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ALWAYS LEARNING

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FiFth Edition Michael R. SoloMon Contributing Editor

MaRy anne PoatSy

Montgomery County Community College

Kendall MaRtin

Montgomery County Community College

330 Hudson Street, NY NY 10013

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ISBN 10: 0-13-452274-5 ISBN 13: 978-0-13-452274-6

Dedication To Rose —Michael R. Solomon For my husband, Ted, who unselfishly continues to take on more than his fair share to support me throughout this process; and for my children, Laura, Carolyn, and Teddy, whose encouragement and love have been inspiring. —Mary Anne Poatsy For all the teachers, mentors, and gurus who have popped in and out of my life. —Kendall Martin

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Brief Contents ChAPTeR 9

About the Authors xv Acknowledgments xvi Reviewers xvii New to the Fifth Edition xx Letter from the Authors xxi Prologue xxii PART 1

Human Resource Management ChAPTeR 10

Online Business and Technology

Production, Operations, and Supply Chain Management 308 Mini ChAPTeR 3

Business Communications

ChAPTeR 1

PART 4

Economics and Banking

Ethics in Business

Marketing and Consumer Behavior

ChAPTeR 14

120

Promotion and Distribution

starting and struCturing a Business 130

Small Business and the Entrepreneur

130

prinCipLes of finanCe

456

Financing and Accounting for Business Operations 456

162

Mini ChAPTeR 2

Constructing an Effective Business Plan

192

managing a Business and empLoyees 200

ChAPTeR 16

Investment Opportunities in the Securities Market 496 Mini ChAPTeR 5

Personal Finance

ChAPTeR 7 200

ChAPTeR 8

Motivation, Leadership, and Teamwork

442

ChAPTeR 15

ChAPTeR 6

Business Management and Organization

410

Mini ChAPTeR 4

Finding a Job PART 5

ChAPTeR 5

PART 3

348

Product Development, Branding, and Pricing Strategies 380

Mini ChAPTeR 1

Forms of Business Ownership

348

ChAPTeR 13

ChAPTeR 4

Business in a Global Economy

prinCipLes of marketing

ChAPTeR 12

ChAPTeR 3

PART 2

338

ChAPTeR 2

Business Law

282

ChAPTeR 11

Looking at the Business environment 2

Business Basics

252

226

528

Appendix 540 Glossary 549 Index 563 Answer Key 592

vii

Contents About the Authors xv Acknowledgments xvi Reviewers xvii New to the Fifth Edition xx Letter from the Authors xxi Prologue xxii PART 1

Planned Economic Systems Market Economies Mixed Economies

Determining Price: Supply and Demand 30 Supply Demand

31 32

Factors That Determine Price

Factors That Affect Demand

ChAPTeR 1

Factors That Shift Supply

Business Defined

Monopolies

The Factors of Production

Common Business Challenges and Opportunities 5

BizChat: Apple: Taking a Bite Out of Microsoft? 8

Monopolistic Competition

Economic Indicators 40 8

Gross Domestic Product

THE LIST: Countries by gdp, 2012

Consumer and Producer Price Indices 42

Globalization 10 Technological Changes

The Unemployment Rate

BizChat: How Much Money Do You Need to Get By? 44

Types of Businesses 14 Local and Regional Businesses

Productivity of Firms

Multinational (International) Businesses

Taking Business Personally 18 Life Skills for Business

Summary 21 Key Terms 21 Self Test 22 Team Time 23 Ethics and Corporate Social Responsibility 24 Web Exercises 24 References 25 ChAPTeR 2

Economics and Banking

The Basics of Economics 27 Economic Systems

Duopolies and Oligopolies

BizChat: Is Sirius XM Radio a Monopoly? 40

ON TARGET: Nantucket Nectars: Tom and Tom’s Partnership 7

Economics Defined

Perfect Competition

Competition 6

National Businesses

ON TARGET: Keurig’s Monopoly

THE LIST: names to know in Business 5

Social Environment

Degrees of Competition 37

The Business Landscape 2

viii

Business and Economics

Looking at the Business environment 2

Business Basics

27 28

Government and the Economy 45 Economic Policies Fiscal Policy

Monetary Policy

OFF THE MARK: The Dodd-Frank Act and the Consumer Financial Production Bureau 47 Reserve Requirements

Short-Term Interest Rates

Open Market Operations

Summary 52 Key Terms 53 Self Test 53 Team Time 55 Ethics and Corporate Social Responsibility 56 Web Exercises 56 References 57

Contents ChAPTeR 3

Global Business Trends

Ethics in Business

Ethics: The Basics 59 Ethics Defined

International Trade 93

Systems of Ethical Conduct Personal Ethics

International Competition

BizChat: Can Living Ethically Make You Happy?

You as a Person and as an Employee

The Conflict of CSR in the Business Environment

Entering Foreign Markets 69

71 72

Recovering from Weak Ethical Conduct

BizChat: Which Is Better—A Strong Dollar or a Weak Dollar? 109

Creating Successful International Businesses 110

Sociocultural Challenges

Creating New Markets with an Ethical Focus

Political Challenges 77

How Businesses Develop an Ethical Environment 79 80

ON TARGET: Playing the Ethics Game

Summary 82 Key Terms 83 Self Test 83 Team Time 84 Ethics and Corporate Social Responsibility 85 Web Exercises 85 References 86 ChAPTeR 4 88

Legal Challenges Ethical Challenges

THE LIST: powerful people to know

Reasons for the Rise in Globalization

111

112

112 113

Summary 114 Key Terms 115 Self Test 115 Team Time 117 Ethics and Corporate Social Responsibility 117 Web Exercises 118 References 119 Mini ChAPTeR 1

Business Law PART 2

120

starting and struCturing a Business 130

ChAPTeR 5

Small Business and the Entrepreneur

What Is Globalization? 89 The Effects of Globalization

110

OFF THE MARK: international Business Blunders

Business Opportunities Created by Ethical Needs 76

Business in a Global Economy

107

Other Economic Challenges to Conducting International Business 108

Legal Regulations and Legal Compliance

Ethical Focus Every Day

106

THE LIST: top u.s. trading partners

Ethical Focus from the Start

The Advantages and Disadvantages of Each Entry Mode 104

The Role of Exchange Rates

Dangers of a Weak Ethical Focus 73

Businesses Going Green

102

International Business: Economic Factors and Challenges 105

The Effects of Individuals on CSR

Regional Free Trade Agreements 99 International Business Strategies 102

BizChat: Corporations as People

Conducting Business Internationally 101

THE LIST: nine Causes americans think Charities should focus on 68

The Effects of CSR on Society

International Organizations Promoting Free Trade

OFF THE MARK: Cheating Pays Off….Until It Doesn’t 67

The Challenges of CSR

Trade Barriers: Winners and Losers 96

The Five Pillars of Corporate Social Responsibility

CSR and Social Networking

The Benefits and Costs of International Trade Types of Trade Barriers

Corporate Social Responsibility 66

Measuring CSR

Free Trade and Protectionism 95

Personal Ethics Meets Business Ethics 62 Identifying a Company’s Ethics

Fostering Competitiveness

The Benefits of CSR

THE LIST: Countries in Which it is easy to start a Business 92

130

Small Business: The Mainstream of the American Economy 131 Small Business and the Economy 131

Contents THE LIST: ten great industries for starting a Business 132

Disadvantages of Incorporation

Small Business and the Workforce

Limited Liability Companies

133

Reasons for Starting a Small Business BizChat: What’s in a Name?

134

135

Social Media and Mobile Marketing

135

137

Entrepreneurial Teams

142

143 144 145

Buying an Existing Business

146

The Risks of Small Businesses and Where to Get Help 148 Why So Many Small Businesses Fail Getting Help

148

181 183

183

Disadvantages of Mergers

184

Summary 186 Key Terms 187 Self-Test 187 Team Time 189 Ethics and Corporate Social Responsibility 190 Web Exercises 190 References 191 Mini ChAPTeR 2

150

Constructing an Effective Business Plan

Financing Considerations 152 Cash and Credit

Mergers and Acquisitions 181

Types of Mergers

Franchising Considerations

179

180

OFF THE MARK: AOL–Time Warner Merger

142

Pros and Cons of Franchising

179

Advantages of Mergers and Acquisitions 182

Buying Franchises and Existing Businesses 143 Franchising Basics

Not-for-Profit Organizations

Mergers versus Acquisitions

139

ON TARGET: Origami Owl

177

Not-for-Profit and Cooperatives 178

Cooperatives

Entrepreneurs and the American Dream 136 Types of Entrepreneurs

176

THE LIST: Largest not-for-profit organizations

136

The Traits of Successful Entrepreneurs

174

175

Comparing Forms of Ownership

The Impact of Technology on Small Businesses OFF THE MARK: iSmell

S Corporations

192

153

Small Business Loans and Grants

154

Angel and Venture Capital Financing

PART 3

154

BizChat: Conducting a SWOT Analysis

155

Summary 156 Key Terms 157 Self Test 157 Team Time 159 Ethics and Corporate Social Responsibility 159 Web Exercises 160 References 161 ChAPTeR 6 162

Business Management

201

Levels of Management

202

OFF THE MARK: How Are Managers Responsible for Employee Behavior? 203

Strategic Planning

164

Advantages and Disadvantages of Partnerships

167

168

BizChat: How Do You Find the Right Business Partner? 169 169 172

173

207

208

Tactical and Operational Planning Contingency Planning

209

210

The Functions of Management: Organizing 211 Changing Structures

Advantages of Incorporation Structure of a Corporation

SWOT Analysis

Organizational Structures

Corporations 171

203

206

Vision and Mission Statement

Partnerships 167

Types of Partnerships

The Foundations of Management 201

The Functions of Management: Planning 205

163

Elements of a Partnership Agreement

200

BizChat: Social Media: How Do Web-Based Tools Make Time Management Easier? 205

Sole Proprietorships 163 Advantages and Disadvantages

ChAPTeR 7

Business Management and Organization

The Skills of Successful Managers

Forms of Business Ownership Starting a Sole Proprietorship

managing a Business and empLoyees 200

212

214

THE LIST: Bits of advice for managers

214

Alternative Organizational Structures 215

Contents

The Functions of Management: Controlling 216 Controlling to Stay on Course Control Strategies

217

Training and Evaluating Employees 259 Training Methods and Requirements 259

217

Performance Appraisals and Alternatives

ON TARGET: Pest Control Company Controls Its Fleet 217

Summary 221 Key Terms 222 Self Test 222 Team Time 223 Ethics and Corporate Social Responsibility 224 Web Exercises 224 References 225

Compensating, Scheduling, Promoting, and Terminating Employees 264 Compensation Strategies Benefits

266

Contingent Workers Promotions

226

268

269

Managing Workplace Diversity 270 OFF THE MARK: one diversity training does not fit all 272

227

Motivating Employees

227

Traditional Theories of Motivation

Labor and Union Issues 273

229

Motivational Theories in the Modern Workplace Evolution of Motivational Theories

230

Organized Labor

273

Collective Bargaining

233

274

The State of Labor Unions

Leadership 234 Traits of Leadership

268

269

Benefits and Challenges of Diversity 271

Motivation 226 Personal Motivation

267

268

THE LIST: top 10 Ways to get promoted Retirement

Motivation, Leadership, and Teamwork

265

Alternative Scheduling and Work Arrangements

Terminating Employees ChAPTeR 8

262

237

OFF THE MARK: Masataka Shimizu Leadership and Corporate Culture

238 238

BizChat: Do You Have to Be Tall to Be a Leader? 239 ON TARGET: Southwest Airlines

275

Summary 276 Key Terms 277 Self Test 278 Team Time 279 Ethics and Corporate Social Responsibility 279 Web Exercises 280 References 281

239

Teamwork 240 THE LIST: does your team function Like google teams? 240 The Advantages of Teams in the Workplace The Challenges of Teams in the Workplace Best Practices for Teams

241

242

ON TARGET: Red Teamers in the Military Your Role on a Team

241

243

245

Summary 247 Key Terms 247 Self Test 248 Team Time 249 Ethics and Corporate Social Responsibility 250 Web Exercises 250 References 251 ChAPTeR 9

Human Resource Management

252

253

BizChat: Social Media and Privacy Hiring

258

257

282

Online Business 282 Marketing Online

283

THE LIST: Brought to you by paypal 284 Types of Online Business Transactions Challenges of E-Commerce

286

287

Technology in Business 289 The Information Technology Organization Information Systems

289

291

Security 293 Threats to Online Business

294

BizChat: How a Simple Mistake Can Lead to a Major Data Breach 295 OFF THE MARK: Spying Scandal at HewlettPackard 296 Privacy

Human Resource Management 253 Managing Staffing Needs

ChAPTeR 10

Online Business and Technology

296

Impact of Social Media and Mobile Technology 297 Social Networking

298

xii

Contents OFF THE MARK: Tasteless Tweet Mobile Devices

300

Summary 302 Key Terms 303 Self Test 303 Team Time 305 Ethics and Corporate Social Responsibility 305 Web Exercises 306 References 307

PART 4

prinCipLes of marketing

ChAPTeR 12

Marketing and Consumer Behavior The Evolution of Marketing

350

Marketing for Not-for-Profits and Others 353 Benefits of Marketing

353

Criticisms of Marketing

ChAPTeR 11

The Production of Goods and Services 309 The Importance of Production

309

Moving to a Service-Based Economy The Global Production Landscape

310

The Make-or-Buy Decision

Marketing Tactics 355 Marketing Strategy: The Four Ps of Marketing

The Marketing Process

358

The Marketing Environment 359 360

361

Common Production Processes and Techniques 312

The Technological Environment

361

ON TARGET: Viral Marketing

361

Social Media and Manufacturing

The Social and Cultural Environment

314

Operations Planning and Management 314 Capacity Planning Facility Location Facility Layout

315

317

The Global Environment

Marketing Research and Planning 363

318

The Market Research Process

BizChat: 3D Printing: An Industrial Revolution? 320

Target Markets

Operations Control 320 Production Process Control

321

Purchasing and Inventory Control

322

324

ON TARGET: The Baldrige Awards 325

Suppliers and Supply Chain Management 327 Supply Chains

362

OFF THE MARK: Technology: Too Much of a Good Thing? 319

Quality Management

362

The Political, Legal, and Regulatory Environments OFF THE MARK: The Hard Lessons of Social Media 362

315

Production Technology

356

The Four Cs of Marketing: Marketing from the Consumer’s Perspective 357

The Economic Environment

312

354

The Competitive Environment

Production Management 311

348

Marketing Fundamentals 349

THE LIST: ten great marketing strategies

Production, Operations, and Supply Chain Management 308

348

328

THE LIST: top u.s. firms in terms of their supply Chains and management 328

Summary 331 Key Terms 332 Self Test 333 Team Time 334 Ethics and Corporate Social Responsibility 335 Web Exercises 335 References 336 Mini ChAPTeR 3

Business Communications

The Marketing Plan

363

365

367

Consumer Behavior 369 B2C Markets

369

B2B Markets

371

BizChat: Augmented Reality: A Passing Phase or the Future? 372

Summary 374 Key Terms 375 Self Test 375 Team Time 377 Ethics and Corporate Social Responsibility 377 Web Exercises 378 References 379 ChAPTeR 13

Product Development, Branding, and Pricing Strategies 380 New Product Development 381 The New Product Development Process 381

338

The Product Life Cycle

383

xiii

Contents

Modifying Existing Products and Product Lines 385 The Total Product Offer Product Differentiation

OFF THE MARK: Volkswagen’s Deceptions—A Public Relations Problem? 420

386

Personal Selling and Sales Promotion 421

386

Personal Selling

Product Lines and the Product Mix

387

Sales Promotions

Consumer Products and Business-to-Business Products 388 Consumer Product Classifications B2B Classifications

424

Social Media Promotions

425

Distribution: Marketing Intermediaries 426

388

Distribution Channels and Marketing Intermediaries 426

389

Branding 391

Wholesalers, Agents, and Brokers 429

Branding Benefits

391

Retailers

ON TARGET: Nike’s Reuse-A-Shoe Brand Loyalty and Brand Equity Branding Strategies

391

392

433

The Benefits and Costs of Transportation Modes

393

BizChat: Brand You: Creating a Personal Brand OFF THE MARK: genericized Trademarks The Importance of Labels

396

397

Pricing Goods and Services 398 Product Pricing and Pricing Objectives

396

Summary 436 Key Terms 437 Self Test 438 Team Time 439 Ethics and Corporate Social Responsibility 439 Web Exercises 440 References 441 Mini ChAPTeR 4

398

Pricing Strategies and Price Perceptions

Finding a Job

400

442

403

Summary 405 Key Terms 406 Self Test 406 Team Time 408 Ethics and Corporate Social Responsibility 408 Web Exercises 409 References 409

PART 5

prinCipLes of finanCe

Financing and Accounting for Business Operations 456 Financial Management 457 The Financial Manager

Promotion and Distribution

Planning for a Firm’s Financial Needs 458

410

Short-Term Financing Options 462

Advertising and Public Relations 413 The Role of Advertising Types of Advertising Advertising Media

Short-Term Loans and Grants

413

Social Funding

414

Internet Advertising

Financing Big Business Activities: Debt and Equity 467

414

417

Mobile Marketing

417

Product Placement

417

THE LIST: interesting mobile marketing facts

418

Global Advertisements

464

465

THE LIST: interesting Crowdfunding Campaigns

414

ON TARGET: Dove’s Real Beauty

Public Relations

460

Financing Small Business Activities 462

Promotion 411

Infomercials

457

Addressing Cash Flow and the Budget

Promotion and the Promotional Mix 411

456

ChAPTeR 15

ChAPTeR 14

Social Media

433

Warehousing and Inventory Control 434

395

Adjusting Prices

430

Distribution Logistics

THE LIST: retailers and their private-Brand Labels 394 Packaging

421

418

BizChat: Negative Political Ads: Do They Really Work? 419

Short-Term Financing Options

467

Long-Term Financing Options

467

Financing with Bonds

468

Financing with Equity

470

ON TARGET: Using Social Networks to Raise Venture Capital 471

Accounting Functions 472 Accounting Fundamentals Types of Accounting

473

466

xiv

Contents OFF THE MARK: How’s This for an Accounting Goof? 474

BizChat: I Cannot Lose Money by Saving, Right? 499

Accounting Standards and Processes

THE LIST: personal finance Blogs Worth reading 500

475

BizChat: The Cost and Benefit of the SarbanesOxley Act 477

Financial Statements 478 The Balance Sheet

Investing in Stocks 503 Primary and Secondary Security Markets 503

479

Assets 480

ON TARGET: Berkshire Hathaway: The HighestPriced Stock 504

Liabilities

Types of Stocks

481

Owners’ Equity

Changing Stock Prices

481

Analyzing a Balance Sheet Balance Sheet Ratios Income Statements

508

OFF THE MARK: The Madoff Ponzi Scheme

481

482

Bond Basics

511

BizChat: Downgrade of the U.S. Debt

Cost of Goods Sold

484

Operating Expenses

485

516

Mutual Funds and Other Opportunities 516

Analyzing Income Statements Income Statement Ratios

486

Statement of Cash Flows

487

Mutual Funds

485

Analyzing a Statement of Cash Flows

517

Risk-and-Return Relationships of Different Types of Mutual Funds 518 Other Investment Opportunities

Components of a Statement of Cash Flows

488

Summary 490 Key Terms 491 Self Test 492 Team Time 493 Ethics and Corporate Social Responsibility 494 Web Exercises 494 References 495 ChAPTeR 16

Investment Opportunities in the Securities Market 496 Investment Fundamentals 497 The Risks and Rewards of Saving and Investing 498

510

Investing in Bonds 511

484

Revenue 484

Investment Risk

504

497

Summary 522 Key Terms 523 Self Test 524 Team Time 525 Ethics and Corporate Social Responsibility 526 Web Exercises 526 References 527 Mini ChAPTeR 5

Personal Finance Appendix 540 Glossary 549 Index 563 Answer Key 592

528

520

about the authors Michael R. Solomon, PhD, Contributing Editor

Michael R. Solomon is professor of marketing and director of the Center for Consumer Research in the Haub School of Business at Saint Joseph’s University in Philadelphia. He also is professor of consumer behaviour at the Manchester School of Business, University of Manchester, United Kingdom. Solomon’s primary research and consulting interests include consumer behavior, branding, and marketing applications of virtual worlds. He has written several textbooks and trade books; his Consumer Behavior text is the most widely used in the world. Michael often speaks to business groups about new trends in consumer behavior and marketing strategy.

Mary Anne Poatsy, MBA, CFP [emailprotected]

Mary Anne Poatsy is a senior adjunct faculty member at Montgomery County Community College, teaching various business, management, and computer application and concepts courses in face-to-face and online environments. She holds a BA in psychology and education from Mount Holyoke College and an MBA in finance from Northwestern University’s J. L. Kellogg Graduate School of Management. Poatsy has been teaching since 1995 at a variety of elementary and secondary institutions, including Gwynedd Mercy College, Montgomery County Community College, Muhlenberg College, and Bucks County Community College, as well as training in the professional environment and presenting at several conferences. Before teaching, she was a vice president at Shearson Lehman Hutton in the Municipal Bond Investment Banking Department.

Kendall Martin, PhD [emailprotected]

Kendall Martin has been teaching since 1988 at a number of institutions, including Villanova University, DeSales University, Arcadia University, Ursinus College, County College of Morris, and Montgomery County Community College, at both the undergraduate and the graduate level. Dr. Martin’s education includes a BS in electrical engineering from the University of Rochester and an MS and a PhD in engineering from the University of Pennsylvania. She has industrial experience in research and development environments (AT&T Bell Laboratories) as well as experience with several start-up technology firms. As a full professor at Montgomery County Community College, she presents nationally on topics of entrepreneurship, student engagement, and technology in the classroom.

acknowledgments

ike any good business, this project could not have been completed without the dedicated efforts of a talented group of people to whom we are eternally grateful. The authors would like to take this time to thank the many colleagues, friends, and students who have contributed toward our vision of an introductory textbook that excites and challenges students. From the conception of Better Business and into this latest edition, a remarkable board of reviewers at schools across the nation has guided us with wise counsel. Our joy in working with such talented and student-centered faculty is deep. We extend our sincerest gratitude to our reviewers. The division of Business Publishing at Pearson has been incredible in devoting time and resources to the creation of Better Business, 5th edition, learning system. We are indebted to Jodi McPherson, our former executive editor, who had the vision for a new introduction to business textbook system that engages and excites students. We also extend thanks to our acquisitions editor, Nicole Sam, who has made a positive impact on our work. Without their vision, passion, dedication, and drive, this textbook would not exist. Our thanks also extend to our content producer, Daniel Edward Petrino, who diligently kept us on track with only gentle threats when we went astray! Daniel’s timely assistance, often delivered with a warm greeting or humorous reply, enabled this complex project to be pleasantly completed on time—a feat not easily accomplished. Maggie Moylan, vice president of product marketing, has been instrumental in shaping the message of the text. We are so appreciative of her ardent attention to all the marketing details that are so important. Additionally, we would like to thank Sue Nodine for her efforts in the design and production of Better Business, 5th edition. Finally, our thanks to Donna Battista, vice president of business publishing, and Stephanie Wall, editor in chief, who have backed this project with the necessary financial and human resources to make our vision a reality. We would be completely negligent if we did not acknowledge all the incredibly talented and devoted designers, permissions researchers, and others who contributed to the project and to whom we extend our sincerest thanks. Additionally, we would like to thank the many supplement authors for this edition: Helen Davis, Maureen Steddin, Laura Portolese, and Kevin Bradford. Everything we do is inspired by the experiences we have in the classroom. We want to thank and encourage our students, whose experiences, struggles, victories, and honesty have shaped this project turn by turn. We strive for Better Business, 5th edition, to serve our students as a stepping-stone to meaningful careers and lives. Last but not least, close to home, our families have sacrificed much to let us focus on the project. We appreciate their patience and support throughout the writing process.

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reviewers Wendi Achey, Northampton Community College Mustafa Akcadogan, Pikes Peak Community College Joni Anderson, Buena Vista University Lydia Anderson, Fresno City College Natalie Andrews, Sinclair Community College Sally Andrews, Linn Benton Community College Roanne Angiello, Bergen Community College Brenda Anthony, Tallahassee Community College Maria Aria, Camden County College Corinne Asher, Henry Ford Community College Susan Athey, Colorado State University Michael Aubry, Grossmont College David Bader, Columbus State Community College Mazen Badra, Webster University Michael Baran, South Puget Sound Community College Ruby Barker, Tarleton State University William Barrett, University of Wisconsin Denise Barton, Wake Technical Community College Dick Barton, El Camino College Crystal Bass, Trinity Valley Community College Jeffrey Bauer, University of Cincinnati Christine Bauer-Ramazani, Saint Michael’s College Leslie Beau, Orange Coast College Gayona Beckford-Barclay, Community College of Baltimore County Robert Bennett, Delaware County Community College George Bernard, Seminole Community College Patricia Bernson, County College of Morris Rick Bialac, Georgia College and State University Danielle Blesi, Hudson Valley Community College Chuck Bowles, Pikes Peak Community College Malcolm Bowyer, Montgomery Community College Steven Bradley, Austin Community College Charles Braun, Marshall University Edwin Breazeale, Midlands Technical College Sharon Breeding, Bluegrass Community Technical College Richard Brennan, North Virginia Community College Robert Bricker, Pikes Peak Community College Lisa Briggs, Columbus State Community College T. L. Brink, Crafton Hills College Dennis Brode, Sinclair Community College Katherine Broneck, Pima Community College Harvey Bronstein, Oakland Community College Deborah Brown, North Carolina State University Sylvia Brown, Midland College Janet Brown-Sederberg, Massasoit Community College Lesley Buehler, Ohlone College

Barry Bunn, Valencia Community College Carroll Burrell, San Jacinto College Marian Canada, Ivy Technical Community College Diana Carmel, Golden West College John Carpenter, Lake Land College Deborah Carter, Coahoma Community College Tiffany Champagne, Houston Community College Glen Chapuis, St. Charles Community College Bonnie Chavez, Santa Barbara City College Sudhir Chawla, Angelo State University Lisa Cherivtch-Zingaro, Oakton Community College Desmond Chun, Chabot College John Cicero, Shasta College Michael Cicero, Highline Community College Subasree Cidambi, Mount San Antonio College Joseph Cilia, Delaware Technical & Community College Mark Clark, Collin County Community College William Clark, Leeward Community College Paul Coakley, Community College of Baltimore County Ken Combs, Del Mar College Jamie Commissaris, Davenport University Rachna Condos, American River College Charlie Cook, University of West Alabama Solveg Cooper, Cuesta College Douglas Copeland, Johnson County Community College Julie Couturier, Grand Rapids Community College Brad Cox, Midlands Technical College Diane Coyle, Montgomery County Community College Chad Creevy, Davenport University Geoff Crosslin, Kalamazoo Valley Community College Ebony Crump, Kennedy-King College H. Perry Curtis, Collin County Community College Dana D’Angelo, Drexel University Mark Dannenberg, Shasta College Jamey Darnell, Durham Tech Amlan Datta, Cisco College Shirley Davenport, Prairie State College Helen Davis, Jefferson Community Technical College Peter Dawson, Collin County Community College David Dearman, University of Arkansas Sherry Decuba, Indian River Community College Andrew Delaney, Truckee Meadows Community College Kate Demarest, Carroll Community College Donna Devault, Fayetteville Tech

Susan Dik, Kapiolani Community College Michael DiVecchio, Central Pennsylvania College Gerard Dobson, Waukesha County Technical College Kathleen Dominick, Bucks County Community College and University of Phoenix Online Ron Dougherty, Ivy Technical Community College Karen Drage, Eastern Illinois University Nelson Driver, University of Arkansas Allison Duesing, Northeast Lakeview College Timothy Durfield, Citrus College David Dusseau, University of Oregon Dana Dye, Gulf Coast Community College C. Russell Edwards, Valencia Community College Karen Edwards, Chemeketa Community College Stephen Edwards, University of North Dakota Stewart Edwards, North Virginia Community College Susan Ehrfurth, Aims Community College Patrick Ellsberg, Lower Columbia College Susan Emens, Kent State University Karen Emerson, Southeast Community College Theodore Emmanuel, State University of New York Oswego Kellie Emrich, Cuyahoga Community College Vince Enslein, Clinton Community College Steven Ernest, Baton Rouge Community College Mary Ewanechko, Monroe County Community College Marie Farber-Lapidus, Oakton Community College Geralyn Farley, Purdue University Janice Feldbauer, Schoolcraft College and Austin Community College Mary Felton-Kolstad, Chippewa Valley Technical College Louis Ferracane, University of Phoenix David Fitoussi, University of California Joseph Flack, Washtenaw Community College Jacalyn Flom, University of Toledo Carla Flores, Ball State University Carol Flowers, Orange Coast College Jake Flyzik, Lehigh Carbon Community College Thomas Foley, Kent State University Craig Fontaine, Northeastern University Joseph Fox, Asheville-Buncombe Technical Community College Mark Fox, Indiana University–South Bend Victoria Fox, College of DuPage Charla Fraley, Columbus State Community College John Frank, Columbus State Community College Leatrice Freer, Pitt Community College Paula Freston, Merced College Fred Fry, Bradley University

