remember the categories of land, labor, and capital resources, also called factors of production since they are required to produce goods and services. Sometimes these are referred to as factor inputs. Historically, different theorists have emphasized different factors of production when considering what makes a strong national economy. With increasing study into the factors of production and political economy, academics today also include the categories knowledge / information and entrepreneurship as important factors of production. More and more, technology is also an important factor of production. People still measure the economic strength of a country according to the factors of production it has and how the country s political system manages those resources to meet the needs of its own customers: society. Goal: Most people consider that the goal of business is to make a profit. But many businesses do not always make a profit every year. And some businesses are started to make a profit for some owners this year, but do not have the resources or management to be successful long-term, creating losses for often different owners in future years. The general term profit simply means that, in a given time period, a business s sales revenues are greater than its expenses. Sales revenues minus expenses equals profit. How would you calculate profit for your own activities? People often use the general term revenues instead of sales revenues. There are many words and phrases that mean the same as profit : earnings, income, and the bottom line all mean profit (specifically net profit). But be aware the terms operating profit and gross profit represent different amounts. We will learn more about these terms in the accounting unit. Who gets the profit? Profit is often invested back into the business. It can also be distributed to owners of the business. Most people think of business owners as those who manage the business day-to-day. But this is not typically the case. Any person or group that invests in a business is an owner of that business. Typically they give money to the business in exchange for ownership, or perform some other valuable service. For publicly traded companies, these people are referred to as stockholders. Don t confuse this term with the very similar term stakeholders. A stakeholder is anyone who is affected by a business s activities. Who are all the stakeholders in Dongguk s business?

8 4 Notice that the kinds of needs customers might have are very different, and there is not a distinction between a need and a want, or between a true need versus an impulse. Is the need to survive from starvation the same as the need to have a fashionable handbag? In its definition and response to needs, business treats both the same: an opportunity for activity and profit. Are there needs that products, services and business activities do not satisfy well? Is profit the best motive for all of society s needs? The simplest business interaction: a market With the definition of what a business is, we can review how a business interacts with the world outside. The typical way for this to happen is in a market. A market is a medium that allows those that supply products and services (also called producers ) to find and transact with those who demand them ( buyers or customers ). Supply and demand in a competitive market is the fundamental theory of modern economics. In economic terms, supply and demand refer to quantities: the supply of a product or service is the quantity that suppliers are willing to sell at each of various prices, and the demand is the quantity that buyers are willing to purchase at each of various prices. If, however, economists talk about demand alone they are referring to the relationship of price and quantity demanded, not just quantity. Why do we say at various prices? Because in the economics of supply and demand we speculate on how much producers and buyers would transact at not just one but at many prices. For producers, they would sell more at a higher price if they could, and fewer at a lower price. But for buyers, the opposite would likely be true: the lower the price, the more buyers there would be demanding the product or service, and lesser and lesser demand as the price increased. This assumes that producers and buyers make rational decisions in their selling and buying activities, which many behavioral economists now recognize is not strictly true. But in principle, there is a theoretical selling / buying price mismatch between producers and sellers at most quantities imagine people walking away from making deals. In fact, in a general supply and demand market, there is only one price/quantity point that truly satisfies both producer and buyer at the same time the equilibrium, or market price. And according to economists, the forces of supply and demand in a simple free market will guide the price and quantity to that market equilibrium. Too much quantity of a good will drive down prices, and not enough supply of what buyers want will drive up prices that buyers are willing to pay. Note that no matter whether there is a shift in supply, demand, or both supply and demand, the market will adjust to an equilibrium price. As this is an introductory course, we will not cover topics related to micro or macroeconomics in depth. If you want to pursue any of these topics further or in theoretical depth, you can review macro and microeconomics. What happens when a business has too much (a surplus) of products to sell? What happens when there is not enough (a shortage) of a product to buy? The forces of supply and demand are credited in classical economics with driving the quantities sold and prices paid in markets. In truth, many forces can impact the prices charged (and paid) in markets, especially in mixed market economies like Korea s. But for markets to work effectively, buyers and producers must have some freedom in making choices regarding their business activities, and they must be able to compete with other producers or other buyers to make those transactions. Some theorists believe that developed societies are now too dominated by the concept of the market. Thinkers like Harvard s Michael Sandel believe that

9 5 markets should be a tool of society for responding to specific needs or problems. Not the purpose of societies. What do you think? People often use the phrase the market to describe the stock market, rather than product or factor markets. Stocks represent quantifiable ownership of businesses. They can be bought and sold like other goods and services for publicly traded companies. Markets, buyers and sellers: the Circular Flow A simple way to understand the role of business around you is to look at the flow of economic value that is transacted in markets to and from the main consumers (buyers demand ) and producers (sellers suppliers ) of the factors of production, products and services. Using very general terms, the primary consumers and producers include businesses (also called firms ), governments, and households. People refer to these as the main sectors in an economy. In a society who are the buyers and who are the sellers? One way of categorizing markets is by what they sell and for what purpose: factor or resource markets are primarily for the buying and selling of the factors of production. This kind of market transacts the inputs for creating other products and services. It s not only for things like raw materials, though; it also includes things like labor wages, the cost of finance, and other factors of production from the previous section. Another kind of market is primarily for the buying and selling of finished goods and services. These product markets deal in the outputs of economic activity. For example, individuals in a household provide their working time in exchange for wages in a factor market. They then use their wages to buy finished goods and services to satisfy their needs from product markets. Students often overlook the role of government in economies. Governments are often the biggest consumers in factors markets and in product markets, but they also are producers in both markets as well. Furthermore, remember that the flow of transactions and economic value is ongoing and interdependent. In other words, one sector of the economy will affect the other sectors if it experiences change. Besides competition for scarce resources, the primary cause of change affecting the sectors of an economy and the markets through which economic value flows is the business environment. Governments are supposed to voice the needs of society as a whole. As a customer of firms in product and factor markets, do governments do a good job representing the needs of societies? Would individuals do better representing their own interests directly? Three trends of competitive markets Three key trends of competitive market economies that shape business are productivity, specialization, and growth (which these days means globalization). Supply and demand market forces, the changing external environment (see next unit), and the interdependence of the government-household-business flow require that businesses constantly adapt. To adapt most effectively, businesses follow one or more of these trends. Productivity is simply the goal to be most efficient at producing and delivering products and services. It is typically measured in the product or service output of a business, workforce, or worker per unit of input (sometimes called factor inputs), usually time. Businesses can increase efficiency by lowering costs of resources (called factor inputs), or increasing the amount of output given the same level of factor input.

10 6 There are many ways to increase productivity or the rate of output. For example, you could improve the way tasks are completed, or automate tasks using machinery. Rapid productivity increases can often lead to layoffs and increased unemployment unless demand also increases at the same time. Another key way to increase productivity is to reduce the cost of factor inputs. Often businesses achieve input cost savings by negotiating with multiple suppliers for the best value. In terms of increasing productivity through reducing the cost of inputs, not all input costs are the same. Some input costs rise and fall with the amount of goods or services produced, while some costs are required no matter how much output is produced. Costs that rise and fall with the level of output are variable costs (they vary with production), and those that do not change no matter the level of output are fixed costs. Note that these are general terms and not related to accounting expense categories. As a company produces and sells output (products and services) in the market, the fixed costs are spread over the number of products or services sold: the more output sold, the less the fixed cost represents as a percentage of the total unit cost of each product or service. In other words, the more a company sells, the more profit they can make per unit of output sold. This is referred to as economies of scale (economies refers to cost savings, and scale refers to the large amount of output), and is one main contributing factor towards the drive towards productivity and growth in competitive markets. Note that at a certain point, theoretically companies also experience diseconomies of scale, in other words when producing additional units actually increases the cost per unit of production. Specialization is the trend towards producing a limited scope of products or services to achieve greater production efficiency. Specialization can refer to labor specialization of a job or task, or of a company s output, or a nation s output. The drive to specialize is a result of comparative advantage, where the opportunity cost for one group to produce one item is lower than to produce another item, when compared to the opportunity costs of another producer. By each group specializing, the whole system is more productive. Companies that specialize increase their knowledge and experience, which increases their productivity and negotiating power. However, companies that specialize without continuing to look at the business environment and competitive forces can quickly become insular (inward-looking) and uncompetitive. Larger companies may combine many different specializations under one corporation or group of companies (called a conglomerate) so that they can earn profits from one business area while another business area is adapting and may be less profitable or competitive. Conglomerates can use many different resources from all of their companies to balance their resources. Growth is the result of the trend toward productivity (including economies of scale) and specialization (including the trend towards creating large conglomerates). Growth enhances a company s ability to gain economies of scale, increases their negotiating power, and gives the corporation or conglomerate more ways to balance revenues and losses across companies and business areas among other advantages. These days, with improved communications and logistical infrastructure for things like shipping and cargo, growth usually means globalization. Globalization simply refers to a business operating in global resource and/or factor markets. Theoretically, a company that can operate globally is likely to be much more competitive than a company that is limited to local resources and markets. Small and medium sized companies must find ways to specialize to meet local demands, or find assistance in reaching global factor and product markets.

11 7 What are the negative aspects of globalization in your mind? Is it possible for a company to not globalize and remain competitive? How? Summary: Business Basics I In this unit you have learned about: The goal of business and the resources it uses The definition of profit, stakeholder, and stockholder The equilibrium price nature of competitive markets The interdependent flow of value in society between businesses, governments, and households The market economy trend towards productivity, specialization, and growth If you are unfamiliar with microeconomics (including the basics of supply, demand, market equilibrium, comparative advantage, specialization, etc.), I strongly encourage you to view the videos at the link below (Korean subtitled!)

12 blank page for your notes 8

13 9 Worksheet 1 (front) Matching: Match the POPCO resource with the resource category that applies. You can choose more than one kind of categorization. a) Land b) Labor c) Capital d) Knowledge/Information e) Entrepreneurship f) Information g) Material h) Financial i) Human 1) Fuzzy yellow material to make Clucky Chickens 2) The minimum wage in Korea 3) Market price survey of artificially intelligent toys for next Christmas 4) Interest rates 5) The availability of factory real estate plots in Korea 6) Our factory buildings 7) Initiative by our marketing team to crowdsource toy ideas 12) If the quantity demanded for board games decreases the equilibrium price will eventually go: up / down 13) Name one reason why toy demand quantity might go down: Multiple choice. Circle the one best answer 14) Productivity is generally measured as: (a) output / input (b) hours per product (c) costs / revenues (d) cost / worker 15) Economies of scale are achieved by: (a) Reducing the per unit productivity (b) Reducing the variable costs to produce each product True or False 8) Profit is the same as Gross Profit (c) (d) Spreading the fixed costs of production over many units Spreading the variable costs of production over many units 9) Sales revenues minus the bottom line equals earnings Fill in the blank 10) Another name for an owner of a publicly traded business (ownership through investment or providing another valuable service) is a. Circle the best answer 11) If the quantity supplied of toys stays the same and the quantity demanded increases, prices will go: up / down True or False 16) Specialization benefits larger companies because more specialized areas make them more profitable. 17) One way a medium size company like POPCO can compete against giant globalized toy conglomerates is to specialize in high quality stuffed animals or get support to sell overseas from the Korean government. 18) On the next page, map all of the stakeholders in POPCO s business you can think of, and the resources we transact with them (buy and sell). Assume we sell our toys in the EU, North America, and Korea, and that our main factory is in Korea.

14 10 Worksheet 1 (back) Map all of the stakeholders you can think of for the POPCO business. Do we transact (buy or sell) with all our stakeholders? (yes or no) Note the resources we transact with stakeholders we do buy and sell with.

15 11 Unit 2 Business Basics II Learning objectives of this unit In this unit you will learn the following concepts: What are the environmental forces that affect business? (in class: forces discussion) What is Gross Domestic Product (GDP)? (in class: example using flow image and formula) What is the business cycle, and what happens during different phases? (in class: GDP x time graph, body analogy) How do governments and financial institutions respond to change? (in class: fiscal and monetary policy problem) What is the social responsibility of business in a competitive global market? (in class: review of flow model versus time, GDP & standard of living, goals)

16 12 Unit 2 Vocabulary GDP( 국내총생산 ): The monetary value of all the finished goods and services produced within a country's borders in a specific time period, though GDP is usually calculated on an annual basis. It includes all of private and public consumption, government outlays, investments, and exports, less imports that occur within a defined territory. 한나라의국경안에서일정한기간 ( 보통 1 년 ) 에걸쳐생산한재화와용역의부가가치또는가계, 대중소비, 정부경비, 투자와수입비용을뺀수출등을화페단위로합산한것을말한다. The Business Cycle ( 경기변동 ): The recurring and fluctuating levels of economic activity that an economy experiences over a long period of time. The five stages of the business cycle are growth (expansion), peak, recession (contraction), trough and recovery. 경제활동의반복적인변화. 확장, 절정, 침체, 골, 그리고회복으로구분되어있다 (Price) Inflation ( 인플레이션 ): The rate at which the general level of prices for goods and services is rising, and, subsequently, purchasing power is falling. 화폐가치가하락하여물가가전반적, 지속적으로상승하는경제현상 Deflation ( 디플레이션 ): A general decline in prices, often caused by a reduction in the supply of money or credit. Deflation can be caused also by a decrease in government, personal or investment spending. 경기가하강하면서물가도하락하는경제현상. 정부, 개인또는투자소비에의해유발되어진다 Monetary Policy ( 화폐정책 ): The actions of a central bank, currency board or other regulatory committee that determine the size and rate of growth of the money supply, which in turn affects interest rates. Monetary policy is maintained through actions such as manipulating the interest rate, buying or selling government securities, or changing the amount of money banks need to keep in the vault (bank reserves or deposit ratios). 중앙은행이이자율에영향을끼치는통화공급량의크기와성장률을결정하는정책. 이자율증가또는은행지급준비금을통하여유지된다 Fiscal Policy ( 재정정책 ): Government spending policies that influence tax rates, interest rates and government spending, in an effort to control the economy. 경제를조정하기위해세율, 이자율과정부지출에영향을미치는정책 Standard of living ( 생활수준 ): The level of wealth, comfort, material goods and necessities available to a certain socioeconomic class in a certain geographic area, often measured in GDP per capita 사람들이자신이보유한돈을가지고살수있는제품과서비스의양 Quality of life ( 삶의질 ): In addition to material well-being it includes such intangible things as the quality of the environment, national security, personal safety, and political and economic freedoms 물질적인요소뿐만아니라무형적인환경, 국가적안보, 개인의안전그리고정치, 경제의자유의행복수준 Social responsibility ( 사회적책임 ): The recognition that business activities have an impact on society and the consideration of that impact in business decision making 기업의활동이사회에영향을끼친다는사실을인지하고이를의사결정에반영

17 13 The business environment: force for change The business environment the external forces affecting business markets, activities and performance is a multi-layered, always changing setting in which business must adapt in order to compete. Particularly in a global business environment, environmental forces may change significantly and often. These forces greatly affect the markets and circular flow of value in economies. Types of environmental forces affecting business include: demographic trends like birthrates and living locations; social customs and cultural norms; laws and regulations; global economic conditions like financial conditions and currency rates; security and law enforcement conditions; the political situation; technological innovations and availability; ecological environmental conditions; public opinion; and ethical considerations. You will often be asked to analyze environmental trends or the environmental forces affecting a business, because they can so quickly and significantly affect the markets and activities of business. This is often referred to as PEST analysis, an acronym for Political, Economic, Social, and Technological forces. There are several environmental forces beyond those four. Some people remember them with STEEPLE including Ethical, Legal and Ecological forces. What are some specific environmental forces that affect POPCO as a toy business? People often use the phrase the environment to describe the external context of the activities they are talking about, rather than the more common meaning about the ecological context. In our class, when we discuss the environment we will usually be talking about the external context in which business operates, unless mentioned otherwise. GDP When looking at a circular flow of value for, say, a country, how do you measure that value in economic terms? Economists and business people use the term Gross Domestic Product, or GDP, to measure that value. GDP measures the total market value of all finished goods and services produced within a country s borders in a given period of time, usually a year. GDP places a value on a country s economic output and is often compared historically to previous years, a base year, and to other countries GDPs. Notice that the market value is the tradable value, rather than the cost of goods. And these are finished goods because the value of intermediate goods is captured in the value of the finished good within one country s borders. Also notice that it is produced within one country not managed by one country. The production is accounted for in the location where it is produced, not where it is owned or managed. GDP tends to increase gradually over time due to increases in productivity. Increases in productivity are typically due to technology innovations, to discovery or increase in the value of held resources, or because of new processes. The business cycle The interdependence of different sectors (the circular flow) of the economy, coupled with the anticipation of supply and demand by looking at the past, tend to create repeating cycles of expansion and contraction in economic activity. This is the business cycle. The business cycle can be pictured as the fluctuations in GDP over time. The business cycle reflects periods of economic growth and contraction in business production, wages, incomes and employment, spending, borrowing and investment. While governments, businesses and households would all prefer

18 14 stable prices, growth, and full employment, the business cycle adapts according to market forces. Yet, market forces really refer to supply and demand, and those are greatly affected by people s emotional attitudes about what has happened in the past, and what they expect to happen in the future. What part of the business cycle is Korea in now? Typically, investors, governments, businesses and consumers will react and adapt in reaction to what has recently just happened in anticipation of the direction of change of the business cycle, and so often act with too much optimism or pessimism. Price inflation One of the biggest triggers to affect households, businesses, and governments in their every day economic decision-making is the price of things. The general increase in prices over time is called price inflation. Inflation measures the rate at which the general level of prices for goods and services is rising, and, subsequently, purchasing power is falling. So as prices go up, the money you have today is worth less tomorrow. Often you see inflation at the peak of business cycle growth. When you see headlines that talk about inflation, they are usually talking about price inflation. In general, prices will rise steadily and slowly over time. Economists disagree about the causes of this, but generally agree that in the long run price inflation is related to monetary inflation, or the increase in the money supply in the economy. (In the short run, it could be due to a sudden loss of supply of a key good like oil, because of more overall demand in the economy as it grows and the three sectors spend more, or because the vicious cycle of workers trying to keep their wages above price levels, which in turn leads to an increase in goods prices.) Inflation is measured by the Consumer Price Index (CPI), which measures the relative increase in cost of an averaged basket of finished goods over time. There is a related Producer Price Index (PPI), which measures the same but for factor inputs. What goods have you noticed that have increased in price in your lifetime? Deflation is a general decline in prices, often caused by a reduction in the supply of money or credit. Deflation can be caused also by a decrease in government, personal or investment spending. The opposite of inflation, deflation leads to increased unemployment since there is a lower level of demand in the economy, which can lead to a downward spiral and economic depression. Countries will try and control excess inflation and deflation through monetary and fiscal policy. Controlling the economy: monetary policy Governments and financial institutions respond to cyclical economic changes through two different kinds of policies: monetary policy and fiscal policy. While economists and politicians may debate how much of a role governments should play in responding to markets and the business cycle, most agree that government should play some role in preventing extremes of the business cycle. Monetary policy is the policy of controlling the money supply in an economy. This affects interest rates, and eventually, demand. Monetary policy is not set by the representative government, but by central banks and their boards. Some central banks are controlled fully by their respective governments, some are partially controlled by the government and partially by private interests, usually the boards of other banks. People set and administer monetary policy, not markets. The stated purpose of most central banks is to stabilize prices (control inflation) and in some cases, target full employment. Central banks control the money

19 15 supply by using three tools: 1) controlling the money supply and interest rates by buying or selling government securities (typically short-term treasury securities like treasury bills and bonds) from its member banks through open market operations; 2) controlling banking risk and the impact of open market operations on the money supply by setting the amount of money a bank must keep in reserve and not lend, called the reserve requirement; and 3) controlling money demand by manipulating the interest banks for banks that must borrow from the bank of last resort, the central bank (called the discount rate); Open market operations (and how it effects interest rates) is the most popular tool employed by central banks. For example, when the central bank wants to stimulate an economy, it will typically buy short term government securities from the market via its member banks, and pay for these by adding a credit to the seller s bank account for the amount purchased. This deposit goes towards that bank s reserves. The bank has to keep a certain percentage of these new funds in reserve, but can lend the excess money to another bank in the overnight lending market between banks. In the example above, the bank has a credit to its reserves, which means it can lend more money. The money banks can lend to each other overnight is called the federal funds market in the US. Why would banks want to lend money to each other overnight? It has to do with the reserve requirement. Banks reserves of money the money the bank must keep and not lend, called the reserve requirement is kept at their local central bank office or in cash in the member bank s vault. The bank must keep in reserve a certain percentage in order to pay for its daily operations. For the bank, it means it cannot easily make a profit on this reserved money because it cannot be lent. Reserve requirements must be met by the close of the day. But banks do lend more to their customers than their reserves allow them to in order to make more profit. To do this without breaking the law and risking penalties, the bank will borrow funds from another bank overnight to meet the reserve requirement (or lend to another bank that is not meeting its reserve requirement which also gives them a profit). The funds they borrow or lend each night are called Fed funds in the US, and the interest rate charged on these funds between banks overnight is called the Fed funds rate in the US (in Korea, previously the overnight call rate and now the base rate). The central bank targets a specific lending rate or funds rate they feel is right for the economy, and then uses open market operations to affect this rate. The rate itself floats. How does the increase or decrease in banks funds using open market operations affect the funds lending rate? Think of it in terms of supply and demand. The price of the money available to borrow from other banks is the interest rate. Banks can earn money on money they lend, so there is stable demand. With increased supply in money available to lend, the price (interest rate on the fed funds) goes down. When this rate falls (or rises), the price of other kinds of borrowing and lending changes too, causing interest rates on things like credit cards, business loans, and mortgages to also fall (or rise). People often use the general term interest rates when talking about monetary policy, when actually they mean the central bank s overnight lending rate, which in the US is called the Federal Reserve rate. Yet the Federal Reserve rate, which is only available to the largest and most creditworthy lending institutions like large banks, is used to lend to other banks over night to keep their balances and reserves square. This interest rate is not available to households or other businesses. The interest rate that banks charge their most creditworthy customers, usually large corporations, is the prime interest rate, or prime rate. The prime rate is set according to the federal funds rate. Retail banks base the interest rates they charge to small businesses and individuals for personal loans and mortgages on the prime rate. In this way, the Federal Reserve rate as set by a central bank has a domino effect on lending and the money supply in an economy. The central bank can also change the reserve requirement. If the percentage of deposits banks are required to keep in reserve, as set by the central bank,

20 16 increase or decrease, you can see how this would affect the money available to borrow and lend in the economy as every deposit can be then used to lend which can then be used to lend, which can then be used to lend, etc. (minus the reserve requirement). This is known as the multiplier effect. The money multiplier of deposits to reserves is simply the amount of total deposits divided by the reserve requirement percentage. So if banks have a reserve requirement of 20% and total deposits are $100, then the actual money that could be circulating in this tiny economy is $500. Finally, central banks may use the discount rate to control the money supply. Occasionally, banks may exceed their reserve requirements, but find that no other banks will lend to them overnight. In this case the banks must turn to the central bank itself to lend them money. The rate the central bank charges to banks for such lending is called the discount rate. The discount rate is higher than the funds rate charged between banks, making the central bank the bank of last resort for borrowing. Typically, central banks effectively decrease the money supply by effectively raising interest rates via selling government securities like Treasury bonds or through repo agreements (securities with an agreement to repurchase). This will filter through the economy as an increase in the interest rate for lending. Raising interest rates discourages borrowers and lenders, and selling government bonds removes money from circulation (puts the bond in circulation, and takes the money out). In situations where inflation is low but economic activity is slow and growth is flat, central banks may increase the money supply in order to stimulate demand. They do this via the opposite path of the above, by buying government bonds or other low risk securities from banks or dealers. This has the effect of lowering shortterm interest rates, which in turn acts as a signal to businesses and institutions to consider borrowing and investing. But what about if the interest rate is already near zero? In that case the central bank may instead buy particular kinds of securities that may not be as low risk, or target specific assets and parts of the economy where credit isn t flowing smoothly. This does not directly affect the funds rate charged between banks. This puts more money into circulation with banks, encouraging them to lend. It raises the risk of inflation, however, as more money is directed into the economy with the same short-term demand for goods. And banks may choose to keep the new money in reserve rather than lend it. This overall strategy is called Quantitative easing. Quantitative easing is a controversial strategy for many economists and investors. Fiscal policy is where the government uses its power as both producer and buyer in factor, product and service markets to impact economic outcomes. Fiscal policy is also known as tax and spend policy: the government redistributes income it collects in taxes by buying products and services, paying wages, and selling or leasing resources. In this way the government influences supply and demand in markets. Politicians disagree on whether increasing taxes and then increasing government spending in the economy, or reducing taxes and hoping for firms and households to spend that available income in the economy is better at stimulating economic activity. Fiscal policy is typically set through the representative body of government with the approval of the central government authority. Governments can also raise money to spend by selling debt in the form of Treasury bills and bonds (borrowing from investors) when tax revenues are not sufficient or there is a budget deficit. What are the current monetary and fiscal policies of Korea? Of other countries?

21 17 What is the goal of an economy? Most governments and their central banks want their economies to grow and be healthy. They want their societies to improve, and do their best using fiscal and monetary policies to make that happen. Common measurements that allow governments to assess the health and improvement experienced by their citizens are socio economic indices. Indices is the plural of index. Socioeconomic indices are by nature subjective in design, and do not generally reflect cultural values. Two commonly cited socioeconomic indices are standard of living and quality of life. Standard of living is a measure of the level of wealth, comfort, material goods and necessities available to a certain socioeconomic class in a certain geographic area. It emphasizes the material choices available for consumption, and people s economic ability to consume. Some simply calculate the GDP per capita (per person) for standard of living. But in reality, it includes variables such as: average incomes, employment availability, poverty rates, quality and affordability of housing, life expectancy, literacy rates, cost of goods and services, affordability and access to healthcare, availability of infrastructure like energy and transportation, etc. Standard of living measures are typically easy to quantify. By participating in trade and economic activity, the standard of living within an economy typically improves. Quality of life measures aspects of society such as: quality of the environment, freedom from corruption, sense of security, religious and political freedom, equal protection under the law, equal pay for equal work, freedom from torture, freedom of movement, right to be treated equally without discrimination, right to privacy and freedom of expression, right to leisure, right to education, etc. Quality of life is less easy to quantify, and very difficult to compare between cultures with different norms of social behavior and different kinds of expectations. The question of social responsibility One of the purposes of government is to ensure the health of the society it governs. And households have a responsibility as citizens to uphold society by abiding by laws and respecting the rights and freedoms of other citizenry. So what is the responsibility of business to society? There are two general views on what the social responsibility of business is. On one side, there is a purely economic view of business s social responsibility: business exists to make profit, and by making economic profit, paying taxes, and participating in markets, business contributes wages and income to those in a market economy, which in turn contributes to the standard of living of those who participate in that economy. In this view, the social responsibility of business is to do what it does best earn profit and to not intervene in other, non-profitable ways in society. Every social issue is a business opportunity waiting for someone to combine the factors of production effectively and make a profit from that social demand. Paying taxes and returning profit to stockholders is the primary job of business. There are merits to this view, particularly in a global context. It is difficult to argue that market economies have not increased the standard of living of those in developing economies, for instance. Despite the seeming unfairness in the difference between incomes and standards experienced by those in developed and developing nations, participation in a global marketplace provides more opportunities for people to raise their standard of living. However, standard of living measures traditionally do not include measures of sustainability, nor do they measure the more subjective quality of life variables that many feel are essential to a healthy life. Sustainability is an extremely

22 18 important measure, because market economies in any context encourage consumption, and some factor resources like natural resources, for instance, are finite (limited). Those who hold an economic view of business s social responsibility claim that entrepreneurship and technology will step in to fix social problems due to unsustainable practices as soon as it is profitable to do so. They do not feel that businesses should operate in a socially responsible manner until it makes business sense to do so. The socio-economic view is different. In this view, businesses are actually a contributing member of society and should thus work for the long-term benefit of society, not just for their own profit. Businesses have a responsibility not just to stockholders, but to all stakeholders because business benefits directly from social and government contributions such as infrastructure, political freedoms, security, an educated and healthy workforce, and other social conditions that they do not necessarily directly pay for. The socio-economic view also sees sustainability as a necessary objective of all sectors of the economy to avoid tipping-point scenarios, where the social problems created by economies are too big for even technology to fix. Those who hold the socio-economic view point out issues that business and economic markets have failed to address effectively with a profit motive, like global warming, poverty, income disparity, under education, and lack of affordable healthcare. They view these issues as significant barriers to society s well being. They claim that only businesses working together with government, targeting sustainability and social well being, will have the resources needed to solve some of these grave problems. Business ethics Many people believe that ethical problems in business arise from individuals breaking the law. This is only one standard of ethical behavior there are several more. But many ethical challenges in business arise with the tension between the needs and stockholders versus the needs of business stakeholders. A business decision that clearly benefits stockholders may harm stakeholders, and the opposite in many cases may be true. Risk management is the business practice of weighing the possibility of bad outcomes against the potential benefits. Often the possibility of bad outcomes is at the expense of stakeholders, while the beneficiaries of potential benefits are typically stockholders. Unfortunately comparison of possible outcomes depends very much on your point of view, and whether you prioritize stockholders or stakeholders. This leads to ethical dilemmas for the people actually making the risk assessments: do they act for the company, or as a stakeholder in society? One person s acceptable risk is far beyond what another person might consider acceptable. Because businesses have low incentive to account for risks as viewed by all stakeholders, they do not often prioritize or even consider non-owner stakeholder concerns in their risk calculations, despite the slogans or vision statements in the company annual report. For this reason, society demands and governments often implement regulation of industries. The purpose of regulation is not to harm business, but to ensure that businesses and industries meet the needs of stakeholders and not just stockholders. In many cases, industries will regulate themselves. While some view this as positive social responsibility, others believe that businesses pursue self-regulation in order to avoid more strict regulatory standards. Those from the economic view

23 19 of social responsibility (and free-market supporters) claim that regulation is not necessary because buyers and producers will make their demands known through their actions as consumers and purchasing agents. However, this point of view over estimates the power and motives of uninformed, misinformed, and independent agents in markets. What ethical issues exist in the toy industry, where the profit motive of stockholders might compete with the interests of stakeholders? What regulations are in place to manage these issues? Summary: Business Basics II In this unit you have learned about: The environmental forces that affect business GDP and the business cycle Monetary and fiscal policy Considerations about social responsibility and business ethics If you are unfamiliar with microeconomics (including the basics of supply, demand, market equilibrium, comparative advantage, specialization, etc.), I strongly encourage you to view the videos at the link below (Korean subtitled!)

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25 21 Worksheet 2 (front) Fill in the blank. 1) The global financial crisis of 2009 was a/an environmental force that affected most global corporations. 2) Relaxing import regulations on toys imported into the EU is a/an environmental force that may affect POPCO s overseas sales. Select the one best answer. 3) One possible cause of high inflation is: a. High unemployment b. Low investment c. Too easy credit d. Low GDP Identify the following as related to fiscal or monetary policy. 4) President s budget proposal 5) Central bank s open market operations 6) Tax increase 7) Government subsidies 8) Quantitative easing 9) Interest rates 11) If a central bank lowers the reserve requirement for banks, it is attempting to stimulate / slow down an economy. 12) The primary way a government raises money is through taxes / lending money. True or False. 13) The socio-economic view of social responsibility believes that businesses should prioritize the needs of all stockholders in their operations. 14) The economic view of social responsibility believes that technology plus entrepreneurship will eventually solve all the issues and needs of society, and so sustainability should only be pursued if it s profitable. 15) The interest rate banks can charge each other overnight for meeting their reserve requirements is called the prime rate. 16) The interest rate the central bank charges to banks that it lends to is called the Fed Funds Rate in the US. 17) The reason a bank will borrow from another bank overnight is so they can lend that money to their customers the next day. Headline explanation. 18) On the following page, explain in your own words what is meant in the following business headline. Explain why it is happening, and what the terms mean. Is this monetary or fiscal policy? Where is the money for the fiscal package coming from? Who are the investors, borrowers, and lenders? What is the purpose of the money? Circle the correct answer about monetary and fiscal policy. 10) If a central bank uses open market operations to sell treasury bills or bonds, it is trying to stimulate / slow down an economy.

26 22 Worksheet 2 (back) Explain the headline from Bloomberg news according to what you have learned in this unit.

27 23 Unit 3 The Operations Department Learning objectives of this unit In this unit you will learn the following concepts: What are the different roles and functions within an operations department? (in class: diagram) What is productivity, and what is capacity? (in class: calculating) What processes are involved in production management? (in class: POPCO exercise)

28 24 Unit 3 Vocabulary Cycle time ( 사이클타임 ): the time required to complete one cycle of an operation, or to complete a task, job, or function start to finish 어떤한공정에서하나의제품이나오는데경과되는시간을말한다. Lead time ( 선행기간 ): the time required to complete all cycles for an order plus any waiting time between tasks, cycles, etc. 상품의주문일시와인도일시사이에경과된시간을말한다. Capacity ( 수용력 ): the amount of products or services that a plant or enterprise can produce in a given time using current resources 공장이나기업이주어진시간동안갖고있는 resource 를이용하여만들수있는제품이나서비스의양 Productivity ( 생산성 ): an economic measure of output per unit of input, where output may be revenues, goods or services, and inputs are labor and capital 인풋당아웃풋의경제척도. 아웃풋은수익, 제품또는서비스, 인풋은노동또는자본이될수도있다. Labor-intensive ( 노동집약형 ): a process where people must do most of the work to generate output 사람들이아웃풋을만들어내기위해대부분의일을하는과정. Capital intensive ( 자본집약적 ): a process where output is generated mostly from plant and equipment 공장이나장비를통해대부분의생산량을만들어내는과정 Specification ( 설명서 ): a written statement of an item's required characteristics and design. A specification is documented in a manner that allows purchasing to find appropriate suppliers, and production to make and test the item's quality. 어떤물품에대해요구되는특징이나디자인에관한진술서. 설명서는적당한공급자를찾고물품의품질을확인하고실험할수있는구매방식을용납하게끔문서화되어있다. Purchasing ( 구매 ): all the activities involved in identifying suppliers, negotiating price, and obtaining required materials, supplies, components and parts from other firms based on a specification 설명서에근거하여공급자식별, 가격협상, 그리고다른회사로부터필요한자재, 저장품그리고부품을얻는것과관련된모든활동. Inventory ( 재고 ): the raw materials, work-in-process goods and completely finished goods that are considered to be the portion of a business's assets that are ready or will be ready for sale. 판매를위해준비되었거나준비될회사의자산의일부분으로여겨지는원자재, 재공품그리고완제품 Inventory management ( 재고관리 ): the process of managing inventories to minimize costs, including holding and stock-out costs 가격을최소화시키기위한재고관리과정으로써보유비용또는재고부족보충을위한조달비용도포함되있다. Stock out ( 재고부족 ): A situation in which the demand or requirement for an item cannot be fulfilled from the current inventory 현재의재고로부터아이템의수요나필요사항이충족될수없는상황 Just in time ( 적기공급생산 ): An inventory strategy companies employ to increase efficiency and decrease waste by receiving goods only as they are needed in the production process, thereby reducing inventory costs. 생산과정에필요한제품만받아서효율성을높이거나낭비를줄이기위해회사들이이용하는재고전략, 결과적으로재고비용을줄인다 Quality control ( 품질관리 ): The process of ensuring that goods and services are produced according to specifications. 설명서에따라서제품이나서비스가생산되었는지를보장하는과정

29 25 What functions does a business require? Imagine you were the founder of POPCO when it first began as a company. When thinking about the tasks you needed to accomplish, and the people you would need to accomplish them, how would you know the best way to organize in order to be most efficient? We know from common sense and theory that specialization helps businesses to be more productive, and that division of labor is one of the most basic kinds of specialization. But what about POPCO s business? Thinking about a toy company like POPCO, you would need people to produce the toys like factory workers, people to buy the materials and get them to the factory, and people to manage that process. You would need people to sell the toys, and promote them as well as to research what people want, and what they are willing to pay. Finally, you would need people to manage the money coming in and out of the business. Figure 3.1 Core functional areas of a typical manufacturing business The main responsibilities of the operations department The operations department is responsible for all the activities required to transform resources such as raw materials, technology, and labor into goods and services that meet customers needs. To fulfill that responsibility, the operations department undertakes many specific tasks. They work with marketing to design new products and services. They work with suppliers to negotiate and purchase resources such as materials, technology, and labor needed for production, and cost and schedule production. Figure 3.2: Typical roles in the operations department Operations Director Production (Operations) Sales and Marketing Finance and Accounting Purchasing Production Manager Crew supervisor Inspection Facilities & Maintenance Logistics Support Transportation These tasks are very different in their nature, and require special skills to complete. You would not expect a factory worker to be able to develop a promotion campaign necessarily, nor would you expect an accountant to make a good sales person. Logically, an effective way to organize your new business would be by grouping people into departments according to the similar activities or functions they perform. And that s what most businesses do. So we will first look at the Operations department of POPCO. Scheduling They design, develop, and organize production processes to make production as efficient as possible, and supervise production. They maintain the company s plant, property, and equipment to ensure it is operational. They organize and control the firm s inventory, and inspect all inventories for defects and suitability to ensure quality standards. Materials Mgmnt & Stock Control Warehousing

30 26 They work with marketing and sales as well as channel partners to ensure smooth holding and transportation of goods with the help of logistics specialists and systems. In manufacturing in particular, the operations department is a broad department with many sub specialties. When talking about operations, many people use the word stock when discussing inventories. In this sense, stock is another word for inventory. In this context, the word does not mean shares as is used in a financing or investment context. The basics of operations management: cost, time, quality Operations management requires balancing the three main variables of production: cost, time, and quality. Often the decisions an operations manager makes will impact one or more of these dimensions. It requires great skill to understand the pros and cons of different decisions and be able to make them quickly under constant pressure and changing requirements in the operating environment. Operations is under constant pressure to increase operational efficiency while at the same time provide greater and greater flexibility and responsiveness. These are competing objectives in most firms. In general, the operations department must consider the constraints of the operating environment set by the company s existing plant, property, and equipment: operating capacity. They will understand the capacity of the firm s own production facilities in order to determine how much output the firm is capable of producing in a given time period, and for particular regions. They will also understand the productivity possible given the inputs of resources (including labor) available, and consider the impact of changes in the type of product or service specified for production on productivity, processes, and quality. Much of the study in operations management is the quantification of the efficiency of processes and systems. Variables that affect the efficiency of a system include such things as whether products are made for inventory or made to order, how much automation can be used, what materials can be used and from which suppliers, the skill and availability of labor, the scheduling method and prioritization of jobs, the variability and complexity of production tasks, and the information management available to inform the production process. Because operations efficiency can make such a significant contribution to company performance, companies are extremely interested in analyzing their operations systems for improvements. Often they hire process improvement or operations analysts for this task. Calculating productivity Productivity as you recall is a measure of output units produced per unit of input. Operating inputs include such things as labor, capital, energy, materials, and management. Productivity can therefore be measured using any of the three operating dimensions: product output per dollar of input (cost), product output per labor hour (time), product output per certain number of defects (quality). Often, a company will target a certain level of productivity increases over a year or several years, depending on how many new products are in production. Thinking about capacity Capacity is the amount of products or services that a plant can produce (output), hold, store, and receive in a given period of time using current resources. Calculating capacity involves an understanding of operating limitations, also called constraints. Systems like companies and factories have a theoretical capacity (called design capacity) that the system can achieve under ideal

31 27 conditions. However, because production is complex and involves so many variables, this theoretical capacity is rarely, if ever, reached. Companies talk in terms of effective capacity or throughput instead of design capacity. Effective capacity is the output the firm expects to achieve given the expected and anticipated operating efficiency of the equipment and constraints of the system (constraints such as asset maintenance, labor time for completing standard tasks, shut down time, lunch breaks, etc., which are usually arrived at by looking at historical data). It is a measure in units or time that it is expected to move an order from receipt to delivery in a realistic calculation. The efficiency of a company or system is calculated as the actual output / effective capacity x 100%. Actual output will always be less than effective capacity because of unanticipated issues such as machine breakdowns, inventory management issues, and quality problems. However, firms should strive for 100% efficiency of operations. This does not always mean cutting costs, as investments can increase output at a greater rate than the required increase in costs. The extent that a company such as POPCO or an industry as a whole actually uses its available capacity at any given time is called utilization. The utilization of a factory is measured as a percentage of its theoretical design capacity, actual output / design capacity x 100%. Utilization will naturally be less than 100% because every system requires upkeep and cannot run 100% of the time. Occasionally economists will look at utilization to analyze the state of demand and inflation. For POPCO, a meaningful measure of capacity of our factory might be the number of Clucky Chickens produced per labor hours, or per sewing machine operating hours. Constraints determining our effective capacity might be the standard operating efficiency of our sewing machines in a 60 hour work week, the stock of materials readily available, and the experience of workers doing the tasks. Constraints that might reduce our operating efficiency below 100% might include strikes by workers, unreliable electricity supply to the factory, unexpected sewing machine breakdowns, errors in the production process, etc. Effective capacity for POPCO Consider the different processes involved in producing Clucky Chickens (called sub tasks ): cutting fabric, sewing fabric, assembling plastic parts and inserting computer chip components, stuffing and gluing, labeling, testing. Each of these processes is unique, and varies in the types of materials involved, the standard operating efficiency of the equipment, the amount and skill of labor required, the time it takes for task completion, and the productivity of the sub-task in terms of units output per labor hour. Each sub task has its own effective capacity. For each sub task, the time required to produce one unit of output per operator or workstation is called its cycle time. The lower the cycle time the higher the sub task s effective capacity. For some tasks, adding additional operators can increase the output per subtask and therefore its capacity. But not for all. The total time of all the cycle times in this process is called its processing time. There may be waiting time between sub tasks that affect the overall output of the whole toy assembly process. The waiting time plus the processing time is called the lead time. Often this is the order processing time. The interaction of these different processes will have an impact on the overall output of our factory, and its effective capacity, even though none of these variables is unexpected or a problem. The limitations of necessary sub process capacities limit the effective capacity. For instance, if one fabric cutting machine worked by one factory worker can cut 15,000 Clucky Chickens worth of fabric pieces per day as its standard operating efficiency (a cycle time of 2.4 seconds/unit for a 10-hour workday), it does not necessarily mean our effective capacity is 15,000 Clucky Chickens per day. Our team of five gluing workers might only be able to glue and complete 5,000 Clucky Chickens per day in total working at maximum speed for minimum defective products. That does not mean our

32 28 gluing workers are slow, it means that that process has a lower capacity than the fabric cutting process, and so is an effective constraint on overall output. Gluing may be our bottleneck task in our toy assembly process. Capacity, productivity and inventory management Considering the fabric-cutting example, what would happen if POPCO worked in that manner for a week? In one week we would have an enormous build-up of inventory of cut fabric. Short-term materials management would help ensure that this material was used effectively over time, but the operations manager might want to consider how to balance the activities of fabric cutting with the other activities of Clucky Chicken production to avoid the costs of excessive materials management and inventory holding costs. Both of these cost money, and that cash resource might be better spent elsewhere. Marketing and operations will work together to identify the capacity required by estimated or actual sales orders. Operations will then determine whether the current plant and facilities available capacity is sufficient to meet the demand even at peak periods, or if additional capacity is required. In the short-term, scheduling and allocation of equipment and resources can help use more of existing capacity. In the medium-term, it may be necessary to increase capacity by adding labor or shifts, improving assets, or outsourcing. Better management of materials and inventory can improve the utilization of increased capacity. In the long-term, the firm must consider adding facilities and equipment in order to increase capacity. All of these changes to utilize and increase capacity can have an impact on productivity, and it is not always positive. Adding workers can slow down efficient production teams, as new workers must be trained. Outsourced activities may have quality control issues. Adding shifts may destabilize work relations. Using more capacity might threaten capacity availability during peak periods, slowing down throughput overall. Operations managers must consider the best use of capacity given all the demands on the system. Labor intensive or capital intensive For manufacturers especially, a key consideration of operating efficiency and efficiency improvement will depend on whether the firm s operations are laborintensive or capital-intensive processes. Labor-intensive processes require manual labor to complete, while capital-intensive processes are usually heavily automated. POPCO s production is extremely labor-intensive, although we do use machinery. Most operations requiring sewing and mixed-materials assembly are labor-intensive. Capital and labor-intensive processes have different costs and risks associated with them. Capital-intensive processes have high initial costs compared to labor-intensive processes, but their running costs and operating risks are lower over time. The operations process Consider the following situation: POPCO s Clucky Chicken toys are selling very well, so POPCO plans to extend its artificial intelligence toy product line by adding a new toy: Rolly Rabbits. As marketing establishes requirements for the product, the operations process begins. The following outlines the basic processes of operations: 1. Develop specification 2. Purchase materials, organize resources, design processes 3. Schedule production, manage and control materials 4. Oversee production and move inventories 5. Store and transport goods

33 29 Specification The specification defines the exact design, capabilities, and materials required of a product or service. While the specification must be exact, it is based on requirements from the marketing department that may be descriptive in nature. Descriptions can be subjective. For that reason, the operations team (or sometimes a product development team) will quickly design and produce a limited amount of the product based on the requirements. These one-off products are called prototypes, and are usually created with the help of computer aided design technology. Prototypes allow operations and marketing to test, evaluate, and clarify the best design, capabilities, and materials for the market s needs and firm s unit cost limitations. Once a completed specification is available, the firm can fully engage in the operations process. One risk is that marketing requirements will change once the operations process has begun. Changes to requirements usually demand changes to the specification and therefore changes to purchases, design, materials, etc. These changes can be extremely costly. To manage such risks, companies try to develop fast prototyping capabilities, more reliable market data and testing techniques, and more flexible operations processes. Purchasing and resource organization Next, companies will purchase required materials and organize all materials, inventories, equipment, and labor for production. While labor is acquired with the help of the human resources department and equipment and machinery required is managed through facilities, purchasing is an often-overlooked key aspect of operational efficiency. The purchasing team will identify multiple suppliers based on their cost, reliability, and reputation for quality. Then they will negotiate amongst suppliers for the best deal. Often cost is not the most important factor. To avoid losing advantage in such negotiations because of time pressure, the purchasing team will often evaluate categories of suppliers long before specifications are available, and evaluate them in a very thorough process known as vetting. Successfully vetted suppliers are then added to an approved suppliers list, and can receive requests for supply quotations at any time. This long-term relationship building can benefit both supplier and buyer in terms of reliability. On the downside, it makes it difficult for new suppliers to build businesses, and can hurt certain vetted suppliers if they do not receive a steady stream of work. Process design is the design of how production proceeds. It can involve the planning of materials movements, the layout and use of production lines and facilities, the standardization of tasks, and the method for incentivizing labor productivity. These processes are communicated in manuals, through training, and on-the-job. Over time what are the risks of long-term supplier relationships where the suppliers are in developing countries with lower standards of regulatory (legal) enforcement? What can companies do to manage these risks? Scheduling and materials management Scheduling involves identifying the most efficient use of labor and equipment considering all of the production happening in a particular firm at a given time. It is the timing of operations. The firm s overall operations will have a planned capacity including its total facility and equipment resources available that is usually planned yearly. The firm might make monthly plans of total output based on total forecasted demand or orders for its products and services. They will then construct an aggregate plan over a long period such as 6-18 months of all the resources and capacity needed. Aggregate planning of considers the facilities available, the inventories in stock, current labor and contract resources to calculate the total output of product or services possible in a given time period,

34 30 typically a month. This allows them to find efficiencies and save on the cost of operations. When people use the term scheduling, they typically are not referring to overall capacity or aggregate planning. Scheduling refers to the production timing for specific products or product lines for each week. Scheduling breaks down capacity and aggregate planning measures into job sequences and specific assignments of personnel, materials, and machinery. The objective of scheduling is to allocate and prioritize demand from forecasts or orders to available facilities. For POPCO, scheduling might be based on demand forecasts (a push system) to avoid shortages of finished goods for sale (called stockouts), or might be based on actual orders (a pull system) to avoid holding excess work in progress inventory. Order-dependent production requires efficient order processing from marketing, and is an important area of marketing-operations interaction. Just in time (JIT) manufacturing is based on a pull system, in other words where a unit and the production system is organized starting from the pull of a specifically required output like an actual order. Most likely, our scheduling would be based on a combination of methods: push anticipating peak times, and pull for off peak periods. Materials management is the management of the material resources used by the production processes in the production schedule. Materials management is essential for ensuring the exact materials required by production are in the correct place at the exact time needed. Inefficient materials management compounds inefficiencies of production and capacity utilization because once a production process is stopped it cannot instantaneously start again there are set up and startup time lags and costs. There are also costs associated with the purchasing process itself. Production oversight and inventory management Production oversight is necessary to ensure that production targets are met and quality standards upheld. But production oversight is also critical for managing inventory. Inventories for manufacturing firms like POPCO are generally classified in the following three broad categories. Raw materials and components are inventories that have been purchased but have not yet entered the production process. Work-in-progress inventory is inventory that is partially processed through the production process, but is not yet finished goods inventory. Finished goods inventory is inventory awaiting shipment or storage. Inventory management is the process of managing inventories to avoid holding costs and stockouts. Production management s goal is to manage production of exactly the output required by established plans. A production line or crew manager should constantly be aware of the productivity of the line compared to targets, as well as unexpected outcomes that will reduce operating efficiency. A production manager s awareness and ability to respond to changes is a major source of a company s competitive advantage. In general, holding too much inventory of any type for too long is extremely costly for businesses, as every minute inventory is held is a minute that the firm incurs costs such as warehousing, materials handling, labor, and even potentially financing costs, with no revenue to match it. These are called holding costs. So production oversight is not about producing the maximum output possible at all times, but producing the required output for a specific job at the quality standard set by the company. Quality These days quality is a focus of the operations process. Ensuring quality helps improve the overall efficiency of an operation by eliminating defects and the cost

35 31 of returns (which require reworking or destroying finished goods, called scrapping) and related legal liability. Increased quality reduces the costs of warranties. (A warranty is a written guarantee issued to the purchaser promising to repair or replace it; in Korea, the A/S contract). Quality reliability enhances a company s reputation, which in turn can increase sales. Quality standards may be required by industry or international regulations. Similar to how the marketing orientation has moved away from product selling towards customer satisfaction, the operations orientation has moved away from output maximization to quality prioritization. For an operations manager, quality tends to be manufacturing and product-based, conforming to standards, product characteristic or performance criteria, and making the product right the first time. The quality inspection process usually involves two dimensions: testing for whether a good is defective or not according to its intended design (called attribute inspection), and testing for its acceptance according to a specification of acceptable values for things like weight, speed, height, strength, etc. (called variable inspection). A Rolly Rabbit might have ears that are 1mm shorter than the design, but still work fine. The company defines the acceptable variation range for variable quality inspection purposes. Companies should determine when and where they intend to inspect inventories. Quality inspections are needed for supplies as well as inventories at each step of the operations process, and can even take place for finished goods at the customers locations. Storage and transportation of goods The final stage of the operations process is the transportation or storage of finished goods inventory. Often storage and transportation are negotiated between the producer and intermediaries in the supply chain. But several considerations are important: who is the rightful owner of the goods at what stage in storage or delivery? Who is responsible for insuring the goods during storage or transportation? Who is responsible for the timeliness and cost of delivery and the security of storage? These are important considerations, and it is essential for operations to be clear by working closely with the trade marketing team and their customers. While we mentioned the costs to hold inventories previously, the costs of transporting goods vary by method. Transporting by air is fast but expensive, by sea is slow but more cost effective. Additional methods include railroads, trucking, and smaller waterways, and for specific products, pipelines. The volume being transported also has an impact on unit transportation costs. Transportation efficiency especially using container shipping revolutionized international trade and supply chains. It so drastically reduced the cost of global shipping that now most companies rely in some part of their supply chain on global container shipping. Companies now have access to suppliers and markets around the world. For most companies, containerized transportation is very standardized and, aside from recessionary times when ships might stay in port, predictable. But there is significant responsibility for managing all the local and regional aspects of moving and storing all the materials and inventories of a company s supply chain. It is an extremely complex effort, beyond the capabilities of most firms. Therefore companies often outsource to specialists the management of how their resources are obtained, stored, and moved to the locations where they are required along the supply chain. This specialized management is called logistics. Logistics is an increasingly important part of global business, as it is required to maintain operating efficiency. Distribution of goods to and from a firm s facilities can account for 25% of the cost of a product! Logistics experts balance timeliness with methods of shipping and storage to arrive at efficiencies. Logistics is becoming more and more efficient every day with the help of technologies, from radio tagging of inventory items to security technologies for stock in transit.