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Reviewers

Albert Fundaburk, Bloomsburg University William Furrell, Moorpark College Michael Gagnon, Kellogg Community College Wayne Gawlik, Joliet Junior College George Generas, University of Hartford Vanessa Germeroth, Ozarks Technical Community College Gerald GeRue, Rock Valley College John Geubtner, Tacoma Community College Katie Ghahramani, Johnson County Community College David Gilliss, San Jose State University Eric Glohr, Lansing Community College Robert Goldberg, Northeastern University Constance Golden, Lakeland Community College Gayle Goldstone, Santa Rosa Junior College Alfredo Gomez, Broward Community College Phillip Gonsher, Johnson County Community College Robert Googins, Shasta College Karen Gore, Ivy Technical Community College– Southwest Carol Gottuso, Metropolitan Community College Gretchen Graham, Community College of Allegheny County (Boyce campus) Selina Griswold, University of Toledo John Guess, Delgado Community College Kevin Gwinner, Kansas State University Peggy Hager, Winthrop University Lawrence Hahn, Palomar College Semere Haile, Grambling State University Lynn Halkowicz, Bloomsburg University Clark Hallpike, Elgin Community College Paula Hansen, Des Moines Area Community College Frank Harber, Indian River Community College LaShon Harley, Durham Technical Community College Jeri Harper, Western Illinois University Deborah Haseltine, Southwest Tennessee Community College Carol Heeter, Ivy Tech Community College Linda Hefferin, Elgin Community College Debra Heimberger, Columbus State Community College Dennis Heiner, College of Southern Idaho Cheryl Heitz, Lincoln Land Community College Charlane Held, Onondaga Community College Rebecca Helms, Ivy Tech Community College Heith Hennel, Valencia Community College Dorothy Hetmer-Hinds, Trinity Valley Community College Linda Hoffman, Ivy Technical Community College–Fort Wayne Merrily Hoffman, San Jacinto College Gene Holand, Columbia Basin College Phillip Holleran, Mitchell Community College Robert Hood, Chattanooga State Technical Community College Sheila Hostetler, Orange Coast College Larry Hottot, North Virginia Community College William Huisking, Bergen Community College Lynn Hunsaker, Mission College Steven Huntley, Florida Community College at Jacksonville Johnny Hurley, Iowa Lakes Community College

Kimberly Hurns, Washtenaw Community College Holly Hutchins, Central Oregon Community College Linda Isenhour, Eastern Michigan University Katie Jackson, Columbus State Community College Linda Jaeger, Southeast Community College Dolores James, University of Maryland University College Pam Janson, Stark State College of Technology Larry Jarrell, Louisiana Technical University Earlene Jefferson, Kennedy-King College Joe Jenkins, Tarrant County College Brandy Johnson, Columbus State Community College Dennis Johnson, Delaware County Community College Floyd Johnson, Davenport University M. Gwen Johnson, Black Hawk College Carroll Jones, Tulsa Community College Jeffrey Jones, The College of Southern Nevada Kenneth Jones, Ivy Technical Community College–Central Indiana Gayla Jurevich, Fresno City College Alex Kajstura, Daytona Beach College Dmitriy Kalyagin, Chabot College Radhika Kaula, Missouri State University John Kavouras, Ohio College of Massage Therapy Dan Keating, Fox Valley Technical College Albert Keller, Dixie State College of Utah Ann Kelly, Georgia Southern University Jeffrey Kennedy, Broward Community College Jeffrey Kennedy, Palm Beach Atlantic University Daniel Kipley, Azusa Pacific University William Kline, Bucks County Community College Susan Kochenrath, Ivy Technical Community College Linda Koffel, Houston Community College Central Todd Korol, Monroe County Community College Jack Kraettli, Oklahoma City Community College Jim Kress, Central Oregon Community College John Kurnik, St. Petersburg College Paul Laesecke, University of Denver Martha Laham, Diablo Valley College Mary LaPann, Adirondack Community College Deborah Lapointe, Central New Mexico Community College Rob Leadbeater, Mission College David Leapard, Eastern Michigan University Denise Lefort, Clemson University Ron Lennon, Barry University Angela Leverett, Georgia Southern University Sue Lewis, Tarleton State University Kathleen Lorencz, Oakland Community College Mark Lowenstein, College of St. Joseph John Luke, Delaware County Community College John Mago, Anoka-Ramsey Community College Jan Mangos, Valencia Community College Christine Marchese, Nassau Community College James Marco, Wake Technical Community College Suzanne Markow, Des Moines Area Community College Gary Marrer, Glendale Community College Calvin Martin, Davenport University James Martin, Washburn University

Kathleen Martinez, Red Rocks Community College Thomas Mason, Brookdale Community College Marian Matthews, Central New Mexico Community College Kelli Mayes-Denker, Carl Sandburg College Kevin McCarthy, Baker University Gina McConoughey, Illinois Central College Lisa McCormick, Community College of Allegheny Patrick L. McCormick, Ivy Tech Community College Pamela McElligott, Meramec Community College Edward McGee, Rochester Institute of Technology Donna McGill-Cameron, Yuba College Vince McGinnis, Bucks County Community College Allison McGullion, West Kentucky Community & Technical College Lorraine McKnight, Eastern Michigan University Bruce McLaren, Indiana State University Juan Meraz, Missouri State University James Meyers, Pikes Peak Community College Miriam Michael, American River College Jeanette Milius, Iowa Western Community College Carol Millard, Scottsdale Community College John Miller, Pima Community College Linda Miller, Northeast Community College Pat Miller, Grossmont College Morgan Milner, Eastern Michigan University Diane Minger, Cedar Valley College Susan Mitchell, Des Moines Area Community College Theresa Mitchell, Alabama A&M University Joseph Molina, MiraCosta College Carol Moore, California State University Wayne Moore, Indiana University of Pennsylvania Richard Morris, Northeastern State University Jennifer Morton, Ivy Tech Community College of Indiana David Murphy, Madisonville Community College Gary Murray, Rose State College John Muzzo, Harold Washington College Mark Nagel, Normandale Community College Conrad Nankin, Pace University Kristi Newton, Chemeketa Community College Steven Nichols, Metropolitan Community College Simon Nwaigwe, Baltimore City Community College Mark Nygren, Brigham Young University Asmelash Ogbasion, Southwest Tennessee Community College Cynthia L. Olivarez Rooker, Lansing Community College David Olson, California State University Anthony O’Malley, Baruch College Lori Oriatti, College of Lake County Robert O’Toole, Crafton Hills College Mary Padula, Borough of Manhattan Community College Esther Page-Wood, Western Michigan University Lauren Paisley, Genesee Community College Dyan Pease, Sacramento City College

Reviewers Jeffrey Pepper, Chippewa Valley Technical College Clifford Perry, Florida International University Melinda Phillabaum, Indiana University– Purdue University Rose Pollard, Southeast Community College Jackie (J. Robinson) Porter, Eastfield College Kathleen Powers, Henry Ford Community College Dan Powroznik, Chesapeake College Sally Proffitt, Tarrant County College Joe Puglisi, Butler County Community College James Pullins, Columbus State Community College Kathy Pullins, Columbus State Community College Bobby Puryear, North Carolina State University Martha Racine Taylor, College of the Redwoods Anthony Racka, Oakland Community College Robert Reck, Western Michigan University Philip Regier, Arizona State University Delores Reha, Fullerton College David Reiman, Monroe County Community College Robert Reinke, University of South Dakota Gloria Rembert, Mitchell Community College Reina Reynolds, Valencia Community College John Ribezzo, Community College of Rhode Island Cheri Rice, Stark State College of Technology Carla Rich, Pensacola Junior College Gayle Richardson, Bakersfield College Dwight Riley, Richland College Renee Ritts, Cuyahoga Community College Susan Roach, Georgia Southern University John Robertson, Amarillo College Robert Robicheaux, University of Alabama Tim Rogers, Ozarks Technical Community College June Roux, Delaware Technical & Community College Carol Rowey, Community College of Rhode Island Mark Ryan, Hawkeye Community College Ray Saenz, Del Mar College Joanne Salas, Olympic College Andy Saucedo, New Mexico State University Jacqueline Scerbinski, Kingsborough Community College David Schaefer, Sacramento City College Elisabeth Scherff, Alabama A&M University Glen M. Schmidt, University of Utah Tobias Schoenherr, Eastern Michigan University

Marcianne Schusler, Prairie State College James Scott, Central Michigan University Carolyn Seefer, Diablo Valley College Eugene Seeley, Utah Valley State College Gary Selk, University of Alaska Pat Setlik, William Rainey Harper College Phyllis Shafer, Brookdale Community College Dennis Shannon, Southwestern Illinois College Richard Sherer, Los Angeles Trade Technical College Lynette Shishido, Santa Monica College Lance Shoemaker, West Valley College Carole Shook, University of Arkansas Dwight Shook, Catawba Valley Community College Susan Sieloff, Northeastern University William Silver, University of Denver Denise Simmons, North Virginia Community College Lakshmy Sivaratnam, Johnson County Community College Steven Skaggs, Waubonsee Community College Jacqueline Slifkin, Monroe County Community College Kimberly Smith, County College of Morris Anne Snell, Pikes Peak Community College/ Tulane University Fred Sole, Youngstown State University Sandra Sousa, Bristol Community College Ed Southeard, Chattanooga State Technical Community College Ray Sparks, Pima Community College Rieann Spence-Gale, North Virginia Community College Cheryl Stansfield, North Hennepin Community College Keith Starcher, Indiana Wesleyan University Carol Steinhaus, Northern Michigan University Jim Stemach, College of the Redwoods John Stern, Davenport University Richard Stewart, Gulf Coast Community College Jack Stone, Linn Benton Community College Connie Strain, Arapahoe Community College John Striebich, Monroe County Community College Chelakara Subbaraman, Central Michigan University Dottie Sutherland, Pima College Deanna Teel, Houston Community College Rodney Thirion, Pikes Peak Community College Carol Thole, Hartnell College

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Michael Thomas, Henry Ford Community College Alexis Thurman, County College of Morris Frank Titlow, St. Petersburg College Kathy Toler, Asheville-Buncombe Technical Community College Edward Tolle, Ivy Tech Community College Terry Tolliver, Indiana University–Purdue University Francis Douglas Tuggle, Chapman University Fran Ucci, College of DuPage Shafi Ullah, Broward Community College Dorothy Umans, Montgomery College Robert Urell, Irvine Valley College Richard Vaughan, Durham Tech Sal Veas, Santa Monica College Kam Vento, Lassen Community College Victor Villarreal, Austin Community College Richard Vobroucek, State University of New York–Rockland Carol Vollmer-Pope, Alverno College Randall Wade, Rogue Community College Leatha Ware, Waubonsee Community College Richard Warner, Lehigh Carbon Community College Michael Washington, Eastfield College Louis Watanabe, Bellevue Community College Bill Waters, Clackamas Community College Tom Watkins, Solano Community College Barbara Joann Wayman, Columbia College Sally Wells, Columbia College Susan Wheeler, Folsom Lake College Donald Wilke, Okaloosa-Walton College Fred Williams, University of Michigan George Williams, Bergen Community College H. Brock Williams, Metropolitan Community College Doug Wilson, University of Oregon Marcus Wilson, Fullerton College Mildred Wilson, Georgia Southern University Colette Wolfson, Ivy Technical Community College John Womble, Cedar Valley College Dan Wubbena, Western Iowa Technical Community College Merrill Yancey, Ivy Technical Community College Sandra Yates, University of District of Columbia Bernard Zannini, Northern Essex Community College Charles Zellerbach, Orange Coast College

new to the fifth edition

e have invested a great deal of work creating the fifth edition of Better Business to give students and instructors a powerful learning and teaching tool that captures the evolving issues and opportunities of business. Enhancements for the fifth edition follow: • The format of each chapter has been modified to highlight the learning objectives in the chapter opener, at the beginning of each section, and in the chapter review. • One of the most significant shifts in the business environment since the first edition of Better Business is the explosive growth of social media in all parts of business. The fifth edition of Better Business continues to feature social media strategies and technologies in more than 85 percent of its chapters as well as significant updates to the technology chapter. • All of the end-of-chapter materials have been reviewed, and we have modified up to 25 percent of these materials to include the most recent events and trends in the business environment. The fifth edition of Better Business provides instructors with wideranging choices for discussion topics, assessment questions, and group activities that cover the most current and timely topics in the business community,

such as major economic shifts, changes in technologies, and ever-increasing globalization. • All of the time-sensitive material has been updated. Stories and examples from the previous editions that have continued to evolve have been updated and placed in the most current context. Timely examples have replaced older material, continuing to give Better Business an up-to-date feel that resonates with students. • Feedback from the previous editions of Better Business indicated that the “The List” feature in each chapter not only interested students but also pushed them to go more deeply into the body of the text. For the fifth edition, we updated these lists, adding new ones where appropriate that reflect current market trends, with a focus on selecting topics that appeal to students. • The fifth edition also includes new or revised boxed features in many chapters with topics such as Volkswagen’s Emissions Falsification, Berkshire Hathaway’s Highest Priced Stock, the Madoff Ponzi scheme, Keurig’s monopolistic market presence, Patagonia’s corporate responsibility, Augmented Reality, Hard Lessons of Social Media, Dove’s Real Beauty advertising campaign, and Advertising and child obesity.

Letter from the authors

hen we set out on this project, we had several goals in mind—and one guiding philosophy. We wanted to have a conversation with our students, not merely to write a text that we hoped they would read. We wanted to change the expectation that students will come to class unprepared. Why can’t they come ready for class, with a desire to know about business? Why can’t we have a little fun with the course while teaching students about the lighter side of business? We think we can. To that end, we worked tirelessly on selecting our topics and our resources to help you, the student. We incorporated a question-and-answer format throughout to get you to want to know the answer and see more—and not simply because it will be on the test. We paid more attention to the details because that is where the course often comes together for you. In each chapter, the “On Target” and “Off the Mark” features illustrate positive and negative outcomes of business ventures related to the chapter material. These features, along with “The List” found in each chapter, can fuel in-class dialogue. Mini chapters are five special sections in the book that give you additional information on key topics in business: Business Law, Constructing an Effective Business Plan, Business Communications, Finding a Job, and Personal Finance. Better Business, 5th edition, offers the content you need for a solid overview of business—but in a better way. By presenting the material in a stimulating way, Better Business encourages you to come to class prepared to have better conversations and a truly engaging classroom experience.

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prologue The 10 Easy Steps for Better Business Success Step 1:

it’s all up to you

You’ve heard that before, right? You’ve bought textbooks and read some of the materials, but maybe still haven’t ended up with the grade you wanted. So the key to success is not just buying the book or simply reading it. Instead, your success depends on three skills: • Finding • Understanding • Applying the information found within this textbook and all of its resources The following steps will help you succeed in this course, and if you apply some of these steps outside the classroom, you may also succeed in business and in life.

Step 2:

go to class with intent

How do your classes go for you? Are you generally able to follow what the instructor and your classmates are saying in lecture and class discussions? Are you able to actively participate in a group discussion, or do you simply observe other group members? Your attitude and the plan you have for using class time can change the entire experience for you. Try these quick tips to make sure your classroom experience is as rich and fulfilling as possible:

Review the Syllabus If you have trouble speaking up in class, try this strategy. The syllabus is one of the most important documents in the course. It acts as a binding contract between you and the professor. Read the syllabus in detail as soon as it comes out. Then, in the next class, ask at least one question about it. It will show the professor you’re serious about meeting your responsibilities in class—and will get you in the habit of speaking up in class.

Show Up! As Woody Allen says, “Eighty percent of success is showing up.” It’s basic advice, but many students lose sight of how important it is to come to class. You should be punctual, if not early; be attentive; and be noticed. Sit near the front and ask good questions so that the professor gets to know your face and name. It’s just as important that the professor knows you as it is that you know your professor (see Step 3). xxii

Prologue

Ask Questions If you’re confused during class, ask a question right then. Don’t think, “I’ll look really dumb if I ask this” or “I’ll probably understand it after I read the text” or “I’ll wait to ask someone else, or go to office hours tomorrow.” Asking now will save you time and effort and will probably help other students in the room. You’ll learn so much more if you ask questions in class. If you do need to contact your instructor after class to clarify a point, stop by during office hours rather than asking the question electronically or over the phone. Keep in mind, face-to-face visits trump e-mail or voice mail. Now, aren’t you glad you invested some time earlier to get to know your instructor (Step 3)? After all, it’s easier to ask for help from someone with whom you already feel comfortable.

Write a One-Minute Review Immediately at the end of class, take one minute and write all that you can recall from today’s lecture. Try to identify what the main takeaway points are by highlighting key ideas. Forcing yourself to be quick and brief helps you to capture the main ideas without the smaller details providing distraction.

Write Down Your “Muddiest” Point When class is finished, also take a quick moment to write down two sentences that describe the most confusing part of today’s lecture. Keep this in one specific part of your notebook—it’s a great thing to bring along to your study group or to office hours. It will also work well in creating your own personalized study guide for the next exam.

Step 3:

Connect with people

Business is all about people. Right now, your business is getting a great grade in this class. As in any business, there are many people available to provide help: instructors, fellow students, and school staff. Look around for these people—and then enlist their help.

Get to Know Your instructor: Go to Office hours Your teachers can be your most helpful contacts on campus. Not only can they become mentors, but as you near graduation, they can write job recommendations or references. They can’t do that unless you get to know them beyond the focus of the course. So plan to make a couple of trips to office hours—even if you know everything.

Create or Join a Study Group Find study buddies early. In the first few days of class, try to get acquainted with at least two classmates in every course. Watch the people in your class to figure out who seems to know what’s going on, who seems dependable, and who you could work well with. Approach those people and ask if they wouldn’t mind forming a study group. You don’t need to meet all the time—the group can be available on an “as-needed” basis. But it’s good to have a group of connected students who can help you prep for exams, confirm or clarify points made during class, and exchange notes if you miss a class. (Trust us: It’s much better to have a buddy give you the information you missed than to ask the instructor, “Did I miss anything important?”)

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Prologue

Use the People around You Do you know students who already took this class? Spend some time with them and ask the right questions. What sections of the course will demand more time out of your schedule? What tools in the library helped them out with their projects? Be sure to look around the class for older students. Many colleges are seeing a large influx of people returning to college after successful careers. These people have that precious thing you may lack: real-world experience. Buy someone a cup of coffee and ask him or her for advice that helps you in the course or in finding a job.

Use All the Resources the School Provides The faculty and staff at your school want you to succeed—we all take pride in our students’ accomplishments! So be sure to investigate all the resources available to you at your school. Talk to your adviser about services such as the following:

Writing Support Many schools provide special clinics that can help you with your writing. Some also provide writing labs where you can get assistance in editing and proofreading your work.

Support Services Look for support services that offer help with note-taking techniques, strategies to combat stress in test taking, and workshops on helping you organize and manage your time. If you discover that you have a pattern of specific struggles (e.g., you always underperform on tests), see if free screening for learning disabilities is offered. You may need specific testing accommodations (such as additional time or larger-print exams), or you may be eligible for help with an in-class note taker. The key is to become your own best advocate. Be informed—know how your mind works and what conditions make you perform your best.

Step 4:

explore the world of business in real time

Although this text intends to apply business concepts to current situations, the examples cannot be as current as those that are exposed in the business press. Until now, you may not have been interested in picking up the Wall Street Journal, Financial Times, BusinessWeek, or The Economist because you did not have the necessary background or interest. Try the following technique. Every day, go online and read the lead story in the Wall Street Journal. Keep a log that notes the theme of the article (e.g., the economic situation in the United States or some other part of the world, a government action that impacts business, an acquisition by a major company, trends in the workplace, the stock market, a new technology, and so on). Also, rate how easy it was for you to understand the article, with “1” being the easiest and “10” being the most difficult. Similarly, rate how interesting the article was, with “1” being absolutely fascinating and “10” being massively boring. Note any questions about the article and how it relates to material being covered in class or note from the syllabus or table of contents where it might apply to future class content. As the end of your course approaches, review your log. You should see that the articles are becoming easier to understand and perhaps more interesting. In addition, you will also have created an informal study of the current

Prologue

business landscape, including the hottest business trends. For example, if you see that a significant percentage of the articles are about government actions, it is fair to assume that governments are taking a more active role in business and the economy for some reason. But, above all, this exercise will demonstrate that business—once you really understand it—is far more fascinating than you ever imagined, and it will also help you develop the exceedingly valuable habit of reading the business press regularly, a habit that will serve you well in both life and business.

Step 5:

experience business

Business is about people. If you want to be a business success, leave your house and find someone who runs a small business (a restaurant, a print shop, a car wash, and so on) where you are a regular customer because you value the quality of their products. It doesn’t matter if you don’t have aspirations to work in this line of business, as you are just trying to understand the foundations of any small business that seems successful to you. Ask the owner or manager if you can interview him (or her). Ask him how he spends his time, what is most important to the success of his business, and what his most troublesome problems are. Perhaps you can even volunteer a few hours per week to do odd chores for him so that you can observe firsthand how he manages the business and continue to ask questions. It may start with meaningless errands, but one day you’ll appreciate the foundation when a real opportunity arrives. Until that day, you’ll be learning by watching a successful businessperson run a company.

Step 6:

know your learning style

Determining what kind of learner you are will help you apply the most appropriate resources to create a successful learning program. Knowing your learning style can help you select and use the study strategies that best fit the way you learn. ■ TABLE 1 will help you figure out whether you learn best by seeing (visual), hearing (auditory), or touching/doing (tactile and kinesthetic). Read the word in the far left column of the chart and then place a check mark next to the statement in one of the successive three columns to the right that best describes how you respond to each situation. Count the number of check marks in each column, placing the total at the bottom of the table. Your answers may fall into all three columns, but one column will likely contain the most answers, which indicates your primary learning style. If one of the remaining columns nears in the number of check marks to your primary learning style, that can be considered your secondary learning style. After you’ve determined your primary—and perhaps secondary—learning style, you can best match up the textbook, system, and resources from your instructor to help you achieve a better grade. And, if you can figure out how to succeed in this course, you can apply the same study strategies to succeed in other courses. Note that your instructor also has a specific style of learning and teaching with which he or she is most comfortable. Watching how your instructor works can be a great clue to helping you succeed in the course. For example, does he or she talk without ever drawing a picture? Or does he or she use visuals to illustrate points? Figure out your instructor’s learning style and use it to predict what kinds of interactions he or she wants in the classroom and on your assignments.

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Prologue

TAble 1

What is Your learning Style?

When you …

Visual

Auditory

Kinesthetic and Tactile

Spell

= You try to see the word.

= You sound out the word or use a phonetic approach.

= You write the word down to find if it looks right.

Listen

= You get easily distracted when asked to listen for a long time.

= You grasp the information quickly and easily.

= You find yourself doodling as you listen.

Talk

= You favor words such as see, picture, and imagine.

= You use words such as hear, tune, and think.

= You gesture and use expressive movements. You use words such as feel, touch, and hold.

Concentrate

= You become distracted by untidiness or movement.

= You become distracted by sounds or noises.

= You become distracted by activity around you.

Meet someone again

= You forget names but remember faces or remember where you met.

= You forget faces but remember names or remember what you talked about.

= You remember best what you did together.

Contact people for class or business

= You prefer direct, face-toface, personal meetings.

= You prefer talking on the phone.

= You prefer talking with people while walking or participating in an activity.

Read

= You like descriptive scenes or pause to imagine the actions.

= You enjoy dialogue and conversation or imagine the characters talking.

= You prefer action stories or are not a keen reader.

Do something new at school or work

= You like to see demonstrations, diagrams, slides, or posters.

= You prefer verbal instructions or talking about it with someone else.

= You prefer to jump right in and try it.

Put something together

= You look at the directions and the pictures.

= You prefer verbal instructions or talking about it with someone else.

= You ignore the directions and figure it out as you go along.

Need help with a computer application

= You seek out pictures or diagrams.

= You call the help desk, ask a neighbor, or growl at the computer.

= You keep trying to do it or try it on another computer.

Total Source: Based on Colin Rose’s Accelerated Learning (1987).

Step 7a:

read this book

What is the best investment you can make in yourself right now? If there were something that could promise you an A in this course and that would help you to succeed in college in general, it would be worth paying for, right? There is: this text, plus your time. Really, all you need to succeed in this course is this book and its resources, plus some investment of your own time and energy. Doing well in this course is a good start at getting As in follow-up business courses that you might take in the future. That leads to a great job after graduation, followed by huge wealth, fame, and fortune! (Well, maybe not those last three, but you get the picture.)

Step 7b:

use the system, not just the textbook

Most likely, when you shelled out the cash to buy your textbook, you thought you were just getting a book, right? As it turns out, you actually bought a “system.”

Prologue

TAble 2

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Better Business Resource Guide

Resource

Where Is It?

When Does It Help Me?

Simulations (interactives that let you try out your skills in many common business situations)

On mybizlab.com

For test prep concept reinforcement

PowerPoint presentations

On mybizlab.com

Before the chapter starts For test prep

End-of-chapter exercises

On mybizlab.com At the end of each chapter

When you’re on the go For test prep concept reinforcement

walks you through everything that comes with the purchase of this book. Remembering your learning style, consider how each of these resources can help you study and learn!

■ TABLE 2

Step 8:

take awesome notes

Even if you’re a strong auditory learner, you’ll benefit from taking notes. Awesome notes are the key when you review and prepare for papers and exams. Take advantage of learning about different types of note-taking strategies. One will certainly work better for your learning style than another. Experiment and see which one best meets your needs. Three popular strategies are outlining, mind mapping, and the Cornell System.

Outlining You might already use an outlining system. The main points are written down, and any supporting or additional points are indented and listed below the relevant main point. Outlining is a great system for taking notes from a book or PowerPoint presentation because the material has already been organized for you. However, this system may not be as effective to record the points made in a lecture or class discussion because the hierarchy structure of an outline is not flexible, and this makes it hard to insert points that are made later on in a discussion but relate to something mentioned previously.

Mind Mapping A mind map is a graphic representation of the content of a lecture or reading. It is a flexible system, and many visual learners find mind mapping beneficial because it organizes a lecture graphically. ■ FIGuRE 1 shows one example. Mind maps capture main and supporting ideas similar to an outline, but instead of a fixed hierarchy, the structure of a mind map is more fluid. The main points are captured in a box or circle in the middle of a page. Supporting points, or subtopics, are then drawn as smaller boxes or circles that radiate from the main circle. If later on another subtopics needs to be added, then a new branch can be drawn. If there is anything off topic that should be noted, it can be recorded in a cloud or circle that is not connected to anything and that sits outside the main concept area. Later, when reviewing, add colors to connect ideas or concepts that aren’t necessarily connected by branches but do share the same theme (such as those topics that your instructor pointed out will be on the test, that were from a PowerPoint presentation, or that should be further explored). As you review for a test or while preparing for a paper, you can use the boxes and colors to help you connect the main ideas of several lectures. Consider creating a progressive mind map (separate from individual lecture mind maps) that will express how specific topics relate to the course overall. Many free online resources, including software and templates,

xxviii

Prologue

■ FIGuRE 1 An Example of a Mind Map of This Prologue

can help you begin to use mind maps. One such product is MindMup, available free online. Even if you just have paper and pencil, you can build useful mind maps.

The Cornell System The Cornell System is a simple and powerful system that, if used correctly, can help with recall and increase the usefulness of your notes. When using the Cornell System, you don’t need to rewrite or retype your notes. Instead, you use a specific setup to define your notes. Begin by setting up your 8½- by 11-inch notepaper as shown in ■FIGuRE 2. Draw a vertical line 2½ inches from the left side of the page. Next, draw a horizontal line about an inch or so from the bottom of the page for a summary. You can also use a product such as Microsoft One Note, which comes preloaded with a Cornell Note System template (see Figure 2). In the largest and main section of the paper, capture the main ideas of the lecture. You can use an outline or mind mapping system, whichever suites you best. Then, as soon as possible after the lecture, jot down in the skinny column ideas or key words that will define the main idea of the lecture. Finally, in the bottom section of the page, summarize the key points in your own words. This forces you to process the information in a new way.

Review With any of these systems, it will help you to vocalize the key points made as you review your notes. As dorky as it seems, reciting out loud is an effective way to learn, especially if you’re an auditory learner, because hearing your thoughts helps you sharpen your thinking process, and stating ideas and facts in your own words challenges you to think about the meaning of the information.

Prologue

xxix

■ FIGuRE 2 The One Note Template for the Cornell Note-Taking System

THE LIST

Extra Tips for the Online Learner

Taking this class online? Here are some additional tips for success: 1. Purchase your textbook and any other course materials before class begins. If you’re buying online, allow for delivery time. 2. Check your technology needs. Make sure your computer, software, and Internet connection are sufficient for the requirements of the course before the class starts. Faulty technology is not a good excuse for missing assignments in an online course. Have a backup computer you can use, just in case. 3. Establish a regular study time. Without specific classroom meeting times, it’s easy to forget about the class. Time passes quickly, and before you know it, your “other life” has taken precedent and you’re playing catch-up to meet the requirements of the course. Set a regular study time—one that works with your schedule—when you can log into the class and do whatever work may be required. 4. Be proactive asking questions about assignments. If you have questions on an assignment, remember that sometimes getting answers is not immediate. You should always count on things taking more time than in a classroom. 5. Participate in discussions and ask questions. Your online instructor should provide a way for you to interact with other students and ask questions. Active participation will enable you to grasp the material better—and to know your classmates better. 6. Exchange contact information. Although it’s harder to meet and interact with others in an online class, try to get contact information for at least one or two people with whom you can share information and questions. 7. Make sure the instructor knows who you are. Take the time in the first week or so to introduce yourself to the instructor via e-mail or through the class chat room. It’s harder for an instructor to get to know you in an online course than in a traditional face-to-face class. 8. Know how to work your class Web site and course management software. Especially know how you can get and submit your assignments, check your grades, and communicate with your instructor as well as with your classmates. 9. Be organized and don’t procrastinate. Especially if the class is self-paced, make sure you know when the big assignments and tests are due. As soon as you get your syllabus, record all assignment due dates on your own personal calendar. 10. Become comfortable expressing your ideas in writing. You’ll need to communicate in a professional way about both course content and your future career.

xxx

Prologue

Step 9:

use your tools: smartphone/ tablet/laptop

Undoubtedly, you come to class armed with at least a cell phone—and may even have a tablet or a laptop. Here are a few ideas of how you can use these tools to get you to that A.

Use a Calendar Organization is a critical skill for success. Enter assignment deadlines into your cell phone’s calendar. You also can use organizational tools such as Microsoft Outlook or Google Calendar to track key due dates and access them from your laptop.

Keep a Class Contact list Collect the contact information for at least three classmates and for your professor in your cell phone or laptop contact list. Be sure to have it all—home phone, cell phone, IM identity, and e-mail address. Consider creating an online group with a tool like Slack, where class members can help each other. This way, you’ll have the information at your fingertips when you really need it and don’t have your notebook with you. This habit will create all kinds of opportunities for you later in the real world. Successful folks call it networking!

Record Audio or Video of the Class Smartphones and tablets are equipped to record audio and video, which can help in class. Note-taking applications allow you to write notes as the audio is being recorded. Then simply tapping on a note you jotted down takes you to that point of the audio recording. Many instructors are now beginning to create their own audio and video recordings of lectures and deliver them as supplements to the class. If your instructor is not, ask for permission to record him or her and explain that you are happy to make the files available to him or her or willing to post them to the other students..

Step 10:

apply these rules outside the classroom

All of these classroom tips also can apply to your career. For example, Step 7 suggests that you find, understand, and apply the information from this textbook system to meet the demands of your instructor. In your working life, you’ll need to find out what your boss or client wants and figure out the best way to meet his or her needs. Likewise, Step 6 encourages you to understand how you best learn. Revisit Table 1—many of the actions apply to a business context as well. Knowing your learning style will help you be successful in business as well as in the classroom. Because business is all about people, think about how you can apply the strategies in Step 3 to your job. If you can, get to know your boss or supervisor. They, too, can become your mentors and be instrumental in recommending you for advancement within the company. Bosses don’t have office hours, but you can stop by their offices periodically to just say hello or ask to meet them for lunch or coffee every month or so. Get to know the people you work with and develop a contact list. You never know when you may need to contact someone in the office when you’re not there or vice versa. So get a coworker’s e-mail, home or cell phone number, and maybe even his or her IM address. Again, it’s much better to have someone in the office to ask, “What did I miss?” or “Can you help me?” than running

Prologue

to your boss (or not having anyone at all) to ask the same questions. Also, don’t ignore the other people outside your immediate office. Get to know the cleaning staff, the elevator attendants, and the security guards in your building. They can help you in a pinch and are more willing to do so if they know your face and name. To get ahead, follow Step 2 and come to work with intent! Don’t be afraid to ask questions; good questions indicate that you’re thinking about the situation at work and trying to apply it to what you already know. If things don’t make sense or you don’t understand something, ask for clarification. Do you think you won’t ever take notes again once you’re out of the classroom? Think again. The workday includes attending lots of meetings, even when they occur over the phone. Use your college career and Step 8 to perfect note taking so when you get to the business world, you’ll have that skill down pat. And although you might occasionally get lucky with an instructor who ignores your absences in the classroom, such luck most likely will not follow you into the office. We also suggested ways you can use your cell phone, MP3 player, and laptop in the classroom in Step 9. These tools can also be used in the office as well. Again, you need to make sure people know about and agree to your taping/recording them but having good records of meetings and discussions can be helpful to you and to your colleagues. And because many people are afraid of technology, establishing yourself as someone who is comfortable and innovative with technology can also be a good thing. Don’t stop learning and reading! In Step 7 we encouraged you to read this book. When you find a career you’re interested in pursuing, seek out books for advice and insight about that career. There is no end to learning—it’s a lifetime activity, so embrace it. And by following the advice in Step 4, you should already have developed a love for reading real-time press. Knowing what is happening in the world around you helps anytime. Finally, in Step 5, we encouraged you to interview a manager or owner of a business, or perhaps even volunteer some of your time. Becoming involved in a business and learning it from the ground up puts you in the position of better understanding any business in which you are involved. After all—as we say in Step1: It’s all up to you! We hope you have found these steps to Better Business success helpful and hope you will be able to apply them to your academic and professional careers. Good luck in whatever endeavors you pursue!

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Part 1 LOOking at the Business envirOnment

Chapter 1

Business Basics OBjectives 1-1 The Business Landscape

Define business, and list the factors of production. The business landscape in the United States is vast and varied. Ben Silberman launched the successful website Pinterest. Meanwhile, the Chang family opened a small Chinese restaurant. What do these seemingly unrelated businesses have in common?

1-2 Common Business Challenges and Opportunities

Explain how competition, the social environment, globalization, and technological changes challenge and provide opportunities to business owners. Leroy Washington is the owner of a local deli in Florida. When a Subway franchise moved in across the street, Leroy had to think creatively to deal with the new competition. How did he manage to keep

his small deli in business despite the major franchise nearby?

1-3 Types of Businesses

Describe the four types of businesses. Wawa convenience stores are located in the midAtlantic region of the United States. Although the chain has more than 500 stores, it is still considered a small, regional business. What would Wawa have to do to expand its business and become a national franchise?

1-4 Taking Business Personally

Explain how life skills translate to the business environment. Do you run your life like a business? Managing a business requires many of the same financial and personal skills you use in your daily life. Understanding how you use business concepts and methods in your life can help you understand how they are used in business.

Objective 1-1

the Business Landscape Define business and list the factors of production.

 Ben Silberman had a hobby when he was a kid in Des Moines, Iowa: he collected bugs. As a twenty-something now out of college and working, Silberman watched social networking sites take off. He thought there should be a better way for people to trade information about their hobbies with their friends. After his girlfriend heard him complain about wanting to leave his job and start a company one time too many, he did just that. He and a couple of friends, Evan Sharp and Paul Sciarra, began working on a web app that would help people pick up new hobbies. They named it Pinterest.

CHAPTER 1

Meanwhile, in a small town in Pennsylvania, members of the Chang family, who emigrated from Hong Kong three decades ago, fulfilled a lifelong dream of opening a Chinese restaurant. Although opening the new business was challenging, the Changs built a reputation for treating people like family and developed a loyal customer base. Are there things both sets of business owners need to know to be successful? What do a billion-dollar software company with hundreds of millions of users and a smalltown family restaurant have in common? These organizations represent the varied spectrum of business in the United States. In this chapter, you’ll learn about the basic concepts important to running a successful business.

Source: Sergii Koval/123rf

Business Defined What exactly is a business? Both Pinterest and the Changs’ Chinese restaurant are businesses—entities that offer products to their customers to earn a profit. A profit is earned when a company’s revenue (the money it brings in) is greater than its expenses (the money it pays out). When expenses exceed revenue, the company posts a loss. What kinds of products do businesses offer? A product can be either a good or a service. Goods are physical products a business sells. A roast beef sandwich at Arby’s, a 42-inch television at Best Buy, and a Honda Fit at your local car dealership are all considered goods because they are tangible items. Conveyer belts, pumps, and parts sold to other businesses are also goods, even though they are not sold directly to consumers. A service is an intangible product that is bought or sold. Services include haircuts, health care, car insurance, and theatrical productions. Unlike a polo shirt on a rack at Hollister Co., services cannot be physically handled. Some companies offer products that are both goods and services. Take, for example, restaurant franchises like T.G.I. Fridays. When you order a sirloin steak at T.G.I. Fridays, you’re paying for the good (a fire-grilled sirloin) as well as the service of preparing, cooking, and serving the steak. Countries change over time in whether goods or services dominate their economic system. Historically, the United States was primarily agricultural based but then moved to a strong manufacturing base that centered on producing goods. Today, that has diminished, and the service sector dominates. Other countries are following different trajectories; for example, in China, the manufacturing of goods is now the dominant business model. What do businesses do with their profits? More often than not, profits are the driving force behind a business’s growth. As more profits are generated, a company can reward its employees, increase its productivity, or expand its business into new areas. The proprietor of a business is not the only one who benefits from the profits it generates. A successful business benefits society by providing the goods and the services consumers need and want. Businesses also provide employment opportunities for members of the community. Because they offer 3

PART one

Looking at the Business Environment

desired goods and services, provide employment, and generate income and spending in the economy, successful businesses contribute to the quality of people’s lives by creating higher standards of living for society. What about not-for-profits? Not-for-profit organizations do not go into business to pursue profits for their owners. Instead, a not-for-profit organization seeks to service its community through social, educational, or political means. Organizations such as universities, hospitals, environmental groups, and charities are examples of not-for-profit organizations. Any profits they generate are used to further the organizations’ causes by expanding the services they provide. Many not-for-profit organizations, such as Amnesty International, operate like a business but do not pursue profits. Instead, they seek to service their community through social, educational, and political means. Source: NetPhotos/Alamy Stock Photo

The Factors of Production What do businesses use to create the products they sell? To fully understand how a business operates, you have to consider its factors of production, or the resources it uses to produce goods and services. For years, businesses focused on the traditional factors of production: labor, natural resources, capital, entrepreneurial talent, intellectual property, and technology. • Labor. Needless to say, businesses need people to produce goods and provide services. Labor is a human resource that refers to any physical work or intellectual work (ideas and knowledge) people contribute to a business’s production. • Natural resources. Natural resources are the raw materials provided by nature that are used to produce goods and services. Soil used in agricultural production; trees used for lumber to build houses; and coal, oil, and natural gas used to create energy are all examples of natural resources. • Capital. There are two types of capital: real capital and financial capital. Real capital refers to the physical facilities used to produce goods and services, such as office buildings and factories. Financial capital refers to money used to facilitate a business enterprise. Financial capital can be acquired via business loans, from investors, through other forms of fund-raising, or by tapping into one’s personal savings. • Entrepreneurial talent. An entrepreneur is someone who assumes the risk of creating, organizing, and operating a business and directs all of a business’s resources. Entrepreneurs are a human resource, just like labor, but what sets them apart from labor is not only their willingness to bear risks but also their ability to effectively manage businesses. For successfully doing so, entrepreneurs are rewarded with profits from the businesses. • Intellectual property. Intellectual property consists of privately owned, intangible assets developed as a result of people’s intellect and creativity. Drug patents held by pharmaceutical companies, copyrights to songs, and trademarks for products such as Coca-Cola are examples. Holding a patent on a drug, for example, means that no other company can compete with your product while the patent is in force. • Technology. In our twenty-first-century economy, an additional factor of production has become increasingly important: technology. Technology refers to goods and services such as computers, smartphones, software, and digital broadcasting that make businesses more efficient and productive. Successful companies are able to keep pace with technological progress and harness new knowledge, information, and strategies. Unsuccessful companies often fail because they have not kept pace with the latest technology.

ChAPTeR 1

You will learn more about labor (Chapter 9), capital (Chapter 15), entrepreneurs (Chapter 5), and technology and knowledge factors (Chapter 10) as you continue reading this text.

 So

how do such different businesses as Pinterest and the Changs’ Chinese restaurant compare? Pinterest provides a service to its users: the ability to instantly communicate their interests, hobbies, and projects to other people. The Changs provide goods to their customers in the form of the food they sell. They also provide a service in the form of the preparation and delivery of that food. Although the business models and products offered by these businesses vary considerably, the two businesses are similar because both were started by creative entrepreneurs determined to make a profit. Pinterest is now worth billions of dollars. For the Chang family, the profits are much more modest. The members are making a solid living but are far from seeing a 10-figure profit. Although these two enterprises differ greatly in many ways, both the Changs and the founders of Pinterest understand what a business is and how the factors of production influence their dreams of running a successful business.

THE LIST

Names to Know in Business

1. Satya Nadella, Microsoft CEO 2. Travis Kalanick, cofounder and CEO of Uber

6. Richard Branson, founder of the Virgin Group 7. Jeff Bezos, CEO of Amazon

3. Jack Ma, cofounder and CEO Alibaba

8. Larry Page, CEO of Alphabet

4. Elon Musk, CEO of Tesla

9. Doug McMillon, CEO of Walmart

5. Warren Buffett, CEO of Berkshire Hathaway

Objective

10. Muhtar Kent, CEO of Coca-Cola

1-2

common Business challenges and Opportunities Explain how competition, the social environment, globalization, and technological changes challenge and provide opportunities to business owners.

 Last year Leroy Washington inherited his family’s deli. The deli had a loyal clientele with a regular lunch crowd. Then a new Subway store moved into a building directly across the street. Because Subway is a national franchise that advertises heavily, the new store has great name recognition. The store also occupies a larger space, has more workers and ovens, and has a more extensive menu.

Source: redav/Fotolia

Business Basics

PART one

Looking at the Business Environment

Leroy found his lunch crowd dwindling as people switched to the national chain with its faster service and greater variety of sandwiches. To better compete with Subway, Leroy had to get creative. So, instead of just offering traditional deli choices, he expanded the restaurant’s menu to include Cuban pressed sandwiches and an “early bird special” consisting of light fare on the dinner menu. Leroy hoped that the changes would appeal to the large number of Cuban immigrants and senior citizens populating the area. How does a business owner turn the changes in competition, technological challenges and the social environment into new opportunities? How do business owners such as Leroy deal with competition and the other business challenges they face? As Leroy found, confronting these challenges can sometimes lead to opportunities for growth. In this next section we’ll discuss how competition, the social environment, globalization, and technological change create both business challenges and opportunities as they have for Leroy.

Competition How does competition influence business? In a market-based economy, such as that in the United States, there is an emphasis on individual economic freedom and a limit on governmental intervention. In this type of market, competition is a fundamental force. Competition arises when two or more businesses vie with one another to attract customers and gain an advantage. The private enterprise system in the United States is predicated on the fact that competition benefits consumers because it motivates businesses to produce a wider variety of better and cheaper goods and services. Competition in Today’s Marketplace A competitive environment is one in which a free market economy thrives. Competition forces companies to improve their product offerings, lower their prices, aggressively promote their brands, and focus on customer satisfaction. Having to compete for a finite number of consumers usually weeds out less efficient companies and less desirable products from the marketplace. To win at the competitive game of business, today’s companies need to deliver customer satisfaction and understand the power of social networking and are finding they need to empower their employees. CuSTOMEr SaTISfaCTION aND BEyOND To understand how successful businesses provide products that are either better or less expensive than those of their competitors, consider the market for home video: As more manufacturers and retailers jumped into the high-definition television (HDTV) market a number of years ago, the prices for HDTV sets fell sharply. This created a market of people hungry for Blu-ray players so they could watch high-definition programs on the new sets. As a result, the sales of Blu-ray players—once the sole dominion of high-end retailers and manufacturers—rose dramatically as the players became a staple in people’s home entertainment systems. The prices of Blu-ray players dropped too. Customers could find moderately priced ones at a variety of retailers, such as Amazon.com, Costco, and Best Buy. These companies are able to turn over merchandise quickly and in high volumes, which allows them to lower the prices they pay for products as well as what their customers pay for them. Later as the market continued to evolved, streaming media became an option through companies like Comcast and Verizon as well as via Netflix and

ChAPTeR 1

nantucket nectars: Tom and Tom’s Partnership

om First and Tom Scott were college buddies who did not want to climb the traditional corporate ladder. After graduating from Brown University, the friends moved to Nantucket, Massachusetts, where they started a floating convenience store called Allserve in a red boat in Nantucket Harbor. The store provided delivery service of almost any item, from newspapers to laundry, to neighboring boats. Although Allserve proved to be a modest success, “Tom and Tom” soon had another idea. They decided to sell their own natural juice blend, and Nantucket Nectars was born.

on TARGeT

The popularity of the juice spread quickly in Nantucket. Allserve then purchased a distribution company to expand the reach of its products, which many national chains now carry. The two entrepreneurs maintained their local roots by subsequently starting the Juice Guys Juice Bar in Nantucket.1 This partnership is an example of how a successful business can be started by two eager and driven people. Tom and Tom have come a long way since their days as floating delivery boys in Nantucket Harbor, and they are now running a nationally recognized corporation.

Google Play. Disc sales plummeted, as did the sales of disc players. Other companies like Amazon and Hulu began offering streaming media services as well, and television manufacturers began integrating streaming players for Netflix, Amazon.com, and Hulu into their television sets. Competition is what made this all happen. SOCIaL NETWOrKINg Websites like Pinterest, Facebook, Twitter, and many others are examples of social networking sites. Social networking sites are websites that make it easier for people to connect with one another online for the purposes of building and supporting social relationships. Facebook and Twitter are examples of social networking sites, each with over a billion users. What do social media have to do with business competition? Today more than ever, customers are connected to each other through a great variety of media—e-mail, texting, blogs, and social networking sites. Companies are therefore increasingly using social networking to connect to their customers. Through these sites, they can promote their products, offer discounts, and build relationships with people interested in their companies. Individuals can use social networking sites to quickly spread the word about good (or bad) services or products. If a customer is dissatisfied, word can spread at the speed of light. As discussed in this text, a happy customer base can be a powerful marketing tool for a company. Other social networking sites are specialized for the needs of businesses. LinkedIn, for example, has more than 400 million users. LinkedIn users exchange résumés and build networking contacts by connecting with old acquaintances, former employers, and coworkers. Companies also use the site to find job candidates and get them interested in their firms.

In a competitive environment, it is essential for a company to empower workers to feel free to deal with customer needs. This means employers seek workers who have interpersonal, communication, and decision-making skills. Companies today need to be more reactive to customers’ needs to retain their competitive advantage. Therefore, more companies are giving employees greater decision-making responsibilities rather than having decisions trickle down through layers of management. This also leads to greater satisfaction and more career advancement opportunities for employees.

EMPLOyEE EMPOWErMENT

Business Basics

PART one

Looking at the Business Environment

Apple: Taking a Bite out of Microsoft?

n an effort to dominate the personal computer (PC) market, Apple and Microsoft have had a long and bitter rivalry. Originally, the main point of contention between the two companies was the graphical user interface (GUI), which is the user interface for the main program that runs PCs. Apple released the first GUI, which included folders and long file names, in 1983. When Microsoft released Windows 2.0 in 1988, Apple took Microsoft to court, complaining that the “look and feel” of the Windows interface was stolen from the Apple interface. This suit continued until 1992, when Apple finally lost. Microsoft led the competition in the early 1990s. It became an industry standard to have Windows operating systems preinstalled on most PCs, which were dominating the computer market at the time. The 10-year battle finally ended when Apple announced an official alliance with Microsoft in 1997. Microsoft

and Apple agreed to a 5-year deal in which Microsoft would continue to develop Office software for Apple computers and Apple agreed to bundle Microsoft’s Internet Explorer in all its operating systems.2 So competition can create new partnerships—strange ones at times. Today, Microsoft is actively wooing Apple in an effort to promote and sell their products to Apple users. If you own an Apple iPhone and use the company’s digital personal assistant “Siri” to conduct a web search, she will use Microsoft’s Bing browser instead of Google to search the Web. What’s in this for Apple? Google has become one of Apple’s main competitors in the mobile phone market with its Android phone platform. The element of competition between these rival high-tech companies drives them all to keep innovating and producing higherquality products than if no one challenged them.

Social environment How does the social environment affect businesses? A social environment is an interconnected system of different demographic factors, such as the race, ethnicity, gender, age, income distribution, sexual orientation, and other characteristics of a population. Social, economic, and political movements and trends are constantly changing the social environment of the United States and other countries. An influx of immigrants can change the racial demographic, or an economic slump can change the income distribution demographic. These changes affect where we live, what we buy, and how we choose to spend our money. To best serve their employees, customers, and the community, businesses must consider the shifts and changes in the social environment when making decisions. Let’s discuss three specific issues surrounding the social environment that present potential challenges and opportunities for today’s businesses. Not only are older Americans living longer, healthier lives, but they are also better educated, are wealthier, and have achieved higher living standards than previous generations. Baby boomers, the generation born between 1946 and 1964, make up the majority of the aging population in the United States. Not only do the 78 million baby boomers make up one of the largest population groups in the United States, but they are also the wealthiest. Baby boomers, who in 2016 were between the ages of 52 and 70, have an estimated spending power of more than $2 trillion per year. This makes baby boomers a large and lucrative target for businesses. For example, the cosmetics company Garnier is eager to make a profit from the aging population with its anti-aging beauty line called UltraLift, which is aimed at baby-boomer women. Garnier released the line in an effort to keep its product offerings aligned with the shift in demographics. Although an aging population presents many opportunities for businesses, it also presents challenges for the U.S. economy. Many analysts have warned that the nation will be faced with difficult choices as baby boomers continue to reach retirement age. Some potential problems include the government having to raise taxes to fund entitlement programs such as Social Security and Medicare, reduce the benefits of these programs, or face higher federal budget deficits. Why does this matter to businesses? As shown in ◼ fIgurE 1.1, in 2050, there will be more than 80 million Americans age 65 or older. Today, almost 40 aN agINg POPuLaTION

ChAPTeR 1

Business Basics

percent of the total personal income for Millions 90 senior citizens comes from Social Security Age 100+ payments. Together these trends imply that 80 there will be a decrease in the number of 70 workers and an increase in the demand Age 86–99 for social services. Longevity is another as60 pect of this demographic shift; the last U.S. Age 75–85 50 census found there were more than 53,000 centenarians (people age 100 or older) in 40 the United States.3 Projections place that 30 number at 580,000 by 2040. The health care 20 programs and services required to care for Age 66–74 this population will need to be in place. 10 Along with these challenges, as we 0 noted, caring for the needs of an older pop1990 1995 2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 ulation will present businesses with opporYear tunities for growth, especially retirement centers, health care and pharmaceutical companies, and the travel industry. A ◼ fIgurE 1.1 bigger population translates to a larger market for these goods and services. u.S. Population age 65 and

2050

Older: 1990–2050

In business, there is no one-size-fitsall way to manage employees and appeal to customers because every person is different. As the United States becomes more diverse, it is important for businesses to mirror that diversity in their workforce. Firms that don’t are at risk for losing touch with their new, more diverse customer base. According to the latest data available, the U.S. Census Bureau reports that the minority population in the United States is about 35 percent, making one in three residents a minority. In some companies, minorities account for the majority of the workforce. At the hotel chain Four Seasons, for example, minorities represent 64 percent of the company’s 12,400 employees.4 However, in today’s business climate, increasing and managing a company’s diversity involves more than just employing an ethnically diverse workforce. Companies must also develop a diversity initiative that outlines their goals and objectives for managing, retaining, and promoting a diverse workforce. A diversity initiative might include a nondiscrimination policy, a minority network, or diversity education. To increase diversity within a business, the company must treat it as a business-critical goal. Although the inclusion and advancement of racial minorities in the workplace is an important step in establishing a diverse workforce, it is only part of the process. Today, the term minority applies to more than just people of different ethnicities. Minority groups might represent a person’s gender, culture, religion, sexual orientation, or disability. Companies must include these minority groups in their diversity initiative to ensure that all minority employees are treated fairly by their managers and coworkers. INCrEaSINg WOrKfOrCE DIvErSITy

THE grEEN MOvEMENT The public’s increasing anxieties about global

warming and climate change have motivated businesses to become involved in a green economy—one that factors ecological concerns into business decisions. Because their customers are concerned about the environment, businesses that manufacture products that contribute to higher emissions of carbon dioxide and consume inordinate amounts of fossil fuels must adapt to this new environmental awareness to remain competitive. In the automotive industry, for example, hybrid vehicles, which run on a combination of electricity and gasoline, have not only become hot sellers but also are critical to meeting national objectives. New fuel economy standards5 in the United States will require cars to get almost 55 miles per gallon by 2025. Almost every major car manufacturer—including Toyota, Honda, and BMW—now offers hybrid models. Vehicles that run on other types of energy sources are appearing as well, such as the Tesla Model S and the Nissan Leaf, which are all-electric

Source: Data from j. Meyer, Centenarians: 2010 Census Special Report C2010SR-03, U.S. Department of commerce, U.S. census bureau, retrieved from https:// www.census.gov/prod/cen2010/reports/ c2010sr-03.pdf.

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Nissan Leaf electric cars are an example of how the automobile manufacturers are responding to changes in the social environment. Source: Portland Press Herald/Getty images

vehicles. The Leaf has a range of up to 126 miles on a single charge—and not a tailpipe to be seen. A focus on environmental issues also opens up a brand-new market that will be increasingly important in the future. The demand for more green products presents new opportunities for entrepreneurs to meet those needs. These “greencollar” jobs can revitalize large swaths of the U.S. manufacturing economy that have been decimated. Creating wind energy turbines, installing solar panels, and landscaping designs that make your microclimate (the climate immediately surrounding your home) energy efficient will be necessary businesses of the twentyfirst century. As a prospective employee, any one of these social issues will probably affect the company for which you end up working. Because workers are increasingly retiring at later ages, the competition for certain jobs and career advancement might be fiercer than in years past. On the other hand, the culture of business is constantly shifting to meet the ever-evolving needs of U.S. demographics. This means more opportunity for employees who can navigate a diverse environment. In addition, jobs aimed at responding to the needs of the growing green economy will also likely present new opportunities for job seekers. Entrepreneurial possibilities always exist for those who have the vision and desire to succeed and are willing to take risks.

THE SOCIaL ENvIrONMENT aND yOu

Globalization How has globalization affected businesses? You’re familiar with multinational companies such as Nike, McDonald’s, and Coca-Cola. Multinational enterprises— companies that have operations in more than one country—are among the leaders of a movement called globalization. Globalization is a movement toward a more interconnected and interdependent world economy. This means that economies around the world are merging as technology, goods and services, labor, and capital move back and forth more easily across international borders. For example, FedEx, the world’s largest express transportation company, conducts business in more than 220 countries and territories around the world.6 The effects of globalization on the business world vary widely, from the economic transformation of China to the shutting down of major manufacturing

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United States

Vietnam In the past

Recently

China

plants in the United States. The Internet and modern technological advances are making it possible for a company of any size from anywhere in the world to compete globally. Lower tariffs and other trade restrictions give U.S. companies the option to export or import goods to and from other countries or conduct their business overseas. Instead of building their products in plants at home, a growing number of companies are relocating their production facilities overseas or subcontracting at least some of the components of their products to foreign companies around the world to achieve lower manufacturing costs. This is called offshoring. The low labor costs in countries such as China and India make these countries ideal locations for multinational companies seeking technology services and manufactured products at a low cost. Although the concept of globalization is essential for many companies, it is still a highly controversial subject for many. Globalization presents both benefits and risks to the U.S. economy. For example, lowered production costs allow firms to lower the cost of products for consumers like you. Yet people remain concerned about workers in the United States who lose their jobs to workers overseas. Globalization poses other risks for U.S. companies, including the following: • • • •

Increased competition from international companies Fluctuations in the value of the U.S. dollar Security and patent protection concerns Unstable political climates in foreign countries

Globalization has therefore sparked fierce debates among politicians, businesspeople, and the general public for the past few decades. We’ll discuss the controversies surrounding globalization in greater depth in Chapter 4. Benefits and risks aside, one thing is for sure: Globalization is here to stay. To stay competitive in the global market, companies must work to enhance quality and develop and implement innovative strategies for the long term. The

India Global outsourcing is always changing. Coach, the American handbag manufacturer, has outsourced production to China in the past but now is moving to lower-wage countries, such as India and Vietnam. Image Source, clockwise from top, then middle: Daboost/Fotolia; Yahia Loukkal/ Fotolia; Daboost/Fotolia; Daboost/Fotolia; Mandarina/Fotolia

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increasingly global nature of business increases the demand for workers who can communicate with international business partners, have up-to-date technological talents, can demonstrate excellent communication and creative problem-solving skills, and possess leadership skills.