36 32 What do you think is the impact of logistics outsourcing on the environment, and corporate responsibility for the environment? Summary: The Operations department In this unit you have learned about: The different roles and functions within an operations department Productivity and capacity Production processes and management considerations

37 33 Worksheet 3 (front) True or False. 1) Capacity is limited by the operating efficiency of machinery. 2) In the short term, firms should consider managing capacity by adding facilities and buying new equipment. 3) POPCO s business is considered both labor and capital-intensive. 4) The specification of a product is a general description of the market requirements for how a product should look and feel. 5) Purchasing selects suppliers based on who is the cheapest. 6) Scheduling for firms is usually done yearly for product lines based on estimated market demand. 7) POPCO most likely uses pull processes during peak times because this will ensure safe levels of inventory for unexpected orders. 8) A stockout may result from poorly managed inventory. 9) Holding excess inventory is cost effective because it will cause a rise in price. 10) Quality standards are absolute and an inspected product is either OK or defective. 11) Because transportation methods are mostly standardized, logistics is a simple job and a very small part of the cost of production. (12-15) Calculate the productivity increase of POPCO in their Clucky Chicken production line between 2011 and Units produced 200, ,000 Labor (hours) 10,000 9,000 Materials ($) 400, ,000 Capital invested ($) 15,000 5,000 Energy (KWH) 60,000 70,000 Labor wage = $2 per hour, Energy cost = $0.07 per KWH Productivity = Units produced / Input used 12) 2011 Clucky Chickens per $ input, to 5 decimal places: 13) 2012 Clucky Chickens per $ input, to 5 decimal places: 14) Productivity increase to the nearest whole % = % 15) List 5 operations management actions that could likely have resulted in the above productivity increase. Look closely at what information you have, and what changed between 2011 and ) On the back of this worksheet, draw a picture of part of the operations you can observe at any business on the Dongguk campus (for instance, Vonie coffee, the cafeteria, copyshop, etc.). Note the subtasks involved, the stations and equipment, the workers per station, and the output for production of one product or service. Note the cycle times and overall process cycle time, lead time, capacities per workstation or machine, for one hour.

38 34 Worksheet 3 (back) Where are the bottlenecks? What would you recommend to improve productivity?

39 35 Unit 4 The Marketing Department Learning objectives of this unit In this unit you will learn the following concepts: What are the different roles and functions within a marketing department? (in class: diagram) What are the 4Ps of marketing? (in class: discussion) How is consumer behavior understood, and how does it impact the various aspects of marketing? (in class: POPCO example) What is margin, markup, and breakeven? (in class: problems) What are different pricing strategies? (in class: pricing exercise)

40 36 Unit 4 Vocabulary Trade marketing ( 트레이드마케팅 ): marketing that relates to increasing the demand at wholesaler, retailer, or distributor level rather than at the consumer level 소비자보다는도매업자, 소매업자또는유통업자의수요를증가시키는것과관련있는마케팅 Market share ( 시장점유율 ): a percentage of total sales volume in a market captured by a brand, product, or company. 브랜드, 제품또는회사가확보한시장에서의전체판매량비율 Markup ( 가격할증 ): the amount a seller adds to the cost of a product to determine its basic selling price 기본판매가격을결정하기위해판매자가제품의가격에더하는금액 Margin ( 마진 ): the amount of revenue that is retained as profit (gross, operating, or net income) 이익으로써보유하고있는수입금액 ( 매출총이익, 영업이익또는순이익 ) Breakeven quantity ( 손익분기수량 ): the number of units that must be sold for the total revenue from all units sold to equal the total cost of all units sold. Every unit sold after the breakeven quantity contributes to profitability. 판매되는모든유닛의비용과총수익이같게되기위하여모든유닛은판매되어야한다. 손익분기점이후모든수량은수익성발생에기여한다. Profit maximization ( 이윤극대화 ): The process where a firm considers the best output and price to create the greatest amount of profit 이윤을극대화시키기위해기업이최고의아웃풋과가격을생각하는과정 New product pricing ( 신제품가격결정 ): consists of either penetration pricing (charging a very low price to get maximum market share) or price skimming (charging a high price ) to maximize profits while the product or service is unique in the market 독특한상품이나서비스의이익을극대화하기위한시장침투가격전략 ( 시장진입시기에가격을낮게책정하여시장에침투하기쉽도록하는것 ) 또는초기고가전략 ( 출시당시고가전략을고사하는것 ) 이다. Differential pricing ( 차등가격 ): charging different prices to customers for the same product and quantity of product 생산물을등급화하여등급별로차등된가격을받는것. Psychological pricing ( 심리적가격 ): encourage purchases based on emotional responses rather than economically rational responses 경제적으로합리적인반응보다는감정적인반응에근거하여구매를격려하는것 Promotional pricing ( 프로모셔널가격 ): pricing products in coordination with promotional activities in order to increase sales volume, drive foot traffic into a store, or to move slow-selling inventory 판매량, 매장으로의상시인파또는느리게팔리는재고를이동시키기위해판촉활동과합동으로제품가격을책정하는것

41 37 The main responsibilities of the marketing department The main responsibilities of the marketing department are to create value for customers and build customer relationships so that the company can capture value from customers in return. Several activities help achieve this goal. The marketing department engages in research activities (called customer insight) to understand the marketplace, including who the target customers are, and their needs and wants. They translate this information and what it means for the company into a strategic marketing plan, which outlines the target customers, what they want, how to acquire them and keep them as customers, and how to encourage their loyalty. They then engage with the rest of the organization as well as outside experts in order to deliver a marketing program that achieves the goal of the marketing plan. The program will likely include several aspects: developing new products or refining existing products that customers want, strategies for targeting specific customer segments, pricing products, deciding the distribution strategy to intermediaries, and the sales and promotion activities needed to ensure the company captures the maximum value from customers. In addition, the marketing department manages the customer relationship of existing customers to try and develop their valuable loyalty. Figure 4.1: Typical roles in the marketing department Marketing Director Trade marketing (sales) Trade support Customer support The marketing department is typically separated into two main areas: trade (sales) and brand marketing. The trade marketing team is responsible for working with intermediaries and customer points of contact in the trade to sell the company s products and services, and encourage others to promote them. Typically they work with points of contact in intermediaries like wholesalers, retailers, or agents and brokers. They often manage intermediary-specific promotions and activities to encourage a profitable relationship between the company and the intermediaries responsible for reaching the customer. They spend a lot of time developing close relationships with intermediaries. Brand marketing, in contrast, manages the development of the company s overall approach to targeting customers, as well as defining the products and services that will satisfy them. They establish base prices and pricing strategies to reach the financial goals in the marketing plan, as well as deciding the channels to market and promotions that will deliver promised revenues. Brand marketing Customer insight New product development Trade marketing is supported by marketing staff. These trade marketing staff work quickly to ensure intermediaries get their products on time and receive promotional incentives to encourage them to sell the company s products and services. These staff members also work to inform intermediary customers about

42 38 how the features, benefits, and promotional support of products will affect the intermediary s bottom line. In contrast, brand marketing is supported by a customer insight team. The customer insight team determines the needs and wants of the market as well as existing customers using research techniques. Brand marketing is also often supported by a new product development (NPD) team. The NPD team designs product changes or new products to answer the customer needs and wants revealed by the insight team. (In some companies product development is a separate division, in others it falls withing engineering or operations.) So what of customer relationship management? In other words, which area supports existing customers who are not satisfied, and encourages happy customers to tell others about their experiences? In most companies, customer support was originally a function of sales, a role that listened to customer complaints via the intermediary, not directly. In the era of call centers (A/S), often this responsibility was outsourced, and sometimes moved to an operations function. These days, though, companies are much more directly aware of customer complaints thanks to the Internet. Some feel that customer relationship management should be a strategic part of the brand marketing function, while others insist that it is rightfully managed and fixed in operations, because they have the knowledge, resources and financial authority to devote to eliminating defects that cause dissatisfaction. For many companies, the idea of a unified approach to customer relationship management is still not well supported organizationally. The 4Ps As mentioned in the overview, the general categories of marketing activities were traditionally group into the 4Ps of marketing. These days, however, this categorization is not as popular because it does not highlight the aspect of customer relationship management that is important for developing long-term, profitable customers. Also it does not emphasize the external relationships and cooperation needed to satisfy and support target customers. For the moment, though, the 4Ps is a good memory device for you to recall all the different areas marketing is involved in. The 4Ps include: Price, Place, Product, and Promotion. (The order does not matter.) Due to time constraints this course will focus on Price, Place, and Product. Before considering each area of the 4Ps in the following sections, we should start with the customer universe. Understanding the market and customer An essential role found within the marketing department is that of customer insight, often called the market research department. This team is responsible for identifying trends in consumer behavior, needs and wants. They also recommend how environmental changes might create opportunities for targeting new customers, creating new products, or new strategies for pricing, distribution, and promotion. As customer insight managers identify new groups of consumers that have different needs and wants, they try to group them according to one or more common characteristics so that the brand marketing team can develop the appropriate pricing, distribution and promotion strategies for them. These groups are called market segments, and the groups that are of interest to the company are called target market segments or target customer segments. Identifying target market segments Target market segments often have one or more characteristics in common. The typical characteristics that the insight team studies and uses for segmenting purposes usually includes some aspects of demographics like age, gender, income, education, social class, technology use, family size, occupation, etc.. It also may include psychographic characteristics such as personality, lifestyle, and motives,

43 39 geographic characteristics such as urban or rural, city size, climate, country, etc., and behavioral characteristics such as amount of product or service used, frequency of purchase, brand loyalty, price sensitivity, and purpose for how they use the product or service. Table 4.1 Characteristics used for segmenting markets Demographic Psychographic Geographic Behavioral Age Gender Income Education level Social class Technology use Family size Occupation Personality Lifestyle Motives Attitudes Country Region Type of dwelling City size Climate Volume of use End use Benefit expectations Brand loyalty Price sensitivity Consumer behavior The last piece of the insight puzzle is about understanding consumer behavior with respect to the company and our products and services. Consumer behavior is involved in every aspect of the end customer s interaction with POPCO and our products. So we must understand their behaviors in order to sell to them and ensure their satisfaction and loyalty. Aspects of consumer behavior include how much time, effort, and interest the end customer spends in selecting a product. Generally, a customer will recognize or act on a need or want by first searching for information, evaluating alternatives, making a purchase, then evaluating their expectations compared to the actual experience after purchase. There are several influences on this process. Figure 4.2 Types of consumer behavior influences on decision-making Situational: immediate Decision influences Psychology: individual Social: community For example, a POPCO target segment might be urban dwelling, technologicallyactive Korean housewives with motherhood anxiety. Our marketing insight team would use a combination of quantitative and qualitative market research to identify how many of these women there are, what messages and product benefits are likely to appeal to them, where they shop, what they feel about our brands and our intermediaries brands, and their sensitivities in terms of product pricing. Situational influences are very specific to the immediate purchase occasion: physical surroundings, social surroundings, time of day, purchase reason, and buyer s mood and condition. Psychological influences are very often within the buyer s individual mind, whether consciously or subconsciously, before they approach the purchase decision. They involve the consumer s perceptions, motives, learning, attitudes, personality, and lifestyle.

44 40 Finally, social influences are about the buyer s family influences, role in their social circle, peer groups, social class, and the culture and subcultures to which the buyer belongs. Often these social rules, obligations, and norms will have a great influence on buyers purchases. However, the level of influence varies greatly in nature between cultures. The customer insight team will use mostly qualitative research to understand the relevant consumer behaviors and their impact on the decision process for a company s particular product or service. Once the insight team has delivered a clear picture of the market trends and opportunities, defined customer segments, and identified the key consumer behaviors that will affect the target market s purchase behavior, the marketing team is ready to go to work on the 4Ps, product, pricing, place (distribution), and promotion. While in reality the marketing team would first likely consider product design and development next, we will look at products in Unit 12. Instead, we will first consider the basics of pricing. Pricing It is the responsibility of the marketing team to deliver revenues to the business (in other words, to generate sales opportunities and convert them to actual sales). A key measurement of their effectiveness is net sales. So a key consideration for the marketing department is to establish a target selling or retail price and projected volume of sales for the products or services the company sells. This target price may change as the company applies different pricing strategies to maximize revenues, encourage purchase and turnover inventory. (This is especially true if actual sales volumes appear to be different than those projected.) However, at the start, the company works with base price assumptions in order to ensure they meet the company s revenue objectives. There are three ways to set this base price: according to the costs of production, according to the demand for products, or according to the prices charged by competitors in the market. Cost-based pricing Setting the base price according to the cost of production is also known as costbased pricing. Cost-based pricing is the simplest form of setting a base price. You simply establish the target profit on a unit basis, then add this to all the costs related to producing the product (including all direct and indirect expenses). The difference between the cost of production and the final price is called the markup. The markup is set to ensure that you cover the costs to produce each product, plus the additional amount in profit you want to make. Expressed as a percentage, the markup is the difference in between the final selling price and the unit cost, divided by the unit cost. (Compare this to the margin, which is the different between the final selling price and the unit cost, divided by the unit price). In order to guide setting target sales quantities with cost-based pricing, operations and marketing teams often together conduct a breakeven analysis. Breakeven analysis Breakeven analysis establishes how many units of a product or service must be produced and sold in order to cover all the costs involved in production of that product or service. The same technique can also be used to determine how many units of a product or service must be produced and sold to reach a set target such as profitability. The costs are viewed as a combination of fixed costs and variable costs. In order to calculate the breakeven for a particular product, for instance, you identify the quantity where the total costs attributable to producing a product are equal to the total revenues earned by selling the product.

45 41 TC = TR Total costs are a sum of the variable and fixed costs attributable to a product. Variable costs may change with the number of units sold, but fixed costs must be paid no matter how many units are sold. In other words, TC = VC* Q + TFC Where VC is the variable costs per unit, Q is the quantity of products and TFC is the total fixed costs Total revenues are simply the target selling price for the product times the quantity sold. The target selling price is set by establishing a target profit margin and then using cost-based pricing. TR = P * Q Where P is the target selling price of the product set according to a target profit margin, and Q is the quantity of products Solving for Q, we have Q = TFC / (P VC) So when examining breakeven, companies must first establish the cost contribution of production. It is easy to establish the direct costs of manufacturing in terms of materials costs, and it is not too difficult to estimate the direct labor contribution costs based on the productivity of a particular product manufacturing line, but testing a small run of production. Similarly, some fixed costs are easy to attribute to a particular product: campaign and marketing costs for that particular product, for instance. But what about the operations management time for a particular product, when it is just one product being produced in a large factory? What about the inventory costs for one product in a warehouse full of inventory being constantly moved and managed? You can see that the process of establishing breakeven is a process of estimations and guessing in many ways based on information that is known. However, the basic steps to calculating breakeven are to establish which costs are fixed and which are variable, and then to calculate the total variable costs based on the same units (per single unit). While cost-based pricing seems simple, it can often cause problems. For one thing, the markup can only be established after all production costs and indirect expenses are effectively calculated. If additional production costs or indirect expenses are later incurred, there is no way to recoup these except by eroding the profit margin on each product. Secondly, cost-based pricing is not reactive to market forces. A markup may make the final retail price too high for the price sensitivities of customers, which will therefore reduce sales volumes, which will in turn erode overall revenues. Costbase pricing therefore often creates the need for promotional pricing strategies to adjust to the market. Cost-base pricing is popular with retailers and wholesalers, and you can see that these intermediaries rely heavily on additional pricing strategies like promotions and sales to clear inventory that may have too high a markup. Demand-based pricing One issue with cost-based pricing is that it does not respond to market demand. For example, cost-based pricing would not capture the possible profit when demand was high, and might be sensitive to falls in revenues when demand is low. Demand-based pricing is a different method for setting the base price of a product or service according to demand. The marketer estimates the quantity of products that will sell at many prices, the selects the price that will generate the maximum total revenues. This method requires the marketer to be able to accurately forecast demand and price sensitivity for products.

46 42 Demand-based pricing can be used to capture the maximum possible revenues from different customer segments, different purchasing occasions, or through different purchasing channels. Price is still set according to demand, but this gives the company more ability to capture more possible revenues than just using one price for every customer regardless of occasion, segment, or channel considerations. This is a form of price differentiation. Competition-based pricing In competition-based pricing, the company bases its price on consideration of competitors prices. They may set the price the same, above, or below competitors prices to meet revenue and profitability objectives. Clearly, though, this pricing is qualified by other conditions such as the costs to avoid making a loss. In such a case, the company would likely exit the product or service market to avoid making losses. Beyond base pricing: pricing strategies Pricing strategies are used to respond to the market in such a way as to ensure that the company s overall revenue, market share, or profitability objectives are met. These overall objectives may not be able to be achieved using stable base prices alone, mostly due to the lifecycle of the product and other market and environmental forces. Types of pricing strategies include: new-product pricing, differential pricing, psychological pricing, product-line pricing, and promotional pricing. New product pricing strategies are used specifically to capture value as new products enter the market. They include price skimming, where the company charges the highest possible price for the product as it is introduced to the market and demand is high for its uniqueness or other desirable benefit. New technology products often use price skimming as they enter the market. The other type of new product pricing is called penetration pricing. The purpose of penetration pricing is to penetrate the market as quickly as possible, acquiring as many customers and quick sales as possible. Penetration pricing does this by setting the product or service price low. In a way, this is opposite to price skimming. Penetration pricing s key objective is market share, while pricing skimming s key objective is profitability and exclusivity. Differential pricing strategies are used to allow a company to maximize revenues and respond to varying demand and price sensitivities by charging different prices to different customers for the same quality and quantity of product. Examples of differential pricing are negotiated pricing, where buyers and sellers negotiate the final price; secondary market pricing, where different target segments are given a different price as in early-bird dinner specials, online-only deals, and different country pricing. Psychological pricing is where companies encourage purchase based on emotional rather than economic responses such as in charging odd numbers rather than whole numbers for items, called odd-number pricing, or giving a bulk price for many units, called multiple unit pricing. Psychological pricing also includes bundle pricing, where a company bundles together many products or products and services together to give the impression of value, as well as everyday low prices, where a company tries to save intermittent marketing and promotion costs by developing a brand promise of consistently low prices, thereby paying for the price discounts. Product-line pricing is a strategy where companies consider how customers view product prices in relation to other products in the same line, like printers and toner cartridges, called captive pricing, or premium items versus everyday versions, called premium pricing. Another method of product-line pricing is setting product prices in a product line at predetermined levels: 29,999, 49,999 and 69,999 for instance. This is called price lining.

47 43 Promotional pricing strategies are where companies coordinate pricing with specific promotional activities to encourage sales (special-event pricing), set prices extremely low to encourage footfall (price leaders), or promote prices by showing them compared to a previous price or competitors prices (comparison discounting). Summary: The Marketing Department In this unit you have learned about: The different roles and functions within a marketing department, including the 4Ps What are the ethical implications of different pricing strategies? When is a pricing strategy unethical if there are buyers willing to pay the price? How does the availability of information affect the ethics of pricing, and the rationality of consumer behaviour in purchase decisions? Ways of understanding customer market segments and consumer behaviors that affect purchase decisions The different ways to determine pricing How to calculate margin, markup, and breakeven, and the impact on sales quantities needed for breakeven and for a target margin % Different pricing strategies

48 44 Worksheet 4 (front) Match the general type of pricing strategy with its use. a) New product b) Differential c) Psychological d) Product-line e) Promotional 1) Papa Johns pizza charges $27.99 for a large pepperoni delivered, $19.99 for the same pizza take away 2) Apple sells the iphone 6 in 2014 at $899 3) Daiso charges 1,000 won, 2,000 won, or 5,000 won for all its products 6) If you were the marketing manager, how would you approach this problem (hint: review what you have learned in this Unit)? List the steps below. a. Step 1: b. Step 2: c. Step 3: d. Step 4: e. Step 5: 4) Lotte Mart has a Chuseok holiday sale on gift boxes of fruits 5) Burger King offer a student set meal including drink, fries and sandwich for 7,000won Problem modeling. POPCO is launching a new product this Christmas season to complement Clucky Chickens: the Clucky Chicken Coop. Based on the strategic goals of the company and the artificial intelligence toy division s targets, POPCO needs the Coop product to contribute 30% operating profit margin. The Operations team needs you to tell them how many units to target for production, and the Sales team need you to give them pre-sales targets.

49 45 Worksheet 4 (back) 19) In the space below, describe 3 different pricing strategies for pricing Clucky Coops at $5, $10, and $25 respectively. Describe why you might choose each strategy. Clucky Chickens retail for $10 each. 20) In the space below, calculate the minimum quantity for production/presales needed for one of your pricing choices from question 7, given the following information from operations and your team: Clucky Chicken Coop related costs Plastic mold for coop $25,000 Design services $8,000 Materials costs per unit $1.30 Production line labor per unit: assembly, packing $1.00 Inventory management cost per 1,000 units $200 Additional direct overheads: per 1,000 units $50 Promotion campaign $250,000

50 46 Unit 5 Supply Chain and Channel Management, Category Management, R&D and NPD Learning objectives of this unit In this unit you will learn the following concepts: Supply chain management for a manufacturing firm (in class: diagram) The kinds and roles of intermediaries in the purchasing and selling of goods and services (in class: discussion) Different possible distribution strategies (in class: discussion) Product mix, product line, product family, product line extension (in class: map of POPCO family exercise) New product development process (in class: exercise) Category management? (in class: discussion)

51 Unit 5 Vocabulary Order processing ( 주문처리 ): receiving and filling customers purchase orders 고객들의구매주문을받고채우는것 Materials handling ( 자재운반관리 ): the physical handling of resources in warehouses as well as during transportation 창고나운송중상품의물리적인처리 Inventory management ( 재고관리 ): the process of managing inventories in such a way as to minimize inventory costs, including holding costs and potential stockout costs 재고유지비와부족재고비를포함한재고비용을최소화하기위한재고관리과정 Warehousing ( 창고저장 ): receiving and storing goods and preparing them for shipment 물품을받고저장시키고수송을위해준비시키는것 Logistics ( 로지스틱스 ): The overall management of the way resources are obtained, stored, and moved to the locations where they are required along the supply chain. resource 가얻어지고저장되고공급망이요구되는위치에따라이동되는방법에대한전체적인관리 Intermediary ( 중개인 ): Individual / firm (e.g., agent, distributor, wholesaler, retailer) that links producers to other intermediaries or the ultimate buyer. 생산자를다른중간상또는최종구매자와연결시키는개인또는기업 ( 대리인, 유통업자, 도매업자, 소매업자등 ) Retailer ( 소매상 ): an intermediary that buys from other intermediaries or producers and sells to end consumers 다른중간상이나생산자에게구매를하고최종소비자에게판매하는중간상 Wholesaler ( 도매상 ): an intermediary that sells to other firms, particularly retailers 특히소매상과같은다른조직에게판매하는중간상 Agent ( 대리인 ): an intermediary that helps exchanges and transactions, usually hired on commission 교환과거래들을도와주는중간상. 보통수수료로고용된다 Intensive distribution ( 개방적유통 ): the use of all available outlets for a product 가능한한많은소매아울렛에제품을두는유통 Selective distribution ( 선택적유통 ): the use of only a portion of the available outlets for a product in each geographic area 각지리적지역에서소규모의가능한소매상집단에만제품을보내는유통 Exclusive distribution ( 독점적유통 ): the use of only a single retail outlet for a product in a large geographic area 큰지리적지역에서단하나의소매아울렛에만제품을보내는유통 Product mix ( 제품믹스 ): all the products the firm offers for sale, often described in terms of width and depth. Width is the number of product lines, while depth is the average number of products within each product line. A wide or broad product mix means a company has many product lines, a narrow or limited product mix means there are few product lines and likely few products in each line. 판매를위해기업이제공하는모든제품. 보통너비와깊이로설명되어진다. 너비는제품라인의개수이며깊이는각제품라인안에있는제품의평균개수이다. 넓은제품믹스는기업이제품라인을많이갖고있다는것을의미하며좁거나제한된제품믹스는제품라인이적다는것을의미하고각라인에제품이적을것이라예상된다 Product line ( 제품라인 ( 계열 )): a group of similar products that differ in only minor characteristics, and use the same production processes. 같은생산라인을이용하며생산되는비슷한제품들중특징이조금만다른제품. Product line extension ( 제품라인확장 ): the development of a product closely related to one or more products in the existing product line, but designed to meet slightly different customer needs. 존재하는제품라인과밀접한관계를가지고있는상품을고객들의요구에맞춰살짝다르게디자인하는제품개발 Category management ( 카테고리관리 ): Retail strategy in which a full line of products (instead of the individual products or brands) is managed as a group in 47

52 48 order to increase sales, using the category manager's knowledge about consumer buying patterns and market trends for that specific product category. 구체적인제품카테고리에대한소비자의구매행동과시장트랜드에대한카테고리매니저의지식을이용하여판매를증가시키기위해모든계열의제품을 ( 개인제품또는브랜드대신에 ) 그룹으로관리하는소매전략