Technological Changes Why does the pace of technological change present challenges to businesses today? Over the past 20 years, advancements in information technology (IT) have been revolutionary. In today’s business world, companies must stay on the cutting edge of technology to remain competitive. No matter the business, technology can be used to keep a company flexible, organized, and well connected—with either customers or employees. There is no question that keeping up with the pace of technology is an expensive and time-consuming operation. The rapid pace of technological innovation means that computers are often outdated after three years and obsolete after five.7 Add to that the cost of applicable software, training, and infrastructure, and it is no wonder that IT is often the single-largest expense for many companies.8 But IT costs aren’t the only challenge. In the same way that robotics completely revolutionized the automotive industry, advancements in computer and telecommunication technology are completely changing the foundation and focus of how many businesses are run. What benefits does technology provide to business? Technology, when used and implemented effectively, can help streamline businesses and cut costs. Technology products such as Twitter and Facebook can promote better communications with customers. Companies now can place specialized ads inside of music recognition software like Shazam or use location-aware software to send ads to your mobile device or even your car’s media center as you approach the store. Companies can also use new technology systems to increase productivity. Giving employees what they need to get their work done more efficiently and effectively is the simplest way to increase productivity. If employees can get more work done in a shorter amount of time, productivity increases. When employees are more productive, they are more valuable. This, in turn, makes the whole company more valuable. But technological benefits aren’t limited to just helping employees; they streamline the internal operations of a business so the entire business can be more effective, efficient, and productive.

Technology makes it possible to work from virtually anywhere. Is that a good thing? Source: fStop images GmbH/Shutterstock

What role does the Internet play in technological growth? If IT is the tool that is changing the functions of business, the Internet is the tool that is changing the scope of business. Although IT by itself would be extremely influential for the business world, the Internet makes it truly revolutionary. In 1995, the Internet was just starting to proliferate. Many people were intrigued by this new technology, but initially there weren’t high hopes for companies that operated solely on the Internet. But this changed in 1995 when both eBay and Amazon.com launched. These companies showed that such an endeavor was not only possible but also potentially lucrative. Their high-profile success paved the way for the general acceptance of public e-commerce. As ◼ fIgurE 1.2 shows, people now are buying every type of product online. We’ll discuss online business and technology in more detail in Chapter 10. E-commerce consists of three different kinds of business trade: business to consumer (B2C), business to business (B2B), and consumer to consumer (C2C). B2C interactions are the ones you’re probably most familiar with, such as buying books at Amazon.com or songs or movies from iTunes. B2C interactions take place between a business and a consumer. B2B interactions involve the sale of goods and services, such as personalized or proprietary software, from one business to another. Although both are fairly similar in many ways, the ways in which they differ are significant. B2B e-commerce often involves large transactions to few customers and customized products and pricing, with numerous managers from both businesses making sure that the transaction is beneficial to both parties. This process is obviously more involved than typical B2C transactions, such as downloading a new ring tone for your cell phone or buying an item from Amazon. C2C transactions have become possible through consumer-driven storefronts like Etsy.com, where individuals can offer their handmade crafts directly for sale to customers. Every year, e-commerce becomes a more significant element of the overall economy. E-commerce has been growing rapidly since the new millennium, forcing many businesses to either adapt or be left in the dust. For example, the CEO of Procter & Gamble (P&G) Bob MacDonald, has announced plans to expand electronic sales of its products from $500 million to $4 billion annually, using Amazon. com and the firm’s own websites.10 P&G even allowed Amazon to set up shop in P&G’s warehouses so that they could fill orders for Pampers and other P&G products more quickly. With the increase of ecommerce happening on mobile devices, this trend shows no sign of stopping. As it becomes easier for consumers to find even the most obscure items at competitive prices, e-commerce will continue to be a driving force in our economy. It is important to note that the commercialization of the Internet has been around only less than two decades. The Internet, as a medium for sales, has E-COMMErCE

Toys & Games

Business Basics

Office Supplies

Furniture

Electronics

Hardware/ Software

Thirty years ago, businesses were often centrally located, with all employees in one building. Today, this is less common. Technology is making it possible for employees to telecommute, or work from home or another location away from the office. The virtual global workforce, or telecommuters who work on a global scale, expands the pool of potential employees so that the right employee can be found for the job no matter where he or she works. In fact, the worldwide population of mobile workers is expected to exceed 12.4 billion by 2020.9 Teleconferencing is keeping CEOs and other corporate representatives from having to travel constantly for meetings. It is also allowing companies to communicate easily no matter the distance. Both of these advancements are saving money on what used to be necessary expenses. With less travel, there is less money spent on plane tickets, hotel rooms, and food. With more employees telecommuting, many businesses can operate out of smaller offices, which are cheaper and easier to manage. The reduction in travel and other services also has an impact on the environment, consuming less energy and fewer resources.

Clothing

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◼ fIgurE 1.2 What are People Buying Online? Image Source: StudioSmile/Shutterstock

PART one

Looking at the Business Environment Data Breaches—Millions of Records Hacked

160

eBay

140 Heartland

120 100 80

Chase

Sony PSN

Target

Home Depot

40 ◼ fIgurE 1.3 How Secure Is your Credit Card? © Kendall Martin

yet to reach its full potential. As the Internet and its influence continue to grow, so will its economic importance and necessity for businesses. This growth will also affect the dangers and concerns associated with the Internet.

ONLINE SECurITy The widespread access to information that the Internet affords affects businesses in a variety of ways. TJ Maxx Personal information, such as Social Security Anthem numbers, credit card numbers, addresses, and passwords, are all accessible online. This sensitive information, even when it is secured, can be vulnerable to hackers. Unfortunately, online data breaches have become commonplace. Target, Sony, and several universities have all been hacked, exposing either customers’ credit card information or private details. ◼ fIgurE 1.3 shows some of most infamous hacking attacks on businesses. New forms of identity theft are emerging as well, such as taking someone’s identity for the purpose of getting medical care.11 The need for more awareness of personal online security and better tools to ensure corporate online security is clear. PrIvaCy Privacy is another important issue for businesses. E-mails, internal

documents, and chat transcripts all contain private information that is not intended for public viewing. Nevertheless, many of these documents can be accessed online because online storage in the “cloud” has become so convenient. With all this universal access, it is increasingly difficult to ensure that information remains private. Cloud-based storage and services offer many benefits to business. Yet privacy and security concerns cannot be overlooked. Over time, technology will continue to introduce challenges.

 Remember our opening story about Leroy Washington? When competition from a national franchise threatened his business, Leroy confronted the challenge head-on. To capitalize on the diversity of the area—particularly the sizable populations of both Latinos and seniors—Leroy expanded his menu. His strategy was a success. The Cuban pressed sandwiches became a local favorite. Moreover, the deli was soon packed every day from 3:30 to 5:30 p.m., when the “early bird special” fare—consisting of sandwiches, soups, and salads at reasonable prices—was offered. As Leroy demonstrated, challenges and opportunities abound, and overlap, in the business world.

Objective 1-3

types of Businesses Describe the four types of businesses.

 In

1964, grahame Wood opened a convenience store in folsom, Pennsylvania. The business’s focus was on providing fresh dairy products and produce and a full-service delicatessen. This marked the beginning of the Wawa chain of convenience stores, which serve the mid-Atlantic region of the United States. The chain now consists of more than 645 stores in six states.12 Although

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Wawa is certainly successful, it’s still a regional company that does not currently serve a national or international market. Regional businesses, such as Wawa, face unique challenges that don’t affect larger businesses, especially involving access to adequate funding and insurance. Wawa continues to expand in the mid-Atlantic region and may one day move into the category of a national business. Which type of business, regional or national, is best for Wawa? What’s the difference between a small business and a large corporation? What about everything in between? A small business has different goals and challenges than a large corporation. Small businesses, such as a local dry cleaner, often provide limited goods or services to a small population. A large multinational corporation, such as Johnson & Johnson, supplies a wide range of goods or services to many customers worldwide. A local or regional business will have different needs and concerns. In this section, we’ll look at the different types of businesses and what constitutes each.

Local and Regional Businesses

Source: Andre jenny/Alamy Stock Photo

What defines local or regional businesses? Take a walk around your town or city, and you’ll see a variety of local and regional businesses. Used bookstores, bakeries, shoe repair shops, boutiques, restaurants, and specialty shops are often local businesses. A local business is usually one of a kind, and it relies on local consumers to generate business. A company is local if it serves a limited surrounding area. A local catering company in Baltimore, for example, might have one kitchen and cater events in Baltimore and its surrounding suburbs. Local companies generally have small numbers of employees and are associated with the towns or cities in which they are located. Regional businesses serve a wider area although, like local companies, they do not serve a national or international market. Wawa convenience store chain is an example of a regional business. What special challenges do local and regional businesses face? The most common challenge for local and regional businesses is managing their money. Poor financial planning, as well as unfavorable economic conditions, can lead to bankruptcy. Undercapitalization occurs when a business owner cannot gain access to adequate funding. When a business can no longer afford to produce goods or provide services, it goes out of business. The owner must anticipate the cost of doing business and estimate the revenue that the business will generate. To avoid going into debt, the owner should have enough projected revenue to cover

Businesses like CVS/pharmacy are national businesses in that they have locations throughout the United States but do not serve an international market. Source: Kristoffer tripplaar/Alamy Stock Photo

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expenses for at least the first year. So if the owner of a local catering company has $100,000 in expenses and expects to generate $75,000 in the first year of business, then the owner should have at least $25,000 to fund the company. Even with adequate funding, there is always a chance that the economy will not support the business. Manysmall businesses fail when the economy slows down because consumers are less likely to spend extra money. Business owners also have to take taxes and insurance costs into consideration, such as health insurance plans to cover their employees. They also need liability insurance to protect their companies if property is stolen or damaged or if employees are injured on the job. If a local jewelry store is broken into and jewelry is stolen, liability insurance will cover the cost of the broken window and the stolen property. If the jewelry store is not insured, the business could go bankrupt if the owner can’t afford to cover the loss and damages.

national Businesses What defines national businesses in the United States? If you drive from New York to Los Angeles, you’ll encounter many CVS/pharmacies along the way. CVS/pharmacy has more than 7,000 locations and can be found in every part of the United States.13 All CVS/pharmacy locations essentially look alike and carry similar merchandise—all within a similar price range. With companies such as this, the customer knows what to expect. A national business serves the country, but it does not serve an international market. It provides goods or services to virtually all U.S. residents, no matter where in the country they live. A car insurance company, such as Allstate, is another example of a national business. It has offices in 49 states and serves the entire country. National companies have become standard symbols of U.S. business.

◼ fIgurE 1.4 The Supply Chain Image sources, left to right: Ragne Kabanova/Shutterstock; Uwe bumann /Shutterstock; Nat Ulrich/Shutterstock; Supertrooper /Shutterstock; tyler Olson /Fotolia

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What special challenges do national companies face? Like local and regional companies, national companies also have to worry about their budgets and managing their finances. But they have other concerns that local businesses don’t have. Because laws vary from state to state, national companies must be aware of state laws in every state in which they do business. For example, each state has its own tax laws. In most states, retail businesses are required to apply for a state sales tax permit to be able to collect sales tax from their customers. Every state imposes a corporate income tax, but the rate varies across states. And some states, such as New Jersey and Rhode Island, require businesses to pay for temporary disability insurance for their employees.14 These laws can be difficult to keep up with and prevent companies from having standardized operating policies. Another challenge that national companies face is longer, more complex supply chains. A supply chain refers to the flow by which a product, information, and money move between a supplier and a consumer (see ◼ fIgurE 1.4). In the case of a manufactured good, raw materials flow from their suppliers to a manufacturer, which makes them into a product, which then flows to wholesalers, to retailers, and finally to the consumer. If the product is returned, it flows from the consumer back to the retailer and then potentially further back through the supply chain. Information flow includes the status of orders and their delivery. Financial flow includes manufacturing costs, payments, credit terms, and profits.

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Let’s look at an example of a supply chain. When you go to Target to buy a bottle of Tide detergent, you are a part of the supply chain, as is the Target store itself. Target’s stock of Tide was supplied by a distributor, whose supply of detergent came from its supplier, P&G. P&G has its own set of suppliers that provide the chemicals and packaging materials required to manufacture the detergent. The bigger a business is, the longer and more complicated its supply chain becomes. If not managed properly, long supply chains can be inefficient because products and materials have to pass through more warehouses and sustain more shipments. Products may get backed up in long supply chains, which can result in delayed shipments and late payments. A lack of communication among companies in the chain can cause mix-ups and delays, especially if there is a sudden change in the process. A national company must therefore rely on the cooperation of all members of the supply chain to keep the business running smoothly.

Multinational (International) Businesses What categorizes a company as multinational (or international)? As we discussed previously, multinational businesses make and/or sell products in several countries. They are businesses that have expanded to provide goods or services to international consumers or serve only one country but have suppliers or production facilities in other countries. For example, you can now find a McDonald’s restaurant in more than 119 countries, all serving distinctly U.S. food.15 However, not every McDonald’s restaurant is exactly the same. They have all been adapted to fit the cultures of the countries in which they are located. For example, if you enter a McDonald’s restaurant in some parts of Canada, you’ll see a McLobster on the menu. The McAloo Tikki Burger is a vegetarian sandwich made with potatoes, peas, and spices served in McDonald’s restaurants in India. Because of the large Hindu population in India, beef is not used in any of their menu items.16 This is the nature of multinational businesses. What special challenges do multinational corporations face? Multinational corporations must be familiar and comply with the laws of the countries in which they operate. Laws concerning the import and export of goods vary greatly from one country to another. Things can get particularly complicated if a product is shipped to one country for assembly, another for packaging, and then yet another country for distribution. Often, several countries are involved in the manufacturing of one product, in which case the laws and regulations of all those countries must be adhered to. It might be necessary for a U.S. company to work with the governments of foreign countries if there are strict importing restrictions or a multitude of taxes. Safety regulations and quality control, copyright, and patent laws are some of the other laws multinational corporations must comply with when doing business in foreign countries. Cultural differences related to business practices have as much impact as legal differences on international business. Some of these issues, which we’ll discuss further in Chapter 4, include the following: • Language barriers present challenges to businesses trying to establish themselves in foreign countries. • Countries may have different business hours or workweek schedules. For example, in Spain, workers tend to take lunch from 1:30 to 3:30 p.m. • Values and customs relating to business etiquette may vary. For example, timeliness is highly valued in Germany, but it is less important in Italy. • Violating local taboos can be a concern, such as the preference for group harmony in many Asian countries.

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• Multinational companies may have difficulty determining wages for foreign workers and pricing for international markets. Multinational companies also must contend with many important economic differences among countries, such as the different levels of economic development, interest rates, and inflation rates that make international business more complicated than purely domestic business.

 The move from being a regional business to a national or even a multinational business is an exciting one, but it also brings a new set of challenges. With operations in six states—New Jersey, Maryland, Pennsylvania, Delaware, Florida, and Virginia—Wawa currently deals with issues that impact a regional company. However, recent attempts to expand into some new states, like New York and Connecticut, proved challenging. Wawa has had difficulty finding the right locations for its stores and duplicating its successful customer service and teamwork outside its regional base.17 The company decided to pull out of those markets and reevaluate. Their next move into Florida has proven a good match and they have added 100 stores in Florida in the last five years. Instead of expanding quickly toward being a national chain, Wawa is carefully choosing its markets and has found other ways to increase revenue, like moving into gas retailing, creating superstores that combine the traditional Wawa convenience center with a gas station. The four types of business—local, regional, national and multinational—each have different demands. Clearly, businesses must proceed carefully as they move from one type to the next.

Objective 1-4

taking Business Personally Explain how life skills translate to the business environment.

Source: javiindy/Fotolia

 Taylor Evans is an organized and orderly person. He prides himself on being efficient and meticulous with his schoolwork, finances, and social life. His friends joke with him about this and tell him that he runs his life like a business. But Taylor doesn’t take offense; why shouldn’t he run his life like a business? His life is just as complicated. He has revenue, expenses, and assets. Heparticipates in commerce. Taylor even likes to keep up with the latest technology to make sure he runs his life most efficiently. He is always looking for costeffective ways to operate his life, and any profits (or money he has left over after paying his bills) are set aside for future purchases. In many ways, his life is a business. Do you maintain your life like a well-run business?

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Each of you probably has a different level of familiarity with the basics of business. Some of you may have witnessed the operations of a business firsthand while employed at a part-time job. For others, your business knowledge may be limited to what you’ve read in books or seen on television or in the movies. Regardless of your prior work experience and business knowledge, you all have experience running a business, and that business is your life. Similar to a small company, your life requires careful planning, precise record keeping, and openness to change. To help you understand some of the business concepts discussed in this text, let’s look at how you run your “business.”

Life Skills for Business How do you receive funding? Regardless of whether you have a job or not, you’re receiving money from somewhere. It could be from work, a family member, a student loan, or your own savings. You need these funds to secure the necessities of your life. Similarly, all businesses need funds to operate. Ideally, a business would produce revenue right away. However, until they get established, many businesses operate on funds received from a bank loan, investors, or their owners’ capital. What are your expenses? Rent, clothing, food, tuition—these are expenses whether they are paid for with cash, credit, or a loan. Ultimately, you will want to generate enough revenue, or income, to cover your expenses and have leftover cash. The lives of some students operate a bit like a start-up business; you may have to pay for expenses with loans until you have enough experience to generate a profit. How does the social environment affect your life? The social environment probably presents similar opportunities and challenges to you as it does to businesses. How do you deal with these opportunities and challenges? Are you open to learn from people who are different from you? Do you embrace diversity? How do you relate to people from an older generation? What about the green movement? Are you finding ways to make your lifestyle more eco-friendly? It is important to address these issues so you can live a more harmonious life and prepare yourself for the modern work environment. How does globalization affect your life? Not only is the world getting smaller for businesses, but the world is also getting smaller for you. Your favorite music group may be a band from Germany. You might like to chat online about movies with a friend from Japan. Just as businesses now have the opportunity to work with other firms from all over the world, you have the ability to make friends or connections on any continent. You purchase items that are designed or manufactured in other countries. As the forces of globalization Most e-commerce requires credit cards to complete transactions. How do you keep your online transactions secure? Source: LDProd/Shutterstock

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continue, the chances of you working in a foreign country for part of your career continue to climb. How do you keep up with new technology? Whether or not you consider yourself to be tech-savvy, chances are you still use some sort of technology to run your life. Perhaps you deposit your checks using the camera on your phone or settle a bet by paying your friend using Google Wallet. Similar to a business, if you don’t keep up with new technology, you may find yourself in trouble. What sort of e-commerce do you use? E-commerce is a popular form of purchasing goods. What sort of things do you buy online? There are many online clothing stores that let you design the products yourself, like the Sole Brother Custom Sneakers online store. Perhaps you even sell things over the Internet. Posting old clothing or other unwanted items on eBay might be your way of making a few extra dollars and gaining more room in your closet. How do you keep your business secure? As businesses work to keep personal information secure, so also should customers. You can help keep your information secure by changing your online passwords on a regular basis, making sure your wireless connections are secure, switching to paperless mail, and removing personal information, such as phone numbers or addresses, from your Facebook account or other social networking sites. Keeping your personal information secure can help you avoid identity theft or other dangerous blows to your financial health. What types of financial goals do you have? The goals of a business typically revolve around achieving financial success. You, too, might have certain financial goals that you would like to achieve in your life. To reach these goals, you’ll need to make informed decisions about how you spend and save your money. Mini Chapter 5 can help you manage your personal finances and plan for the future.

 So when Taylor’s friends say he runs his life like a business, maybe that is a compliment! Many of the same concepts and strategies used to run a business can be used to monitor your day-to-day activities. As you learn new business concepts in upcoming chapters, you may find them easier to understand by applying them to your own life. However, not everything in the business world parallels your own life. The business world has its own unique issues and strategies that may not work for your personal life. Think about the material presented in this course carefully both as a consumer of business goods and services and as a future business leader.

Chapter 1

summary 1-1

borders. Although globalization provides profitable opportunities, such as increased markets and offshoring, it also leads to greater competition for U.S. businesses and workers.

Define business and list the factors of production.

• Profits are earned when a company’s revenue exceeds its expenses. • Goods are the physical products offered by a business. Services are intangible products, such as a haircut, health care, or car insurance. • A business is an entity that offers goods and services to its customers to earn a profit. A not-for-profit organization is an organization that does not pursue profits but instead seeks to service its community through social, educational, or political means. • The factors of production are the resources used to create goods and services. The factors of production include labor, natural resources, capital, intellectual property, entrepreneurial talent, and technology.

1-2

Explain how competition, the social environment, globalization, and technological changes challenge and provide opportunities to business owners.

• Competition arises when two or more businesses vie to attract customers and gain an advantage over one another. Competition forces companies to improve their product offerings, lower their prices, aggressively promote their brand, and focus on customer satisfaction. • Social environment encompasses demographic factors, such as race, ethnicity, gender, age, income distribution, sexual orientation, and other characteristics. An aging population, increasing diversity, and the green movement both challenge and pose opportunities to business owners. • Globalization involves the merging of economies around the world as technology, goods and services, labor, and capital move back and forth across international

• Technology items and services such as smart phones, computer software, and the Internet make businesses more efficient and productive. E-commerce is well established and still growing, offering even small firms a chance to sell to a global market. At the same time, keeping up with the pace of technology is an expensive and time-consuming operation for many businesses.

1-3

Describe the four types of businesses.

• A local business relies on local consumers to generate business. • Regional businesses are companies that serve a wider area than local businesses but do not serve national or international markets. • A national business has several outlets throughout the country, but it does not serve an international market. It provides goods or services to all U.S. residents, no matter where in the country they live. • Multinational enterprises also known as multinational companies or corporations, multinational businesses, or international businesses, are companies that have operations in more than one country. They are among the leaders of a movement called globalization.

1-4

Explain how life skills translate to the business environment.

• You have income, expenses, and profits. • You are affected by globalization and technology. • You have concerns with security.

key terms businesses competition e-commerce entrepreneur expenses factors of production financial capital globalization goods green economy

identity theft intellectual property labor local business multinational enterprise national business natural resources not-for-profit organization offshoring profit

real capital regional business revenue service social environment social networking sites supply chain technology telecommute undercapitalization 21

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MyBizLab To complete the problems with the

, go to EOC Discussion Questions in the MyBizLab.

self test Multiple Choice You can find the answers on the last page of this text. 1-1 Which of the following are the factors of production?

1-7 B2B and B2C interactions are a. common now because of the explosive growth of e-commerce.

a. Labor, natural resources, capital, entrepreneurs, technology, and intellectual property

b. important only for businesses, not consumers.

b. Labor, capital, entrepreneurs, motivation, and good ideas c. Natural resources, entrepreneurs, profits, and creativity

c. two different names for the same thing. d. dominated by sole proprietorships.

1-8 A social environment is an interconnected system of different demographic factors such as

d. Labor, profits, natural resources, technology, and motivation

a. climate conditions. b. globalization and political conditions.

1-2 Goods are products a business sells like

c. gender, age, and income.

a. haircuts.

d. tax policy and legal restrictions.

b. conveyer belts. c. car insurance.

1-9 Which of the following is not a common challenge facing most national companies?

d. health care.

a. Undercapitalization

1-3 Which of the following is a current sociocultural

b. A complex supply chain

trend?

c. Complying with each state’s different tax rates

a. A decrease in the overall U.S. population b. An increase in the population of Americans ages 30 to 45 years old c. A decrease in the U.S. minority population

d. Differences in state laws

1-10 You are managing your own life like a business when you

d. An increase in the population of Americans ages 65 and older

a. consider how your expenses, the social environment, and globalization impact your life. b. create an online avatar.

1-4 A green economy

c. post revealing photos on your Facebook page.

a. depends on cash on hand.

d. None of the above

b. factors ecological concerns into business decisions. c. uses a more diverse workforce. d. will not impact the auto industry.

1-5 If a firm decides to shift the production of goods

or services to an overseas company, this is called a. diversifying. b. offshoring. c. telecommuting. d. forming a partnership.

1-6 The four types of businesses are a. foreign and domestic, large and small. b. local, regional, national, and multinational. c. private, public, government, and medical. d. employee owned, government owned, foreign owned, and bank owned.

True/false

You can find the answers on the last page of this

text.

1-11 Profit is another word for revenue. True or False 1-12 Identity theft is mainly a problem for senior citizens.

True or

False

1-13 The supply chain is the process by which products, information, and money move between a supplier and the consumer.

True or

False

ChAPTeR 1

1-14 Globalization poses risks to the U.S. economy because of security and patent protection concerns.

True or

Business Basics

1-15 A not-for-profit organization uses any revenue to

False

reward the management team.

True or

False

Critical Thinking Questions 1-16 Consider all the factors of production: labor, natural resources, capital, entrepreneurs, technology, and knowledge. Is each resource a vital part of the school you attend or the company for which you work? Which factors do you believe are most important to the goods and services provided by your organization? 1-17 It is increasingly important for businesses to have green practices—reducing their carbon footprint, offering green options for consumers, and so on. What examples can you think of where a

company’s marketing campaign has highlighted its concern for the environment? What might the costs to a company be for going green? What consequences might a company face if it does not? 1-18 Many businesses now both maintain an online presence and have physical stores. Select a few specific companies and research the options for delivering product to customers. In what way does the online store compete with the physical store? How do the two storefronts support each other?

team time THE COMPETITIvE EDgE You now know that competition arises when two or more businesses contend to attract consumers and gain an advantage over one another. Divide into three groups: Company A, Company B, and Consumers.

Process Step 1. Companies A and B. Collectively decide what type of business you

want to represent, for example, sports apparel companies, beauty salons, or pet care agencies. Then choose a product or service applicable to that type of business. (Both groups should choose the same type of business and product or service.)

Step 2. Companies A and B. Decide how you will present your product to your

customers. Focus on the following factors: • Packaging/presentation • Price/budget • Quality Consumers. Compile a list of what is important to you when choosing this product or service.

Step 3. Companies A and B. Provide a brief presentation to your competition

and consumers. Consumers. Provide in-depth feedback to both companies as to how they could improve; consider your initial list.

Step 4. Companies A and B. Use the consumer feedback to alter your product

or service to gain advantage over your competition. Consumers. Discuss how the two companies compare to real-life companies offering similar products or services. Would you consider purchasing from either of these two companies? Why or why not?

Step 5. Companies A and B. Present your product again. Explain why your

product or service surpasses that of your competition.

PART one

Looking at the Business Environment

team time (continued) Consumers. Discuss the changes made by both companies and consider how they accommodated your needs. Did each company effectively incorporate your feedback into its revised presentation? Choose one company that you think gained the competitive advantage. Entire Class. Openly discuss the factors real companies must face in competition. Were these factors considered in the challenge?

ethics and corporate social responsibility CuLTuraL aWarENESS: uNWrITTEN LaWS There are many challenges facing multinational companies. Complete the following exercise to experience one challenge.

Process Step 1. Divide into six groups, each representing one of the following coun-

tries: Hong Kong, France, Egypt, Japan, Mexico, and the United States. Examine the cultural practices, customs, and values of the country you will represent. This may be done in class, if you have Internet access, or as homework.

Step 2. Each group should pair together with a second group as follows: United

States with Japan, Mexico with Egypt, and Hong Kong with France.

Step 3. Each group should produce one scenario of a business transaction

that would be affected by cultural differences found in your research. Fabricate specific companies, characters, interactions, and resolutions.

Step 4. Answer these questions and discuss with the class:

• What were some challenges encountered in your business scenario, and how did you overcome them? • Why is it important for multinational companies to research a foreign country with which they intend to conduct business?

Web exercises 1-19

1-20

Are You Savvy to Society? Imagine you are starting a new business. To what demographic area would you market? Think about the following factors: the race, ethnicity, gender, age, income, and sexual orientation of the population. Visit www.census.gov to locate reports on the demographic area you are interested in. Do you believe your business can thrive in this area? If not, what area would be conducive to your future customers? The Languages of the Global Marketplace As globalization increases and the world markets become more intertwined, language barriers become important. Investigate online resources for automated translation tools. How could you add a website translator gadget to your web page? What happens if you want to read a web page posted by a German firm?

Can you make online purchases from a company based in Asia? What resources are there for translating telephone conversations in real time? Investigate Babelfish.com and personal interpreter services like LanguageLine.com. 1-21

Business Technology on the Go Mobile devices are evolving quickly and are setting the style of advertising and marketing. From www.exacttarget .com, select Resources and then Downloads. Find the current Mobile Behavior report.

1-22

Nonprofit Business Is Still Business What tools are available to help evaluate the performance of a nonprofit business? Visit CharityNavigator. org. Examine three different nonprofit organizations and compare their performance, suggesting specific issues that concern you or that impress you.

ChAPTeR 1 1-23

Business Basics

applicable in the states in which these companies are based. How do the workers’ compensation and tax laws differ for each company? Which company do you think was more difficult to establish based on state laws?