53 49 Supply chain management defined Figure 5.2 Sample information input informing supply chain You have learned about operations management and some of the overlap between marketing and operations in the satisfying of customer needs and wants. You can see that some of these tasks and processes would benefit from being Consumer feedback Customer forecasting Supplier relationships and discounts Inbound logistics considered together, with improved communication and coordination throughout the whole process, instead of being thought of as separate, unconnected functions. Scheduling and customer prioritization Stock levels Customer inspection Logistics integration The concept of supply chain management arose from the recognition that coordination and cooperation between different company departments as well as between different companies along the path from product idea all the way through to satisfied end customer could have benefits to all parties involved. Supply chain management attempts to apply a total system approach to the flow of resources (information, material, human, financial) through processes in the transformation of a customer need into customer satisfaction. Figure 5.1 Sample supply chain Design Production Return logistics Order processing Inventory management Scrap rework or redesign Purchasing Quality testing Materials management Storage or Distribution Customer feedback Key aspects of the supply chain include product design, purchasing, materials management, inventory management, quality acceptance testing, storage and warehousing with the help of logistics, distribution to intermediaries following a distribution strategy, and then return logistics for items that are unsold, defective, or otherwise unsatisfactory, which may then need to be scrapped, reworked, or redesigned. Market feedback With the trend toward more informed and demanding consumers, companies must be more agile (quick and flexible) in satisfying customer needs. This often requires a higher level of coordination between departments and between companies than in the past. Notice that purchasing, order processing, quality testing, storage or distribution, and return logistics require coordination with outside companies. Supply chain management is therefore often facilitated using enterprise resource planning (ERP) systems. ERP systems bring together quantitative, real-time data for all the resources in the supply chain so that managers can make better decisions. ERP systems also help record and retain information in the supply chain, which otherwise might be lost between departments and organizations. This

54 50 organizational learning can be an important source of market information and therefore competitive advantage. Distribution channels and strategies One aspect of the supply chain that is critical to a company s success is the development of distribution channels and channel strategies. This is one area where operations and marketing overlap, although many would consider it a marketing function (P place ). In fact, distribution channel and marketing channel are used interchangeably. Marketing is solely responsible for determining who are the intermediaries in the channel of distribution between finished production and the end customer. Operations is responsible for fulfilling the orders and managing the outflow of goods to the channel. The word channel in business refers to the means used to deliver goods or services to consumers. Often people talk in terms of indirect through many intermediaries or direct channels straight to the consumer. The term has been adapted to other process contexts, though, and can be applied to sales, such as we are moving most of our sales to the online channel, or promotions, as in the outdoor promotions channel was very successful. In these contexts channel does not simply refer to distribution only, it refers to the medium between customer and product or service provider. Distribution and marketing channels In the distribution of goods, most companies work with intermediaries who add value to the product or service in the channel of distributing or marketing products. Intermediaries are, literally, the people in the middle between the producer and the consumer of goods and services. Often several interdependent intermediaries form a chain in the successful marketing of goods and services. These interdependent intermediaries are known as a company s channel to market. For instance, POPCO s channel to market in the USA might include a North American sales agent, who sells to regional wholesalers who then sell on to small toyshops. We might also sell and distribute directly to a national toy retail chain, coordinating with their logistics company to distribute our toys to large regional distribution centers, which ship on to the various regional super stores. There is great variety in the kinds of marketing channels we may use. It is important that intermediaries in the marketing channel add value to the product or service proposition. Ways intermediaries add value include providing information back to the producing company about the market and customer, through promoting the product or service, by finding and locating prospective buyers, through negotiating price and selling terms, through financing the distribution of goods, and of course for the distribution itself. For some industries, channels to market are very standardized, like in the automotive industry. In others, like ours, there is considerable variety. Most every marketing channel in every industry has been affected by the development of online technologies and advanced information systems. In what ways could the Internet have affected our marketing channel? How might it affect the automotive channel in the future, and who benefits? No matter what the product or service, intermediaries in the channel require motivation from the producing company to market the good or service. Intermediaries may be working with a producer s competitors at any given time. Therefore it is important to build strong relationships with channel intermediaries. There are two basic categories of intermediaries: wholesalers and retailers. Wholesalers conduct all the activities to sell products or services to retailers or other intermediaries in the channel, and to end business customers. While many wholesalers these days sell to both consumer and intermediary customers, those that sell primarily to business end customers and other intermediaries are termed wholesalers. Another term for wholesalers is merchant wholesalers.

55 51 In addition to transportation and warehousing, wholesalers add value by selling and promoting on the behalf of producers, by buying in bulk and then selling in smaller bulk units (bulk breaking), by building in-demand assortment of products that may complement a producer s product lines and ranges, by financing through extending credit to their customers and buy placing advance orders to producer companies and paying on time. They also are excellent sources of market demand information for producers. A special category of wholesalers is agents and brokers. They different from merchant wholesalers in two important ways: they do not take title (ownership) of the goods, and they do not provide many of the value-added functions of merchant wholesalers. Why are agents and brokers helpful? They are specialists in types of products or types of customers, and are very often exceptional at managing the paperwork required in global trade. Very often agents and brokers will specialize in inbound or outbound trade for a particular region, product category, or specific manufacturer. This requires expertise in regulations and customs amongst other skills. Brokers match buyers and sellers and assist in negotiations, while agents are typically longer-term representatives of producer companies. They often perform the role of sales staff or sometimes purchasing staff that is done in-house in larger companies. Retailers conduct all the activities to sell products or services directly to end customers (in this case consumers) for their own use. While many intermediaries do retailing, in other words, showcase and sell products and services, retailers derive their primary revenues from retailing. Retailing can be conducted in a retail environment like a store, or in a non-retail environment like through personal selling door to door or in a home, through kiosks or vending machines, or through direct channels like direct mail, home shopping, and of course the Internet. Nonstore retailing is growing rapidly as people choose the convenience and information setting of the personal environment to make purchase decisions. There are a wide variety of types of retailers, including specialty stores with limited types of products, super stores with many kinds of products, discount stores and off-price retailers (such as factory outlets), department stores, supermarkets, and convenience stores. As non-store retailing grows, retailers must seek new ways to entice consumers to their locations, and offer additional value beyond the mere distribution and display of goods and services. Marketers must consider the number and quality of intermediaries in their channels to market, and support and evaluate channel partners. In this way they manage channels to market. Marketers may have different distribution strategies, depending on the types of goods or services that they sell and the customers to whom they sell them. Intensive distribution means selling in every available outlet, and will require many different channels to market. Examples include low price consumables like chewing gum or other convenience store items. Selective distribution means selling via select outlets, perhaps based on product category, location, or other considerations. POPCO would likely use selective distribution to ensure our products are sold in relevant outlets like toy stores, department stores, but not convenience stores. Exclusive distribution means selling your goods through only a few, handpicked or controlled outlets in a region. Apple attempts to maintain the desirability of its products by trying to ensure exclusive distribution in Apple stores or select partner dealers. The product mix The final P of marketing is product. We have discussed how marketers conduct research and segmentation to understand different customer needs and wants and their buying behaviors. This helps marketers develop new product requirements. Truthfully the process of new product development varies considerably from industry to industry, company to company. But how do marketers manage existing products, and the relationship of customers and

56 52 consumers to all of the products or services a company has to offer? This is called managing the product mix. The product mix is a signal to intermediaries about the strengths and knowledge of a company in particular areas of customer needs and wants. A company with a wide product mix is involved in satisfying a wide variety of customer needs and wants, with many product lines. A product line is a group of products produced using primarily the same production process, with minor differences that respond to different customer needs. A company with a narrow product mix might only focus on a particular category of needs. A deep product mix means that the company offers many products in each product line to customers, hoping to capture more customers overall. Larger companies with deep product lines will try to own the customer through all of the purchasing required in that particular experience of needs and wants fulfillment. They develop product families that are product lines related to the same customer experience. Developing a product family can help use the loyalty of a customer for one product or product line in order to sell them more products in different but related lines. Product families often also provide consumers opportunities to share their product experience and encourage purchase with new customers who have different needs. Managing multiple, deep product lines or product families requires sophisticated knowledge of the consumer, as well as proactive management of products through their lifecycle. A successful product or product line may demand the addition of new products to meet slightly different customer targets or new customer demands, in order to renew buying opportunities. The addition of such products to a line is called product line extension. On the other hand, the company may need to quickly replace or delete a product from a product line to adjust to changing customer needs and wants. A single product or service unit has a unique identity within the set of products a company sells, that allows it to be tracked in the supply chain and especially for inventory purposes. This is called a stock keeping unit or SKU. New product development New product development to extend product lines or establish new product lines is a critical aspect of company development. The process of new product development varies from company to company, but includes stages of market or product research, concept testing and financial assessment, prototyping, market testing, further development, product launch, and evaluation. These days with the pressure to bring products to market more quickly, many companies are shortening their market and product research time and instead doing in-house or observational research to correct or establish the requirements for new products. Consumer products companies have developed the expertise (or the suppliers with expertise) to rapidly prototype and then launch products into the market, knowing that there may be a chance of problems, dissatisfaction, or even failure. However, with the volume of products launching so quickly, the cost of this failure may be acceptable compared to the relative cost of timeconsuming an expensive research as was conducted in the 20 th century for each new product. Such a just good enough product development strategy relies on live feedback from the market to make incremental improvements. You can see this kind of development cycle for products in industries that rely on software (which can be more easily updated and improved compared to incentivizing a new hardware purchase), or where the standard product development cycle is very short, as in fast moving consumer goods industries ( FMCG ). For products that demand more spend and consideration from the consumer such as automobiles and white goods, new product development is still a rigorous process involving extensive testing and market research.

57 53 Companies are always looking for ways to launch products that look and feel new and improved to the customer, but without the operations or research cost and risk required of breakthrough innovation. Managing the risks involved in new product development is much easier for larger conglomerates than smaller companies. However, any new product development risk can harm a company s reputation. Category management In addition to developing the channel to market for a company s products and services, it is important that a company who sells ultimately through retail understand the concept of category management. Understanding category management is essential so that a company can best support and control the availability and desirability of its products against competitors. In the retail sector, category management is the key principle for organizing and evaluating businesses. Products and services are managed along category lines, groups of products related to one another in the customer s mind. A category manager will take decisions on which products are represented in each category, and which products are given priority within categories in the display and promotion of category items. Category managers are responsible for the inventory turnover and profitability of their whole category (which includes every product within it), even though the product producers themselves are likely to be competitors. They will have a deep understanding of the role of the category with respect to other categories in the retailer, and try to maximize their category s profitability by setting categoryappropriate targets, retail strategies, and sales tactics. Product producers often play a very important part in these sales tactics and retail strategies. or sales support for the retailer. Category managers are experts in the changing needs of consumers for their particular category items, and are up-to-date with new technologies and other environmental forces impacting product development. For this reason, they are an extremely valuable source of competitive market information for a producer s sales team and for sales agents In what ways can channel cooperation help address social responsibility issues? Summary: Supply chain, channel, and category management In this unit you have learned about: The definition of supply chain management The difference between different intermediaries Distribution strategies Product definition and the meaning of SKU The definition of a product mix, a product line, product families, and product line extensions Channel management Decisions that affect which products category managers choose to stock include price, sell through rate, reputation, popularity, promotion support, and discounts

58 54 Worksheet 5 (front) Fill in the blank with the appropriate term. 1) is a system technology to help provide real time supply chain data. 2) A retail is groups of products related to each other in the consumer s mind. 3) The number and type of intermediaries defines a company s marketing or distribution strategy. 4) Smaller companies without a sales force often use to fulfill this role. 5) The addition of Rolly the Rabbit adds to our of artificial intelligence toys. 6) Our distribution strategy would unlikely be because we would like to have more than one retailer in any given region, and our price point is relatively low. 7) All of the toys POPCO sells, including traditional toys, board games, artificial intelligence toys and accessories, are known as our. 8) These days it is difficult to tell apart retailers from because many sell directly to the public in addition to business customers and intermediaries. 9) Catalog, Internet, and vending machines are all examples of retailing. 10) The process of managing the return of items because of defects or other problems is called. 11) New product development cycles are faster these days, involving rapid of new products for testing (building working samples). Multiple choice. Select the one best answer. 12) If POPCO executives decided that we must be more efficient in our supply chain, what solution would we likely not pursue? a. Move to intensive distribution b. Outsource logistics c. Consolidate intermediaries d. Open direct sales via an online shop 13) If POPCO executives determined that there is unsatisfied demand for artificially intellgient toys, but they do not want to invest heavily in new equipment or staff, we should recommend the following: a. Adding a new product familiy b. Widening our product mix c. Deleting the Clucky Chicken product line d. Extending our Clucky Chicken product line 14) Which category should we negotiate our artifically intelligent Farm Friends family of toys to be placed next to with our supermarket customers? a. Baby food b. Gardening and pets c. Outdoor equipment d. Children s art supplies 15) Visit a store that sells Zhu Zhu Pets or many stuffed animals. On the back, draw an overview layout of the store, including the product categories. Why do you think the stuffed animals are located where they are? Explain on the diagram.

59 Worksheet 5 (back) 55 Draw your diagram and include category names here, plus your explanation.

60 56 Unit 6 Reaching Global Markets Learning objectives of this unit In this unit you will learn the following concepts: Two international organizations that facilitate international trade (in class: examples) The different ways firms grow and expand internationally (in class: exercise) The different tools for restricting trade and when are they utilized (in class: exercise)

61 Unit 6 Vocabulary IMF and the World Bank ( 국제통화기금 & 세계은행 ): Two international organizations that help the globalization and development of nations. 세계화와각국의발전을돕는국제적인기구 Balance of Payments ( 국제수지 ): A record of all transactions made between one particular country and all other countries during a specified period of time. BOP compares the dollar difference of the amount of exports and imports, including all financial exports and imports. A negative balance of payments means that more money is flowing out of the country than coming in, and vice versa. 특정기간내에다른나라와의거래를기록한것. 국제수지는수입과수출의차이를비교하며국제수지적자는들어오는돈보다나가는돈이더많다는것을뜻한다. Licensing ( 라이센싱 ): A contractual agreement in which one firm permits another to produce and market its product or resources and use its brand name in return for some consideration, typically in the form of a royalty payment or other compensation. 상표등록된재산권을가지고있는개인또는단체가타인에게대가를받고그재산권을사용할수있도록상업적권리를부여하는계약. Intellectual property ( 지적재산 ): The set of intangibles owned and legally protected by a company from outside use or implementation without consent. Intellectual property can consist of patents, trade secrets, copyrights and trademarks, or simply ideas if executed in a tangible form. 외부에서동의없이사용또는구현될경우법적으로보호받을수있는회사소유의무형의집합체. 지적재산은특허, 영업비밀, 저작권과상표등이될수있으며, 간단하게는아이디어등도유형의형태로실행될경우해당될수있다. Patent ( 특허 ): A government license that gives the holder exclusive rights to a process, design or new invention for a designated period of time. 지정된기간동안과정부터디자인, 신발명품등의권리를정부가소유자에게부여하는일종의라이선스 ( 허가 ). Trademark ( 상표 ): A brand name or brand mark with the same protection from the government patent office. 브랜드이름이나브랜드마크 ( 로고등 ) 가정부특허청에서받는보호. Franchise ( 체인점 ): A type of license that a party (franchisee) acquires to allow them to have access to a business's (the franchisor) proprietary knowledge, processes and trademarks in order to allow the party to sell a product or provide a service under the business's name. In exchange for gaining the franchise, the franchisee usually pays the franchisor initial start-up and annual licensing fees. 프렌차이조의상표, 상호의사용권이나제품의임대또는매매권리등을프렌차이지에게주고그에따른적정의수수료를받는계약이다. Contract manufacturing ( 계약생산 ): Production of goods by one firm, under the label or brand of another firm. Also called outsourcing. 한회사가다른회사의라벨또는브랜드의이름으로제품을생산하는것. 아웃소싱이라고불리기도한다. FDI ( 해외직접투자 ( 외국인직접투자 ):): Also known as Foreign Direct Investment, an investment made by a company or entity based in one country, into a company or entity based in another country. 한나라의기업이다른나라에서새로운사업체를설립하거나기존사업체의인수를통하여이를통제할수있는투자지분을획득하여장기적인관점에서직접경영에참여하는것을목적으로하는투자. Joint venture/ strategic alliance ( 합작투자 / 전략적제휴 ): A business arrangement in which two or more parties agree to pool their resources for the purpose of accomplishing a specific task. 둘이상의기업이특정목표를달성하기위해경영자원을공유하거나협력하는일정기간동안의지속적협력관계를말한다. Horizontal merger ( 수평합병 ): A merger occurring between companies in the same industry typically to gain economies of scale. 동일산업에있는기업간의합병. 시장점유율을확대하거나제품생산에서의규모의경제를달성하기위해경쟁기업을매수하는것이다. Vertical merger ( 수직합병 ): A merger between two companies producing different goods or services for one specific finished product. 57

62 58 제품의생산이나원재료의공급등이상이한단계에있는기업간에이뤄지는합병을말하며, 주로대기업이원료에서부터완제품의유통까지모든단계를지배하려는목적에서기업의상하계열관계에있는회사를매수하는형태. Conglomerate merger ( 혼합합병 ): A merger between firms that are involved in totally unrelated business activities. 상호관련성이없고경쟁관계가없는이종업종의기업들간에이뤄지는합병을말한다. 주로재무적측면에서상승효과를얻기위한합병이지만일반관리기술의이전등경영측면에서의효과도있을수있다. Trade Deficit ( 무역적자 ): An economic measure of a negative balance of trade in which a country's imports exceeds its exports. 국가의수입이수출을초과했을때나타나는무역수지적자. Tariff ( 관세 ): A tax imposed on imported goods and services. 수입에부과되는세금. Dumping ( 덤핑 ( 투기 / 폐기 )): In international trade, the export by a country or company of a product at a price that is lower in the foreign market than the price charged in the domestic market. 상품가격을국내보다수출국현지에서더낮추어판매하는행위. Import Quota ( 수입할당 ): A government-imposed trade restriction that limits the number, or in certain cases the value, of goods and services that can be imported during a particular time period. 한국가가수입하는특정범주의상품수를제한하는것. Embargo ( 금수조치 ): A government order that restricts or forbids commerce or exchange with a specified country, organization, or individual. 특정상품의수입이나수출에대한완전한금지또는특정국가와의무역을완전히중단하는행위. Foreign Exchange Control ( 외환통제 ): Types of controls that governments put in place to ban or restrict the amount of foreign currency or local currency that is allowed to be traded or purchased. 사고팔수있는외환의금액을제한하는것. Currency Devaluation ( 통화평가절하 ): A deliberate downward adjustment to a country's official exchange rate relative to other currencies. 한나라의통화의대외가치가하락하는것.

63 59 From local to global: financing growth You have seen in Units 1 and 2 how competitive market economies encourage firms to be more productive, specialized, and global. One of the key resources needed to take advantage of these trends is money (also called capital). Private companies can raise money to finance growth through several means, including incorporating and selling stock, accepting private loans, or in the case of more substantial companies by issuing bonds. But if you are a small or struggling firm wanting to compete domestically or internationally, how do you find the capital to enter these supplier and customer markets? Some companies rely on subsidies; others on support or tax concessions from their governments. Trade and industry organizations occasionally also provide financial support (which is often redistributed funds from the government). Governments play a key role in this distribution of capital to fund and encourage trade, and set their trade and economic policy accordingly. So how does a country access the capital required to compete in global markets, and how are these markets facilitated? Facilitating trade: IMF and the World Bank Two international organizations that facilitate international trade between nations are the International Monetary Fund (IMF) and the World Bank. While they share some of the same objectives in fostering global trade and development, their purposes are quite different. The IMF s purpose is to promote monetary and exchange stability, facilitate the expansion and growth of international trade, and help countries to manage international transactions and balance of payments by lending funds. In this way, it is like the central bank of the world. The IMF monitors monetary policy and exchange rates around the world in order to facilitate global market stability. The IMF s economists and researchers examine environmental trends on a country, region and global basis to alert its member states to developments that might threaten trade. They also provide a forum for countries to discuss policies that may restrict trade. Globalization can impact countries dramatically with swift movement of capital and comparative advantage, which can drive political responses that harm trade, restrict capital and labor movement, and create unsustainable tax policy. The IMF provides guidance and mediation to avoid such trade obstacles. Often political or economic instability in one country can lead to economic difficulties in another region or industry. The purpose of the IMF is to avoid such domino effects on the world economy. They provide technical advice and development support in the form of loans to developing nations. They also provide short-term loans particularly foreign currency loans for countries experiencing short-term challenges with their balances of payments. These loans are often made at concessionary rates, that is, below the market rate. The money available for loans is contributed regularly by IMF members on a quota system that reflects the relative economic size of the country in the world economy. The quota system is also the basis for member states voting power in the IMF, much like the corporation model of voting rights for investors. In the past the IMF has been accused of favouring wealthy large countries while harming the development of low-income and developing economies in its activities. This is a problem because developing and growing economies provide the engine and dynamism for the global economy as a whole. This critique has been the legacy of the quota system. In 2008 the IMF members voted to reform the quota system to better reflect the contribution (but not size) of developing and fast-growth economies. The World Bank s stated goal is to free the world of poverty. Its activities are also to promote trade and development, but not for the purpose of stability, but to

64 60 eliminate poverty. Towards that end, they offer financing, advice and research to low-income countries to aid their economic development. The World Bank is comprised of two institutions: the International Bank for Reconstruction and Development (IBRD) and the International Development Association (IDA). IBRD members are also required to be members of the IMF. All members contribute funds to the bank, and their voting power reflects their economic size (and contributions). Leadership of the World Bank is controlled by the most wealthy and developed nations (notably the U.S.) through their voting system. Many criticize the World Bank for favouring wealthy countries and encouraging economic approaches that are harmful to developing economies. A former World Bank Chief Economist, Joseph Stiglitz, has repeatedly criticized the World Bank s focus on GDP figures as a measure of development and loan performance, rather than sustainable measures of improved standard of living, industry health, employment figures and equality standards. Ways to grow and enter foreign markets There are many ways to grow and enter foreign markets, other than simply producing your products locally and exporting them overseas. Exporting can be costly and requires knowledge of consumer tastes and behaviors, regional regulations, tax laws, import regulations and trade restrictions. Often companies will use agents, brokers, or wholesalers rather than sell directly in foreign territories. We will explore these more in the marketing and operations units. But to grow as a company, there are several different common ways, each with their advantages and disadvantages. Licensing Licensing is one of the simplest forms of growing a company s market. It requires limited investment from the firm, and can result in hassle-free fees and royalty income. A license is a contractual agreement in which one firm permits another to produce and market its product or resources and use its brand name in return for some consideration, typically in the form of a royalty payment (a fee granting the permission) or other compensation. The license typically grants permission to use intellectual property in the form of patents or trademarks by the licensing firm for a specific period of time, in a specific region, and for a specific purpose. Licenses are only of interest if the licensor company s products, services, brand or other intellectual property is in demand and difficult to imitate. The risk of licensing is that a company loses control of its brand and therefore reputation in territories not in its control. However, licensing is a fast way of raising low-effort income. Franchising You are probably familiar with franchises, particularly in the fast food industry. A franchise is a type of license that a person (franchisee) acquires to allow them to have access to a business's (the franchisor) proprietary knowledge, processes and trademarks in order to allow the person to sell a product or provide a service under the business's name. In exchange for gaining the franchise, the franchisee usually pays the franchisor initial start-up and annual licensing fees, and sometimes royalty fees as well. Some franchisees also pay a share of their revenues back to the franchisor. There are clear benefits of franchising for a firm wanting to grow: fast and controlled growth; low capital investment and operating costs (these are paid and arranged by the franchisee) which means more money for developing and marketing the franchised brand, products and services; clear standards of operation for the franchisee that can allow for standardization; and ongoing cash income. The disadvantages for the franchisor of franchising are the hassles of dealing with franchises often run by inexperienced business people who are in competition

65 61 with rivals and each other. This often leads to poorly run franchises or lawsuits where the franchisee sues the franchisor. For this reason some franchisors invest a great deal in developing their supply chains, set-up capital systems and resources, real estate and financial expertise to eliminate the risk of underqualified franchisees damaging the company s reputation and brand. What has the growth of global franchises meant for local companies and industry? Why have they been so successful, even when many people oppose them? Contract Manufacturing Another way to grow is for a firm to contract with a different company in another region to produce their products or services, under their own brand or label. Another term for contract manufacturing is outsourcing. Contract manufacturing is how most businesses access international markets in some part of their supply chain. Difficulties arise with outsourcing when the terms of the contract are not met, or the conditions of the contracted firm do not meet the standards of the contracting firm. Outsourcing is often pursued to reduce the impact of labor and material costs, but puts pressure on low-income nations where standards for resource protection, health and safety, equality and human rights may be low or unenforced. Increasingly firms are examining how best to monitor and control these aspects of the firms to whom they outsource production and services. Foreign Direct Investment (FDI) FDI is an investment made by a company or entity based in one country, into a company or entity based in another country. It is similar to contract manufacturing, but the relationship between the companies is more significant, giving the investing firm some amount of control over the local firm. FDI is often heavily subsidized by governments seeking inward investment. The investing company may make its overseas investment in a number of ways - either by setting up a subsidiary or associate company in the foreign country, by acquiring shares of an overseas company, or through a merger or joint venture. The accepted minimum ownership for a foreign direct investment relationship, as defined by the OECD, is 10%. That is, the foreign investor must own at least 10% or more of the voting stock or ordinary shares of the investee company. For this reason, it often requires more investment and involves more investment risk than contract manufacturing. Open economies with good growth prospects tend to attract larger amounts of foreign direct investment than closed, highly regulated economies. FDI is not only used for accessing lower labor and material costs, but it can be an effective way of opening up new markets particularly in the retail sector. Joint ventures (JV) and strategic alliances Joint ventures and strategic alliances are very similar in providing a path to growth for companies. They are a business arrangement in which two or more parties agree to pool their resources for the purpose of accomplishing a specific task. This task can be a new project or any other business activity. In a JV each of the participants is responsible for profits, losses and costs associated with it. However, the venture is its own entity, separate and apart from the participants' other business interests. The JV typically lasts only for the duration of the project or until the goal is accomplished. Joint ventures tend to be very structured with clearly quantified objectives. Joint ventures require a significant amount of capital and management investment, however this investment is much lower than it would be if any of the involved firms were to attempt the project alone. In fact, in many cases the JV is used for projects where no one firm could afford the required investment.

66 62 A strategic alliance is less involved and often less quantifiable than a joint venture. In a strategic alliance, each company maintains its autonomy while gaining a new opportunity. The opportunity could be external or internal for the company. A strategic alliance could help a company develop a more effective process, expand into a new market, or develop an advantage over a competitor, among other possibilities. Mergers For firms that have mutually beneficial resources and the potential to save money by combining resources, a merger may be appropriate. A merger is where two or more companies join operations and ownership to become one entity. Unfortunately, mergers rarely create the synergies (cost savings and increased revenues) anticipated, while they can increase share price volatility and also destabilize the company s workforce. In many cases, mergers destroy market value in the long term rather than create value. There are three main types of mergers: Horizontal: A Horizontal merger is a business consolidation that occurs between firms who operate in the same space, often as competitors offering the same product or service. Horizontal mergers are common in industries with fewer firms, as competition tends to be higher and the synergies and potential gains in market share are much greater for merging firms in such an industry. Vertical: A vertical merger occurs when two or more firms, operating at different levels within an industry's supply chain, merge operations. Most often the logic behind the merger is to increase synergies created by merging firms that would be more efficient operating as one. Conglomerate: A merger between firms that are involved in totally different business activities prior to the merger. There are two types of conglomerate mergers: pure and mixed. Pure conglomerate mergers involve firms with nothing in common, while mixed conglomerate mergers involve firms that are looking for product extensions or market extensions. What way should POPCO use to access foreign markets? What paths to growth are not appropriate for POPCO? Why restrict trade? As companies grow and enter global markets, they will encounter restrictions to trade. Restrictions to trade are often discussed at the same time as trade balances and trade deficits. Countries have a national interest in keeping a healthy trade balance the balance between the value of imports and exports with other countries. This helps stabilize their economies. A trade deficit represents an outflow of domestic currency to foreign markets. Economic theory dictates that a trade deficit is not necessarily a bad situation because it often corrects itself over time. But long-term or significant trade deficits can drain a country s resources and political power eventually. For this reason, trade restrictions (imposed through trade policy) are often used to stabilize the balance of trade of a particular country. Often they are intended to increase exports or reduce imports, or protect domestic production. In this way global trade and international policy and politics are intertwined. Trade restrictions can therefore limit access of growing companies to global markets. It is important for firms to understand the different kinds of trade restrictions, why they are used, and where they are likely to be encountered. Types of trade restrictions Tariff Tariffs are the most common form of trade restriction, and one of several tools available to governments to shape trade policy. Tariffs are simply taxes levied on

67 63 imported products and services. Tariffs increase the price of imported goods and services, making them more expensive to consumers. Governments may impose tariffs to raise revenue or to protect domestic industries from foreign competition, since consumers will generally purchase cheaper foreign produced goods. The main benefit of tariffs is clear: tariffs raise revenue for the levying government. However, tariffs can lead to less efficient domestic industries, and can lead to trade wars as exporting countries reciprocate with their own tariffs on imported goods. The World Trade Organization was set up to mediate between countries in conflict due to trade disagreements, often caused by the use of toohigh or unfair tariffs. People often use the word levy when discussing trade restrictions: to levy a tariff for instance. Levy simply means to impose. It is often used with tariffs and also fines: the government levied a tariff on sugar imports. The word duty is often used in discussions of trade restrictions. It does not mean in this case a moral obligation, but instead it means a tax, fine or other legally enforced obligation. Dumping A different way of undermining foreign competition and manipulating markets is through dumping. Dumping usually involves one country exporting massive volumes of a particular product typically at below-market price, causing local producers and manufacturers to go out of business. Dumping is regulated by the WTO and countries can petition for restrictions or fines to be placed on nations seen to be dumping. Import quotas An import quota can limit the number or value of particular goods imported to a country, but do not have the benefit of raising revenue. Import quotas are mostly used to restrict foreign competition and increase domestic production. Unfortunately, because of the interdependency of companies from different countries in every step of the supply chain, import quotas can often protect one kind of producer or manufacturer while harming another in a particular industry. Many foreign manufacturers and producers respond to import quotas by varying the specification of their products, or launching joint ventures to produce the product or service in the restricted area. In this way they circumvent the restrictions. Import quotas can have the undesirable effects of increasing corruption amongst administrative officials selecting approved importers, and also of smuggling. Governments can also use the selection of importers to exert political power abroad. Embargo An embargo is typically motivated by politics rather than economic rationale, and is viewed as an extreme measure. Because an embargo restricts or more often prohibits trade with a country, organization, or individual, it can be a potent political tool. Critics claim that embargoes actually do the most harm to those that are already victims of the unfavorable practices. Foreign exchange (Forex) control Governments use foreign exchange controls to stabilize their currencies and currency inflows and outflows, as well as the influence of foreigners and their capital on the local economy. Common exchange controls include banning the use of foreign currency and restricting the amount of domestic currency that can be exchanged within the country. Developing economies or those with vulnerable economies often must rely on foreign currency controls to prevent volatility in their markets, which can lead to sharp increases in currency values against foreign currencies, which in turn drive inflation. Because foreign currency controls can be used as a political weapon rather than a beneficial economic policy tool, the International Monetary Fund

68 64 regulates the use of foreign exchange controls amongst its members to those with transitional economies only. Foreign exchange controls often have the undesirable effect of encouraging black markets to exchange local domestic currency for stronger international currencies. Because the stronger currency is in more demand, black market exchange effectively weakens the value of the domestic currency significantly, increasing the exchange rate of the foreign currency to higher than that set by the government. Currency devaluation Regulations While regulations are typically enforced not to restrict trade but to ensure fair operating standards to protect stakeholders, they can also be used to effectively restrict trade. Governments and industries wanting to limit competition can employ regulations to restrict market entry to only a few competitors. In this way regulations can favor large, established corporations over smaller, less developed or more innovative ones. What types of trade restrictions affect the toy industry? Currency devaluation is the monetary policy of reducing the value of a currency with respect to a foreign currency. In a fixed exchange rate regime, only a decision by a country's central bank can alter the official value of the currency. The bank does this either through the trading of foreign currency reserves which alters the supply of its currency and thus the value, (and in the open market the demand through anticipation of devaluation of the domestic currency), or through exchange controls limiting the buying and selling of the domestic currency. Devaluation makes a country's exports relatively less expensive for foreigners, encouraging foreign consumption. It also makes foreign products relatively more expensive for domestic consumers, discouraging imports.. As a result, this may help to reduce a country's trade deficit. However, other countries may complain about this practice limiting international growth and fair competition. Devaluation does not necessarily encourage domestic demand, however, and perception that low cost domestic goods are inferior can create political issues with domestic consumers wanting more choice

69 65 Summary: Reaching global markets In this unit you have learned about: The main international organizations that facilitate growth and trade The different methods firms use to grow and enter international markets, and the benefits and drawbacks of each method The common restrictions to trade, their purpose and limitations

70 66 Worksheet 6 (front) True or False. 1) Both the IMF s and the World Bank s activities directly work to stabilize currencies and interest rates. 2) The World Bank s purpose is to end poverty in the world, so its members have equal voting rights and power. Match the growth strategy with its main benefits. Select the one best answer. a) JV by sharing resources b) Outsourcing s c) FDI investment d) Licensing that would otherwise be unaffordable for single firms e) Vertical merger without profit and loss responsibility 3) Can improve efficiency in a single supply chain 4) A fast way of raising low-effort income for well-known brands or firms with unique technologie Match the trade restriction with its main disadvantages. Select the one best answer. a) Tariff b) Dumping c) Regulations d) Embargo for the company and country involved e) Forex controls 8) Can protect large corporations unfairly and limit market entry of small firms 9) Politically-motivated prohibition that can harm political and economic victims 10) Can encourage currency black markets and so destabilize local currencies 11) Can lead to intervention by the WTO and fines 12) Often leads to trade wars if seen as unfair 13) Explain and analyze the headline story on the reverse based on what you have learned in this unit. 5) Helps to reduce labor costs without long-term 6) Helps make possible giant, expensive projects 7) Gives some foreign production control to a firm

71 67 Worksheet 6 (back) Explain the headline from the Korea Times news according to what you have learned in this unit. Describe why it might be unrealistic in terms of growth strategies, their costs, requirements, and barriers. Also, give you opinion: do you think Caffe Bene will succeed?

72 68 Unit 7 Corporate Organization and Planning Learning objectives of this unit In this unit you will learn the following concepts: How companies organized, and the principles of company organization (in class: walk through) The tools that help companies to organize effectively (in class: organization chart exercise) The general categories of jobs and job functions (in class: discussion) Organizational design and how it is related to authority and hierarchy (in class: discussion) How organizations plan (in class: organization exercise)

73 69 Unit 7 Vocabulary Departmentalization ( 부문화 ): the process of grouping activities into departments. Division of labor creates specialists who need coordination. This coordination is facilitated by grouping specialists together in departments. 분화된여러활동을분류해유사한직무끼리집단화하는것. 분업은전문가들의합동을요구하며이합동력은전문가들을집단화함으로가능해질수있다. Organization chart ( 조직도 ): a graphic representation of the structure of an organization, showing the relationships of the positions or jobs within it in a hierarchy. 조직의편성, 직위의상호관계나책임과권한의분담계열, 지휘, 명령계통등을한눈에볼수있게제작한표. 최고경영층에서부터조직의모든사람들에게조직의권위와권한이위임되는순서. 지시는지휘계통의아래로흐르며책임은위로흐른다. Line management ( 계통관리 ): the direct supervision and coordination of the employees directly involved in producing the business s products or services. 기업의제품이나서비스생산에직접적으로관련된직원을직접감독하고조언하는것. Staff functions ( 직원직능 ): secondary business activity that supports the line functions of a business (typically by advising them) to achieve the business s objectives. In business management, staff functions are usually defined as all functions that are not line functions. 기업의목표를달성하기위해기업의 ( 주로조언을통하여 ) 라인기능을지원하는보조사업활동. 경영에서직원직능은라인기능을제외한모든기능으로정의된다. Job Design ( 직무설계 ): the systematic and purposeful allocation of tasks to individuals and groups within an organization. Job design originated with the ideas of Taylorism, but has since evolved through a systems approach as well as individual personality-driven model. 개인과조직을연결시켜주는가장기본적인단위인직무의내용과방법및관계를구체화하여개인의욕구와조직의목표를통합시키는것. 직무설계는테일러리즘의아이디어들에서비롯되었다. 하지만그이후체계론적접근법과개인의성향위주의모델에의해서발전되었다. Chain of command ( 지휘계통 ): the order in which authority and power in an organization is wielded and delegated from top management to every employee at every level of the organization. Instructions flow downward along the chain of command and accountability flows upward.

74 70 Organizing a company When companies start they tend to group people by the similar tasks that they perform or skills they have. This is called functional departmentalization, and is very common form of organization for small to medium-sized firms. Functional departmentalization allows companies to refine and standardize the processes of each department. Employees hone their skills and become familiar with the tasks required. The coordination between department members increases. This type of organization emphasizes efficiency and processes. The internal focus of departments helps companies to document and standardize the tasks they perform to make them most efficient within each department. Functional departmentalization drawbacks Functional departmentalization has many benefits, including inter-departmental coordination and process-driven efficiency. But by nature it encourages departments to look inward rather than outward, and decreases coordination between departments if managed in a scientific way. (Scientific management, sometimes called Taylorism, is the principle of evaluating the most efficient method for doing a task regardless of labor or operator, then ensuring uniformity and conformity in execution of that task. This is in contrast to rules of thumb, intuition, or individual choice in how one conducts their job tasks.) In a modern competitive context where firms are encouraged to not only be economically efficient but also to compete and grow, an inward, departmental focus creates its own inefficiencies. During early industrialization, the pace of change was relatively slow by comparison, so departmentalization and scientific management worked well. But competitive forces and the need for innovation increased throughout the 20 th century, seeing a decline in strict departmentalization and scientific management. Much of the principles of scientific management have been absorbed into operations process analysis. In a modern competitive context with ever-changing environmental forces, a firm requires extreme coordination between departments, as well as an outward focus on competitors and especially the customer. Creativity and innovation are critical to being competitive, and flexibility is essential to respond to fast-changing environments. A company needs to manage the human relations within the firm to best ensure employees are effective and innovative, not just efficient. And companies need exceptional access to information to do their increasingly complex jobs well and respond to changing environments. Figure 7.1 Functional areas of a modern business Production (Operations) Human Resources Marketing (Including Sales) Information Technology What other functions do you think POPCO should include as part of its essential business? What functions do you think could or should be outsourced? Modern departmentalization Finance and Accounting These days, firms often develop a mixed form of departmentalization as they grow: they may incorporate a focus on a product line or category of products, or a particular geographic region, or according to a type of customer. Often these different organizing methods are added on top of a foundation of functional departmentalization, and organically change as the firm grows into new markets.

75 71 In order to clarify the organization of a company, firms typically diagram their organization of different departments and people using an organization chart. An organization chart not only describes the separation between different departments, it also graphically shows the chain of command who reports to whom. It is important for employees to have clear lines of authority, and not report to two different people who might instruct them to do competing tasks. Figure 7.2 POPCO s original organization chart before launching Clucky Chickens Clucky Chickens were a new kind of toy for POPCO, and required a new production setup. How could they best re-organize to focus on expansion and efficient Clucky production, without threatening their existing operations? As stated before, they had many choices: they could reorganize according to product, by geography, or by type of customer. Following are some examples of what that new organization might have looked like. Figure 7.3 Product-led departmentalization CEO Chief Operating Officer Corporate Secretary Director of Marketing Chief Financial Officer Clucky toys Company Secretary CEO Traditional toys Non-toy business Production Brand Development Accounts Operations Marketing Operations HR Sales Payroll Asia Marketing IT New Product Development North America In this early organization chart, POPCO designed jobs and allocated tasks according to function. This is how POPCO s head office was organized until last year. Before launching Clucky Chickens, POPCO produced a wide variety of very simple kinds of toys. At that time, they marketed their toys directly in the Korean market, and through distributors in America and Europe. POPCO was a small company by toy company standards. But with the launch of Clucky Chicken last year, POPCO wanted to organize so they could grow rapidly. EMEA

76 Figure 7.4 Geographic-led departmentalization Ai Toys Asia Pacific Company Secretary Traditional & non-toys CEO North America Sales EMEA Sales 72 What are the drawbacks to each of these kinds of organizations illustrated in Figures 7.3, 7.4, 7.5? What are the benefits? Determining the right kind of organization at the right time is a critical step in managing a growing business. After reviewing the options, POPCO management was concerned that a product-based organization would create internal competition between product groups, and draw all of the marketing focus away from their current production. They felt that this kind of organization would be reasonable if they had many different established toy product lines, however their traditional toys are not market leaders. Marketing Operations Maketing Operations A regional departmentalization was possible, however there would seem to be a lot of duplication as the production facilities were, last year, centralized in Korea. Confusing the chain of command between the operations for different regions might become a problem. Figure 7.5 Customer-led departmentalization So, like many organizations, POPCO decided on a combined form for their new organization. CEO Company Secretary Tween toys Infant and baby Heritage toys Operations Marketing Operations Operations Korea Sales Marketing Marketing Global Sales

77 73 Figure 7.6 POPCO s new organization at the launch of Clucky Chickens Company Secretary CEO Legal & PR In the company context, this vocabulary persists. Line management refers to the supervision and coordination of the company s core business activities, typically the production and sales of goods and services. These core line activities typically include production and sales, marketing, and sometimes finance. If the competitive market is the company s battlefield, then line management describes who coordinates and supervises whom from factory worker to CEO in the execution of the company s battle plans from strategy down to tactical plans. Operations Marketing Finance and Administration People often use the term line with other terms to indicate how close the responsibility is to the actual production or selling of the good or service. It also can mean the directness of supervision of authority, or the practical nature of the Ai Toys Brands and NPD Sales Accounting position. Line responsibility is synonymous for direct responsibility, as in she has line responsibility of 30 employees, while line management suggest that Traditional Toys Asia Pacific HR and Payroll the job involved actual production or selling responsibility, rather than research or advisory responsibility. North America EMEA Line versus staff management IT There are other roles in a business that require expertise and help the business run smoothly, but that aren t directly involved in the chain of command in the production and selling of goods and services. These areas are sometimes called non-core functions or staff functions, although they may be extremely important. People in these functional areas generally provide advice to management on how best to run the business, or on how to interact with the environment. There are different kinds of responsibilities within a business, and different levels of authority. A chain of command describes who reports to whom in an organization, and typically is reflected in a detailed organization chart. The term originated in the military and helped identify exactly who should direct whom, from the lowest soldier in the field to the highest general. This line from solder to general was termed the line of authority. Typical staff functions are Accounting, Research, Human Resources, Corporate Communications, Public Relations, and Legal Services. They generally do not have direct supervisory authority over anyone in the chain of command. It is a challenge for staff managers to effectively influence line managers, and this interaction often causes conflict within organizations. One way of minimizing such conflicts is to establish rules or guidelines from the expertise of staff managers for the implementation by line managers. Consider HR policies, or instructions for

78 74 legal compliance, or even Internet and policies from the IT department! Such policies and guidelines are often needed in order for the expertise of staff managers to be embedded within the organization. But you can imagine how line managers might feel about such guidelines and focus on activities and processes other than those of their line responsibility: intrusive, bureaucratic, and a threat to their authority. Management authority and delegation Different departments require management no matter what their basis of organization. And different levels of the company organization require different levels of management authority. In general, people refer to different management levels as executive management, middle management, and first-line management. First-line managers are directly responsible for employees and the tasks closest to actual production and actual sales, and are one level above nonmanagerial employees. Middle management generally manages groups or departments below that are run by first-line managers, and report to executive managers. Figure 7.7 Distribution of management authority and levels Executives People often confuse the general concept of line management with first-line management. First-line managers do not manage any other managers, only nonmanagerial employees, while general line management includes first-line managers, but can include second, third or further management responsibility up the chain of command. By definition, first-line managers do not report to other first-line managers. There may be many of them, but they are spread thinly across an organization s core activities. Middle management, however, typically includes many management layers, of groups reporting to other middle management layers. Executive management often includes at least two layers of management, including vice presidents and senior executives, but rarely many more. Review the organization chart adopted by POPCO last year. How many executives, middle managers, and first-line managers do you think it has now? Delegation of authority means assigning responsibility of management to another, giving that person the authority to fulfill that responsibility, and also defining their accountability for fulfillment of that responsibility. Executives delegate responsibility to middle managers, who delegate to other middle managers, and so on down the chain until first-line managers delegate responsibility of core tasks to first-line workers. This hierarchy of delegation can be reflected in formal organization, like in our organization chart, or it can also be more informal, and not reflected in the formal organization. Organizational centralization and height Middle management First-line management The amount of layers of delegation, the kinds of tasks and responsibilities delegated, and the number of people delegated to define the spread of authority within an organization. In centralized organizations, authority is concentrated at in the upper levels of the organization. In decentralized organizations, authority is spread out to other layers. It is very difficult to establish purely from an

79 75 organization chart whether an organization is centralized or decentralized: you must know the kinds of authority that have been delegated to know. One thing you can tell by a detailed organization chart is how many general layers of management that exist in the company, and how many people each manager directly manages. The number of people a single manager manages is known as the span of control. A narrow span of management control is characteristic of a tall organizational height or hierarchical organization. With a narrow span of control and tall hierarchy there are many organizational layers, while a wide span of management control suggests a flat organization. Critics contend that hierarchical organizations struggle with too many layers of administration and paperwork, and with distorted communications between bottom and top layers of management. They also contend that hierarchical organizations are slow to make decisions and adjust to change. This contention is controversial, as there are plenty of examples where hierarchical companies and organizations are extremely decisive and effective. The particular data sampled, the organizational culture, the context culture, and indeed the types of departments being analyzed often heavily influence such theories. Flat organizations with wide spans of control are thought to increase the empowerment of employees, as well as encourage more employee participation, improved communications, and quick decision-making. However no conclusive research evidence shows that this is true either. The most clear distinction between these two types is that the path to promotion goes through more steps in a tall organization than in a flat hierarchy, but even this assertion can be misleading: in a flat hierarchy, promotion may never occur at all or require such a long time that it effectively requires the same time as in a many-layered organization. Korean corporations typically are extremely hierarchical, yet also can be characterized as decisive, for example Samsung is known for its decisive management style. What aspects of Korean culture do you think contribute to this paradox? Planning Planning is related to organizational design in that there are different kinds and levels of planning that take places within organizations. Generally, executive management executes strategic planning. It includes setting corporate strategy and long-term goals, and sometimes short-term but strategically important objectives. Strategic plans typically attempt to fulfil a corporate vision or mission. For instance, POPCO s vision could be, to be the most admired brand in innovative toy entertainment around the world. Notice that this vision is quite different from being the most recognized toy brand in the world. Defining the corporate vision is a key task for executives. Strategic plans often focus on a two-to-five year planning horizon, based on market projections. Strategic planning became popular in firms in the 1960s and is still the engine that drives corporate action in many companies today. Recently theorists have criticized the idea of the strategic planning process as being uncreative, too formalized and execution-driven particularly in light of the fast pace of environmental change. In other words, theorists today fear that the rationality of the planning process lends itself to pursuing known or familiar goals, projects and outcomes rather than innovation. Based on the strategic plan, department executives or directors typically translate the overall goals into tactical department plans for their particular groups or departments. These plans may be very strategic in nature, but they typically cover a year period and for that reason do not include step-by-step detail. They do, however, include concrete, quantifiable objectives for the department or group, and the manager is accountable for the department fulfilling these objectives according to the plan. Examples might include the company s marketing plan, operations or financial plan. Typically, budget is allocated to each department

80 76 based on these plans. Sometimes, departments are given fixed budgets, and asked to meet certain objectives within those budgets. Based on these department or group-level plans, middle managers usually create operational plans with the input of first-line managers. These plans are typically project-based, with quantifiable and concrete steps for execution and accountability. These plans typically cover periods less than one year. But consider how organizations cope with change: how can they adapt their plans? Figure 7.8 Traditional planning process Strategic plan Department plans+ Contingency plans Project or operational plans Because of the changeable nature of competitive markets, it is important to have alternative plans in case circumstances change or plans fail. Alternative plans are also called contingency plans. Most contingency planning is done at the department or group level, rather than at the executive or first-line level. For executives, routinely changing strategies will cause investors to become nervous, which will in turn hurt earnings and market valuation. On the other extreme, operational plans are very specific by nature, and so often there is no time or budget to develop detailed alternatives. For this reason, contingency planning tends to happen at the level of planning objectives with department plans. In American English, people often refer to contingency plans as backup plans, or Plan B. You will often hear managers ask, what s our Plan B if this fails? In summary, strategic plans are by nature long-term, simple, and include broad goals for two to five year horizon. Department plans include objectives for the department in fulfilling the strategic goals of the company, cover typically a oneyear planning period, and are more detailed. Operational plans are the most detailed plans, and are typically organized around project that can be accomplished within one year. Contingency plans are alternative plans, and they typically are created as alternatives to department-level plans. The planning process is by nature a rational, top-down process. What are the implications of such a process on human values? Do you think the planning process itself could contribute to unethical behaviour? How? Control in the corporate form In the hierarchy of a company and the chain of command it should be clear who reports to whom. But what about at the very top? Who hires and manages the CEO, and to whom does the CEO report? Who other than the senior executives is involved in the strategic planning for a company? In the corporate form, there is an important relationship between the performance of the firm, the CEO and corporate officers, and the owners of the firm. This relationship is mediated through the board of directors. The board of directors is the top governing body of a company, and can be chosen from inside or outside the corporation. In theory board members are chosen based on their knowledge and experience with respect to the company s activities or needs, but often they are chosen because of relationships with the company founders or other board members, or prestige in the field. Board members are elected by stockholders of the company, and are compensated by the company for their involvement.

81 77 Board members appoint the CEO and other corporate officers like the chairperson, executive vice presidents and chief officers (e.g. CFO, COO), the company secretary, and treasurer. The board of directors helps executives to form the company s vision and strategic plans. Corporate officers routinely meet with the Board of Directors to get advice and approval on a variety of things including operating budgets and capital expenditures, and the capital budgeting process (see the next unit for an explanation of these). Figure 7.9 Control in the corporate form Summary: Corporate Organization and Planning In this unit you have learned about: The different approaches to corporate organization The concept of job design and departmentalization The difference between line management and staff functions Stockholders Elect Board of directors Appoint Corporate officers Hire Employees The different layers of management, and their typical distribution The idea of span of control and organizational height What governance issues might arise from the corporate form of control? The basics of business planning and the weaknesses in the strategic planning process The basic form of control in corporate form

82 78 Worksheet 7 (front) True or False 1) As companies grow, they must move towards functional departmentalization to be efficient. 2) Firms never mix types of departmentalization in their organizational structure because it confuses workers 12) Review the organization chart in 7.6. Now assume that, in addition to expanding our production facilities to a factory in Brazil, POPCO has also made two acquisitions: a small animation production company called Sunnyside, and a web design company called Studio 103. On the reverse, draw a new organization chart for POPCO, bringing in the animation production, graphic effects production, and web design functions into the company in an effective way. How has this changed the company? Match the organizational term with the best description. a) Organization chart b) Job design c) Staff function d) Chain of command e) Line management 3) Management of Clucky Chickens production and sales 4) Human resources and public relations 5) Manager of Korean sales for POPCO 6) Describes the chain of command 7) Describes the allocation of tasks to groups and individuals 8) Who is responsible to whom in POPCO from factory worker to CEO True or False 9) An organization with a wide span of control is centralized in authority 10) A hierarchical organization makes slow decisions 11) A narrow span of control suggests a tall hierarchy in an organization

83 79 Worksheet 7 (back) Draw your new organization chart here, and explain how this will change the company.