Comparing Companies Consider two national companies discussed in this chapter—Allstate and CVS/pharmacy. In what states is each based? Go to www.sba.gov to research the laws

MyBizLab Go to the Assignments section of your MyBizLab to complete these writing exercises. 1-24

Most business owners agree that keeping up with the pace of technological change is a challenging task. Imagine you are the owner of a new business and must decide what technology would best suit your needs. From what types of technology would this business benefit? Consider the factors of production, organization, and communication in your decision. 1-25 You can already think of yourself as a business—your life already has many of the same needs to manage. How do you manage your life financially— what are your sources of income? How do you track and predict your expenses? How do the changes in society impact your decisions, your opportunities, and your challenges? What role does globalization play in your life today?

references 1. Nantucket Allserve, Inc., “Nantucket Nectars from the Beginning,” www.nantucketnectars.com/fullstoryphp? PHPSESSID=996c6c936ce6351082022525b73e9fce. 2. Danny Sullivan, “With iOS 9, Apple’s Siri & Spotlight Search Get Smarter,” September 16, 2015, http:// searchengineland.com/ios-9-apple-siri-spotlight -search-230814. 3. J. Meyer, U.S. Department of Commerce, U.S. Census Bureau, Centenarians: 2010 Census Special Report (C2010SR-03), 2012, www.census.gov/prod/cen2010 /reports/c2010sr-03.pdf. 4. Four Seasons Hotels, 2014, http://money.cnn.com/ magazines/fortune/best-companies/2014/snapshots /91.html. 5. “Obama Administration Finalizes Historic 54.5 MPG Fuel Efficiency Standards,” August 28, 2012, www.whitehouse .gov/the-press-office/2012/08/28/obama-administration -finalizes-historic-545-mpg-fuel-efficiency-standard. 6. FedEx, “About Us,” http://about.fedex.designcdt.com/ our_company/company_information. 7. “Client Question: How Long Is My Computer Technology Really Supposed to Last?,” July 19, 2013, www.intechit .net/client-question-how-long-is-my-computer-technology -really-supposed-to-last. 8 R. van der Meulen, “Gartner Says Organizations Must Focus on Continuous IT Cost Optimization,” August 20, 2013, www.gartner.com/newsroom/id/2576517. 9. J. Rizzo, “Navigant Research Predicts That by 2020 We Will See Twice as Many Global Utility Mobile

10. 11.

12. 13. 14. 15. 16.

17.

Workers,” January 6, 2014, www.mobilitytechzone.com/ topics/4g-wirelessevolution/articles/2014/01/06/ 365518 -navigant-research-predicts-that-2020-we -will see.htm. Jack Neff, “Beyond Online Ads: P&G Sets $4 Bil E-Commerce Goal,” Advertising Age 80, no. 29: 3–25. Laura Shin, Forbes.com, “Why Medical Identity Theft Is Rising and How to Protect Yourself,” May 29, 2015, http:// www.forbes.com/sites/laurashin/2015/05/29/whymedical-identity-theft-is-rising-and-how-to-protectyourself/#7636f171e200. Our Core Purpose, 2016, retrieved August 13, 2016, from https://www.wawa.com/about.aspx. CVS Caremark, “History,” http://info.cvscaremark.com/ our-company/history. Rhode Island Department of Labor and Training, “Temporary Disability Insurance,” www.dlt.ri.gov/tdi. McDonald’s, “About Us,” www.mcdonalds.ca/en/ aboutus/faq.aspx. Telegraph, “Fancy a ‘Modern Chinese Burger’? Weird McDonald’s food around the world,” October 16, 2015, http://www.telegraph.co.uk/food-and-drink/ news/weird-mcdonalds-food-around-the-world/ mcrice-burger-phillipines. Robert Wolcott, Kellogg School of Management, “Building a Business within Wawa,” http://hbr.org/product/wawa -building-a-new-business-within-an-established/an/ KEL240-PDF-ENG.

Chapter 2

Economics and Banking OBjEctivEs 2-1 The Basics of Economics

Define economics, and describe the different types of economic systems. Why does water cost less than diamonds? It’s a matter of supply and demand—a problem that Bryan Weirmoyer faces every day as a sales executive for a real estate development company. How can businesses use basic economic concepts to their advantage?

2-2 Determining Price: Supply andDemand

Explain the principles of supply and demand, and describe the factors that affect each principle. For many business owners, weathering shifts in supply and demand is like playing tug of war. The levels of supply and demand for a given good or service shift constantly, each influenced by a variety of factors. Consider the example of a kiosk owner selling coffee on a college campus. Ideally, the owner wants to sell the coffee at a price most students are willing to pay without anyone wanting more, or without any being left over. What factors play into this decision?

2-3 Degrees of Competition

Describe the various degrees of business competition. Perhaps you’ve played the board game Monopoly. Once you own all the property of the same color in the game, you have a monopoly and control all that happens on that property.

Although that’s the goal of the board game, large monopolies are rarely allowed in the United States. What is a monopoly? Why are there laws against it? And how does it differ from an oligopoly, monopolistic competition, and perfect competition?

2-4 Economic Indicators

Explain how the various economic indicators—particularly the gross domestic product (GDP), price indices, the unemployment rate, and productivity— reflect the health of an economy. Greg Johnson is managing the inventory of a large automobile dealership. Before the Great Recession, ordering inventory was simple because the demand for new cars seemed relatively constant. These days, Greg’s not sure about his company’s direction. The economy seems to be improving, but is it really? Are there economic measurements he can use to help him make his decision?

2-5 Government and the Economy

Describe the four stages of the business cycle, and explain how the government uses both fiscal policy and monetary policy to control swings in the business cycle. Nick and Jacinta Robertson are looking to buy their first home. What information do they need before getting a mortgage? Can government actions have an effect on what Nick and Jacinta do?

CHAPTER 2

Objective 2-1

the Basics of Economics Define economics, and describe the different types ofeconomic systems.

 It

was the third phone call this week, and Bryan Weirmoyer knew it wouldn’t be the last. Bryan is the sales executive for a residential and commercial real estate developer in Oregon. A couple of years ago, he enjoyed taking phone calls that generally ended by closing contracts for the construction of new homes. But now, the phone doesn’t ring much, and when it does, it’s generally a call to cancel contracts Bryan had worked hard to negotiate. Why were there so many sales a couple years ago and so few now?

Bryan’s dilemma of diminishing sales is to the result of the economic concept of supply and demand. Have you ever wondered why water, a basic commodity that is critical to life, is priced so low, and diamonds, which aren’t necessities, are expensive? This paradoxical situation illustrates a fundamental concept of economics—supply and demand. Supply and demand determine how goods are priced and how much of them are exchanged. The exchange of products and services between people, companies, and even countries is the root of economics. In this chapter, we’ll examine the laws of supply and demand, discuss economic indicators, and look at how government actions affect the economy. First, let’s begin with a discussion of some basic economics concepts.

Source: Slavo valigursky/Shutterstock

Economics Defined So what is economics? Economics is the study of how individuals and businesses make decisions to best satisfy wants, needs, and desires with limited resources. It is about businesses making goods (such as books, pizza, or computers) or supplying services (such as giving haircuts, painting houses, or installing home entertainment centers) that we want or need to buy. Because businesses don’t have enough tools, money, or products to provide all the books, pizza, or haircuts that we want, they must decide what and how much to make. Likewise, not everyone will be able to have what he or she wants because people’s resources are limited. Therefore, economists look at how resources are distributed in the marketplace and how equitably and efficiently those resources are disbursed. There are two basic studies of economics: microeconomics and macroeconomics. MICroEConoMICS Microeconomics is the study of how individual businesses, households, and consumers make decisions to allocate their limited resources in the exchange of goods and services. When Bryan Weirmoyer tries to determine how a change in prices may help generate sales or analyzes the number of existing houses that are already for sale in the local market, he is using the microeconomic principles of supply and demand. MaCroEConoMICS Macroeconomics looks at the bigger picture. Macroeco nomics is the study of the behavior of the overall economy. Economy-wide occurrences, such as changes in unemployment, interest rates, inflation, and price levels, are all part of the study of macroeconomics. Macroeconomists, for example, look at how changes in interest rates affect the demand for housing or

PART onE

TAblE 2.1

Looking at the Business Environment

Types of Economic Systems around the World

Type

What to Produce

How to Produce

For Whom to Produce

Planned (Controlled): • Communism • Socialism

The government or other centralized group completely or partially determines what to produce.

The government or other centralized group completely or partially determines and controls the resources and means of production.

The government or other centralized group completely or partially determines wages and sets prices. Resources and products are distributed to the common group.

Market: • Capitalism

Individuals and businesses make decisions based on consumer needs and wants.

Individuals and businesses determine the production methods. The focus is on efficiency and profitability.

Individual income ultimately controls purchasing decisions.

Mixed

A blend of planned and market economies. Individuals and businesses determine what to produce, along with some level of government involvement.

Individuals, businesses, and the government control resources and determine production methods.

The government distributes some goods and services through selected social programs. Individual income determines purchasing decisions for other goods and services.

how changes in the housing market affect the overall economy. The government and individuals in a society also affect how resources are allocated and the type of economic system the society uses.

Economic Systems What are the types of economic systems? An economy is a system that tries to balance the available resources of a country, such as land, capital, and labor, against the wants and needs of consumers. An economy is defined by (1) what is produced, (2) how it is produced, and (3) who gets the finished product. The world’s various economies can be classified into three basic economic systems: • Planned (or controlled) economies • Free market economies • Mixed economies ◼ TaBLE 2.1 explains the differences between these basic types of economic systems. Planned and free market economies lie at opposite ends of the spectrum in terms of government control. Each national economy has some element of planned and free economic systems. The main difference between each economy, and between planned and market economies in general, is the degree of individual autonomy.

Planned Economic Systems In a planned economic system, the government plays a significant role in determining the goods and services produced and distributed. Communism and socialism are examples of planned economic systems. Communism is an economic system in which a state’s government makes all economic decisions and controls all the social services as well as many of the major resources required for the production of goods and services. Karl Marx, the originator of communist principles, envisioned in his landmark book The Communist Manifesto that workers themselves would eventually take over the government’s responsibilities to provide services. No country operating in a

ChAPTER 2

communist system has achieved this level of Marx’s vision. Existing communist states, including North Korea and Cuba, are failing economically. This is a result of problems that have arisen with communist systems, such as shortages of goods and services. In fact, in the later years of the twentieth century, most former Soviet republic states and Eastern European countries turned from communism-based economies to market economies to combat these problems. Socialism is a system whereby the government owns or controls many basic businesses and services and the profits from them are distributed evenly among the people. In socialist economic systems, governments traditionally run some of the social services, such as education, health care, retirement, and unemployment, as well as other necessary businesses, such as utility companies (telephone, electric, water, and sewer companies). The government charges high tax rates to pay for the services it provides. For example, the economies of the Scandinavian countries of Norway, Sweden, Finland, and Denmark are more characterized by socialism than the United States is. Scandinavian countries have some of the highest tax rates in the world, with tax revenues representing between 52 and 57 percent of their economy. By contrast, tax revenues represent less than 20percent of the United States’ economy.1 Although Scandinavians pay more taxes, they benefit from social programs that the taxes fund. For example, education at even the best universities in Denmark is free. Although paying high taxes may seem unappealing, recent studies have indicated that Scandinavians rank among the most satisfied people in the world.2 Although government-controlled and supplied social services likes those associated with communism and socialism can lead to resources being equitably distributed among a nation’s citizens, these economic systems have a downside: They tend to reduce people’s motivation to work as hard as they might otherwise. Why work harder when you will receive as many goods and services as your neighbor who doesn’t? Or why work a lot of overtime if you have to give half of your overtime pay to the government in the form of taxes? Therefore, it is difficult to find purely socialist economies. For this reason, many formerly socialist and communist countries have changed their economies into free market economies through the practice of privatization—the conversion of government-owned production and services to privately owned, profit-seeking enterprises.

Market Economies In a market economy such as we have in the United States, individuals are able to make many of their own economic decisions. For example, there may be several pizza parlors in your town, and each one may sell slices of pizza at different prices. No one is restricting the number of pizza parlors, and no one is controlling what prices they can charge. Similarly, you are free to buy any pizza you’d like. This freedom of choice for both the buyer and the seller defines a free market economy. Capitalism is an economic system that allows freedom of choice and encourages private ownership of the resources required to make and provide the goods and the services we enjoy. Capitalism has become a major influence in the Western world’s economic systems. In a capitalist economy, the production and pricing of goods and services is determined through the operation of a market—the mechanism by which buyers and sellers exchange goods and services.

Mixed Economies Most economic systems are mixed economies—a blend of market and planned economies. One way to think about the various economies and how they relate to each other is to place them on a continuum, as shown in ◼ FIGUrE 2.1. Most Western European countries, for example, operate with a mixed economy of privately owned businesses and government control of selected social programs, such as health care. The United States has been more of a capitalist economy than its European counterparts, but with the passage of the Affordable Care Act, a U.S. health care law passed in early 2010, the United States economic system has shifted.

Economics and Banking

PART onE

Looking at the Business Environment

◼ FIGUrE 2.1 Continuum of Economic Systems: Degree of Government Control

Planned Systems High degree of government control High level of social services

Free Market Systems Low degree of government control Low level of social services

Russia China

Cuba

Italy South Africa

United States

Norway

Canada

India

COMMUNISM

United Kingdom

SOCIALISM

Hong Kong Singapore

CAPITALISM

business and Economics Why do business managers need to be concerned with economics? Business managers and owners need to understand the principles of economics because the nature of business is to provide items or services for purchase in exchange for something, generally money. Businesses need to know how much of their goods to produce or services to offer as well as how much to charge for these products. Additionally, business managers need to be aware of the potential impact that government decisions (such as changing interest rates) and the decisions of collective businesses (such as the general level of unemployment) can have on their individual business or industry. We will discuss how economics impacts business throughout this chapter.

 One dilemma Bryan Weirmoyer faces as the need for new housing dwindles is whether he’ll have customers to build houses for. His decisions affect other areas of the business, such as land acquisitions, inventory purchases, and staffing. Bryan watches the movement of interest rates carefully because he knows that even the smallest change in interest rates will affect whether homebuyers are more or less inclined to take out mortgages, which will affect Bryan’s sales.

Objective 2-2

Determining Price: supply and Demand Source: revelpix/Fotolia

Explain the principles of supply and demand, and describe the factors that affect each principle.

 Eddie Walker finally received the approvals he needed to open a coffee kiosk on his college’s campus. He knew there would be demand, as he had seen how coffee stores on other campuses seemed to make a killing— how hard could this be? He wasn’t sure how much to charge for a cup of coffee but felt that the need was so great that students would be willing to buy coffee at almost any price! Was Eddie right? Would students buy coffee at any price? What is the relationship between supply, demand, and prices?

ChAPTER 2

In the days of bartering, when people traded goods or services without an exchange of money, the price of something was determined by the needs of each person in the bartering exchange and what they were willing to trade. For example, suppose you wanted milk but had no cow. Instead, you had chickens, and you were willing to exchange eggs for milk. Then you would look for someone who wanted to trade his or her milk for your eggs. At the end of the trade, everyone was happy because you received the milk you needed and the other person received the eggs he or she needed. However, there are problems with this exchange system. Bartering can be inefficient and inconsistent. What if theperson who had the cow didn’t need eggs, or what ifthe cow owner thought his milk was worth a chicken but the egg owner thought it was worth only a dozen eggs? To offset some of the difficulties of bartering, the concept of currency, or money, was developed. Currency, a unit of exchange for the transfer of goods and services, provides a consistent standard. Initially, the value of the standard was based on an underlying commodity, such as gold. Today, the U.S. currency isn’t based on gold but rather on a perceived value of its worth. In a system using currency, items such as milk, eggs, cows, and chickens are assigned a price or a value based on how much the item is worth. The worth, or ultimately the price, of a good or service is determined by two fundamental concepts of economics: supply and demand. Supply and demand is actually a complicated process because many factors are involved, such as income levels and tastes, as well as the amount of competition in the market. However, to simplify things, economists ignore those factors for the moment (they call it “all else held constant”) and examine the fundamentals only. When just the fundamentals are examined, we find that the market price for a good or a service is the price at which everyone who wants the item can get it—without wanting more or without any of the item being left over. When the need and availability for an item are in balance, the price is in equilibrium. The need or want for an item is demand, and the availability of that item is supply. The closest real-world example of determining a market price that is based on pure supply and demand is the auction process, like that found on eBay. In an auction process, bidders state the price they are willing to pay for a particular item. The price increases depending on the demand: The greater the demand, the higher the price the bidders are willing to pay. Supply also affects price: If similar or identical items are available for auction, the supply of those items increases, and so the price for them overall is lower. By contrast, when a unique item is auctioned, prices tend to be higher because demand is higher and supply is lower. Eventually, the winning bid establishes the market price.

Supply What is supply? Supply refers to how much of a good or a service is available for purchase at any given time. Supply is dependent on the resources that are required to produce the good or offer the service, such as land, labor, and capital (buildings and machinery), and the quantity of similar products that can easily be substituted for the product and that are competing for a customer’s attention. However, if all these factors are ignored or held constant, then supply is directly affected by price. Supply is derived from a producer’s desire to maximize profits. The more money a business can get for its good or service, the more of its product it is willing to supply. In economic terms, the amount supplied will increase as the price increases; also, if the price is lower, less of the product will be supplied. This is known as the law of supply.

Economics and Banking

Currency developed as a means to make the exchange of goods and services more consistent and equitable. Source: brad Pict/Fotolia

PART onE

Looking at the Business Environment

TAblE 2.2 The Relationship between Price and Supply Price ($)

Coffee Supply (cups)

0.50

0.75

1.00

1.25

1.50

1.75

100

2.00

115

TAblE 2.3 The Relationship between Price and Demand Price ($)

Coffee Demand (cups)

0.50

120

0.75

1.00

1.25

1.50

1.75

2.00

Let’s look at an example. Eddie opens a coffee kiosk in the middle of his college campus. He will want to supply more cups of coffee at $2.00 per cup than at $0.50 per cup. The reason for this is obvious: Eddie has a greater incentive to supply more cups of coffee if he can sell them at $2.00 each rather than at $0.50 each because he’ll generate more profit at the higher price. Notice in ◼ TaBLE 2.2 that Eddie wants to supply only 10 cups of coffee at $0.50 per cup. However, if Eddie can charge $1.25, Eddie will supply 70 cups of coffee because he has a greater incentive to supply more cups at the higher price. Finally, at the price of $2.00, Eddie’s incentive to supply coffee is at its greatest. At that highest price, Eddie wants to supply 115 cups. We can illustrate this relationship between supply and price in a graph that economists call a supply curve, like the one shown in ◼ FIGUrE 2.2. You can see that Eddie’s desire to supply, or sell, more cups of coffee is affected by price. The more he can charge, the more he wants to supply. However, as you can imagine, the demand for coffee has a different reaction to price.

Demand What is demand? Demand refers to how much of a good or a service people want to buy at any given time. People are willing to buy as much as they need, but they have limited resources (money). Therefore, people will buy more of an item at a lower price than at a higher price. In our coffee example, as shown in ◼ TaBLE 2.3, students are willing to buy only 12 cups of coffee at $2.00 a cup. When he reduces the price to $1.25, there is more demand with 55 cups being purchased. But the most demand is generated when the price is lowered to $0.50 a cup, and 120 cups are sold. In other words, as price decreases, demand increases. Again, economists illustrate the relationship between demand and price with a graph that they call a demand curve, as shown in ◼ FIGUrE 2.3.

Factors That Determine Price What factors determine price? As you’ve seen with Eddie’s coffee kiosk, there is an obvious conflict when setting a market price. Notice that Eddie wanted to supply coffee at a higher price but that he didn’t attract many customers by doing so. Customers were more willing to pay for coffee as the price dropped. As the price of a product increases, more of it is likely to be supplied. As the price of the product decreases, more of it is likely to be demanded by customers. Because these two concepts of pricing are at odds with each other, what determines the final price? Holding all other factors constant, prices are set at a point where supply equals demand. The supply-and-demand relationship is one of the fundamental concepts of economics. At Eddie’s coffee kiosk, for example, at some point, supply and demand balance each other out. Although Eddie would love to sell coffee at $2.00 a cup (or even more), he realizes that not too many students are willing to buy coffee at that price. At $2.00 a cup, Eddie would end up with unsold product left over, creating a surplus. As Eddie begins to lower his price, he finds that more students are willing to buy his coffee. However, if Eddie lowers his price too much, to $0.50 a cup, for example, then the demand would be so great that Eddie would run out before he was able to satisfy all the students who wanted coffee, creating a shortage. Ideally, Eddie would strive to determine a price at which he is willing to supply the coffee and at which students are willing to buy (demand) the coffee without anyone wanting more or without any coffee being left over. A surplus usually means that suppliers will lower prices to clear out inventory, whereas a shortage means suppliers will raise prices to take advantage of the higher

ChAPTER 2

Demand Curve —Coffee Kiosk

Supply Curve—Coffee Kiosk 2.5

$2.50

$2.00

1.5

$1.50

Price ($)

Economics and Banking

1 0.5

$1.00 $0.50

0 0

60 80 100 Quantity Supplied

120

$–

140

60 80 100 Quantity Demanded

120

◼ FIGUrE 2.2 The Supply Curve

◼ FIGUrE 2.3 The Demand Curve

The supply curve illustrates the incentive to supply more as prices increase.

The demand curve illustrates that demand increases as prices decrease.

140

demand. In both cases, the price will converge toward the market price, which, as noted previously, is the price at which supply equals demand. The market price (or equilibrium price) is illustrated in a supply-and-demand chart as shown in ◼ FIGUrE 2.4. In this case, 60 cups of coffee is equally demanded and supplied at a price of $1.15. In a perfect world, this is how pricing for products would be set. But we don’t live in a perfect world. Other factors that make us want more or less of a product outside of price can affect demand. There are also factors that affect our willingness or ability to provide a product, which can affect supply. We’ll look at those factors next.

Factors That Affect Demand ◼ FIGUrE 2.4

What other factors besides price affect demand? Not too long after Eddie The Market Price figured out the “perfect price” for a cup of coffee, he receives news that the college’s The market price is determined at the bookstore will begin to offer coffee, too. In addition, the college announces a tuition point where supply equals demand. © Mary Anne Poatsy increase. How do these events affect the student’s willingness to buy coffee from Eddie? Will the new competition and higher student Supply and Demand Curves —Coffee Kiosk costs decrease demand for Eddie’s coffee? There are many factors that affect the demand for $2.50 a product besides its price. These factors, known as Demand Supply the determinants of demand, are as follows: $2.00

Changes in income levels Population changes Consumer preferences Complementary goods Substitute goods

A positive change in any of these determinants of demand shifts the demand curve to the right, and negative changes shift the demand curve to the left. ◼ TaBLE 2.4 summarizes the key determinants of demand. Let’s look at each in more detail.

$1.50 Price

• • • • •

Market Price $1.00 $0.50 $– 0

60 80 Quantity

100

120

140

PART onE

Looking at the Business Environment

TAblE 2.4

Key Determinants of Demand

Determinants of Demand

Examples

Changes in income levels

A job loss or tuition increase will reduce discretionary income and decrease the amount of coffee one buys. A promotion may allow a home owner to buy a larger house or a house in a better neighborhood.

Population changes

An increase in young, working professionals in a neighborhood may increase the demand for coffee shops and single-family homes.

Consumer preferences

Needs and wants change based on fads and often as a result of advertising. A health alert concerning the negative effects of caffeine might reduce the demand for coffee.

Complementary goods

If new houses are in demand, complementary goods, such as appliances and other home goods, are also in demand. A reduction in new housing would negatively affect these complementary industries. If donuts or other food products are offered along with the coffee, the demand for coffee may increase.

Substitute goods

Products or services that can be used in place of another. A purchase of a treadmill may substitute for a gym membership, or you could use Google Chrome as a web browser instead of Internet Explorer or Firefox. The bookstore offering coffee could shift the demand curve for Eddie’s coffee to the left.

When income levels increase, people are able to buy more products. Conversely, when income levels decrease, most people cut back on spending and buy fewer products. Therefore, as we’ll discuss later in this chapter, when the economy enters a recession and people begin to lose their jobs, the demand for some goods and services decreases. An improving economy will bring an increase in spending as more people find jobs and create an increase in demand for some goods and services. A change in income levels is one factor that affects the housing market, for example. With an increase in income, people can afford to buy a home for the first time or can afford to upgrade to a bigger, more expensive home if they already own a home. On the other hand, if people begin to lose their jobs, they may need to downsize into a smaller home and sell their more expensive home.

ChanGES In InCoME LEvELS

PoPULaTIon ChanGES Businesses in resort communities experience an increase in demand during the “in” or “high” season. Increases in population create a greater demand for utilities (such as telephone, electric, sewer, and water services) and public and consumer services (such as restaurants, banks, drugstores, and grocery stores). Demographic changes, such as the aging baby boomers, also affect the demand for certain goods and services. ConSUMEr PrEFErEnCES The demand for a product can change based on what is popular at any given moment. Tickle Me Elmo dolls, Xbox One game systems, and the Apple iPad are all products that had high initial demand. As demand for these items increases, the demand curve shifts to the right. As demand begins to wane, the demand curve shifts to the left.

Products or services that go with each other and are consumed together, such as the iPhone and the apps associated with it,

CoMPLEMEnTary GooDS

ChAPTER 2

Decreased Demand with Competition $2.50 $2.00

Price ($)

are considered complementary goods. The demand for apps is great as long as consumers are buying and using iPhones. When the Android-based phones emerged on the market, the demand for iPhones and apps in the Apple store decreased, shifting the demand curve for iPhone apps to the left. When the new iPad came out, the demand to download content from iTunes and the Apple store increased, shifting the demand curve for the online site to the right.

Economics and Banking

$1.50 $1.00

Goods that can be used in place of other goods, such as Coke for Pepsi or $0.50 McDonald’s Quarter Pounder for Burger King’s Whopper, are substitute goods. Suppose, for $– example, someone reported getting violently ill 0 20 40 60 80 100 120 140 after eating a McDonald’s Quarter Pounder. The Quantity Demanded demand for the McDonald’s Quarter Pounder will decrease, shifting that demand curve to the left, Coffee New Demand Demand with Competition whereas the demand for the Burger King Whopper might increase, shifting the Whopper’s demand curve to the right. ◼ FIGUrE 2.5 In our example, a tuition increase may mean that students have less Demand and Competition money to spend on items such as coffee, so Eddie may see his demand deIncreased competition negatively crease. Additionally, competition from the bookstore offering coffee might changes coffee demand and moves the also decrease Eddie’s demand, as ◼ FIGUrE 2.5 shows. Eddie should also exdemand curve to the left. pect a temporary decrease in demand during the summer and holidays when © Mary Anne Poatsy fewer students are on campus. However, if Eddie begins to offer complementary items, such as breakfast and lunch foods, he may see an increase in demand. SUBSTITUTE GooDS

Factors That Shift Supply What makes supply change? Eddie started his business with a used industrial-sized coffeemaker. It makes good coffee, but Eddie is now thinking that he might need to buy a newer coffeemaker that would make coffee faster. In addition, he has heard that the price of the type of coffee beans he uses is going up. He could switch to a lower-quality bean, but he doesn’t want to reduce his standards. How could these new costs affect Eddie’s business and his willingness and ability to supply coffee? There are many factors that can create a change in supply. These factors, known as the determinants of supply, are as follows: • • • • •

Technology changes Changes in resource prices Price expectations The number of suppliers The price of substitute goods

Changes in any of these factors that help to create a good or a service can affect its supply and shift the supply curve to the left (have a negative impact on supply) or to the right (have a positive impact on supply). ◼ TaBLE 2.5 summarizes the key determinants of supply and how they might affect business. Let’s look at each in more detail. Improvements in technology enable suppliers to produce their goods or services more efficiently and with fewer costs, thus

TEChnoLoGy ChanGES

PART onE

TAblE 2.5

Looking at the Business Environment

Key Determinants of Supply

Determinants of Supply

Example

Technology changes

Continuing improvements in technology, such as a better coffeemaker or software program, result in lower costs of production and create a higher level of productivity, which increases the quantity supplied and lowers the price.

Changes in resource prices

A decrease in the cost of lumber may increase the number of new homes built, or an increase in union wages may affect the number of workers a business can afford to employ, decreasing the business’s ability to generate a product.

Price expectations

An anticipated lowering of interest rates may indicate a future increase in new housing contracts.

The number of suppliers

An increase in home builders increases the supply of new homes and decreases the cost of new homes.

The price of substitute goods

The construction of cheaper townhouses in an area could lead to less building of more expensive single-family residences.

increasing their ability to supply more. For example, if a bakery purchases a new modern oven, it would be able to make more fresh desserts in less time. Similarly, in other industries, a sales force that uses software on their smartphones to connect immediately to inventory when placing orders will be more efficient than the sales force having to process paper orders. ChanGES In rESoUrCE PrICES Increases and decreases in the price of the resources used to produce a good or a service affect the cost of their production. An increase in resource prices increases the cost of production and reduces profits, thus lowering the incentive to supply a product. For example, an increase in the minimum wage will increase the cost of labor, thus potentially affecting how many workers a small business could employ. Not having enough workers could limit a company’s ability to supply the necessary quantities of a product, shifting the supply curve to the left. Likewise, a decrease in the price of gasoline could reduce the costs of shipping services and shift the supply curve to the right. PrICE ExPECTaTIonS The expected future price of a product will affect how much producers are willing to supply of it. For example, if the price of crude oil is expected to increase, companies like ExxonMobil will ramp up their production to supply more oil at the higher price. However, sometimes if prices are expected to increase significantly in the future, a supplier might stockpile the product and supply more at a later time when prices are higher. Similarly, if prices are expected to significantly decrease in the future, the supplier might make every attempt to sell its supply of the product while prices are high. From a buyer’s perspective, the reverse can be true as well. For example, if Eddie is anticipating an increase in the price of coffee because a cold snap adversely affected the supply of coffee beans, he may want to buy more coffee beans than he needs to now at a lower price to continue to keep his prices low. Or he will need to consider raising his prices to compensate for the future increase in his costs.

The supply of a good or a service increases as the number of competitors increases. It makes sense that the number of suppliers often increases in more profitable industries. Think about what Starbucks has done to the coffee business. Although Starbucks remains the leader in the retail coffee market, there are many companies, such as Dunkin’ Donuts and McDonald’s, supplying beverages to coffee drinkers, thus increasing the availability of good

nUMBEr oF SUPPLIErS

ChAPTER 2

Economics and Banking

coffee. Similarly, as an industry becomes less popular as a result of a change in technology or other cause, the number of suppliers decreases. For example, when the digital camera became popular, the number of suppliers of film cameras decreased drastically. PrICE oF SUBSTITUTE GooDS The price of comparable substitute goods also affects the supply of a product. If there are equally comparable goods available at a lower price, the supply of the more expensive goods will be affected. For example, if cable Internet access, a substitute for DSL Internet access, is priced lower than DSL, then consumers switching from DSL to cable may affect the supply of cable (which will increase) and the supply of DSL (which will decrease).

 Through some ongoing trials, offering his coffee at various prices, Eddie finally settled on a price at which he felt most of his product was being sold and where he had little left over at the end of the day. He realized that not every day was the same, so some days he ran out, and other days he had much more left over, but overall he was satisfied with the price he set. However, Eddie is keeping a close eye on his prices because he knows that any number of changes could affect the demand for his coffee and ultimately the success of his business.

Objective 2-3

Degrees of competition Describe the various degrees of business competition.

 In

1996, Microsoft developed its own web browser, Internet Explorer, and tried to pressure computer manufacturers and Internet service providers to carry it exclusively. As a result, the U.S. Department of Justice began investigating the corporation for attempting to establish a monopoly over the market. In 1999, a U.S. district court found Microsoft to be in violation of the Sherman Antitrust Act and ordered the company to break up. In 2001, an appeals court overturned this order but maintained that Microsoft was illegally monopolizing the market for web browsers. What exactly is a monopoly? And why doesn’t the government allow large monopolies to exist in the United States?

Some products or services have no substitutes, whereas others share the mar ket with many similar products. The number of substitutes for a certain good or service determines the level of competition. Various degrees of competition exist, from monopolies to perfect competition, as shown in ◼ FIGUrE 2.6. Keep in mind that these degrees of competition are points on a continuum, not absolute measures. For example, many industries fall somewhere between a monopolistic competition and an oligopoly.

Source: Fjstudio/Fotolia

PART onE

Looking at the Business Environment

Monopolies

MONOPOLY • One company dominates an entire industry; no substitutes exist DUOPOLY • Only two suppliers exist in an industry or have dominant control OLIGOPOLY • Only a few sellers exist, and each seller has a fairly large share of the market MONOPOLISTIC COMPETITION • Many buyers and sellers and little differentiation exists between the products, but there is a perceived difference among consumers PERFECT COMPETITION • Many buyers and sellers of virtually identical products; no barriers to market entry ◼ FIGUrE 2.6 Degrees of Business Competition © Mary Anne Poatsy

Why aren’t there many monopolies? Without competition, a firm that has a monopoly can charge a higher price and may be less responsive to consumer needs. Monopolies can occur when companies that offer the same service or provide the same good merge and thus control the market. The U.S. Federal Trade Commission and the Department of Justice must review mergers between large competitors to determine whether the combined firm would result in a monopoly that would thwart competition. For example, in 2011, the Department of Justice blocked the proposed merger between AT&T and T-Mobile on the grounds that the deal was anticompetitive. When US Airways and American Airlines merged, the Department of Justice required the companies to sell the gates they own in certain airports to other airlines to enhance competition in the airline industry after the merger.3 In the United States, natural monopolies are an exception. Utility companies, such as those that sell natural gas or water to consumers, may be permitted to hold monopolies in an effort to conserve natural resources. However, the government regulates the prices for these goods and services, thus preventing the utility companies from overcharging for their products.

Keurig’s Monopoly

What is a monopoly? A monop oly occurs when a provider of a service or a good has control of all or nearly all of its market. If one company were the sole provider of automobile tires and no other tire manufacturers were available to the automobile industry, that would be considered a monopoly. Monopolies can also happen in a local or a regional market. For example, if Eddie’s coffee kiosk is the only place students can buy coffee on campus, then Eddie has a monopoly on campus coffee sales. In the United States, as well as in other countries, large monopolies are rarely allowed.

n 1998, Keurig Green Mountain, Inc., began shipping its first single-cup coffee-brewing machines to customers, starting a revolution in how coffee is prepared. Keurig machines are in millions of U.S. households, with little threat of competition. In the single-cup coffee machine industry, because of patent protection, Keurig holds a monopoly. In addition to the machines, Keurig sells more than 200 different flavors of coffee packets, or “pods,” used in the machines. Like the machines, Keurig’s multibillion-dollar coffee-pod business also faces little competition. In 2012,

on TARgET

Keurig’s patent on the coffee pods expired, allowing generic brands of pods to creep into the marketplace. In 2013, generics had captured 11 percent of Keurig’s market share. To protect the company’s market dominance and the source of much of its revenue, Keurig released a new coffeebrewing machine, the Keurig 2.0, which is compatible only with pods that Keurig produces—not generic coffee pods. The Keurig 2.0 has spurred several complaints and lawsuits from competitors claiming the new machine will help Keurig maintain its monopoly.4

ChAPTER 2

Economics and Banking

Duopolies and oligopolies What happens when one or two other companies enter a monopolistic market? To answer this question, let’s look again at Eddie and his coffee kiosk from the previous section. At first, Eddie’s coffee kiosk was the only place on campus to buy coffee; Eddie had a monopoly. But after the bookstore on campus opened a café and started to sell coffee, students now had a choice to buy coffee at two places—either at the bookstore or at Eddie’s coffee kiosk. The situation changed from a monopoly to a duopoly. A true duopoly is where only two suppliers exist, although in reality the definition is generally used to describe situations where only two firms dominate a market. Examples of duopolies include PepsiCo and Coca-Cola in the soft-drink market and Intel and AMD in the computer processor market. However, if the campus cafeteria also begins to sell coffee, then an oligopoly is created. An oligopoly is a form of competition in which only a few sellers exist, each with a fairly large share of the market. For example, the cellular phone market in the United States is controlled by an oligopoly of four companies: Verizon, AT&T, Sprint, and T-Mobile. Typically, oligopolies (and duopolies) occur in industries in which a high investment of capital must be made to enter the market. Because there is little differentiation between products, competition is strong in a duopoly and an oligopoly, and prices differ only slightly, if at all, between the few suppliers. If one company cuts prices, its action is usually matched quickly by the competition. Therefore, firms that compete as duopolies and oligopolies more often compete by differentiating their products from one another (making one product stand out from another) rather than competing on prices.

Monopolistic Competition What happens when there isn’t much differentiation between products? Let’s assume that the coffee the cafeteria begins to offer is perceived among students to be superior to Eddie’s and the bookstore’s coffee. The added choice of a perceived superior product creates monopolistic competition. Monopolistic competition occurs when there are many buyers and sellers and the products are similar but not identical (coffee versus coffee). Often there is a perceived difference among consumers who thereby favor one product offering over another so that the products are not perfectly substitutable products. Monopolistic competition is everywhere. Think of the traditional strip mall or local shopping center in your neighborhood where most likely there is a pizza parlor, a dry cleaner, a hair or nail salon, and a dollar store. These mom-and-pop stores are traditional, monopolistic competitive businesses because there are many buyers and sellers and the products are similar but not identical. Often, the real distinction between these products is price.

Perfect Competition What happens when products are almost identical? Perfect competition occurs when there are many buyers and sellers of products that are virtually identical and any seller can easily enter and exit the market. When these conditions exist, no single supplier can influence the price. In reality, there are few, if any, examples of perfect competition. However, agricultural products, such as grains, fruits, and vegetables, come close. Many of these products appear to be identical, and, because there are many sellers in the market, no single seller can set the prices for these products. Competition encourages businesses to make creative decisions and gives customers options. Because of this need for competition, U.S. businesses face stiff penalties if they are found holding illegal monopolies. By keeping a close watch on monopolies, the U.S. government tries to ensure that no single seller drastically influences the price of a certain service or good.

Verizon, AT&T, Sprint, and T-Mobile together control the majority of the U.S. cellular phone market, forming an oligopoly. Source: carr/Mct/Newscom

PART onE

Looking at the Business Environment

Is Sirius XM Radio a Monopoly?

n 1992, satellite radio service hit the U.S. airwaves after the U.S. Federal Communications Commission awarded licenses to American Mobile Radio and CD Radio to use the newly created frequencies. American Mobile Radio spun off XM Satellite Radio, which launched its first radio service officially in September 2001. CD Radio changed its name to Sirius Satellite Radio and went live nine months later. Since then, there have been no further entries into the satellite radio market. Satellite radio offers a wide variety of programs to large geographic regions with no or little advertisements. A subscription service is required to enjoy satellite radio. XM Radio and Sirius Satellite Radio competed fiercely with each other to grow their market share, causing each company to operate unprofitably because of accumulated heavy debt burdens. It became apparent that to survive, the two companies would need to merge. A merger would combine the exclusive contracts each service offered. A potential subscriber who wanted to listen to Howard Stern (offered by Sirius) but who also wanted to receive play-by-play delivery of Major League Baseball games (offered by XM Radio) would not need to choose between the two subscription services or pay for subscriptions for both services.

The merger clearly created a monopoly, yet in 2008, the U.S. Justice Department approved the merger. Why was the merger allowed to go through? Broadcasters and consumer groups predicted the price of satellite radio in the United States would increase, new programming options would decrease, and subscribers would get poorer service from the merged company. The Justice Department’s antitrust division believed otherwise. The Justice Department also claimed that although the merged firm would create a monopoly, consumers had other music source options, such as HD Radio and MP3 players, they could connect to in their cars and homes. Meanwhile, the Federal Communications Commission was worried that without the merger, the two competing companies would drive each other into bankruptcy, thus eliminating satellite radio in the United States altogether. Since the combined company, Sirius XM Radio, was established, the prices the firm has charged its listeners have gone up. Although there has been some improvement in the service the merged company provides, it has begun to drop stations, and critics say its playlists are smaller and more repetitive. What are your thoughts on satellite radio? Did the Justice Department make the right decision?

 Microsoft is still a leader of personal computer software, but it does not hold a monopoly, with its operating system (Windows) or its web browser (Microsoft Edge, which replaced Internet Explorer with the release of Windows 10). Microsoft faces stiff competition from Apple and Google in both the mobile and personal computer markets, forming an oligopoly. Objective 2-4

Economic indicators Explain how the various economic indicators—particularly the gross domestic product (GDP), price indices, the unemployment rate, and productivity—reflect the health of an economy.

 Greg Johnson needs to decide how much inventory to purchase for his large automobile dealership. A few years ago, the recession resulted in fewer new car purchases but improved the sales of used cars on his lot. His company’s service department also did better because customers were choosing to fix their cars rather than trade them in. As a result, Greg found he needed to stock more auto parts. Now, however, Greg is beginning to see demand for new cars rise. He knows his staffing and inventory supply will mostly likely be affected—but how quickly?

ChAPTER 2

Economics and Banking

Does he continue to retain the same number of service-repair personnel and increase the number of salespeople he hires? How many new cars should he be buying for the upcoming sales season? Not knowing exactly by how much demand will increase, how is Greg to decide how much inventory to hold or what staff to retain or hire? The economy plays a big part in business. Which aspects of the economy should Greg watch to help him make his business decisions? How can he tell how well or how poorly the economy is doing? Business managers need to be aware of certain statistics about economic activities, called economic indicators. (Leading indicators are statistics that can be used to help predict how the economy will do in the near future. Coincident indicators are statistics that reflect how the economy is currently doing. Lagging indicators are statistics that change only after the economy as a whole changes.) The following economic indicators are closely watched by businesspeople: • Gross domestic product • Consumer and producer price indices • The unemployment rate

gross Domestic Product How do we determine the health of an economy? The broadest measure of the health of any country’s economy is its gross domestic product (GDP), which measures how productive a nation is, that is, the overall market value of final goods and services produced in a country in a year. It is important to note that only those goods that are actually produced in the country are counted in the country’s GDP (hence the term domestic in gross domestic product). For example, Toshiba Corporation, a Tokyo-based high-tech company, has a plant in Lebanon, Tennessee, that manufactures color television sets. The value of all television sets produced in the Tennessee plant is counted in the U.S. GDP, not in Japan’s GDP.

ThE LIST Country United States

Countries by GDP, 2012 GDP (Billions of U.S. Dollars) 16.245

China

8.227

Japan

5.960

Germany

3.428

France

2.613

United Kingdom

2.472

Brazil

2.253

Russian Federation

2.015

Italy

2.015

India

1.842

Source: central intelligence Agency, “the World Factbook: country comparison: GDP (Purchasing Power Parity),” https://www.cia.gov.

Source: Happy Ales/Fotolia

PART onE

Looking at the Business Environment

◼ FIGUrE 2.7 Debt to GDP of World Economies Source: based on the World bank, retrieved from http://data.worldbank.org/ indicator/NY.GDP.MKtP.cD?end=2014 &locations=it&start=2014&view=bar. © Mary Anne Poatsy

Debt as a % of GDP Japan Italy Greece Ireland United Kingdom France United States Germany Brazil Canada 0%

50%

100% 2011

150%

200%

2010

How does the GDP act as an economic indicator? GDP is the most widely used indicator of economic growth by countries worldwide. It is a coincident indicator and moves at the same time the economy does. A rising GDP indicates that more goods and services are being produced and that businesses are doing well. A downwardmoving GDP indicates that fewer goods are being produced, fewer services are being offered, and businesses are not doing as well. Business owners such as Greg use GDP data to forecast sales and adjust production and their investment in inventory. A nation’s GDP is often viewed in tandem with the country’s debt level. A low debt-to-GDP ratio indicates an economy that is healthy, whereas a high debtto-GDP ratio indicates a country that is spending beyond its means. The debtto-GDP ratio is calculated by dividing either the amount of government debt or total national debt by the country’s GDP. As illustrated in ◼ FIGUrE 2.7 the most current data indicates that Japan’s debt-to-GDP ratio is close to 200 percent almost double that of the United States.5

Consumer and Producer Price Indices What else is used to gauge the health of an economy? There are two price indices used as economic indicators: the consumer price index and the producer price index. You may not hear about these indicators often, but you’ve probably heard of inflation and deflation. A consistent increase in either indicator indicates inflation. Inflation is a rise in the general level of prices over time. A decrease in the rate of inflation is disinflation, and a continuous decrease in prices over time is deflation. How are changes in the price of consumer products measured? The consumer price index (CPI) is a benchmark used to track changes in the price of goods and services that consumers purchase over a period of time. It is a lagging indicator, so it shifts after the economy changes. The CPI measures price changes by creating a “market basket” of a specified set of goods and services that represent the average buying pattern of urban households. The value of this market basket is determined by the combined prices of these goods and services and is compared to its value in a prior period (generally a month). The change in the overall price of these goods is then noted. What goods and services are included in the CPI? The basket of goods and services is evaluated by the U.S. Bureau of Labor Statistics to ensure that it reflects current consumer buying habits. The current market basket was determined by tracking the spending habits of about 7,000 families during 2011 and 2012.6 The goods and services are classified into 200 categories, which are further arranged into eight major groups7 (see ◼ FIGUrE 2.8): • Apparel • Education and communication

ChAPTER 2

• • • • • •

Food and beverages Housing Medical care Recreation Transportation Other goods and services (such as tobacco and smoking products, haircuts and other personal services, and funeral services)

Transportation 15%

Economics and Banking Apparel 3%

Education & Communication 7%

Food & Beverages 15%

Recreation 6% Other Goods & Services 3%

Does the CPI measure the change in price of all Medical Care goods? The CPI measures the change in prices of 9% consumer goods only. It does not measure the change in prices of those resources that are used to create the goods. The producer price index (PPI) is a coincident indicator that tracks the average change in prices at the wholesale level (i.e., from the seller’s perspective). The PPI tracks the prices of goods sellers use to create products, such as raw materials, product components that require further processing, and finished goods sold to retailers. The PPI excludes energy prices and prices for services. Why are price indices important? The CPI and PPI are important economic indicators because they measure purchasing power and consequently trigger some business decisions. During periods of increasing prices as reflected by the CPI, the purchasing power of a dollar decreases—meaning that less is bought with a dollar today than could have been purchased with the same dollar yesterday. As a result, wages eventually need to be increased to compensate employees for the higher cost of living (see the Biz Chat in this section). Businesses in turn must eventually increase the prices of their products to offset the higher cost of labor. Similarly, if the price of intermediary products used to produce final goods or services sold to consumers increases (as measured by the PPI), businesses may need to pass on those cost increases in the form of higher prices, again decreasing the consumer’s purchasing power. Therefore, business leaders watch the CPI and the PPI to determine the rate at which consumer and wholesale prices, respectively, change.

Housing 42% ◼ FIGUrE 2.8 CPI Components Source: based on Relative importance of components in the consumer Price indexes: U.S. city Average, December 2015, retrieved from http://www.bls.gov/ cpi/usri_2015.txt. © Mary Anne Poatsy

The Unemployment Rate What other indicators are used to measure the economy? The unemployment rate is a lagging indicator that measures the number of workers who are at least 16 years old and who are not working but have tried to find jobs within the past four weeks. Because there are different reasons why people are not working, there are several different measurements of unemployment: • Frictional unemployment is temporary unemployment that results when workers move between jobs, careers, and locations. Frictional employment occurs because it simply takes a certain amount of time for workers to find the right jobs and employers to find the right workers. • Structural unemployment is permanent unemployment that occurs when an industry changes in such a way that those jobs are terminated completely. Many steelworkers and miners lost their jobs when there was a decline in those industries. Likewise, robots have replaced many automobile workers, and computers have replaced many newspaper typesetters. Workers displaced by these types of circumstances can

The unemployment rate is an economic measure that businesses and the government watch carefully. Source: Max Dallocco/Fotolia

PART onE

Looking at the Business Environment

how Much Money Do You need to get by?

he cost of living is the average monetary costs of the goods and services required to maintain a particular standard of living. It is closely related to the CPI. In fact, to keep up with inflation, the Social Security Administration calculates automatic cost-of-living adjustments to the Social Security benefits retirees receive. The adjustments are based

on annual percentage increases in the CPI. As you can imagine, the cost of living varies greatly by state and city. The cost of living in New York City or San Francisco is much higher than in Topeka, Kansas, or Little Rock, Arkansas. Why do you think these differences exist? What factors account for the differences?

hopefully learn new skills or receive additional training in an effort to keep their jobs or find new ones. • Cyclical unemployment is unemployment that occurs when firms must cut back their workforces when there is a downturn in the business cycle. Once the demand for goods and services increases, companies begin to hire again. • Seasonal unemployment occurs when workers get laid off during the offseason, such as those in snow- or beach-related industries or agriculture or after the holiday shopping season ends. Unlike other economic recoveries, unemployment in the United States has remained at historically high levels since the end of the Great Recession. There is still no consensus as to what is causing the high unemployment rate. The debate centers on whether it is because of reduced demand as a direct result of the recession (cyclical unemployment) or whether the lost jobs are never coming back because of changes in business and technology (structural unemployment).8 Why is unemployment an important economic measure? Businesses, as well as government policymakers, pay close attention to unemployment rates. High unemployment results in an increase in unemployment benefits and government spending on social programs, such as Social Security, welfare (now called Temporary Assistance for Needy Families), and Medicare. High unemployment can also result in increases in mental stresses and physical illnesses and can bring on increases in crime. It is costly for businesses to lay off workers and then, as the economy improves, hire and train new employees. In a declining economy, businesses prefer to reduce their workforces through retirement and natural attrition, which takes planning. Ironically, if the unemployment rate drops too low, meaning the workforce is nearly fully staffed, policymakers in the government become concerned that the economy is overheating: More workers have increased buying power and spend more, which ultimately causes prices to increase, resulting in increasing inflation. The challenge for policymakers is to keep both inflation and unemployment low— a difficult task because the two seem to have an inverse relationship to each other.

Productivity of Firms How is the productivity of a firm’s workforce measured? In its broadest terms, productivity measures the quantity of goods and services that a firm’s human and physical resources can produce in a given time period. It can be calculated as a physical measure or as a monetary measure. For example, an automobile assembly plant might measure its productivity in terms of the total number of cars it produced in a given period of time (week, month, or year) per worker-hours needed to produce them. Or the plant might measure its productivity as the total dollar value of cars produced in a given period per

ChAPTER 2

Economics and Banking

worker-hours needed to produce the cars. As you might expect, the calculation of productivity in the service sector may be slightly different, but it generally focuses on revenues generated per employee for a certain time period. Why is measuring productivity important to businesses? No matter how it is measured, productivity is an indicator of a business’s health. An increase in productivity indicates that workers are producing more goods or services in the same amount of time. Therefore, higher productivity numbers often result in lower costs and lower prices. Increasing productivity means that the existing resources are producing more, which generates more income and more profitability. Companies can reinvest the economic benefits of productivity growth by increasing wages and improving working conditions, by reducing prices for customers, by increasing shareholder value, and by increasing tax revenue to the government, thus improving the GDP. In aggregate, overall productivity is an important economic indicator of an economy’s health.

 So how do all these indicators help Greg and his inventory and staffing decisions? After ensuring there is inventory to fill current needs, Greg keeps a close eye on all economic indicators, especially the CPI and the unemployment rate, to help guide his future buying decisions. He knows that movements in the CPI determine the trend of current prices. Such trends can help Greg determine whether it is better to stock up on inventory and hire new employees now or wait until later. Equally important is the unemployment rate. A continued improvement in the economy will decrease the unemployment rate, an indicator for Greg that his new car inventory might move more quickly because more people are working and have money to spend. Although none of the indicators can guide Greg’s decisions precisely, watching the indicators over time allows Greg to get a feel for future expectations and helps him make better business decisions.

Objective 2-5

Government and the Economy Describe the four stages of the business cycle, and explain how the government uses both fiscal policy and monetary policy to control swings in the business cycle.

 nick

and Jacinta robertson have been saving for years to buy their first house. Over the past several years, the interest rates banks charge for home loans have been at historically low levels. Recently, however, all Nick and Jacinta hear about is news of the rapid changes in the stock market, reports from the chairman of the Federal Reserve Board about changes in interest rates, and debates on how the government might change its tax policies to control the economy. Nick and Jacinta aren’t sure what effects all of this will have on their ability to be approved for a mortgage loan and buy a home. Is now the best time to buy a house?

Source: Andy Dean/Fotolia

PART onE

Looking at the Business Environment

If you or someone you know has tried to buy a house or if you know a small business owner who needs to make a big investment, you may have realized that the state of the economy can have a big impact on that decision. What makes the economy change? How does the government help control the economy? What do you need to be aware of when deciding whether to make a large investment?

Economic Policies Why does the state of the economy change? In 1980, the rate of inflation was at its highest level—nearly 15 percent.9 Only eight years before and six years after that high inflationary period (1972 and 1986), inflation was hovering around 2percent.10 Over time, the economy naturally goes through periodic increases and decreases in inflation. Economists refer to these increases and decreases as the business cycle. There are four stages of the business cycle, as illustrated in ◼ FIGUrE 2.9: • Peak. The peak occurs when an economic expansion is at its most robust point. • Recession. By definition, a recession is a decline in the GDP for two or more successive quarters of a year. In recessionary times, corporate profits decline, unemployment increases, and the stock market reacts with large selling sessions that result in decreasing stock prices. The U.S. economy has experienced seven recessions over the past 40 years; the most recent recession began in late 2007 and ended in the fall of 2009. This was the country’s worst and longest recession since the Great Depression. Avery severe or long recession is a depres sion. Depressions are usually associated with falling prices (deflation). After the onset of the Great Depression in 1929, the government used policies to control the economy to avoid another such depression. • Trough. A trough occurs when the recession hits bottom and the economy begins to expand again. • Expansion or recovery. After a recession or a depression, the economy hits a trough and begins to grow again and therefore enters into an expansionary or recovery phase. Eventually, the recovery will hit a peak, and the cycle begins again. How does the government control swings in the business cycle? Ideally, the economy should stay near its peak all the time. But left to its own forces and in reaction to external actions on the economic system, such as wars and variations in the weather, it is inevitable that the economy cycles through recessions and recoveries. To smooth out the swings in the business cycle, lawmakers use fiscal policy to determine the appropriate level of taxes and government spending.

◼ FIGUrE 2.9 The Business Cycle

Fiscal Policy

Peak

wth

o si es n

Trough Time

s es

co very

Gro

c ov ery

d Tren

Peak

Level of real output

Peak

io n

Trough

Why does the government increase taxes to influence the economy? Threats of increasing taxes are a concern to Nick and Jacinta. They feel they pay too much already and need as much of their paychecks as possible to make their anticipated mortgage payments. However, they are told that an increase in taxes is necessary to offset rising inflation. Higher taxes translate into consumers spending less money, which in turn slows the growth of businesses and consequently slows down the economy by reducing the amount of money in the system. This, in turn, lowers inflation. Decreasing taxes does not have quite the opposite effect on the economy as increasing taxes. It would seem that if increasing taxes would slow down an economy, a tax cut would help stimulate the economy. Although that is partially true, the amount of money entering into the

ChAPTER 2

Economics and Banking

system depends on how much of the reduction in taxes consumers spend and how much of it they save. Money put into savings does not help stimulate the economy immediately. To stimulate the economy more quickly, the government uses another form of fiscal policy: government spending. How does government spending help stimulate the economy? The government spends money on a wide variety of projects, such as infrastructure improvements and projects that benefit the military, education, and healthcare. Because the money gets spent immediately and not saved, government spending increases the cash flow in the economy faster than decreasing taxes does. Often, government spending creates additional jobs, which also helps stimulate the economy. The American Recovery and Reinvestment Act was a huge stimulus plan introduced in 2009 to help jump-start the failing economy. It included government spending for infrastructure, education, and health care improvements. During periods of high economic growth, the government may decrease its spending. But reducing government spending is more easily said than done. There always seem to be government programs that are essential and cannot be cut regardless of the state of the economy. This is always a debate around election time, and there really isn’t one right answer to this issue. Overall, fiscal policy has its critics. Some economists think government spending has a mixed record when it comes to jump-starting the economy. That was the case with the last stimulus. Other economists believe the impact of the spending would have been greater if the stimulus had been larger. This issue is still being debated.

Monetary Policy What else can be done to control the economy? The second tool used to manage the economy is monetary policy. Monetary policy is not exercised by the government. Instead, it is exercised by the Federal Reserve System (the Fed). The Fed is the central banking system of the United States. Created by Congress as an independent governmental entity, it includes 12 regional Federal Reserve Banks (see ◼ FIGUrE 2.10) and a Board of Governors based in Washington, D.C.

The Dodd-Frank Act and the Consumer Financial Production bureau

he United States is slowly recovering from the Great Recession—the most serious economic plunge since the Great Depression, which persisted throughout the1930s. The Great Recession was caused, in part, by large financial institutions making risky, highly leveraged “bets” with depositors’ money that ultimately didn’t pay off. Huge and steadfast companies filed bankruptcy and even permanently closed their doors as a result of receding revenues that could not cover staggering debt levels. The investment bank Lehman Brothers closed its doors with more than $600 billion of debt, creating the largest bankruptcy in U.S. history.11 General Motors filed the fourth-largest bankruptcy proceedings with over $170 billion of debt,12 and Chrysler followed suit shortly thereafter with a much smaller but nonetheless significant bankruptcy. The recession hit individuals with similarly severe results. Before the recession, consumers were carrying significant levels of personal debt in the form of mortgages, auto loans,

oFF ThE MARK

home equity loans, and credit card debt. The amount of accumulated personal debt became unmanageable as wage increases began to slow down and layoffs began to rise. Personal bankruptcies rose sharply.13 In 2010, the government passed the Dodd-Frank Act in an effort to prevent another collapse of a major financial institution like Lehman Brothers as well as protect consumers from being taken advantage of by aggressive lending and mortgage practices by banks. As part of the Dodd-Frank Act, the Consumer Financial Protection Bureau (CFPB) was created. The bureau’s purpose is to crack down on unfair deceptive acts and financial practices that can affect consumers, including transactions related to all types of consumer banking products, such as mortgages, private student loans, and other consumer bank products and services. The CFPB also requires financial information about mortgages to be presented in “plain English” to customers along with their credit scores.

PART onE

Looking at the Business Environment

◼ FIGUrE 2.10 The 12 Federal reserve Districts Source: the twelve Federal Reserve Districts, retrieved from: www.federalreserve.gov/otherfrb.htm. © board of Governors of the Federal Reserve System.