84 80 Unit 8 The Finance Department Learning objectives of this unit In this unit you will learn the following concepts: The main responsibilities of the finance department (in class: diagram) The different roles and functions within a finance department (in class: diagram) The different kinds of budgets (in class: diagram) Different ways to raise money (in class: exercise) Some of the ways the finance department uses to compare different financing options (in class: financing exercise)

85 81 Unit 8 Vocabulary Cash flow ( 현금유동성 ): the total amount of money flowing into and out of a business, directly affecting a company's liquidity. 기업활동을통해나타나는현금의유입과유출. 기업의자산유동성에직접적인영향을끼친다. Operating budget ( 영업예산 ): A detailed projection of all estimated income and expenses based on forecasted sales revenue during a given period (usually one year). It generally consists of several sub-budgets, the most important one being the sales projection, which is prepared first. Since an operating budget is a shortterm budget, capital outlays are excluded because they are long-term costs. 주어진시간 ( 주로 1 년 ) 동안의예상매출액을기본으로모든예상수입과지출의상세히예상하는것. 일반적으로여러개의소규모예산들로이루어져있으며가장먼저준비되는판매전망이가장중요하다. 운영예산은단기예산이기때문에장기비용인자본지출은제외된다. Sales projection ( 판매전망 ): an estimate of a business s sales revenues for a future period, typically based on the actual sales of similar products and services from the same period in the previous year. 전년도와같은기간의제품과서비스의실제매출액을기준으로사업의미래영업수익을추정하는것. Operating expense ( 운영예산 ): a category of expenditure that a business incurs as a result of performing its normal business operations regardless of the level of sales or production. opex 라고도불리며판매또는생산의수준과관계없이정상적인업무를수행하는과정에서발생하는지출의카테고리. Capital budget ( 자본예산 ): also called a capital expenditure budget, or capex budget for short, a plan for raising large and long-term finance for investment in plant and machinery or other fixed assets, over a period greater than the period considered under an operating budget. 공장설비및기계투자를위한대규모장기금융에대한자세한예산계획. Capital budgeting ( 자본예산 ): the process in which a business determines whether projects such as building a new plant or investing in a long-term venture are worth pursuing. Oftentimes, a prospective project's lifetime cash inflows and outflows are assessed in order to determine whether the returns generated meet a sufficient target benchmark. 장기적벤처투자나신규공장건설등의프로젝트가추구가치가있는지의여부를결정하는과정. 때때로유망한프로젝트의현금유입과유출수명을평가하여수익이충분한기준점을충족하였는지확인한다. Cash budget ( 현금수지예산 ): a simple short-term budget typically prepared monthly or quarterly, used to quantify an immediate, short-term (i.e. less than one year) cash flow such as cash on hand, cash receipts, credit receipts and shortterm payments to suppliers, creditors, and investors 수중에있는현금, 현금영수중과공급자, 채권자그리고투자자들의단기납입금과같은단기 (1 년이안된 ) 현금흐름을수량화하기위해매달혹은분기별로만들어진단기예산. Liquidity ( 유동성 ): the possession of sufficient cash or cash equivalent assets to pay for current liabilities. 유동부채를지불하기위해자산을현금으로전환할수있는능력. Liability ( 부채 ): an obligation of an entity arising from past transactions or events, i.e. something owed by a company. 제삼자에게지고있는금전상의의무. Operating leverage ( 영업레버리지 ): a measurement of the degree to which a firm or project incurs a combination of fixed and variable costs. 기업의프로젝트가얼마만큼의고정비와변동비를발생하는지측정하는정도 Security ( 담보 ): any marketable asset used as collateral against a loan obligation, which the lender may seize if the borrower does not meet their loan obligations. 채무자의채무불이행에대비하여채권자에게채권의확보를위하여제공되는모든유가자산. Debt capital ( 부채자본 ): capital raised by taking out a loan, with related future principle and interest payment associated liabilities.

86 82 미래의원리및이자와관련된부채를감안하고대출하여모은자금. Financial leverage ( 재무레버리지 ): The amount of debt used to finance a firm's assets. 기업의자산을융자하기위해사용된부채 Bond ( 채권 ): a debt investment in which an investor loans money to company or government that borrows the funds for a defined period of time at a fixed interest rate. 정부또는기업이일반인으로부터자금을조달하기위해정해진기간동안고정이율로발행하는차용증서. Equity capital ( 자기자본 ): capital received for an interest in the ownership of a business, which is capital free from any debt obligations. 기업의자본중에서출자의원천에따라출자자 ( 주식회사의경우는주주 ) 에귀속되는자본부분. 총자본에서부채를한다. Retained Earnings ( 유보이익 ): the portion of net income which is retained by the corporation rather than distributed to its owners as dividends. 주주에게배당금으로지급되지않고기업에남는당기순이익의일부분.

87 83 The main responsibilities of the finance department The main responsibilities of the finance department vary, and have a short term and a long term focus. The finance department conducts budgeting for the operations and capital investments of the company; it budgets and manages cash flow; raises the required short and long term financing for the company; controls incoming revenues and payments of production costs, operating expenses, and capital expenses; negotiates with suppliers for purchases; and audits the use of funds of the various departments. The finance department also helps the company improve operations through budgeting and forecasting the company s short and long term financial needs and performance. Finally, the finance department advises senior management on strategic decisions with respect to productivity, specialization, and growth using financial analysis and modeling. Figure 8.1: Typical roles in the finance department Financial reporting Tax and investment Accounting Auditing Payroll Finance Director Financial Administration Controller Billings and collections Purchasing Financial Analysis and Planning Planning and forecasts Corp. finance Financial analysis Forecasting and planning: The operating and capital budgets The financial planning and forecasting for a business for a year is reflected in the operating budget of the company. The operating budget includes all estimates for revenues and income for the business, as well as all expenses and costs associated with both production and the day to day running of the business not directly involved in production. The operating budget typically begins with an estimation of revenues. The finance department typically works with the marketing department s sales team to estimate future revenues in a sales projection (also called sales forecast), and works with the operations department s purchasing team and the company s general administrative team to estimate the costs and expenses related to production and day to day running of the business, respectively. The operating budget includes payments that are due in the future, as well as anticipated revenues not yet received. Do not confuse the operating budget with operating expenses. Operating expenses are the day to day expenses of running a business not related to the costs of producing goods or services. An operating budget, in contrast, includes all of the costs associated with running the business including those related to production. We will explain more about operating expenses in the accounting unit. The finance department also works with the various departments and executives to determine more strategic investments for the company, and the long-term finance required for these types of acquisitions. This type of estimation is focused on the purchase of assets for the company that will create income in the future, such as a new factory, machinery, or repairs of existing fixed assets. A major focus of long-term planning therefore is capital expenditures, included in the capital

88 84 budget (also called the capital expense budget, or capex budget). Capital expenditures are accounted for differently than everyday expenses, because their value is not consumed in one year but over time. They typically require long-term financing, too. The operating budget is the counterpart to the capital budget. Very often, each department will create their own operating and capital budgets. These department budgets will then be combined into a master budget for the company. Managing cash flow: the cash budget The finance department is responsible for day-to-day transactional accounting of the business, including keeping track of all transactions as well as any reporting to the government of transactions. The finance department also manages the cash flow of the business, to ensure there are enough funds to pay for the company s day to day financial needs. This requires issuing clear purchasing policies for suppliers, as well as credit terms for customers for billing. It also involves active collection of balances due to the company so that the company is paid on time. A financial controller usually manages the company cash flow. To estimate the cash flow of a business, the finance department creates a cash budget to estimate short-term cash needs. The forecast of these day-to-day sales and collections minus purchases and expenses is done on a very short-term basis, typically quarterly, monthly or even weekly. Often the company may forecast periods when there is insufficient cash to cover the day-to-day needs for a particular month or quarter. This is particularly true for companies with seasonal sales cycles, or long lead times for production. Consider POPCO: the peak toy-buying season is during December-January Christmas sales season, yet production for this period (and the expenses associated with production) begins the previous spring. Long before POPCO receives revenues for toy sales, they must pay suppliers for the costs of producing inventory. This is referred to as speculative production, because there is a time lag between production and revenue generation. If POPCO toys are not selling well in December, they might invest in short-term promotions with retailers to boost sales. How are the cash budget and the operating budget related? The cash budget simply reflects the cash on hand of the business at the beginning and end of each period. In other words, if your cash budget shows extra cash for a period, then the operating budget should show how that extra cash will be spent, like paying debts, investing in longer-term activities, or issuing dividends to shareholders. If the cash budget shows a shortfall in the future, the operating budget will show where money will be retained to cover the shortfall, or reflect the short-term financing activities planned to cover it. Access to cash or failure to provide for enough cash or cash equivalents is very often the root of small and new business failure. For this reason investors are interested in a company s liquidity, which is its ability to pay for what it owes within one year (called current liabilities) with the cash or cash equivalents it will have in that same period. Strategic financial forecasting and analysis: capital budgeting The finance department is responsible for evaluating and advising the company on how best to be productive, specialize, and grow. For instance, productivity improvements might include improving equipment or facilities. Specialization might include developing a new product or launching a division with new expertise. Growth might involve expanding facilities, well as investments in market entry strategies like new licenses, mergers and acquisitions, joint ventures, and FDI. It may even involve market investment strategies for the company s liquid assets. Managing long-term financing effectively can be very complex and

89 85 demanding as the business environment changes, so requires detailed projections, modeling, and analysis to evaluate. This process is known as capital budgeting. Capital budgeting is much more than simply forecasting the amount of money something costs, however. It involves analyzing the comparative cost and return of the different possible investment projects available to the company. Imagine that POPCO wanted to know the best way to increase production capacity: it could expand its current facilities, acquire another company, invest in a factor overseas, or contract with a company to manufacture on its behalf. Which is the most efficient course of action, and the most effective for the organization? The finance department is responsible for evaluating the alternatives and modeling each option s costs and benefits. Its job is to determine which expenditures and projects are worth the investment of the company s capital structure, which is just a term for POPCO s financing options (debt, equity, or retained earnings). An important consideration in evaluating alternatives is the operating leverage of each project. Operating leverage measures the degree to which a company or project incurs fixed versus variable costs in the production of revenues and profit. A project that has a high proportion of fixed costs compared to variable costs uses a lot of operating leverage. It may be considered riskier, requiring lots of money up front, but with higher potential returns in the future. A business that has very few sales, but with very high gross profit margins, is also considered highly leveraged. Raising finance: sources of funds Another responsibility of the finance department is to raise finance for the company. Financial needs can be related to short-term (within one year needs), or can be more strategic, requiring long-term financial consideration. Short term needs are typically revealed through the cash and operating budget process, and include: monthly expenses and inventory needs, speculative production, short-term promotions, cash flow problems, and emergencies. Long term financing needs are identified through the capital expense budget and the capital budgeting process, and can include those for capital improvements, expansion, mergers and acquisitions, and new product development. Once the financial needs of the business are identified, the finance department will evaluate the different sources of funds for the finance required. The sources of funds are quite different, and so are the risks and costs associated with each method. The four main sources of funds are sales revenues from the current planning period; equity capital in the form of stock; debt capital meaning borrowed funds; and sale of the company s assets. Each source of funds has pros and cons of its use. They are not specifically related to short or long term needs, and some can be used for either. Figure 8.2: Sources of funds to pay for financial needs Do you think the expansion into Clucky Chicken production overseas increases Sources of funds or decreases our operating leverage, or does it stay about the same? Why? Sales revenues Debt capital Equity capital Sale of assets

90 86 Sales revenues Most of the financing for a company s needs, especially short-term requirements, come from sales revenues for the current period: in the budgeting process, this is reflected in the costs and expenses deducted from sales projections. Even uncollected revenues and inventories are fairly liquid (meaning easily transferable to cash) in nature, and can be used as security for borrowing money (debt capital). Debt capital short term Debt capital is simply borrowed money. Money can be borrowed for short or long term use, but can take many more forms that just a simple bank loan. Retailers can often get effective debt capital from manufacturers through trade credit, where they have a month or more to pay for merchandise. Trade credit is free from interest, and is an exceptional way for a retailer or wholesaler to buy time. On the other side, manufacturers may issue promissory notes to suppliers, which are literally an I owe you. Promissory notes usually carry some amount of interest on them, however. Outside of trade credit and promissory notes, businesses usually turn to banks for short-term debt capital. A line of credit is a kind of loan that is approved by a bank even before the money is needed, with agreed, short-term repayment terms. Banks also offer short-term unsecured loans to businesses, depending on their credit rating and relationship with the bank. Each of these trade credit, promissory note, line of credit, and unsecured bank loan is an example of unsecured short-term debt capital. Usually the amounts are small, and if the company has a good relationship with the lender, the interest levied can be small as well. If the company requires more financing, or more financing on better interest terms, they may turn to secured short term financing. Companies can use assets like inventory, accounts receivable, or even equipment to secure loans and other financing. For instance, a company can pledge its inventory as security for a loan, in which case the lender might require that the inventory is stored in a public warehouse. The borrower would then only receive the inventory back once the lender was paid in full, plus interest. The borrower would also need to pay for the storage and insurance of the inventory, rather than be able to sell it. A better option might be secure a loan against payments due to the company (accounts receivables). Particularly when a company issues trade credit, they may be owed a lot of money by their customers, but not have access to this cash. A lender would evaluate the credit worthiness of the company s customers before entering such an agreement, but might agree to lend up to 80% of the value of accounts receivables. Debt capital long term Long term debt capital primarily consists of long term loans and issuance of bonds. In a few occasions in industries where capital investments in machinery are high but standardized, suppliers might extend long-term credit to their customers rather than forego a sale. Term loans are long term loans whereby the borrower agrees to repay both the money borrowed (the principle) and the interest due on the loan in period installments agreed with the lender. Term loans are typically from three to seven years long. The lender has a lot of discretion on setting the interest and repayment terms for such loans, and often includes additional conditions for lending such as maintaining a certain amount of working capital in the company. Long term loans are almost always secured. Large corporations with excellent credit as well as governments may issue bonds, another form of debt capital. A bond is an agreement to repay a specified amount of money (called the face value, or par value) with interest by the maturity date, when the repayment is due. Until the maturity date, the corporation repays the interest (called the coupon) due to the lenders at regular intervals, usually every six months. Bonds vary in face value, maturity date, and coupon. The higher a

91 87 bond s interest rate (coupon), the higher the risk of the bond. Bonds are traditionally sold in units of $1,000. Bonds are not first issued directly by the borrower to members of the public; instead they are issued to the market through an intermediary (also called an underwriter), typically one or more investment banks. The investment banks marry bond sellers with bond buyers (typically large institutional investors like pension funds, insurance companies, banks, bond mutual funds, and other corporations). Bond holders can sell their bonds before the maturity date in the secondary marketplace through dealers. Pricing of bonds may vary from dealer to dealer, because each dealer charges a fee or commission on the transaction. Using a lot of debt to finance assets is not necessarily a bad thing, so long as the company uses the borrowings for something that provides a greater return than the expense of the capital borrowed. In other words, so long as they can repay those debts and remain competitive, borrowing may be smart financial management in the push to be more productive, specialize, and grow. The amount of debt a firm uses to finance its assets, including revenues as well as other kinds of assets, is referred to as financial leverage. Different industries may have a range of acceptable financial leverage, and different ways of calculating financial leverage. We will look at the ratios used to calculate operating leverage, financial leverage, and total leverage in unit 7. What kinds of companies can you imagine typically operate The general term leverage is used in business to describe any method to multiply gains (or losses). It can be used as a verb or adjective. Examples are, We leveraged our house through a mortgage, and Microsoft has become highly leveraged by borrowing at the same time they have excess cash. While leverage is not in itself a bad thing, and many companies these days with high credit ratings are increasing their borrowings because of extremely low interest rates, analysts look for those companies to use their leverage wisely: by creating new profit-generating profit lines, diversification, and expansion. But with the increasing movement of capital into financial instruments and markets (termed financial engineering), instead we have seen companies put this money into things like securities, hedge funds, and other financial instruments. Analysts complain that such investments do not build the core asset base of the company, and can be risky (remember leverage multiplies gains and losses because of the interest and credit rating costs of debt). But companies avoid criticism by paying out high cash dividends to shareholders. This is just one example of what is being called the financialization of modern economies. According to one writer, Like their middle-class customers, corporations have made up in the past decade for a lack of core profit generating ability through leverage. Equity capital Equity capital is a source of funds used almost exclusively for long-term financial needs. Very small companies usually raise equity capital from the money invested directly by the business owners into the business no stock is issued. But in the case of corporations, the two primary forms of equity capital are retained earnings and stock issuance. Retained earnings are simply the earnings left from the previous period s operations that are not repaid to owners in the form of dividends. They are considered equity financing because they are effectively undistributed profits. Many companies large and small do not pay dividends and instead reinvest profits into the business. Retained earnings can provide the finance department with the means to become more productive, specialize, and grow. Stock issuance is the granting of a percentage ownership in the company in exchange for capital. The first time a company issues stock is called an Initial Public Offering, or IPO. IPOs are most often managed by intermediaries like investment banks. The immediate cost of an IPO is extremely high due to the

92 88 legal fees paid to consultants in order to comply with filing regulations, as well as the fees and commissions charged by investment banks. However, the ongoing costs of issuing stock after the initial offering (also called floatation) are small. Companies are under no obligation to issue dividends, although shareholders may demand dividends if they feel the retained earnings are not adding value to the stock. Stockholders can of course sell their stock in the stock market. The supply and demand of a given stock in the stock market can cause the value of the company to go up or down, and hence the value of the stock ownership stake can rise or fall. The market capitalization of a company is reflected in the market value of all its outstanding shares. Market capitalization not only shows the size of the firm, but can suggest the relative risk of investment in the firm. In special cases companies may pursue alternative equity financing: venture capital or private placement. Venture capitalists are private investors or investment companies that seek out high-return opportunities. In return for investing, the venture capitalists receive an equity stake in the firm plus a share of the firm s profits. Venture capital not only targets start-up businesses, but also highly profitable ventures by established companies. A private placement is a stock issuance sold directly to large institutional investors, not the general public. The costs of private placements are generally lower and the legal filing requirements are fewer than in public stock filing. Specific terms are negotiated between the buyer and seller in private placements. Sale of assets A company may sell its assets to raise short or long-term capital. In a mature firm, management of assets is handled dynamically, constantly evaluated against other alternatives. A buy or lease decision may depend on the cost for capital expenditure, the value of repairing old assets versus buying or leasing new assets, and the operating leverage position of the company. For this reason, sale of assets may not be a sign of desperation, but sound financial management. The finance department at work: comparing the return of different financing strategies If you were to try and understand how well a company was doing, you might look at their net income (i.e. bottom line profit). But, does that mean that a big company is always doing better than a small company, because their absolute net income is likely to be greater? Of course not. In order to best evaluate the effectiveness of companies in turning resources into profit, you need to instead look at ratios of their performance. Ratios help to avoid making evaluation errors due to absolute numbers. People like company and financial analysts use financial ratios to compare one company to another in the same industry and of the same size to see how the company is doing. They also use financial ratios to examine the performance of a company over time. You will see in the next section how financial ratios help analysts, investors, and researchers calculate and compare the performance of firms. How does the finance department compare and analyze the benefits of raising finance in one way versus another? In capital budgeting, typically they compare the internal rate of return, discounted cash flow, and the net present value of one project versus another. You may learn more about these analysis techniques in an advanced financial management course. We will not discuss those measures, but instead we will use a basic financial ratio to show how simply financial leverage works. Two ratios that help measure how effectively a company uses its financial resources are Return on Equity (ROE) and Return on Assets (ROA). Return on equity measures a corporation's profitability by revealing how much profit a company generates with the money shareholders have invested. In other words, it measures how much of each $ raised through issuing common stock is returned

93 89 in net income (i.e. bottom line profit). For example, a company that generated 100 worth of profit for the year for 1000 of equity has a ROE of 10%. ROE is expressed as a percentage: ROE = Net Income / Shareholder s Equity Equity is another word for the value of ownership, or shares outstanding. By contrast, Return on Assets measures how effectively a company manages all of its assets to return a profit. In other words, it measures how much profit is generated by each $ of assets. The job of managers is to make the most of the assets of a company, with only as much borrowings or investment as is necessary. Assets are valued at the cost of borrowing plus the amount invested by shareholders, or in other words, assets = liabilities + owner s equity (debt and equity). Companies use both debt and equity to finance their assets. For example, if one company has a net income of $1 million and total assets of $5 million, its ROA is 20%; however, if another company earns the same amount but has total assets of $10 million, it has an ROA of 10%. Based on this example, the first company is better at converting its assets into profit. ROA = Net Income / Total Assets Let s compare some financing options for POPCO. If POPCO wants to raise $100,000 for new machinery, which is the better way: borrowing from the bank or issuing shares? Let s say that POPCO s options for raising this cash were limited to issuing stock or borrowing from a commercial bank. Suppose that the bank loan rate is 9% interest Suppose POPCO already had received $500,000 in investment from shareholders (so has outstanding shares of $500,000 value total) Suppose that POPCO s finance team estimates that their operating profit in the year the finance is raised at $95,000. Here s a very simple comparison of these financing methods, using Return on Equity (ROE), or what % of each $ of shareholder investment is expected to be returned as net profit. Figure 8.3: Comparing the impact of different financing methods on ROE Finance through debt capital Finance through equity capital Owner s equity $ 500,000 Owner s equity $ 500,000 No additional equity $ 0 Plus additional equity $ 100,000 Total equity $ 500,000 Total equity $ 600,000 Plus debt capital $ 100,000 No debt capital $ 0 Total capital $ 600,000 Total capital $ 600,000 Expected Return on Owner s Equity (ROE) at Year End Finance through debt capital Operating income (Operating profit) Less other expense (loan interest) Net income (ignoring tax) ROE = $86,000 / $500,000 Finance through equity capital $ 95,000 Operating income (Operating profit $ 9,000 No other expense (loan interest) $ 86,000 Net income (ignoring tax) 17.2% ROE = $95,000 / $600,000 $ 95,000 $ 0 $ 95, % The increasing use of corporate leverage to invest in non-core activities such as financial instruments is a natural result of globalization, but what are the downsides to this financialization of market value?

94 Summary: the Finance Department 90 In this unit you have learned about: The main responsibilities of the finance department The different roles and functions within a finance department The difference kinds of budgets The concept of operating leverage The different ways to raise money The concept of financial leverage How finance teams might compare different finance methods

95 Blank page for your notes 91

96 92 Worksheet 8 (front) Match the budget type with the forecasted item. a) Operating budget b) Capital budget c) Cash budget 1) Estimated purchase cost of all new computers 2) Reinvestment of extra cash expected 3 rd quarter 3) Overall inventory needed to support projected sales for the year 4) Forecast of quarterly sales revenues 5) Cash gain or loss estimated for a month 6) The money spent to purchase a new company van True or False 7) Equity capital in the form of an IPO is a great source of funds for companies with limited cash flow. 8) Issuing bonds is a short-term form of debt capital available to all companies. 9) A cheap form of debt capital is trade credit. 10) Operating leverage measures how well a company turns assets into equity. Multiple choice. Consider what would happen in the example in Figure 6.3 under the following conditions, and select the best answer. Include your calculations on the reverse. 11) If the interest rate fell to 3%, then if all other conditions remained the same as in Figure 8.3, a) The firm should use equity financing according to ROE b) The return on equity would decrease for both financing methods c) The return on equity would increase for debt financing only d) There would be less operating income 13) If the amount of capital needing to be raised rose from $100,000 to $500,000, interest rates were 2.5%, but other conditions were the same as in Figure 8.3, then a) The firm should use equity financing according to ROE b) The rate of return on equity would increase for both financing methods compared to 8.3 c) The rate of return on equity would decrease for both financing methods compared to 8.3 d) There would be less operating income 12) What do you think would be the immediate impact on ROA of the best option for ROE in 12 above? Why?