The Federal Reserve Banks carry out most of the activities of the Fed. The Fed also includes the Federal Open Market Committee, which sets the policies of the Fed, including its monetary policies. Through its monetary policy, the Federal Reserve affects the nation’s money supply and helps shape the direction of the economy. What is the money supply? It is natural to think that just all the coins and bills held by people, businesses, and banks make up the country’s money supply. However, that would represent only a portion of the country’s money. The money supply is the combined amount of money available within an economy, and it includes not only currency (coins and bills) but also personal savings and checking accounts as well as the deposit accounts from large institutions. In particular, the money supply consists of the following different “layers” of funds (see ◼ FIGUrE 2.11): • M1. Coins and bills (currency), traveler’s checks, and checking accounts constitute the narrowest measure of our money supply, which is referred to ◼ FIGUrE 2.11 Money Supply Measures for M-1 and M-2

$14,000

Surprisingly, currency is not the biggest component of the U.S. money supply. Savings and other deposits represent the largest component of the money supply.

$12,000

Small-Denomination Time Deposits Retail Money Funds

$10,000

$8,000

$6,000

Small Savings

$4,000 Other

$2,000

Demand Deposits

M-1

Currency

$0 M-1

M-2

ChAPTER 2

Economics and Banking

as M1. M-1 assets are the most liquid in that they are already in the form of cash or are the easiest to convert to cash. • M2. Another part of the money supply is that which is available for banks to lend out, such as savings deposits, money market accounts, and certificates of deposit (CDs) less than $100,000. This layer of the money supply, in addition to the M-1 layer, constitutes M2. • M3. The third layer of the money supply is M3. M-1 and M-2, plus less liquid funds, such as larger CDs (greater than $100,000), money market accounts held by large banks and corporations, and deposits of Eurodollars (U.S. dollars deposited in banks outside the United States), make up M-3. The Federal Reserve Board of Governors has stopped publishing M-3 data. Why is the money supply important? Money has a direct effect on the economy: The more money we have, the more we tend to spend. When we as consumers spend more, businesses do better. The demand increases for resources, labor, and capital because of the stimulated business activity, and, in general, the economy improves. However, too much money in the economy can be too much of a good thing. When the money supply continues to expand, eventually there may not be enough goods and services to satisfy demand, and, as was previously discussed, when demand is high, prices will rise, resulting in inflation. (Remember the demand curve? It shifts to the right.) Economists carefully watch the CPI to monitor inflation, because they don’t want inflation to go too high. An opposite effect can happen when the supply of money becomes limited following a decrease in economic activity. When the economy begins to slow down as a result of decreased spending, either disinflation (reduced inflation) or deflation (falling prices) results. To help manage the economy from being in the extreme economic states of inflation or deflation, the Fed uses three tools to affect money supply (see ◼ TaBLE 2.6): • Reserve requirements • Short-term interest rates • Open market operations

Reserve Requirements What are reserve requirements? The reserve requirement, determined by the Federal Reserve Bank, is the minimum amount of money banks must hold in reserve to give to their depositors who want to withdraw it. When you deposit money in a bank, the money does not sit in a vault waiting for you to withdraw it later. Instead, banks use deposits to make loans to others: people, small businesses, corporations, and other banks. Banks make money by the interest charged on those loans; however, a bank must be able to give you back your money when you demand it. If a bank doesn’t have enough money to cover what

TAblE 2.6

Federal Reserve bank Monetary Policy

Federal Reserve System Action

Increase the Supply of Money to Stimulate the Economy and Offset Potential Deflation/Recession

Decrease the Supply of Money to “Cool” the Economy and Tame Inflation Concerns

Reserve requirements

Lower reserve requirement

Increase reserve requirement

Short-term interest rates

Lower discount rate

Increase discount rate

Open market operations

Buy securities

Sell securities

Source: based on Federal Reserve bank of New York, “Historical changes of the target Federal Funds and Discount Rates 1971–Present,” www.ny.frb.org. © Michael R. Solomon.

PART onE

Looking at the Business Environment

its customers want to withdraw on a given day, they might get nervous and try to withdraw all of their funds. This is referred to as a bank run. Bank runs that occurred in 1929 helped spark the Great Depression. At that time, people were so nervous about banks not being able to cover their deposits that the massive withdrawals forced many banks to close. Banks do not lend out the entire balance of their deposits. The Fed mandates banks retain a certain reserve requirement sufficient to cover the demands of their customers for on any given day. This includes trips to automatic teller machines, the use of debit cards, requests for loans, and the payment of checks that you write. The Fed can ease or tighten the money supply by increasing or decreasing the reserve requirement. For example, if the Fed increases the reserve requirement, it forces banks to hold on to more money rather than lending it out. This slows down economic activity. However, the Fed rarely uses the reserve requirement as a means of monetary policy because these actions would be very disruptive to the banking industry.

Short-Term Interest Rates What is the discount rate? The Federal Reserve Bank serves as the bank to other banks. Occasionally, commercial banks have unexpected draws on their funds that might put them near their reserve requirements. In those instances, banks may turn to the Federal Reserve Bank for short-term loans. For this reason, the Fed is sometimes referred to as the “lender of last resort.” When banks borrow emergency funds from the Fed, they are charged an interest rate, called the discount rate. The Federal Reserve has the power to increase or decrease the discount rate in its efforts to control monetary supply. When the Fed lowers the discount rate, commercial banks are encouraged to obtain additional reserves by borrowing funds from the Fed. Commercial banks then lend out the reserves to businesses, thereby stimulating the economy by injecting funds into the economic system. However, if the economy is too robust, the Fed can increase the discount rate, which discourages banks from borrowing additional reserves. Businesses are then discouraged from borrowing because of the higher interest rates that the banks charge on their loans. Is the discount rate the same as the federal funds rate? The federal funds rate is not the same as the discount rate. It is often reported in the news that the Fed intends to change the federal funds rate in its efforts to stabilize the economy. The federal funds rate is the interest rate banks charge other banks when they borrow funds overnight from one another. (As mentioned previously, the Fed requires banks to have so much money on reserve, depending on the deposits in the bank and the other assets and liabilities held by each bank. Banks avoid dipping below their required reserves by borrowing from each other before they have to borrow from the Fed at the discount rate.) Despite news reports, the Fed does not control the federal funds rate directly. Instead, the federal funds rate is the equilibrium price created through the Fed’s open market operations and the exchange of securities. The excess reserves that are available to lend between banks come from securities that the Fed buys and sells through its open market operations. If there are excess reserves on hand, banks have adequate funds to lend to other banks. On the other hand, if excess reserves are not as plentiful, banks lend funds to one another more sparingly. To increase the federal funds rate, the Fed sells bonds in the open market. Banks buy the securities, thus reducing their excess reserves available for loans. The decrease in excess reserves increases the federal funds rate. The opposite holds true as well. To decrease the federal funds rate, the Fed will buy bonds in the open market. Buying securities from banks increases the banks’ excess reserves, making money more available, which decreases the federal funds rate and helps stimulate the economy. ◼ FIGUrE 2.12 shows the trend

ChAPTER 2

FIGUrE 2.12 Trend of Effective Federal Funds rate 1954–2016

20.0

Source: “Historical changes of the target Federal Funds and Discount Rates 1971– Present,” Federal Reserve bank of New York, http://www.ny.frb.org/. Retrieved from FReD, Federal Reserve bank of St. Louis, https://fred.stlouisfed.org/series/FF, August 29, 2016.

17.5 15.0 (Percent)

Economics and Banking

12.5 10.0 7.5 5.0 2.5 0.0 1960

1970

1980

1990

FRED

2000

2010

Effective Federal Funds Rate

of federal funds rates over the past several decades. As you can see, the federal funds rate has been at a historically low of .25 percent for many years.

open Market operations What are open market operations? The primary tool the Fed uses in its monetary policy is open market operations, buying and selling U.S. Treasury and federal agency bonds on the “open market.” The Fed does not place transactions with any particular security dealer; rather, securities dealers compete for federal transactions in an open market. When the Fed buys or sells U.S. securities, it is changing the level of monetary reserves in the banking system by adding or taking away money from the system. When the Fed sells securities, reserves are reduced to pay for the securities (money is said to be “tight”), and interest rates rise. However, when the Fed buys securities, it adds reserves to the system (money is said to be “easy”), and interest rates drop. Lower interest rates help stimulate the economy by decreasing people’s desire to save and increasing their demand for loans, such as home mortgages. Using open market operations is probably the most influential tool the Fed has to alter money supply. To make their decision about whether to buy a home, Nick and Jacinta would benefit by paying attention to the Fed’s monetary policies. If the Fed buys securities, it’s likely that interest rates for mortgage loans will fall. Additionally, Nick and Jacinta can look to the discount rate and the federal funds rate. News about the lowering of the discount rate will signal that banks might have funds available to lend out at potentially lower rates. Although the federal funds rate does not have a direct impact on mortgage rates, it does have an indirect effect because interest rates respond to economic growth and inflation. Reports on the news that the Fed is striving to change the federal funds rate will indicate to Nick and Jacinta whether it’s likely that interest rates will increase or decrease in the near future. This in turn can help them determine the best time to buy a home.

Chapter 2

summary 2-1

increase with a duopoly, or an oligopoly, in which two or a few sellers exist, respectively. Monopolistic competition is characterized by many sellers that sell slightly different products at slightly different prices. This increases the supply of the products and choices for consumers. Similarly, there are many sellers in perfect competition, which also increases the supply of a good or service. In a perfectly competitive market, the product being sold is virtually identical across suppliers and sells for the same price. No single producer is able to affect the price at which the product is sold.

Define economics, and describe the different types of economic systems.

• Economics is the study of how individuals and businesses make decisions to best satisfy wants, needs, and desires with limited resources and how efficiently and equitably resources are allocated. • There are different types of economic systems. • A planned economic system is a type of economy in which the government has more control over what is produced, the resources to produce the goods and services, and the distribution of the goods and services. Commu nism and socialism are planned economic systems. • In market economies which are characterized by capitalism, individuals and private firms make the decisions about what to produce and how goods and services are distributed. • Most modern economies in the Western world are mixed economies, which are a blend of market and planned economies.

2-2

Explain the principles of supply and demand, and describe the factors that affect each principle.

• Supply refers to how much of a good or service is available. The amount of it supplied will increase as its price increases. Supply is affected by five factors: • Technology changes • Changes in resource prices • Price expectations • The price of substitute goods • The number of suppliers • Demand refers to how much people want to buy of a product at any given time. The amount demanded increases as a product’s price declines. Demand is affected by five factors: • Changes in income levels • Consumer preferences • Changes in population • Changes in the prices of substitute or complementary goods • Changes in expectations

2-3

Describe the various degrees of business competition.

• There are several degrees of competition, including monopoly, oligopoly, duopoly, monopolistic competi tion, and perfect competition. • In a monopoly, where only one seller supplies a good or service, supply may be limited. The supplies may

2-4

Explain how the various economic indicators— particularly the gross domestic product (GDP), price indices, the unemployment rate, and productivity—reflect the health of an economy.

• The gross domestic product (GDP) measures the overall market value of final goods and services produced in a country in a year. GDP is an important economic indicator of an economy’s productivity and health. When a nation’s GDP goes up, the country’s economy is moving in a positive direction. • The consumer price index (CPI) and producer price index (PPI) are indicators of inflation or deflation. • The CPI tracks changes in prices over time by measuring changes in the prices of goods and services that represent the average buying pattern of urban households. • The PPI tracks the average change in prices of those goods sellers use to create products, such as raw materials and product components that require further processing, and finished goods sold to retailers. • The unemployment rate is watched as an indicator of how well the economy is performing. If unemployment is high, the economy is not using all of its resources and is probably experiencing a downturn. An increasing unemployment rate generally has a corresponding increase in government spending on social policies (such as welfare and unemployment payments). • Increasing productivity means that a firm’s existing resources are producing more, which generates more income and more profitability.

2-5

Describe the four stages of the business cycle, and explain how the government uses both fiscal policy and monetary policy to control swings in the business cycle.

• The four stages of the business cycle are the peak, recession, trough, and expansion or recovery. • The government’s fiscal policy determines the appropriate level of taxes and government spending. An increase in taxes translates into lower consumer

ChAPTER 2 spending and helps contain an economy that is growing too quickly. Lowering taxes will stimulate spending and help boost a sluggish economy.

Economics and Banking

• The Federal Reserve System is responsible for the monetary policy of the United States. The Fed keeps the economy from experiencing severe negative or positive swings by controlling the money supply through open market operations and by making changes in banks’ reserve requirements and changes in the discount rate.

• Monetary policy is the means by which the Federal Reserve manages to control inflation by changing interest rates, buying and selling government securities, or trading in foreign exchange markets.

Key terms business cycle capitalism communism complementary goods consumer price index currency cyclical unemployment deflation demand demand curve depression determinants of demand determinants of supply discount rate disinflation duopoly economic indicators economics economy equilibrium price

federal funds rate Federal Open Market Committee Federal Reserve System fiscal policy frictional unemployment gross domestic product inflation law of supply M-1 M-2 M-3 macroeconomics market market economy market price microeconomics mixed economy monetary policy money supply monopolistic competition

monopoly oligopoly open market operations perfect competition planned economic system privatization producer price index productivity recession reserve requirement seasonal unemployment shortage socialism structural unemployment substitute goods supply supply curve surplus unemployment rate

MyBizLab To complete the problems with the

, go to EOC Discussion Questions in the MyBizLab.

self test Multiple Choice You can find the answers on the last page of this text. 2-1 Which of the following is a good example of microeconomics?

a. How a specific company would maximize its production and capacity so it could better compete in its industry

2-2 There are four coffee shops in your town. All of

them claim to have the “freshest-tasting coffee.” Each shop advertises the unique benefits of its coffee and prices. This is an example of a. pure monopoly.

b. How an increase in the unemployment rate would affect a country’s GDP

b. monopolistic competition.

c. How a decrease in taxation affects consumer spending

d. an oligopoly.

d. All of the above

c. a regulated monopoly.

PART onE

Looking at the Business Environment

2-3 Jeannette has a successful organic spa busi-

ness in which she gives massages, facials, and organic body treatments. Last summer, another organic spa opened up in town. The supply curve for Jeanette’s business would shift in which direction? a. To the right b. To the left c. No change would occur. d. There is a shift along the demand curve only.

2-4 Which of the following is a determinant of

2-8 Which of the following is an example of the government’s fiscal policy to stimulate an economy? a. Increased government spending b. Increased taxes c. Decreases in the discount rate d. Selling government securities in open markets

2-9 What results when there is an increase in overall prices?

a. Inflation b. Deflation

demand?

c. Expansion

a. Technology changes

d. Recession

b. Changes in income levels c. Price of substitute goods d. Price expectations

2-5 Racerback Swimwear, an Australian company, opens a factory near Tallahassee, Florida. The value of the swimsuits produced in the new Florida factory is included in which country’s GDP? a. Australia b. United States c. Both Australia and the United States d. It is not included in the GDP at all.

2-6 Which of the following tracks the prices of

goods and resources sellers use to create their products? a. GDP b. CPI c. PPI d. GNP

2-7 Jackson Paulson works as a waterskiing in-

structor at Migis Lodge on Sebago Lake. He claims unemployment from October through April. Jackson experiences which type of unemployment? a. Frictional b. Seasonal c. Cyclical d. Structural

2-10 At which point in the business cycle is the econ-

omy when GDP declines for two or more successive quarters? a. Peak b. Recession c. Trough d. Expansion or recovery

True/False You can find the answers on the last page of this text. 2-11 Microeconomics is the study of the behavior of the overall economy.

True or

False

2-12 The discount rate is what is charged when banks borrow emergency funds from each other.

True or

False

2-13 Sweden, with its high taxes and widespread gov-

ernment programs, is a good example of a market economy.

True or

False

2-14 To celebrate the first day of summer, an ice cream

shop dropped the price of its cones to 10 cents and sold out of them within two hours. This created a shortage of ice cream cones.

True or

False

2-15 The M-1 money supply measure consists of currency, traveler’s checks, and checking accounts.

True or

False

Critical Thinking Questions 2-16

To smooth out swings in the business cycle, the government influences the economy through its fiscal and monetary policies. Compare and contrast the monetary and fiscal policies of the United States.

2-17 The U.S. Postal Service and Amtrak are examples of large organizations operated by the federal government. Discuss the pros and cons of privatizing these businesses.

ChAPTER 2

2-18 The text defines GDP as a measurement of economic activity. Think about other things that may “help” the GDP that are really not good for our society in general, such as the economic activity required to clean up oil spills or increases in consumer debt to buy more goods. In addition,

there are other situations that may “hurt” the GDP by limiting expenditures on items but help the overall good of society, such as reusing plastic bags or installing solar water heaters (thus limiting spending on oil, gas, or electricity). Does the definition of GDP need to be revised?

team time ThE GrEaT DEBaTE Your instructor will divide the class into three groups and assign each group one of the following debate topics. Once in your group, divide the group into two smaller groups to prepare stances on your assigned debate issues.

Debate Topics 2-19

In 2009, the government bailed out several large banks and automotive and insurance firms in an effort to thwart a huge financial crisis. Were the government’s actions successful?

2-20

Minimum-wage laws were introduced in the 1930s to protect workers after the Great Depression. Whether to increase the minimum wage continues to be an animated topic of discussion. What impact does increasing the minimum wage have on small business owners? Does increasing the minimum wage benefit the worker, or does it ultimately result in higher unemployment?

2-21

Taxation and tax cuts are fodder for volatile debate among political leaders. Many of them claim that tax cuts help strengthen the economy by freeing up money to increase spending. Others claim that past tax cuts have not had a positive effect on the economy, have caused greater stress on the government’s budget, and have reduced the government’s ability to spend on important public needs. Do tax cuts benefit the economy?

Process Step 1. After dividing your group into two debate sides, meet separately to dis-

cuss the issues of the debate.

Step 2. Group members should then individually prepare their responses to their

side of the debate issue.

Step 3. Gather your smaller groups and discuss the responses provided by each

group member. Develop a single list of responses.

Step 4. Determine who will be the group’s primary spokesperson for the debate. Step 5. Each group will be given five minutes to present its side of the issue.

After each group has presented its argument, each team will be given five minutes to prepare a rebuttal and then three minutes to present the rebuttal.

Step 6. Repeat this process with the other groups.

Economics and Banking

PART onE

Looking at the Business Environment

Ethics and corporate social Responsibility EConoMIC InEQUaLITy Economic inequality refers to the differences of assets and income among groups. It has long been the subject for great discussion and can refer to the inequality among individuals, city/rural areas, countries, or economic structures.

Questions for Discussion 2-22

How do you define economic equality? For example, is economic equality simply making sure everyone has equal income, or is it enough to provide all equal opportunity to earn income?

2-23

Is economic equality feasible? Would other problems result from economic equality?

2-24

One method used to measure differences in national income equality around the world is the national Gini coefficient. Research the Gini coefficient. Which countries have the most equality? Which have greater inequality?

2-25

What other methods could be used to measure economic equality?

Web Exercises 2-26

2-27

2-28

you do? What are the important variables? How does this game illustrate the effects of supply and demand?

Getting Acquainted with Your Local Federal Reserve Bank What Federal Reserve Bank branch is nearest your home or school? Go to the website of your local Federal Reserve Bank and outline its latest policies. What kind of information does the website give you?

2-29

AT&T and Antitrust Regulations Watch the video “AT&T History” by Stephen Colbert, which is posted on YouTube. Then look at a more complete diagram of the outcomes of the forced breakup of AT&T in 1984 on the Quest Communications page on Wikinvest. Briefly describe the government’s rationale for forcing the breakup of AT&T in 1984 and then comment on the subsequent corporate actions by AT&T and the “Baby Bells.” How have these corporate actions impacted the communications industry?

Pro Sports and the Economy How do professional sports and the economy interact? Play Peanuts and Crackerjacks on the Boston Federal Reserve Bank’s website (under Education Resources: Games and Online Learning) and test your knowledge of basic economic principles in the context of professional sports. Write a brief summary of your experience. What did you learn from playing the game?

2-30

Monetary Policy: You’re in Control How would it feel to be in control of the monetary policy for a country? Go to the Federal Reserve Bank of San Francisco website and under Student Activities find the Fed Chairman Game. In this game, you act out the role of a fictitious central bank by implementing monetary policy in a simple virtual economy so you can get a feel for the options and limitations of monetary policy. Write a brief summary of your experience. What did you learn from playing the game?

Learning More about Supply and Demand Find the Supply and Demand Game on Shmoop.com and play a round or two. Using information you learned from this chapter, discuss your experience. How did

ChAPTER 2

Economics and Banking

MyBizLab Go to the Assignments section of your MyBizLab to complete these writing exercises. 2-31 How have the Kindle and the iPad affected the supply and demand for newspapers and other printed material (such as textbooks)? Discuss the impact of technology on those industries that produce printed information. 2-32 The text describes how a monopoly occurs when a provider of a service or good has control of all or nearly all of its market. Using this definition, consider whether professional sports leagues such as the National Football League, Major League Baseball, and the National Hockey League are monopolies or whether these leagues consist of a group of individual companies that operate under a single governing entity. Consider players’ salaries, contract negotiations, and ticket sales in your answer. What are the implications if these professional sports leagues are monopolies?

References 1. Average tax rate is defined as total tax revenue divided by gross domestic product. See “Taxes and Other Revenues,” in CIA World Factbook, www.cia.gov/library/publications/ the-world-factbook/rankorder/2221rank.html (Country Comparisons: Taxes and Other Revenues n.d.), accessed April 6, 2016) 2. Ruut Veenhoven, “World Database of Happiness,” http://worlddatabaseofhappiness.eur.nl (accessed April 6, 2016). 3. U.S. Department of Justice, “Justice Department Requires US Airways and American Airlines to Divest Facilities at Seven Key Airports to Enhance System-Wide Competition and Settle Merger Challenge,” November 12, 2013, http:// www.justice.gov/opa/pr/2013/November/13-at-1202. html (accessed April 6, 2016). 4. Vanessa Wong “With Keurig 2.0, Green Mountain Wants Its Monopoly Back,” Bloomberg Businessweek, March 11, 2014, www.businessweek.com/articles/2014-03-11/greenmountain-releases-keurig-2-dot-0-to-help-restore-itsmonopoly (accessed April 6, 2016). 5. The World Bank, Table: Central government debt, total (% of GDP), http://data.worldbank.org/indicator/GC.DOD .TOTL.GD.ZS/countries (accessed April 6, 2016).

6. Bureau of Labor Statistics, “Frequently Asked Questions, Question 6,” www.bls.gov/cpi/cpifaq.htm#Question_6. 7. Bureau of Labor Statistics, “Table 1: Relative Importance of Components in the Consumer Price Indexes: U.S. City Average,” December 2010, www.bls.gov/cpi/cpiri2010.pdf. 8. Allison Schrager, “The Great Debate,” Reuters, August 28, 2013, http://blogs.reuters.com/greatdebate/2013/08/28/five-years-after-recession-we-stillcant-agree-on-what-causes-joblessness. 9. “Historical Inflation,” www.inflationdata.com/Inflation/ Inflation_Rate/HistoricalInflation.aspx. 10. “The U.S. Inflation Rate—1948–2007,” www.miseryindex .us/irbyyear.asp. 11. Sam Mamudi, “Lehman Folds with Record $613 Billion Debt—MarketWatch,” Wall Street Journal, September 15, 2008, www.marketwatch.com/story/ lehman-folds-with-record-613-billion-debt?siteid=rss. 12. “Humbled GM Files for Bankruptcy Protection Business Autos Msnbc.com,” June 1, 2009, www .msnbc.msn.com/id/31030038/ns/business-autos/t/ humbled-gm-files-bankruptcy-protection. 13. Teresa Sullivan, “Bankruptcy Statistics 1980–2010,” www .bankruptcyaction.com/USbankstats.htm.

Chapter 3

Ethics in Business OBjEctivEs 3-1 Ethics: The Basics

Describe ethics and the systems of ethical conduct, and illustrate how someone can create a personal code of ethics. Ethics and business—many people consider these terms to be unrelated. How can you maintain your own personal integrity while still fulfilling your business responsibilities? Examining your own personal ethical code is the first step in successfully navigating this potentially tricky terrain.

3-2 Personal Ethics Meets Business Ethics Explain how personal ethics might play a role in the workplace and what resources one may use to evaluate a company’s ethical code.

Randy Marks had a recipe for success with his pottery business, but it went against his personal beliefs. What do you do if your own ethics conflict with your business success?

3-3 Corporate Social Responsibility

Analyze the ways in which a company’s policies and decisions affect its achievement of corporate social responsibility, and discuss the challenges it may face in balancing the demands of social responsibility with successful business practices. Although the primary focus in business seems to be on making money, many businesses also make meaningful contributions to the social, environmental, and economic development of the world. CEO Howard Schulz runs Starbucks with a mission to be a company with values and guiding principles that his employees could be proud of. How can such a lofty goal lead to amazing profits and growth?

3-4 Dangers of a Weak Ethical Focus Summarize how legal compliance affects ethical conduct, and describe some strategies a company can use to recover from ethical lapses.

Of course, DVDs are copyrighted, but with a big trade show coming up, Lana’s project team needed to rip some videos to hard drives for testing. Who would it hurt, after all? Sometimes it seems that if you break ethical standards just a bit, you’ll come out ahead. But does it really pay in business to ignore ethics? Or do good guys come out ahead?

3-5 Business Opportunities Created by Ethical Needs Identify ways in which companies can apply ethical standards to create new business opportunities.

Richard Stephenson saw a need—more compassionate medical care that was still state of the art in terms of its quality. By creating new markets based on ethical needs, many companies like Stephenson’s reap financial rewards, improve employee morale, and make valuable contributions to the world.

3-6 How Businesses Develop an Ethical Environment

List some approaches that a company can use to develop and maintain an ethical environment. Unbelievable. There they were—the once-frozen test tubes of samples, leaking all over the back delivery dock. Rashid Divecha’s heart sank. He needed to manage his client—and his bosses—in an ethical way. But what did that mean exactly?

CHAPTER 3

Objective 3-1

Ethics: the Basics Describe ethics and the systems of ethical conduct, and illustrate how someone can create a personal code of ethics.

 When

Tracy Bingham gets up each morning, he turns on SiriusXM Radio to listen to the Howard Stern broadcast, laughing along with the quips and jokes about stereotypes. Next, Tracy grabs his keys and heads out the door to school. As he leaves the line in the school cafeteria, he realizes that he received $20 in change instead of $1 and just keeps on walking. He then heads into the photocopy room to duplicate his homework but discovers that the answer key to his next exam was left on the machine. He shoves the answer key into his backpack, not sure what, if anything, he’ll do with it. Before the end of class, the professor compliments him in front of everyone for outstanding writing on his last paper. Tracy knows the writing came from a friend in class but just nods in thanks. That night, he thinks over the day, reviewing the choices he made along the way as he drifts off to sleep. How do Tracy’s personal ethics compare to your own?

Source: ivelin Radkov/Fotolia

Like Tracy, we all make ethical decisions every day. We decide how we will act, which thoughts we will feed, and which we will dispel. We make these decisions based on a set of beliefs about how the world works and what kinds of behaviors are rewarded. These beliefs can be classified as our set of values. In this chapter, we’ll see that businesses are similar in that they also have a set of values that guide their actions. Let’s start by examining what ethics are and how we create a personal code of ethics.

Ethics Defined What exactly is ethics? Ethics is the study of the general nature of morals and the specific moral principles that govern a person’s behavior.1 In effect, ethics represents the guidelines you use to make decisions every day. But not all people share the same ethics. Many systems of ethical conduct exist. Some are based on religious systems, some are cultural or national, and some have been passed from generation to generation within a specific ethnic group.

Systems of Ethical Conduct What are the different systems of ethical conduct? One ethical system is moral relativism, a perspective that holds that there is no universal moral truth; instead, there are only people’s individual beliefs, perspectives, and values. This means that there is no single view that is more valid than any other. Thus, no single standard exists to assess ethical truth. According to moral relativists, each person has his or her own ideas of right and wrong, so no one should judge anyone else. Imagine trying to organize any group of people—a family, a company, or a country—according to this ethical system. 59

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Another ethical system is situational ethics whereby people make decisions based on a specific situation instead of universal laws. Joseph Fletcher, a Harvard Divinity School professor, developed the concept of situational ethics because he believed that applying the Golden Rule—treating others as you would like to be treated—was more important when it comes to making ethical decisions than applying complex sets of moral rules. Because it challenged the idea that universal rules exist and can be applied to every situation, Fletcher’s ethical system was considered controversial. Many other ethical systems exist, some of which are defined by religious traditions. For example, Judeo-Christian ethics refers to the common set of basic values shared across both Jewish and Christian religious traditions. These include respecting property and relationships, respecting one’s parents, and being kind to others. Of course, people sometimes act in a manner that violates the beliefs they hold or the beliefs of the ethical system they say they follow. Unethical behavior is defined as behavior that does not conform to a set of approved standards of social or professional behavior. This is different from amoral behavior, in which a person has no sense of right and wrong and no interest in the moral consequences of his or her actions.