97 Worksheet 8 (back) 93

98 94 Unit 9 The Accounting Team and Financial Statements Learning objectives of this unit In this unit you will learn the following concepts: How accountants view business activity, and the different forms of accounting (in class: diagram) The basic principles behind financial accounting (in class: formula) The process of financial accounting (the accounting cycle) (in class: discussion and exercises) The main financial statements (in class: statements exercises) The balance sheet and how is it used (in class: statements exercises) The income statement and how is it used (in class: statements exercises)

99 95 Unit 9 Vocabulary An Account ( 계정 ): A separate and specific record of financial transactions that occur in each of the main financial transaction categories: assets, liabilities, shareholders equity, revenues, and expenses. For example, in the main financial transaction category assets, a company will have an account each for the following asset subcategories: cash, accounts receivable, supplies, building, and machinery. It will also have separate, individual accounts within liabilities, shareholders equity, revenues, and expenses. Transactions are shown as either debits (abbreviated Dr) or credits (Cr). 계정은자산, 부채, 자본, 수익, 비용같은주요금융거래들을기록하는분리되고구체적인금융거래기록이다. 예를들면주요금융거래범주인 자산 에는각자의계정이있는데자산의하위범주에는현금, 매출채권, 저장품, 건물그리고기계들이있다. 부채, 자본, 수익그리고비용도각자의분리된계정이있다. 위의금융거래들은기업의재무제표 ( 대차대조표, 손익계산서 ) 에보고된다. 거래들은차변 (debits 줄여서 Dr) 또는대변 (Credits 줄여서 Cr) 에보여진다. Debit ( 차변 ): Indicates the left hand side of an accounting entry. It DOES NOT mean decrease. The act of recording an amount on the left side of an account is called debiting. Refer to the debits and credits table to review how debit transactions affect each category of accounts (increase or decrease). 차변은회계분개에서좌변을나타낸다. 하지만왼쪽에있다고감소를나타내지는않는다. 좌변에액수를기록하는것은 debiting 이라불린다. 아래에차변대변표를보고차변매매거래의거래범주가어떤영향을받는지보십시오 ( 증가또는감소 ). Credit ( 대변 ): Indicates the right hand side of an accounting entry. It DOES NOT mean increase. The act of recording an amount on the right side of an account is called crediting. Refer to the debits and credits table to review how credit transactions affect each category of accounts (increase or decrease). 대변은회계분개에서우변을나타낸다. 하지만증가를나타내지는않는다. 대변에액수를기록하는것은 crediting 이라불린다. 차변대변표를보고대변매매거래의거래범주가어떤영향을받는지보십시오 ( 증가또는감소 ). Assets ( 자산 ): A resource with economic value that a corporation owns with the expectation that it will provide future benefit. On the balance sheet, an asset represents what a firm owns. In the context of accounting, assets are classified as current, fixed (non-current), or intangible. Current means that the asset will be consumed within one year. Generally, this includes things like cash, accounts receivable and inventory. Fixed assets are those that are expected to keep providing benefit for more than one year, such as equipment, buildings and real estate. Intangible assets are not physical in nature. Corporate intellectual property (items such as patents, trademarks, copyrights, business methodologies), goodwill and brand recognition are all common intangible assets. 개인이나법인이소유하고있는유형과무형의유가치물 ( 有價値物 ). 재무상태표에서자산은기업이소유하고있는것을나타낸다. 회계에서자산은유동자산, 고정 ( 비유동 ) 자산또는무형자산으로분류된다. 유동자산은일년이내에소비되는자산을일컫는다. 일반적으로현금, 미수금 ( 외상매출금 ) 그리고재고가유동자산에속한다. 고정자산은일년이상이익을주는것을말한다. 장비, 건물, 부동산이예시이다. 무형자산은말그대로형체가없는자산이다. 기업의지적자산 ( 특허권, 상표권, 저작권, 사업방법론등 ), 영업권, 브랜드인지도등이보통무형자산으로분류된다. 자산 = 자본 + 부채 Liquidity ( 유동성 ): The ability to convert an asset to cash quickly. Assets that can be easily bought or sold are known as liquid assets. 기업이갖고있는자산을현금으로바꿀수있는능력을말한다. 쉽게말해현금으로바꿔쓸만한재산을얼마나갖고있는가를나타내는말이다. Owners equity ( 자본 ): Assets minus liabilities, or equivalently share capital plus retained earnings minus treasury shares (stock that may is from a repurchase or buyback from shareholders, or stock that was never issued to the public). Shareholders' equity represents the amount by which a company is financed through common and preferred shares. Also called Shareholders equity. Owners equity comes from two main sources. The first is the money that was originally invested in the company, along with any additional investments made thereafter, including investments made through stock issues. The second comes from retained earnings that the company accumulates over time through its operations. In most cases, the retained earnings portion is the largest component.

100 96 자산 - 자본 = 부채또는주식자본 + 이익잉여금 - 자사주처분 ( 주주들에게다시사거나재구매한주식또는외부에발행하지않은주주 ). 자본은보통주와우선주를통하여기업의자금조달양을보여준다. 자본은두가지의주요출처에서온다. 첫째는회사에원래투자된돈또는후에추가로투자된돈이다. 더하여주식발행으로인해벌어들인돈도포함된다. 둘째로는영업활동하면서모아진이익잉여금이다. 대부분의경우이익잉여금이주로구성되있다. Retained earnings ( 이익잉여금 ): The percentage of net earnings not paid out as dividends, but retained by the company to be reinvested in its core business or to pay debt. It is recorded under shareholders' equity on the balance sheet. 이익잉여금은기업의영업활동, 고정자산의처분, 그밖의자산의처분및기타임시적인손익거래에서생긴결과로서주주에게배당금으로지급하거나자본으로대체되지않고남아있는부분을말한다. 이것은재무상태표에서주주지본아래에기록된다. Operating expenses ( 운영비용 ): In business terms, some refer to operating expenses as only those expenses for the day to day running of the company that are NOT involved in production costs (COGS). However in accounting terms, the expenses not involved in COGS are referred to by their expense account names: Sales, General and Administrative expenses. In the accountant s view, ALL costs to do with operating activities (as opposed to investing or financing activities) are referred to as Operating expenses. 비지니스용어에서운영비용은가끔나날이회사가운영되면서드는비용만언급하기도한다. 하지만회계용어에서는매출원가에포함되있지않는비용은비용회계용어로불린다 : Sales, General and Administrative expenses. 회계사의입장에서는운영비용 ( 투자활동이나재무활동과는대조적으로 ) 과관련된모든비용은운영비용으로언급된다. 운영비용 : 기업이단위기간동안윤영하면서거기에서조수입을올리기위하여필요한모든비용이다. Cost of Goods Sold COGS ( 매출원가 ): The direct costs attributable to the production of the goods sold by a company. This amount includes the cost of the materials used in creating the good along with the direct labor costs used to produce the good. It excludes indirect expenses such as distribution costs and sales force costs. COGS appears on the income statement and can be deducted from revenue to calculate a company's gross margin. Also referred to as "cost of sales." 회사가판매하는제품을생산할때드는직접적인비용이다. 이총액은제품을만들때드는재료나생산할때드는직접적인노동비용이포함된다. 이것은유통비용이나판매인력비용은제외한다. 매출원가는손익계산서에나타나며회사의매출총이익을구하기위해수익에서빼서계산되기도한다. "cost of sales" 이라불리기도한다. 판매된상품의생산원가혹은구입원가를말한다. 기초재고액 + 당기순매입액 기말재고액 = 매출원가로계산된다. Accrual basis ( 발생주의 ): The standard of corporate accounting, where revenue is recognized when earned (i.e. when the goods or services have been provided) regardless of when cash is received, and expenses are recognized when incurred (i.e. when the benefit is received) regardless of when cash is paid. Accrual basis creates a much more accurate picture of the position and performance of the business than the alternative, cash basis. 발생주의는기업회계의표준이다. 발생주의란수익이발생했을때현금의수입이언제얻어졌는지와관계없이그리고비용은현금의지출이언제사용되었는지랑관계없이발생했을때를기준으로인식한다는원칙이다. 발생주의는현금주의보다는조금더정확하게기업의실적이나위치를보여준다.

101 97 An accountant s view of business Before talking about what accounts do, it is helpful to see business through the eyes of an accountant. In the eyes of an accountant, businesses are very simple. Businesses are involved in three kinds of activities only: a) Financing activities: raising external funds in order to run the business; these funds contribute to the company s resources. Figure 9.1 Accountant s framework for viewing business Investing activity b) Investing activities: purchasing or enhancing resources the company needs in order in order to run the business, using the funds raised in financing activities. c) Operating activities: actually running the business (including all aspects of running the business from marketing, operations, finance to HR, IT, etc.), using the resources obtained through investing activities; running the business contributes resources in the form or revenues and equity to financing activities. Financing activity Operating activity Thinking back to the finance section, you can see that investing activities will likely involve capital expenditures as well as sale (disposal) of assets, like a reverse investment. Financing activities include all the activities involved in raising funds through debt or equity capital, as well as their reverse, such as distributing dividends. Finally, operating includes all the transaction activities related to operating the company, which most often involve the flow of cash in the form of paying bills and recording revenues. This simple framework for understanding business influences all of accounting practice. Different accounting specialties Accountants have many responsibilities, all to do with recording, processing, and projecting information regarding business transactions and financial events. Depending on the company s size and form, a company may use a bookkeeper to do its internal accounting, or hire an accredited accountant like a CPA. Many medium-sized and most large firms have their own in-house accounting teams to do their accounting, because qualified accountants provide information to make decisions as well as report on past activities. There are different specialty areas of accounting, summarized below.

102 98 Managerial accounting Managerial accounting practice provides economic and financial information for managers and other internal users. They help managers determine budgets, and guide decisions by providing analysis of actual results versus planned objectives and standard costs. Managerial accounting practitioners relate to managers the relationship among activity levels, costs, and profits. As managerial accounting is a very sophisticated form of accounting we will not focus on it in this course. Table 9.1 The five basic financial elements Financial element Description Assets A resource with economic value that a corporation owns because of past transactions or events, with the expectation that it will provide future economic benefit Other accounting areas of specialization There are many other branches of accounting, the most popular being tax accounting and auditing services. Accounting practice has moved swiftly into nearly all staff areas of company management, particularly those that are liable to be outsourced, including human resource and legal advice, forensics (often involving IT), and even management consulting. However, in addition to managerial accounting, the most essential kind of accounting handled within a firm is financial accounting. We will introduce financial accounting in this course. Financial accounting Within the basic framework of Financing, Investing, and Operating a business, financial accounting considers five basic financial elements: Assets, Liabilities, Owner s Equity, Revenues, and Expenses. When a financial accountant creates an account (the basic container for accounting data) in which to record financial data, the account will involve at least one of these elements. Liabilities Owners Equity Revenues (Income) Expense A present obligation of an entity arising from past transactions or events. Settling these obligations is expected to result in an outflow of resources from the business. The remaining value of the assets of a business after deducting all its liabilities. Also called 'net assets'. An increase in economic benefits during the accounting period, other than those relating to contributions from owners, in the form of inflows or enhancements of assets or decrease in liabilities, which will result in increase in equity A decrease in economic benefits during the accounting period, other than those relating to distributions to owners, in the form of outflow or use of assets or increase of liabilities that result in a decrease in equity Financial accountants analyze and record financial transaction data in order to report to company stakeholders the financial position (orange entries in the table)

103 99 and financial performance (green entries in the table) of the company, as well as the flow of cash into and out of the company, and status of ownership. Stakeholders might include shareholders, managers and employees, suppliers and customers, creditors, and the government. Financial accountants records ultimately are recorded in four key financial statements: 1) The Balance Sheet: shows the financial position of the company at a given point in time, which is the balance of assets, and liabilities and owner s (sometimes referred to as shareholders ) equity. Assets always are equal to liabilities plus owner s equity. 2) The Income Statement: shows the financial performance of the company for a period of time as net income, which is simply the difference between revenues and expenses. Note that finance that is raised through non-revenue means (such as by issuing shares, issuing bonds, and incurring debts) are NOT reflected in the income statement, but are reflected in the Balance Sheet as an increase in cash and either liabilities for debt or owner s equity for equity issue. 3) The Statement of Cash Flows: shows the cash receipts, cash payments, and net change in cash resulting from the company s operating, investing, and financing activities. 4) The Statement of Changes in Owner s Equity reflects changes in owners equity like share capital. We will focus primarily on the financial position and financial performance statements, also known as the Balance Sheet and Income Statement respectively. Before discussing these two financial statements, we will look at how accounting is done and several aspects of modern accounting: the double entry concept, the fundamental accounting equation, accrual basis, and the matching principle. Double entry accounting explained Every transaction has two effects. For example, if someone purchases a Clucky Chicken from a toyshop, she pays cash to the shopkeeper and in return, she gets a Clucky Chicken. These are two financial effects: a decrease in her personal cash by the cost of the Clucky Chicken, and at the same time an increase in her personal assets of one Clucky Chicken. Conversely, the toyshop s cash increases by the purchase price of one Clucky, while their revenues also increase by the selling price of one Clucky Chicken. Accountants record both effects of a financial transaction in their financial records, which eventually will be categorized, totaled, and summarized on the financial statements. Remember, these two effects must be recorded in one or more of the following five elemental categories of accounting: Assets, Liabilities, Owner s Equity, Revenues, and Expenses. Credits and debits Traditionally, the two effects of a financial transaction recorded in accounting entries are known as Debit (Dr) and Credit (Cr). In accounting, a debit DOES NOT refer to a decrease, and a credit DOES NOT refer to an increase. They are simply accounting conventional terms that signify entered on the left for debits, and entered on the right for credits, respectively. In the original Latin for Debit and Credit (Debere = to owe and Credre = to entrust ), the terms recorded the duality of financial transactions. The Debits and Credits method records the flow of financial resources from a source (Credit) to a destination (Debit). Every accounting transaction in a business involves this flow of financial resources. The uniqueness of the Debit and Credit classification method is found in the fact that while various individual account values may change with each new

104 100 transaction, the accounting equation that underpins the accounting system (Assets = Liabilities + Equity) always remain in balance. This is the application of the double entry concept. Without applying the double entry concept, accounting records would only reflect a partial view of the company's affairs. How to handle Debits and Credits Debit and credit records can reflect an increase or a decrease in a financial amount depending on which of the five accounting categories the transaction falls under. Table 9.2 summarizes the conventional effects of Debit (Dr) and Credit (Cr) transactions in each of the five main categories. Accounting students typically memorize these effects. Table 9.2 How debits and credits impact the five financial elements Assets Liabilities Dr = Increase Cr = Decrease Dr = Decrease Cr = Increase Equity Dr = Decrease Cr = Increase Expenses Revenues Dr = Increase Cr = Decrease Dr = Decrease Cr = Increase The fundamental accounting equation From an accounting point of view, when owners initially form a new business, the new business has zero assets. The only way a new business can have assets is if others provide the assets. Others in this case may be external funders like banks who lend money to the business (debt capital in the form of Liabilities) or internal funders like owners who invest money in the business (share capital in the form of Owners Equity). Because all the assets of a business have been supplied by others (Liabilities and Owners Equity), then these others have an economic claim over the business that is the equivalent of the value of the total assets that the business controls. Or, Assets = Liabilities + Shareholders Equity Owners equity is the sum of the original investment made in a company, plus any further investment including funds raised through issuing stock (together known as paid-in capital), less treasury stock (which is stock that was issued, but bought back by the company. The process of financial accounting In order to record and make sense of these double-entry (credits and debits) financial transaction effects in an orderly manner, over time, so that they can eventually be reported in financial statements (and accounting books finished and closed so that the next accounting period can begin), accounting practice has developed a concise, multi-step process.

105 101 Figure 9.3 The accounting process incurred (earned or owed) in the period in question. But many expenses and revenues might cover a longer period or bridge one period and the next. Generally, adjusting entries are needed when nothing has been entered in the accounting records for certain expenses or revenues, but those expenses and/or revenues did occur and must be included in the current period's financial statements; or something has already been entered in the accounting records, but the amount needs to be divided up between two or more accounting periods. For example the use of supplies or inventory stored at the company. The categories of both purchases and receipts of money are recorded in accounts. And accounts are consolidated into super-categories in order to prepare financial statements of financial activities. Financial statements are very easy to understand and remember if you are clear about how they are made. You are likely familiar with receipts already. Businesses, however, do not often pay in cash or with credit cards, and are not always paid immediately. They rely on payment terms and trade credit, which separates the time the goods are transaction from the time that the money changes hands. This can make accounting difficult. Creating accounts, making journal entries and posting to accounts If you wanted to keep track of the finances of a business, how would you do it? You would probably categorize your spending by the type of goods you purchased, and you might choose to record the money coming in by type of transaction. You would also want to record when the transaction was made. The accounting process is exactly this intuitive process, but including the double entry system for accuracy. The accounting process also includes making a trial balances that is then adjusted with additional entries. What are additional entries? In accounting, it is important that, for financial statements to be accurate, they include accurate revenues and expenses that are In order to keep track of these kinds of transactions, businesses use different kinds of receipts to record transactions of goods and services that are not yet paid or that are paid in advance, and accountants keep separate accounts of these things too. The receipt a business uses to record an ordered good or service with payment due in the future is called a Purchase order. When a company wishes to record the contracted moneys due for products or services that have been or will be transacted, they issue a Sales Invoice demanding payment, including the terms of conditions of the contract. A purchase order secures the budget for purchasing goods and services, and receipt and analysis/recording of an invoice starts the recording of payment due in the accounting cycle.

106 102 The accounting team keeps track of invoices and other regular bills that are due but not yet paid in an account called Accounts Payable (A/P for short). Conversely, the accounting team will keep track of invoices they have issued for due moneys in their Accounts Receivable (A/R for short). In addition to actual cash and credit receipts and payments, these are the type of records identified and analyzed in step one. The other most often used account is the account Cash. Ultimately most transactions are recorded via Cash and A/R or A/P in the accounting life of a transaction. The information taken from business receipts and sales invoices is the date of the transaction, the kind of accounts involved, and the amount transacted. At first, these records are simply kept chronologically in an accounting journal, including the appropriate credit and debit information, the accounts involved, and the date transacted. Then the journal entries are deconstructed, pulling the separate account entries together into account ledgers for each account. Acccounts can be more or less specific depending on the company s requirements: examples include Cash, A/R, A/P, Sales revenues, Loan interest, Equipment, Supplies, etc. Normal balances Notice that each accounting category (Assets, Liabilities, Equity, Expenses, and Revenues) has its own ledger accounts associated with it. After each account is credited and debited appropriately in an accounting period, a trial balance for the ledger account is created. Most companies keep a single (these days computerized) record of all the accounts and their various credits and debits in one super-record, called a general ledger. Typically, the accounts in the 5 major accounting categories have balances in one or the other column once netted in performing trial balances. For instance, Assets should have a total Debit balance for a going concern, likewise Expenses also will likely be Debit balanced. On the other hand, Liabilities, Equity, and Revenues all have normal Credit balances. Retained earnings is an Equity account. These are the accounting categories normal balances. Note: some accounts within these common accounts do not have the normal balances, and so are known as contra accounts (contra means against ). For instance, Dividends, Treasury Stock, and drawings by owners are all contra accounts within the Equity account. They have debit balances. Other examples include Sales Returns and Allowances, and Sales Discounts (Debit balances rather than the normal Credit balance for Revenues accounts) and Accumulated Depreciation (Credit balance rather than the normal Debit balance for Asset accounts). Examples of Steps One, Two and Three of the accounting process follow, showing separate accounts. Example 1: Document to be analyzed: A receipt submitted to POPCO s accounts department for purchase of $100 using cash of furry yellow material on May 2. Step One: Accounts involved: Cash, Materials; Date: 05/02; Amount: $100 Analysis: flow from Cash (an asset account, credited) to Materials (also an asset account, debited) Step Two: Record the financial transaction in the chronological journal May 2 Dr Material $100 Cr Cash $100 Step Three: Post into different accounts. (If there is not an appropriate account, create it.)

107 103 Materials (new account) Cash (existing account) 05/ / Notice that these are both assets accounts in the five basic financial elements! Also, notice that you do not put a minus sign for the credit to cash. That will be reflected when all of the credits and debits in Cash are netted before reporting in the trial balance of the Cash account. Example 3: The accounts department records from bank records the automatic payment of monthly rent from POPCO to our property owner on June 30 for $450. Step One: Accounts involved: Cash, Rent Expense; Date: 06/30; Amount: $450 Analysis: flow from Cash (credited) to Rent Expense (debited) Step Two: Record the financial transaction in the chronological journal June 30 Dr Rent Expense $450 Cr Cash $450 Step Three: Post into different accounts. Example 2: The accounts department receives an invoice from a sewing machine company, showing that POPCO purchased a group of sewing machines on account (meaning, it will be paid for in the future), for $1,000 on June 10. Step One: Accounts involved: Accounts Payable, Equipment; Date: 06/10; Amount: $1,000 Analysis: flow from Accounts Payable (credited) to Equipment (debited) Step Two: Record the financial transaction in the chronological journal June 10 Dr Equipment $1000 Cr Accounts Payable $1000 Step Three: Post into different accounts. Rent Expense (existing account) Cash (existing account) 06/ / / Just using these three transaction examples, you can see that five different accounts are involved, and think about the five financial element categories that they are in: Cash (an Asset account), Rent Expense (an Expense account), Accounts Payable (a Liabilities account), Equipment (existing account) A/P (existing account) Equipment (an Asset account), and 06/ / Materials (an Asset account) Let s try three more examples.

108 104 Example 4: POPCO receives payment by check on September 7 from a wholesaler who was invoiced in August for $15,000 in Clucky Chickens that were delivered in August. Step One: Accounts involved: Accounts Receivable, Cash; Date: 09/07; Amount: $15,000 Step Two: Record the financial transaction in the chronological journal Sept 25 Dr Accounts Payable $300 Cr Cash $300 Step Three: Post into different accounts. Analysis: flow from Accounts Receivable (credited) to Cash (debited) A/P (existing account) Cash (existing account) Step Two: Record the financial transaction in the chronological journal Sept 7 Dr Cash $15000 Cr Accounts Receivables $15000 Step Three: Post into different accounts. 09/ / / / / A/R (existing account) Cash (existing account) 09/ / / / NOTE: the reason why Revenues is not involved in this September record, is because a credit of Revenues would have been recorded in August, along with a debit to Accounts Receivables. Example 5: On September 25 POPCO paid $300 to various creditors through bank transfer. Example 6: POPCO completes production of a $50,000 order for a large company and delivers toys on November 4 that are paid on account (in other words, we issue trade credit to the company, they have not yet paid us). Step One: Accounts involved: Revenues, Accounts Receivable; Date: 11/04; Amount: $50,000 Analysis: flow from Revenues (credited) to Accounts Receivable (debited) Step Two: Record the financial transaction in the chronological journal Nov 4 Dr Accounts Receivable $50000 Cr Revenues $50000 Step One: Accounts involved: Cash, Accounts Payable; Date: 09/25; Amount: $300 Analysis: flow from Cash (credited) to Accounts Payable (debited) Step Three: Post into different accounts. A/R (existing account) Revenues (existing account)

109 105 11/ / / Figure 9.2 Example trial balance POPCO Trial Balance December 31 Debits Credits Cash 514,150 Creating a trial balance Typically, a company will have many separate accounts showing transactions, all recorded in an organized way in the general ledger (and they typically give each account a unique number that shows which of the five financial elements it is, as well as the order it appears on financial statements). At the close of an accounting period, each account is netted, meaning the total balance is calculated subtracting credits from debits (or debits from credits, depending on the normal balance of the account). The account balance is recorded into the trial balance in either the credit or debit column (whichever is greater). A trial balance showing the credits and debits of all the accounts is created, to ensure that credits and debits balance, no matter which accounts net more or less. For an accounting period including all our examples (and including the result of the Check It! Example), the trial balance would look like this: Accounts Receivable (A/R) 35,000 Materials 100 Equipment (sewing machines) 1,000 Accounts Payable (A/P) 700 Share Capital 500,000 Sales Revenues 50,000 Rent Expense 450 TOTALS 550, ,700 Notice the order of items on the trial balance: Assets listed first, then Liabilities, then Owners Equity, then Revenues, and finally Expenses. From recording to reporting With complete records of the net credits and debits for each account, listed in the trial balance in order of the elements (Assets, Liabilities, Owners Equity, Revenues, Expenses), we now can use the trial balance to prepare the statement of POPCO s financial position (the Balance Sheet) at the point in time that, in this case, will be the end of the year, as well as POPCO s financial performance during the course of the year.

110 106 In truth, between the preparation of a trial balance and the preparation and final reporting of statements, we would make adjusting entries for items with no financial records attached to them, that we might need to count at the end of the accounting period. Examples include accounting for changes in supplies and, importantly, inventory. For this explanation, though, we will move onto preparing financial statements. Using the trial balance of very simple transactions in Figure 7.2 we can now state POPCO s performance through the period (Income Statement) as well as the financial position (Balance Sheet) on December 31. The performance statement looks at revenues and expenses, while the position statement looks at assets, liabilities and owners equity. Note that we calculate the income statement first to identify net income. Figure 9.3 Sample POPCO Income Statement POPCO Income Statement for the Year ended December 31 Figure 9.4 Sample Statement of Position for POPCO POPCO Statement of position (Balance Sheet) for the Year ended December 31 Assets Current Assets Cash 514,150 Accounts Receivable (A/R) 35,000 Materials 100 Total current assets $549,250 Non-current Assets Equipment (sewing machines) 1,000 Total non-current assets 1,000 TOTAL ASSETS $550,250 Revenues 50,000 Less Expenses Rent expense 450 Total Expenses 450 Net Income $49,550 Next, we can consider the financial position of POPCO at the end of this period using the information from the trial balance, as well as the results from the Income Statement. Assuming we do not pay dividends on the net income realized in this period, net income would be reflected as retained earnings. Therefore, the following is a statement of the current position of POPCO at the end of the period. Liabilities and Owners Equity Current Liabilities Accounts Payable (A/P) $700 Owners Equity Share Capital 500,000 Retained Earnings 49,550 Total Owners Equity 549,550 $550,250

111 107 As you can see, our example calculations are accurate and support the fundamental accounting equation. One difficulty with this stepped accounting process is that misreporting can still lead to an accurate-looking trial balance. What ethical issues can you anticipate arising from the accounting process? The Income Statement in more detail To explain more about these two financial statements, the Income Statement shows the revenues and expenses during the period. In addition to the net income, someone reviewing this statement might want to know: What percentage of revenues are returned in net income What contribution to operating expenses make towards net income What are the values compared to past years What are the ratios of net income, revenues and expenses compared to others in the industry What is the company s ability to generate income from revenues and expenses However what is not shown on this simplified example is the division between types of expenses. As mentioned before, a stakeholder reviewing the statements would want to see clearly the division between expenses related to the production of goods or provision of services sold by the company, and other day to day kinds of expenses to keep the company going. For manufacturing companies, these are divided into Cost of Goods Sold (known as COGS), and day-to-day expenses categorized into Sales, General and Administrative expenses. So, materials to produce Clucky Chickens are part of the cost of goods sold (in actuality, the cost to produce inventory). Salaries of our marketing team are sales expenses. More about COGS One challenge in measuring the cost of producing goods sold is the aspect of inventory. During a given accounting period, you may be purchasing materials, using some of those materials and not others, completing production of some goods and leaving some partially completed. You also will likely use some inventory you already have on hand for sale, for production, or both. For this reason, COGS needs to account for the state of inventory of the company at the beginning of the accounting period and at the end, as well as changes to inventory during the period. At the end of a period, a company may have many goods available for sale, but not all of them will be sold. Therefore, we must consider the ending inventory in at the close of the period. During the period, a company will use the inventory it already had at the beginning of the period plus new purchases like materials to produce all of the goods available for sale. Thinking about inventory in these ways, you can consider it this way: Beginning Inventory + Net Purchases = Cost of Goods Available for Sale But after we count the entire inventory left at the end of the period, we will likely have inventory left of one sort or another (like materials, partially finished goods, or even fully produced goods). So actually, the Cost of the Goods Available for Sale is really the Cost of Goods Sold, plus the Ending Inventory we have. In summary, we arrive at this conclusion: Beginning Inventory + Net Purchases = Cost of Goods Sold + Ending Inventory

112 108 And therefore, Cost of Goods Sold = Beginning Inventory + Net Purchases Ending Inventory What does Net Purchases mean? Purchases typically are for materials and for delivery of materials to the place of production (but not distribution of finished goods to their destination, which is considered a sales expense). But occasionally we may receive discounts on the purchases we make, or return such items if they are faulty. These are subtracted from Purchases. Net Purchases is simply the total purchases less the Returns, Allowances, and Discounts between us and our suppliers. Sales, General and Administrative The day-to-day expenses of running the company are categorized in sales, general and administrative expenses. Clearly, in analyzing an income statement you would want to see any increases in sales (including marketing expenses) to be reflected in increased revenues, and you would want a company to minimize general and administrative costs as much as possible while still effectively supporting production and marketing. Generally, a company may call these expenses simply Operating Expenses, although generally accountants consider all costs incurred by a company for its operations as Operating costs (as opposed to Investing and Financing). The Balance Sheet in more detail The statement of financial position, or balance sheet, shows what kind of resources the business has and what kind of obligations it owes. In addition to the raw totals, someone reviewing the statement might want to know: What are the values compared to income What are the values compared to the values in past years What are the ratios of assets and liabilities compared to others in the industry What is the company s ability to pay its liabilities quickly, if necessary The last point drives the organization of the balance sheet items: assets are listed by liquidity, or the ability to transfer them into cash to pay for liabilities. Liabilities, on the other hand, are listed according to when they are payable (due). Accrual accounting Now that you have an idea of the construction and purpose of these two key financial statements, it is helpful to review how time impacts the accounting process. Notice that the Balance Sheet reflects the net value of the company at a specific point in time, while the Income Statement reflects the net income of the company during a specified period. Time, it appears, is very important in financial accounting! If you are an accountant, you could consider transactions actually occurring at two different points in time: when the money (cash) actually passes from one party to another, or when the value of the resource is recognized. In cash accounting, transactions are recorded according to when cash is paid or received. However, this is not an accurate reflection of operations for most firms where payments and value transactions happen far apart. In accrual accounting, which is the basis of good accounting practice for corporations, transactions are accounted for when the value of the resource is transacted, not when money is transacted. In other words, revenue is recognized when it is earned (not when it is received in cash), and expenses are recorded when they are incurred (not when they are paid in cash). As an example, consider that POPCO purchases Clucky Chicken material in June, but pays for it in August. In what month should the value of the material be accounted for?

113 109 According to accrual accounting, the expense of the material is recorded when POPCO takes ownership of the material in June. Similarly, if POPCO receives an order for Clucky Chickens in June and delivers the products in August, POPCO recognizes the revenue from sale of the products when the products actually change ownership, not when the contract is struck, or the customer actually pays for them. This is true whether the customer pre-pays for the merchandise, or buys on credit. In case where payment is received before the event triggering recognition of revenue happens, the debit goes to cash and credit to unearned revenue. In case the event triggering revenue recognition occurs before payment is received, the debit goes to accounts receivable and credit to revenue. The latter is the most common occurrence for most firms. Often in production you buy materials and create additional inventory to sell, but at the end of the financial period (the end of the year, for instance) you have extra inventory left. How is this inventory accounted for? This brings us to the matching principle and adjusting entries. Lastly, the matching principle The matching principle in accrual accounting is where accountants try to match recognition of revenues with the expenses incurred in their generation in the same period. So, if we sell $2,000,000 worth of Clucky Chickens in one month, our accounting team will want to account for all the expenses incurred to generate that $2,000,000 in revenue in the same financial period, not earlier or later. If we started with no inventory, incurred $1,200,000 in expenses in that period, but at the end of the period have $200,000 in inventory left, then our profit should not include the expense of that $200,000 in inventory. The most accurate reporting of the amount of expenses required to generate that much revenue is not $1,200,000 but $1,000,000. And our income from that is $1,000,000. That s the matching principle. Ideally, the matching is based on a cause and effect relationship: sales cause the cost of goods sold expense and the sales expense. If no cause and effect relationship exists, accountants will show an expense in the accounting period when a cost is used up or has expired. Lastly, if a cost cannot be linked to revenues or to an accounting period, the expense will be recorded immediately. An example of this is advertising expense and research and development expense. Summary: the Accounting Team and Financial Statements In this unit you have learned about: How accountants view business activity, and the different forms of accounting The basics principles behind financial accounting The process of financial accounting The main financial statements, including the Statement of Income and Statement of Financial Position (Balance Sheet) A sample income statement and how its information might be used A sample balance sheet and how its information might be used

114 Worksheet 9 (front) Section 1: Fill in the missing amounts for each activity Assets Liabilities Equity a $ 4,000 $ 2,500 b 12,800 5,700 c 2,800 3,900 Section 2: Show the Debits and Credits associated with the following transactions, put in their correct general account categories (Assets, Liabilities, Equity, Expense, Revenues). Activity Assets Liabilities Equity Expense Revenues A) Purchased land on credit. B) Made a cash sale. C) Purchased delivery truck for cash. D) Paid this month s rent E) Paid an invoice due. F) Sold merchandise on account. Section 3: For "T" accounts listed below, state which side represents an increase and which represents a decrease Section 4: For the accounts listed below, indicate if the normal balance of the account is a debit or credit. Accounts Normal Balance Debit or Credit a) Service Revenue b) Rent Expense c) Accounts Receivable d) Accounts Payable e) Share Capital f) Office Supplies g) Insurance Expense h) Dividends i) Office Building j) Notes Payable Section 5: For each transaction noted below, write in the appropriate column the names of the accounts to be debited and credited. Transaction Debit Credit 1) Issued ordinary shares for cash 2) Paid salary expense 3) Purchased a truck on credit 4) Received cash for goods sold 5) Paid accounts payable 6) Borrowed money from a bank issuing a note (worksheet continues on the reverse) 110 Dr Assets and Expense Cr Liabilities, Owners' Equity and Revenue Dr Cr

115 111 Section 6: Journalize the following business transactions in general journal form. a) Shareholders invest $25,000 in cash in starting a business as a corporation: 13/11/03. b) Purchased $500 of office supplies on credit: 13/12/24 c) Purchased office equipment for $6,000, paying $3,500 in cash and wrote a 30-day, $2,500, note payable: 14/01/03 d) Product sales revenue billed to customers amounts to $40,000 (not received yet): 14/01/2 e) Paid $700 in cash for the current month s rent14/02/01 Service Revenue Dr Cr Dr Cr Dr Cr Dr Cr Dr Cr Accounts payable Section 8: Match the item with its appearance in its related financial statement. a) Income Statement b) Statement of Financial Position (Balance Sheet) 1) Cash of $50,000 2) Accounts Payables of $10,000 Section 7: Record the following transactions in the accounts listed below a) Received $25,000 from product sales b) Purchased equipment for $1,000, making a down payment of 30% c) Incurred utilities expense on account, $100 d) Paid $400 to creditors 3) Sales revenues of $25,000 4) Owners Equity of $500,000 5) Loan interest expense of $125 each month Cash Equipment Utilities Expense

116 112 Unit 10 The Human Resources Department Learning objectives of this unit In this unit you will learn the following concepts: The different roles and responsibilities within an HR department (in class: diagram) The key steps in acquiring employees (in class: discussion) The key steps in maintaining employees (in class: discussion) The key steps to developing employees (in class: discussion) The key trends affecting human resource management these days (in class: article exercise) How human resource management varies by company, country, and culture (in class: discussion)

117 113 Unit 10 Vocabulary Job analysis ( 직무분석 ): a systematic procedure for studying jobs to determine their various elements and requirements 직무의다양한요소와자격요건을결정하기위해직무를연구하는조직적절차 Paper-and-pencil tests( 지필검사 ): tests designed by an organization that attempt to measure applicant skills and abilities, interests, and personality and match them with those desired by the company 회사가원하는지원자의기술과능력, 관심과성격을 match 하기위해조직에서 designed 한시험 Orientation ( 오리엔테이션 ): the process of training new employees about the culture, goals, and vision of the company. Orientation may also include taskbased training, usually of a general nature. 회사의문화목표그리고회사의비전에대한신입사원교육. 오리엔테이션은대체적으로작업중심교육울포함할수도있다. Compensation ( 보상 ): the payment employees receive in exchange for their labor 직원들이노동의대가로받는보답 Salary ( 월급 ): a specific amount of money paid for an employee s work during a set calendar period, regardless of the actual number of hours worked 직원이실제로일한시간에따른것이아닌, 지정된날짜사이 ( 보통 1 달 ) 동안특정한금액의돈을지급하는것 Commission-based pay ( 커미션 ( 수수료 )) : a payment based on a percentage of sales revenues 매출수입의일정비율을지급하는것 Incentive payment ( 장려금 ): payment in addition to wages, salary, or commissions 월급, 연봉, 커미션이외에도추가적으로지급되는것 Profit sharing ( 이익배분제 ): awarding shares to employees as incentive payments, often used instead of cash compensation 직원들에게장려금으로써주식을주는것. 현금보상대신주는것으로자주이용된다. Employee Benefits ( 사원특전 ): a reward in addition to regular compensation that is provided indirectly to employees, such as insurance coverage 일반적인보상뿐만이아닌간접적으로직원들에게지급되는보상. 예를들면보험 Performance appraisal ( 업적 ( 근무 ) 평가 ): the evaluation of an employees current performance and estimated potential contributions, in order to make human resource management decisions 인적자원관리결정을하기위해직원들의현재업적과추정된잠재적기여에대한평가 Performance feedback ( 성과피드백 ): a process where employees are informed of their performance appraisal. In some cases the employees are allowed to also give feedback, or are asked for self appraisal. 직원들이자신들의업적평가에대해통보받는과정. 어떤경우에는직원들도피드백을줄수있거나자기평가를하도록하기도한다. Job rotation ( 직무순환 ): the systematic shifting of employees from one job or department to another 직원들을하나의직무나부서에서다른직무나부서로순환시키는체계적인이동 Seniority based system ( 연공서열 ): System where pay levels, promotion and compensation or benefit increases are determined by the length of time on the job and not performance. 이시스템은성과에따른것이아니라근무한기간에따라급여수준, 승진및보상또는특전이오르는것을말한다. Performance based system ( 성과에따른승진 ): System where pay levels, promotion and compensation or benefit increases are determined by appraised performance and not length of time on the job. 근무한기간에따라보상을받는것이아니라성과에따라급여, 승진, 보상을또는특전을받는시스템이다.

118 114 The main responsibilities of the human resources department The human resources department is a unique department in many ways. Unlike other departments, the human resources department shares their responsibilities with managers from other departments. The human resources department guides managers in managing their human resources, and facilitates the satisfaction of an organization s internal customers: employees. For instance, line managers will work with human resource specialists to conduct human resource planning and job analysis, and to hire employees. Figure 10.1 Typical roles in the human resources department Staffing Human Resource Director Risk Management Benefits Administration as a resource to be controlled. More recently, management theorists and managers themselves have come to realize the competitive value of satisfied, motivated employees. The view of employees has changed from simply perceiving their utility to embracing their emotions and motivations as human beings. This change has caused an elevation of the human resources function from simply an administrative role to a more strategic one. It has also increased the demands on human resources managers to understand a broad spectrum of human-based influencers such as culture, psychology, situation, group and power dynamics. It has placed more focus on strategic aspects of human resource management. Despite this trend, many small companies do not have an official human resource manager. In these small companies, managers, executives, and administrative staff (i.e. an office manager) carry out the various human resource responsibilities. Interestingly, many larger companies that recognize the importance of HRM choose to outsource the specific areas of it to specialist firms like accountants, headhunters, trainers, and consultants. The primary responsibilities of the human resources department remain to acquire, maintain, and develop an organization s human resources. Acquiring employees Acquiring employees involves human resources planning, job analysis, Employee Relations Compensation Analysis Training recruitment, selection, and orientation of new employees. It is often referred to as staffing in the human resources department organization. Planning In the past, the human resource function was limited by a production-oriented view of the firm. Starting with scientific management, managers viewed workers The purpose of human resource planning is to meet an organization s human resource needs into the future. It is a very strategic activity, and is developed from the company s vision and strategic plan. The human resource team must determine what skills and experience are needed by each of the various

119 115 departments of the company (and sometimes for departments that do not yet exist), where those kinds of employees can be found, and how to attract them to the company. They must do all this in the most economical way possible. Figure 10.2 Three areas of human resource management The difference between laying off employees and firing them is that employees are laid off for economic reasons unrelated to performance, while being fired is due to poor performance of the employee. Job analysis As part of the planning process the human resources department with the help of department managers conducts job analysis. Job analysis determines what tasks and set of responsibilities are involved in a particular job. Job analysis usually Planning Job analysis Recruiting, selecting, orienting Acquire Maintain Compensation Benefits Employee relations Appraisal Training Management development Develop results in a job description and a job specification. A job description describes the tasks and responsibilities of a particular job, including the job title. A job specification lists the experience, skills and qualifications needed to perform the job as described. Often, the human resourced department uses the job description and job specification later when evaluating an employee s performance. Once an organization has developed job descriptions and specifications for their needed hires, they can proceed with recruiting, selection, and orientation of employees. An economical approach to fulfilling human resource requirements is to hire employees that already work for the company. In order to plan for such situations as new human resource requirements, or replacement of an employee who resigns or retires, companies will routinely conduct a skills audit and maintain a replacement chart. A skills audit evaluates all the skills current employees possess. A replacement chart identifies potential candidates that could fulfill key positions if need be. A replacement chart is a kind of contingency plan. In some cases, a company actually has a greater supply of employees than it requires. In this case, the human resources department consults with department managers to identify ways of reducing employee numbers. Typical means of reducing a workforce include: laying off employees due to not enough work, asking employees to retire early, or firing employees. Recruitment Companies try to recruit to the most qualified employees, because the cost of acquiring employees is high. Estimates range from several thousand dollars to an entire year s salary in some industries for just the cost of acquiring a new employee. Human resources teams look for candidates that will meet their current and future needs, and consider candidates inside and outside the company. Recruitment is essentially a targeted promotional activity: promoting employment of the firm to the best candidates, cost-effectively. Recruitment usually includes instructions for applicants about the selection process. Typical recruitment strategies include:

120 116 Job fairs Job postings in company or industry media Classified advertising in online and offline media Headhunting using specialist recruitment firms, usually for very specific or high-ranking positions Selection The selection process involves coordinating activities that inform the company about job applicants. Activities that provide information can include: receiving ed application forms and resumes, employment applications, employment tests (usually for new candidates) and assessment centers (usually for existing employees), interviews, and references. In Korea, for instance, many large conglomerates require all applicants to take a general, standardized skills and knowledge test, before selecting top scoring applicants for interviews. These kinds of tests are called paper and pencil tests. In the US, large firms more typically use automated resume screening software to identify candidates that match their required job description and specification, rather than paper and pencil tests. Both countries use interviews as a last step in the selection process. However in Korea, panel interviews (interviewing many applicants at once by multiple interviewers) are common, whereas in the US, individual interviews are the norm. The word recruitment is often used to refer to all the activities in the acquisition stage of human resources, except orientation. In addition, the word job description and job specification may be used interchangeably to refer to the contents of both. Upon selection, if the candidate decides to accept the job offer, an employment contract is agreed. In Korea, such contracts are typically very brief, and standardized for all employees. In other countries, these contracts may be very long, detailed, and individualized depending on the company and industry. Orientation Once hired, new employees participate in orientation. Orientation activities and focus vary from country to country, company to company. In most large Korean conglomerates, orientation includes induction into the company culture, history, and principles along with team building activities. It often lasts for several weeks or even months. In western countries, orientation is generally for a shorter duration, and is more focused on training staff-related job skills like using company IT systems, administrative forms, and the reporting structure. It may also include career-path information. What do you think is the relationship of Korean employees to their employers? Do you think it is different in Korea than in other cultures? Why? Maintaining employees In order to maintain good employees, it is important to offer them fair compensation and appropriate and valuable benefits in exchange for their labor. Furthermore, it is essential to develop employee relations that allow the organization to understand the changing needs of the workforce and their level of satisfaction with the firm and managers. Compensation Compensation is the monetary (money) payment called the wage employees receive in exchange for their labor. Negotiating compensation is a key issue for management, as compensation is often a significant percentage of operating costs. Typically companies develop a compensation system to determine a logical

121 117 and fair distribution of wages according to job position, department, and responsibilities. This is called a wage structure. A company s wage level is how much it pays employees relative to other firms in its industry. Government ministries and trade associations conduct industry surveys of wage levels. Human resource managers consult these surveys for guidance in setting wage levels. Quite often labor unions, work councils, and other management-employee bodies disagree over one or more aspects of the compensation system. The sum of regular compensation a company pays to employees is called the payroll. Three typical types of compensation include: Hourly wage: a specific amount of money paid each hour in exchange for labor Weekly or monthly salary: a payment made for a specific calendar period, regardless of the actual number of hours worked Commission: pay determined as a percentage of revenue (sales) Base plus performance pay: a combination of weekly or monthly base salary, plus some additional payment made according to commission, lump sum (one fixed amount), or other agreed performance-determined amount Compensation types are not necessarily associated with compensation levels. For instance, lawyers are typically paid an hourly wage, as are low-skilled workers. Within a company, the difference in pay between positions, departments, and jobs is created using job evaluation techniques. Job evaluations compare the relative worth of one job versus another within a company. Unfortunately, many areas of the workforce and types of jobs are undervalued in the process of job evaluation and wage setting. Social prejudice, tradition, labor market structural issues, or simple supply and demand can lead to undervaluing particular kinds of jobs. The idea of comparable worth attempts to counteract undervaluing employees. Comparable worth is the principle that jobs requiring the same level of education, skills, and training should receive equal pay. Comparable worth seeks to intervene in the supply and demand of the labor market to set wage price levels. In addition to basic compensation, many companies add incentives as part of compensation. Incentives are rarely fixed. They are most often determined by overall company performance. Therefore, employees are motivated (i.e. incentivized) to help the company perform well. Typical incentives include: Annual bonuses: an additional payment typically awarded to all employees once a year, depending on the company s performance Merit pay: a bonus or reward for outstanding work or a specific achievement usually awarded to individual employees Lump-sum salary increase: where an employee due a percentage salary increase is given the equivalent of one year of that increase in a single payment Profit sharing: a distribution of a percentage of company profit to employees, often in the form of marketable shares Benefits Benefits are rewards in addition to regular wage-style compensation given to employees in exchange for labor. Compensation plus benefits is often referred to as a compensation package. Benefits usually consist of pay for time not worked such as vacation time, services like workers compensation and health insurance paid for by the employer, and expenses reimbursed by the employer such as college tuition for employees dependents. Some benefits are universal and required by law, such as unemployment insurance, workers compensation for job-related disability or injury, and in some

122 118 countries health coverage. Other benefits are voluntary. Companies may create benefits that suit their particular company culture or employee needs and wants. Often, benefits may be influenced by the culture of the society in which the employees reside. For instance, for many years Korean companies provided university tuition reimbursement to all employees of a particular level or position. This benefit was extremely important in a culture that attributes status and importance to university education. Table 10.1 Examples of benefits by category Insurance benefits Services benefits Pay for time not worked Workers compensation Company pension and Vacation time retirement Health insurance Free meals Holidays Dental insurance Tuition reimbursement Sick leave Life insurance Vehicle Community service Unemployment Child care insurance Social security and welfare Stock options Health club Miscellaneous discounts As companies become more global and feel increasing pressures to compete internationally, it becomes more and more difficult to reward employees with high-cost benefits. Some innovative companies offer quirky and unusual benefits in the form of prize draws, gift-giving, and extra-curricular activities. It is unclear whether such socially oriented benefits are linked to improved moral, loyalty, or performance, and this is a new area of academic study. Some complain that such benefits actually disguise a reduction in key valuable benefits that employees need like health insurance and childcare. In order to better meet the needs of employees, some companies are moving towards flexible benefits plans, where employees are given credits that can be used to purchase a individualized selection of benefits from a benefits menu. The cost of flexible benefits plans is high, however for multinational corporations it may better help them address benefits programs that span cultures and countries. Employee relations Employee relations cover two broad areas: general employee relations, and industrial relations. Employee relations covers all activities that attempt to understand and evaluate the employee relationship, while industrial relations is typically used to describe the relationship between company management and collective representation of workers, often in a union. The human resources department manages employee relations, while experts, senior executives, and labor representatives or works councils of representative employees and managers usually manage industrial relations. The goal of employee relations is to increase satisfaction of effective employees and ensure their retention. Good employee relations are often measured in terms of employee churn rate also called attrition rate or employee turnover. Employee turnover can be due to employees deciding to resign or retire (called natural attrition), or it can be through layoffs or firing. Human resources departments

123 119 often manage payroll costs by using a hiring freeze not hiring new employees for a specific period, knowing that payroll decrease due to natural attrition. High employee turnover is not ideal, as it costs companies money. In some industries it is the norm, however. Acceptable employee turnover is most often evaluated by industry and company size. Human resources departments routinely measure employee turnover to understand whether the company s human resource system is working effectively or not. The phrase churn rate often is used instead of employee turnover to describes attrition of employees above what would be considered desirable. A company that has high employee churn is not doing a good job in the area of human resource management compared to competitors. Developing employees Developing employees involves improving their knowledge, skills, and expertise. Development is achieved by first understanding their performance and capabilities through performance appraisal, then delivering the appropriate training to enhance their performance and capabilities. Performance appraisal Performance appraisals serve multiple purposes. They can be used to inform employees how they can do better. They can be used to determine rewards or identify employees for disciplinary action or layoffs. They can be used to determine the effectiveness of the company s human resource system, including their methods for selecting, maintaining, and developing employees. Performance appraisal processes vary by industry and by culture. For instance, performance appraisals may take the form of a discussion between an employee and their manager, giving the employee an opportunity to feed back on the manager s performance as well as their own. Or, performance appraisal may not include the employee at all, and may be simply a report on all employees that perform below a certain standard. A performance appraisal may rely on the judgment of a superior, and there is much scope there for subjective errors or prejudice. On the other hand, objective appraisals that rely purely on quantifiable measure may not take into account important conditions or circumstances that are not in the control of the employee. Training Training seeks to improve the skills and knowledge of existing employees. Training can allow the firm to remain competitive in changing environments, while keeping the same employees and thus lowering the costs of employee acquisition. Companies first do training needs analysis before determining what method of training is appropriate. Typical training methods may include: On the job training where employees learn by doing the work, often with a more experienced mentor Simulations where the work is simulated in a controlled environment, often in an assessment center Classroom teaching and lectures Seminars and conferences Role playing where participants act out the roles of other employees, managers, customers, suppliers Often companies include a training allowance as part of compensation packages for employees. Each employee is budgeted with a certain amount of training allowance they can use each year. The employee and their manager work together to determine what training opportunities best suit the company s and employee s needs in order to spend that budget.

124 120 Management development Management development is a specific kind of employee training that seeks to enhance the general management skills of selected employees that the company wishes to develop into senior managers. Management development programs often will first develop the knowledge of the manager in all aspects of the business in addition to their own functional area of expertise. Next they will focus on developing the employee s management skills in things like negotiations, dispute resolution, motivating employees, and controlling employee behavior. The particular management skills and style a company trains is heavily influenced by the culture of the organization, the behavior model established by the founder and other significant company leaders, and the culture in which the company operates. In some companies, employees are evaluated on their management potential through a process of job rotation. In other companies, high-performing new employees are selected for fast advancement in special management development programs to accelerate their rise to the top of the organization. This is called fast tracking employees. HR systems and culture Overall, you can see that the hr strategies employed by a company may be determined by their culture and history. A company with a history and culture that values seniority will likely rely on a seniority-based HR system, including seniority-based pay. Seniority-based system awards promotion and pay increases according to the time served at a company, regardless of position or rank. Seniority-based pay has long been the norm in Korean companies. Since the Asian financial crisis, however, some companies that compete in global markets are moving to performance-based systems in order to give themselves more payroll and promotion flexibility. Many Chaebol-owned companies in Korea have moved from seniority to performance-based systems. Seniority-based pay is favored by labor unions. They are unlikely to use shared feedback in appraisal, or fast tracking employees. A company that operates in a more individualized culture might rely more on performance-based system. A company working in a culture where social equality and cooperation is valued may choose a different system still. Of any of the functional areas you have studied, the human resources department is probably the most influenced by the social culture in which the company operates. Given the influence of culture on HR systems and policies, how should HR departments in multinational or global companies decide what is the best HR strategy? Summary: The human resources department In this unit you have learned about: The different roles and responsibilities within an HR department The key steps in acquiring, maintaining, and developing employees Key trends affecting human resource management, especially in Korea The impact of culture, and country on human resources management Now, go to eclass and apply what you have learned in this week s Challenge Question!

125 Worksheet 10 (front) 121 Select true or false. 1) T F It is better economically to be paid a regular salary than an hourly wage. 2) T F Korean companies most likely use performance based pay because of Korean culture and history 3) T F POPCO determines the appropriate wage level for employees by evaluating the value of the their role and experiences to the company, as well as the industry averages for wage level. This is called appraisal. 4) T F General skills paper and pencil tests are a common selection technique in American companies. 5) T F Many kinds of insurance style benefits are required by law in most countries. Such legally required employer payments include workplace accident coverage and vehicle insurance. Match the aspect of HRM with the HRM group in POPCO that would handle it. a) Risk management b) Benefits administration c) Staffing d) Employee relations e) Compensation analysis f) Training 6) Administering POPCO s retirement program. 7) Establishing health and safety rules to prevent fires 8) Estimating comparable worth of our managers pay 9) Conducting a survey on what charity POPCO should donate to. 10) Learning and performing the company pledge and song 11) Review the graphic and story from the Korean Herald on the back, then to the right list the following: Identify 3 negative impacts this productivity phenomenon might have on Korean human resource management. List 5 HRM company policies that you think could solve the problems behind this productivity phenomenon.

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