Personal Ethics What are personal ethics? Every day, you have thoughts that lead you to say and do certain things. As you choose your words and actions, you’re following a set of personal ethics, the principles that guide the decisions you make in your life. Sometimes, people have a clear, well-defined set of principles that they follow. Other times, a person’s ethics are inconsistent or are not applied the same way in every situation. Still other times, people have not taken the time to clarify what they value most. Sometimes, it seems clear that making an unethical decision will produce an immediate benefit. This is when it is hardest to adhere to your own ethical system. Consider this example: When applying for a dream job, a college senior exaggerates a bit on her résumé about her experiences and responsibilities during an internship to seem more qualified. Is this lying, or is it justified behavior? Now consider how you treat property. Say you bring home a few pads of paper, some pens, and a stack of blank Blu-rays from the supply closet at work. Is this stealing? What if it were just one piece of paper you brought home? Some people would say it depends on whether you use the material to do work at home. What if you used some of it on work projects and some of it on personal projects? What if it wasn’t you who was taking office supplies but someone else with whom you work? It’s often easy to have one view when you’re taking the supplies and another when it’s the person you like least in the office taking the supplies. How can I clarify what my personal ethics are? Taking the time to examine your personal ethical code is of great value. If you have a clear idea of which values are most important to you, it will be easier to handle situations in your personal and professional life that require you to make complex ethical decisions. ◼ TABLE 3.1 outlines one way to analyze your own ethical system. Let’s look at each step in the process: 1. Write down what kind of person you are. What is your character? Would a friend describe you as honest and kind? Ambitious and self-serving? Interested in others’ well-being? Be honest in your assessment of yourself. 2. List the beliefs that influence your decision making. For example, would you feel comfortable working in a lab that uses animal testing for medical research purposes? Do you think it is okay to lie? If so, which kinds of lies

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TAblE 3.1

Ethics in Business

Determining Your Code of Personal Ethics Questions

Examples

Base character

What characteristics would others use to describe you?

Honest, reliable, kind, self-centered, aggressive, courageous

Beliefs

What are the most important beliefs you hold and use to make decisions in your life?

“Nice guys finish last.” “Hard work always pays off.” “We must stand for right against wrong.”

Belief origins

Where did your beliefs and your view of your character come from?

Family, religion, movies, personal experiences, people you admire

Behavior

How do your relationships reflect your character and beliefs?

“I have mostly shallow relationships because I tend not to follow through on my commitments.” “I have many deep, long-lasting friendships because I value friendship and work to take care of my friends.”

are acceptable to you, and which kinds are not acceptable? Are your answers inflexible—that is, are you committed to adhering strictly to your ethical positions? 3. Now that you have your beliefs written down, think about how you came to believe them. What we experience during our lives offers all of us opportunities to develop our personal ethics. We also are taught about ethical behavior by our families, places of worship, first-grade teachers, and so on. Sometimes, our experiences lead us to abandon some ethical rules and adopt others. And for some of us, our ethical rules are modified depending on what is at stake. Have you accepted your ethical beliefs without investigation, or do they stand up to the test of real-world experiences in your life? 4. Consider your behavior with regard to the places you work, study, and live and how you relate to people around you. Would you like to change anything about your behavior? For example, do you ever find yourself gossiping or speaking in a way that creates a more divisive atmosphere? You may feel justified in the comments you’re making, but is your ethical position on gossiping creating the kind of environment you ultimately want to live in? How can an ethical life get me ahead? Sometimes, ethics feels like an abstract ideal—ideas that would be nice in a utopian world but have no real impact on your life in the here and now. Yet there are some clear benefits from living ethically. First, society has established its own set of rules of conduct as laws. Of course, ignoring laws can have an immediate negative impact on your life. But because we live in a society of many different cultures, religions, and ethical systems, the laws do not always reflect our personal ethics. Acts of civil disobedience occur when people choose to nonviolently follow their own beliefs even when they go counter to current laws. Whether it is complying with a law about the way you run your business or following laws that affect your personal life, deciding how your own ethics align with a society’s laws is critical. Living ethically may even be good for your health. When your day-to-day decisions are in conflict with the values you consider most important, you often feel stressed and angry. In situations where constant conflict exists between what you value and what actions you take, a variety of types of mental and physical damage may follow. Renate Schulster* is an example. Schulster, a vice president *The name in this story was changed.

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Can living Ethically Make You happy?

esearch suggests that happiness itself is a result of living ethically. Psychology has established this as a new focus with the emergence of an area of psychology known as positive psychology. Dr. Martin Seligman of the University of Pennsylvania’s Positive Psychology Center pioneered this field.2 Seligman and his colleagues work to discover the causes of happiness instead of addressing the treatment of mental dysfunctions. His research has shown that

by identifying your personal strengths and virtues (things like having empathy or a sense of justice) and aligning your life so you can apply your personal strengths and values every day, you will see an increase in happiness (and a decrease in depression) equivalent to the effects of antidepressant medication and therapy. Finding a way to identify and then apply your ethics and virtues to your daily life does indeed have an impact on your happiness.

for the human resources department at a financial services firm, was asked to investigate an employee’s allegation that the company’s CEO’s had engaged in sexual harassment.3 Schulster’s investigation led her to believe that the CEO of the corporation was guilty of the offense. Her personal ethics dictated following through with the employee’s claim, which put her at odds with the company. As pressure from the conflict between her own values and those of the CEO grew, she sought psychological counseling for the emotional impact of the stress she was experiencing. Schulster was eventually able to recover her medical and legal expenses from her employer and left the company. Although she held on to her integrity, the battle was not an easy one.

 Personal ethics are a large part of how people define themselves, their roles in society, and their business conduct. Remember Tracy? Like all of us, Tracy will continue to face ethical decisions throughout his lifetime. By truly thinking about his thoughts and actions—that is, by developing a code of personal ethics—he will be in a better position to see what his options are in complex and challenging situations.

Objective 3-2

Personal Ethics Meets Business Ethics Explain how personal ethics might play a role in the workplace and what resources one may use to evaluate a company’s ethical code.

 “It

was a beautiful glaze,” Randy Marks says with a sigh. His small pottery shop depends on orders from individuals and small architecture firms looking for authentic, custom pieces of tile to adorn their kitchens, floors, or fountains. “I used copper and a special firing method to give the glaze a stunning crimson color,” Randy explains. “It was our best-selling item.” An architect in New York City quickly contracted with Randy’s shop to produce a much larger number of tiles for his clients. This meant Randy had to work more hours and hire more employees to handle the extra business. However, part of the production process entailed the introduction of additional copper during firing, producing a thick black

ChAPTER 3

Ethics in Business

smoke laced with toxic copper. As the orders increased, more often than not, the kiln in the back of the workshop spewed this smoke into the air, in contrast to the clean white smoke produced by normal glazes. Randy had been part of environmental groups in his community for years, so he knew how detrimental to the environment this process was. How could he find a way to stay true to his ethical standards and still be mindful of his responsibilities to his employees and customers? We often find ourselves torn between several choices, and finding a path that works for both you and the company you work for can be challenging. In some settings, the line between right and wrong is difficult to see. Other times, your own personal values just won’t align with the company’s, and you may wish you had better understood the company’s sense of ethical culture early in your career—before you invested your time and effort. Let’s explore how personal ethics play a role in the workplace and some resources and techniques you can use to evaluate a company’s ethical code. Source: Kendall Martin

You as a Person and as an Employee What role do personal ethics have in a business environment? Our personal ideas of right and wrong influence our actions, words, and thoughts. But how does that carry over into the work environment? After all, our employer is purchasing our time and energy. As employees, we feel a responsibility to follow the ethics that the owner or director has established for the business. However, a business owner has no control over or even input into your conduct outside the office. But is this really true? Perhaps at one time this model applied to life in the United States, but the modern workplace is more complex. Today, off-the-job behavior, integrity, and honesty relate to on-the-job performance. For example, in the modern workplace, workers telecommute, working from home using technologies to connect electronically to office documents and meetings. In this newly expanded workplace, an employer may indeed care if an employee drinks at home during the workday or experiments with drugs recreationally. Corporate boards of directors may keep a close eye on the decisions their CEOs make in using social media. Tech CEO Greg Gopman posted a scathing rant on Facebook attacking the homeless population of San Francisco, painting an image of an elite, uncaring tech industry. The backlash had personal consequences, derailing his career, but also had impact on the growing disenchantment of long-term San Franciscans with the tech industry in general. The business environment is a changing landscape, and the lines of privacy laws are becoming blurred. Should employers have a say over an employee’s behavior outside the office if that behavior may affect the company for which the person works? Likewise, stockholders (people who own stock in a company) and employees sometimes have a say over the behavior of management outside the office. A classic example is seen when Boeing was recovering from a set of scandals involving how it obtained military contracts.4 The aerospace leader fired its current CEO and hired a former Boeing employee, Harry C. Stonecipher, to lead the company back to

Boeing fired its CEO, Harry Stonecipher, for unethical conduct. Ironically, Stonecipher had been hired to lead Boeing back to stability after a number of scandals had rocked the aerospace company. Source: Pierre verdy/AFP/Getty images

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stability. Fifteen months later, Stonecipher, who was married, was discovered having an affair with a female employee. The same code of ethical conduct that Stonecipher had created and pointed to as a sign of the return of ethical conduct at Boeing was used to force his resignation. There were no charges of sexual harassment, and the woman did not work directly for Stonecipher. He never showed her any favored treatment within Boeing. But there still was a conflict between his personal ethics and his role in the business. It took a great toll on him personally as well as the company he was working to restore.

ADM was at the center of an international price-fixing scandal, meeting with its own competitors to set the price and amount of product it sold. ADM employee Mark Whitacre became an FBI informant for three years to expose the scandal. He was portrayed by Matt Damon in The Informant, a dark comedy about these events. Source: timothy A. clary/AFP/Getty images

What if you are asked to do something that conflicts with your understanding of ethical behavior? It can be challenging to decide whose ethics to follow, yours or your company’s, and each path has legal and moral consequences. For example, Andrea Malone* was ordered by the president of her company to fire an employee who had a brain tumor because the tumor had lowered the employee’s productivity.5 Andrea knew that the Americans with Disabilities Act (ADA) covered such situations and that it was a violation of federal law to fire the employee under these conditions. However, her company insisted she fire the employee and say that it was for other reasons, not the tumor. Andrea chose to leave the company rather than fire the person unfairly, but she has since had difficulty finding another job. Andrea held to her personal ethics but was not properly prepared for the short-term consequences. What if you find you are taking part in unethical activity without realizing that you were doing so? Before Bruce Forest* accepted a job offer as a human resources director, he asked the firm about rumors that they hired undocumented immigrants. He was assured that was no longer the case. However, soon after Bruce started to work for the company, he began receiving information that the illegal hiring was still going on at the company. Bruce’s boss ordered him not to investigate the situation, saying that the company would prefer the risk of being fined by U.S. Citizenship and Immigration Services. According to his boss, the fine would be “an acceptable business expense.”6 So now Bruce was complicit in an illegal activity and had to make some tough decisions. Should he quit his job? Doing so might mean he would have to move his family, take a pay cut, and lose a bonus his company had promised him. Mark Whitacre faced a situation similar to Bruce’s. Whitacre was a senior executive with the agricultural giant Archer Daniels Midland (ADM). For years, ADM was involved in a multinational price-fixing scheme. Price fixing occurs when a group of companies agree among themselves to set a product’s price artificially high so customers have to pay more than they should for the product. Whitacre was a participant in the illegal activities and was set to rise to the top of the organization. His wife, however, became increasingly conflicted with what was happening at ADM and with her own ethical values. She finally threatened to divorce Whitacre unless he found a way to end his involvement. Whitacre then went to the FBI and became the highest-level corporate executive in U.S. history to become a whistle-blower. He agreed to record secret meetings at ADM, ultimately capturing incriminating audiotape and videotape for the FBI over a three-year period.7 Whitacre himself ended up spending almost nine years in prison. He is now the chief operating officer of a biotech firm in California. The story is so compelling that it was made into a film starring Matt Damon— The Informant. To stumble unknowingly into unethical and even illegal activity like Whitacre did puts people in a difficult situation, especially when their jobs are on the line. Although some people decide they will “be flexible” with their own ethical *The name in this story was changed.

ChAPTER 3

standards in the workplace, it can often take a toll on their mental state, relationships, and physical health.

Identifying a Company’s Ethics How do I examine a company’s ethics? Some companies may have a written code of ethics, or a statement of their commitment to certain ethical practices. Also called a code of conduct, it is meant to give employees guidance on how to handle themselves in challenging ethical situations. Additionally, many companies have a public mission statement that defines the core purpose of the organization— why it exists. The mission statement describes the company’s values, goals, and aspirations. Consider the following mission statement of Fetzer Vineyards: Our vision is to operate in a way that restores, revitalizes, and regenerates ecosystems and communities, while producing premium quality wines, advancing the health and well-being of employees, and producing sustainable growth for shareholders.8 This mission statement has led to a plan to be fully green by 2030, awards for the conservation of energy, and a company-wide English as a Second Language training program offered as part of its education package for its employees. How can I find out the best and worst aspects of a company’s ethical conduct? In addition to a company’s code of ethics and mission statement, other resources allow you to evaluate the acts of a company and legal violations it may have committed. For example, you can check the legal compliance of a corporation by researching actual charges that have been filed or cases that have been adjudicated against a company. Websites such as lawcrawler.findlaw.com help you find relevant case law generated by lawsuits filed by or against many corporations. There are also organizations, such as the Boston College Center for Corporate Citizenship, that work with corporations to help them define, plan, and institute their corporate citizenship. This center also highlights companies that act in positive ways by publicizing responsible corporate activities and listing on its website reports in the general media of ethical issues in business. By doing so, the center works with companies to “leverage their assets to ensure both the company’s success and a more just and sustainable world.”9 We’ll discuss other ways you can assess a company’s ethics and sense of corporate responsibility in the next section.

 What did Randy Marks decide to do when his personal and business ethics collided with the production of the special pottery glaze? No one was “watching”; there was no censure from any environmental authority, and no laws were being broken. But the conflict for Randy was too much. “I had campaigned against factory emissions of air pollution for years,” Randy said. “The ethical conflict was too great; I had to stop making the glaze.” Randy’s decision led to difficult times for the shop. The New York architect canceled his order—the glaze had been the winning factor for his business. The workers in the shop were also frustrated. They loved producing interesting, beautiful pieces, and the new orders meant extra hours and extra earnings. Their shop was so small, they argued, how could a little smoke possibly matter in the big scheme of things? Although Randy’s pottery shop does not have a formal written mission statement, his behavior and willingness to discuss his decision behind discontinuing the popular glaze let each employee see clearly the priorities Randy held for the business. Randy had to be firm, repeatedly explaining that his personal ethics had to be consistent with his workplace ethics and that he was sure that, in the long run, the shop would benefit from his decision. Even though Randy’s employees did not easily accept his decision, they felt the larger mission of the business was well defined and respected.

Ethics in Business

PART onE

Looking at the Business Environment Objective 3-3

corporate social Responsibility Analyze the ways in which a company’s policies and decisions affect its achievement of corporate social responsibility, and discuss the challenges it may face in balancing the demands of social responsibility with successful business practices.

 With

Source: Francis Dean/Getty images

a lofty mission of becoming a national company with values and guiding principles his employees could be proud of, in 1987, Howard Schulz purchased Starbucks, a Seattle storefront that sold fresh-roasted whole-bean coffee. Since then, Starbucks has become an entrepreneurial dream business, with more than 22,000 stores in over 65 countries. How are the goals of helping communities, protecting the environment, and inspiring employees related to the bottom line of business—profit and growth? Corporate decisions reflect a company’s desire to fulfill a sense of corporate social responsibility. Every day, large companies like Gap, Disney, and Shell, as well as medium-size firms and small local businesses, must make decisions that reflect their corporate social responsibility. Let’s look at what corporate social responsibility means, who it affects, and how companies can achieve balancing corporate social responsibility with successful business practices.

The Five Pillars of Corporate Social Responsibility What is corporate social responsibility? Corporate social responsibility (CSR) is defined as a company’s obligation to conduct its activities with the aim of achieving social, environmental, and economic development. Being socially responsible requires a company to make good decisions in the following five major areas (see ◼ FIGURE 3.1): 1. 2. 3. 4. 5.

Human rights and employment standards in the workplace Ethical sourcing and procurement Marketing and consumer issues Environmental, health, and safety concerns Community and good-neighbor policies

Let’s look at each of these areas. HUMAN RIGHTS AND EMPLOyMENT STANDARDS IN THE WORkPLACE CSR

concerns affect the world outside the office in both local and global communities. For example, employment standards—how a company respects and cares for its employees—are reflected locally in the policies a company sets and the impact a company has on the community. As a business interacts more with

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Ethics in Business

Business

Human Rights and Employment Standards in the Workplace

Ethical Sourcing and Procurement

Marketing and Consumer Issues

Environmental, Health, and Safety Concerns

Community and “Good Neighbor” Policies

◼ FIGURE 3.1 The Five Pillars of Corporate Social Responsibility Corporate social responsibility is the collection of policies covering five major areas and can be the foundation of a business. © Pearson education

the global marketplace, a company will have to make decisions about ethical standards on tough issues, such as child labor, pollution, fair wages, and human rights. Consider the case of cobalt, a mineral used in battery production. Many electronics manufacturers like Apple, Sony, Samsung all use cobalt from mining operations exploiting children, some working 12 or more hours a day in the mines. Companies like Apple must first identify that their suppliers are violating child labor laws and take action. They also work to evaluate other materials that would bring fewer labor and environmental risks.10 ETHICAL SOURCING AND PROCUREMENT Finding a source for raw materials and making agreements with suppliers is an aspect of many businesses. In today’s global marketplace, many companies find themselves working with international suppliers.

Cheating Pays off….Until It Doesn’t

olkswagen engineers needed their diesel models to meet the emission standards of the U.S. Clean Air Act within the time frame and budget they had been given. Their solution was to install software that could detect if an emissions test was being conducted on the car. If the car was being tested, then the program would output false readings of the carbon dioxide levels, up to 40 times lower than they actually were.

oFF ThE MARk

This cheat went unnoticed for years and impacted more than 11 million cars. But when it was finally uncovered, it led to billions of dollars of fines and lawsuits and the resignation of the CEO. The full implication on the company’s future is still unfolding. Does a corporate culture that tolerates cheating pay? What if Volkswagen had never been caught?

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Once a business considers purchasing materials from a supplier in a different country or even a different region of their home country, the company is tied to environmental and social concerns in that area. Consider a company that has an assembly plant in a different country. That company is now tied to the social conditions there. To keep its supplier operating or keep an assembly plant running smoothly, the company has a vested interest in the quality of the schools in that area so that the local workforce is educated. The banana supplier Chiquita, for example, has a vested interest in the parts of the world where it gets its produce. Chiquita had a decades-long reputation of allowing its farmworkers to toil in dangerous conditions, contaminating water and clear-cutting tropical forests. Because workers’ rights and environmental issues were endangering its brand name, Chiquita began to improve conditions. It constructed housing for its workers and schools for their children. Now the environmental group Rainforest Alliance certifies all of Chiquita’s farms, ensuring they meet specific standards regarding the use of pesticides, workers’ health issues, and related topics.11 A commitment to CSR means that companies must be aware of the ethical impact of their actions—both at home and in communities far from their shores. MARkETING AND CONSUMER ISSUES Marketing can often present ethical challenges. In addition to issues regarding truth in advertising, marketers must consider messages that may be manipulative even if they contain no outright lies. For example, several major fashion labels, such as Prada, Versace, and Armani, have agreed to ban size-zero models from their fashion shows. As more medical authorities have linked the viewing of these images with an increase in eating disorders among women, the fashion industry is faced with a decision. There are many marketing and consumer issues that companies must consider if they are to behave in a socially responsible way. What do you think? Is the use of size-zero professional models socially irresponsible? What about retouching photos for advertisements so that the models look perfect? Is that okay? How do we judge when responsible behavior turns into irresponsible behavior? ENvIRONMENTAL, HEALTH, AND SAFETy CONCERNS Many industries, even small companies, make decisions every day that affect the environment and the safety of their workers or neighbors. From multinational manufacturing giants to local auto body shops, any industry involved with processes that produce toxic waste must make decisions that directly affect the environment. Meanwhile, the production of toxic materials is moving at a far faster pace than the growth of proper storage and disposal facilities and techniques, so disposing of the materials becomes more and more expensive. One of the most infamous cases was documented in the award-winning book A Civil Action (Vintage, 1996). A high incidence leukemia among the children in a small Massachusetts town led to the case. Ultimately, it was discovered that the town’s water supply had been poisoned by trichloroethylene dumped by two local businesses. What are the short- and long-term costs of ignoring these concerns? Companies that have a CSR focus work to recognize the social impact of their decisions.

THE LIST

Nine Causes Americans Think Charities Should Focus On

1. Education

6. Disaster relief

2. Youth and families

7. Global health

3. Medical research

8. Animal rights

4. Human rights

9. Arts

5. Environment

COMMUNITy AND GOOD-NEIGHBOR POLICIES Finally, CSR relates to how a company affects the communities in which it does business, particularly the surrounding neighborhoods. This issue has been a challenge for Walmart for

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years. In the documentary Wal-Mart: The High Cost of Low Price, film director Robert Greenwald argues that Walmart pays its associates so little that the arrival of a Walmart outlet in a community actually costs the community.12 Some stores have held holiday food drives for their own employees. Because workers are paid poorly and are not offered medical benefits to cover their children, Medicaid expenditures for the communities increase, which the public must pay with their taxes. In addition, Greenwald argues that many local and smaller businesses cannot compete with the giant and are forced to close. Adding insult to injury, often a community has given Walmart subsidies to attract the company to the area. Finding a way to be a good corporate neighbor is important to avoid the tensions and bad publicity that Walmart has struggled against.

The Conflict of CSR in the business Environment Can a corporation really be socially responsible? The Nobel Prize–winning economist Milton Friedman said, “Asking a corporation to be socially responsible makes no more sense than asking a building to be.”13 He argued that an abstract idea, like a corporation, cannot perform human functions, such as meeting responsibilities. There has long been debate around these ideas. The Citizen United decision of the U.S. Supreme Court in 2010 ruled that corporations have the same constitutional rights as people to choose elected officials—and therefore have the ability to make unlimited political contributions. A company has a unique responsibility to its stockholders: to deliver a profit at the end of the year. It is difficult to measure how that responsibility interacts with a long-term responsibility to the community or the planet. There can be a conflict between a company’s need to produce profit for its shareholders and the demands of CSR. Are the demands worth it? Although a business reaps benefits by being socially responsible, managers at high strategic levels must have a common vision of how the interests of the business can be supported by an effective CSR policy.

The benefits of CSR What are the benefits of CSR? Having a strong and clear ethical policy helps a business in a number of ways: • A company develops a positive reputation in the marketplace with consumers as well as with its suppliers and vendors. • A company is able to recruit and retain the best available talent. • Efficiency increases when companies use materials resourcefully and minimize waste. • Sales increase through new product innovations and environmentally and ethically conscious labeling.

Measuring CSR Is it possible to measure a company’s CSR level? It may seem impossible to measure something as complex as CSR, but there are ways to get a picture of the overall strength of a company’s CSR effort. SOCIAL AUDITS A social audit is a study of how well a company is meeting its social responsibilities. It is an internal and systematic examination that measures

Walmart’s impact on local communities is hotly debated. Detractors argue that the company’s employees are paid so little that they often need social services in combination with their Walmart jobs just to survive. Source: jim West/Age Fotostock

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Corporations as People

n the famed Citizen United case, the U.S. Supreme Court ruled that corporations, which are made up of individuals, have the same constitutional rights as people to choose elected officials and so can make unlimited contributions to political campaigns. It opened the door to a discussion of the state of democracy in the United States. Does this decision allow corporations and a small collection of the ultrarich to overpower the voice of the individual in U.S. politics?

Should a corporation have all the same rights as an individual? Could a company plead the Fifth Amendment and avoid self-incrimination in criminal proceedings? In what sense do we want corporations to be legal entities with rights and responsibilities? Should corporations be measured to the same standard of ethical conduct and compassion that we hold for the people we admire?

and monitors what goals a company has set, what progress it has made, and how resources, such as funding and labor, have been applied to the CSR goals.

The Bill and Melinda Gates Foundation commits more than $1.5 billion a year in grants to global health and development projects, such as vaccination campaigns. Source: Pius Utomi ekpei/AFP/Getty images

RATINGS AND RANkINGS In addition to social audits, organizations like the Boston College Center for Corporate Citizenship assess corporate responsibility and publish their findings. And companies like the Calvert Investment Company provide corporate responsibility ratings and reports to consumers. The Calvert Investment Company assigns companies a score based on their performance in the categories of environment, workplace, business practices, human rights, and community relations. Investors can use the “Know What You Own®” tool to investigate a fund and check the environmental and social performance of the companies in the fund. In addition to social audits and the Calvert ratings, various magazines, such as Fortune, publish lists of admired companies each year. Other organizations award businesses for superior CSR. For example, Chroma Technology Corp., a manufacturer of optical filters, has many innovative practices.14 In this global company, employees hold all the seats on the board of directors. In addition, the company’s salary structure heavily rewards loyalty. Each employee makes a base salary that depends on his or her specialty in the organization and that then increases on the basis of seniority.15 Another often-cited CSR award winner is Clif Bar, Inc., a manufacturer of organic energy bars. Gary Erickson started the company in his kitchen with $1,000. After 10 years of consistent growth, Erickson was about to accept an offer of $120million for the company. At the last minute, he learned that the purchasers were planning to move Clif Bar out of state and lay off all the firm’s current employees. He felt his integrity and his vision for the company were at stake, so he canceled the deal and took over the company again. SELF-REPORTING The practice of companies self-reporting their own efforts when it comes to addressing ethically complex issues and issues of social responsibility is also becoming more prevalent. Every year, the entertainment company Time Warner presents to its stockholders a CSR report that discusses its advances in corporate citizenship, including its focus on journalistic integrity, socially responsible programming (including issues such as the depiction of smoking in films), content accessibility, consumer privacy, content diversity, and child protection.16 CORPORATE PHILANTHROPy Many companies participate in corporate philanthropy, which is the practice of donating some of their profits or resources to charitable organizations. Often,

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companies view philanthropic activities as a marketing investment designed to build stronger relationships with the communities in which they do business, their own employees, and consumers in general. Target, for example, donates 5 percent of its pretax profits to charity, which is about $3million a week.17 This is more than twice the average of other U.S. corporations. Another example is the Bill and Melinda Gates Foundation, started by Microsoft chairman Bill Gates. With an endowment of $40 billion, the Gates Foundation has tackled issues like global infant survival rates, began an initiative for a malaria vaccine, and is working to support innovation in education. Even though the foundation is not directly associated with Microsoft, it has had a positive impact on the public’s perception of the company.

CSR and Social networking What does social networking have to do with CSR? As is the case with many aspects of business, social networking is changing the face of CSR. At one point, the hamburger chain Wendy’s used Twitter to raise money for its founder’s foundation, the Dave Thomas Foundation for Adoption. Each time the message #TreatItFwd was retweeted, Wendy’s contributed 50 cents to help kids in foster care. The Father’s Day promotion raised $1.8 million.18 The banking conglomerate Chase moved into crowdsourced philanthropy with its Chase Community Giving Program. Chase has used a Facebook page to let visitors to the site decide to which nonprofits the company makes donations. What does Chase get in return? Perhaps a more positive reputation and increased engagement by its customers.

The Challenges of CSR What challenges does CSR pose? It’s clear that the many conflicting demands facing businesses today pose numerous ethical challenges. Consider the dilemma facing companies that produce unique products, such as pharmaceutical companies that develop medications to treat AIDS. What is their exact moral and ethical obligation with regard to the AIDS pandemic in sub-Saharan Africa? More than 25 million people are living with HIV in Africa.19 One-third of them are also infected with tuberculosis. Another 1 million or more people in Africa die from malaria each year, mostly children.20 Meanwhile, 70 percent of Africans exist on less than $2 a day and are unable to pay for the medications that would reimburse pharmaceutical companies for their research investment to develop them. It is a challenge for modern business leaders to balance their need to respond to investors and produce a profit with their desire to alleviate human suffering. There is no fixed training that prepares and equips business decision makers to navigate such difficult decisions. Nonetheless, some corporations manage to consistently balance the demands of social responsibility and successful business practices. Intel scores high as an industry leader in terms of its commitment to strong CSR practices.21 Environmentally, it has decreased the emissions from its operations over the past four years, mitigating its impact on global warming. It has shown a strong commitment to its employees by providing benefits for domestic partners as well as carefully monitoring workers for exposure to hazardous chemicals. The company also has human rights policies in place in each country in which it operates. In addition, it donates computer equipment to many organizations, supports many charitable organizations through monetary donations, and is responsive to community needs.

The Effects of CSR on Society How does CSR affect society as a whole? Businesses do not operate separately from society as a whole, so CSR affects us all in many ways.

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ENvIRONMENTAL EFFECTS Environmentally, how businesses operate has both local and global effects. For example, people living in the Silicon Valley area near San Francisco rely on groundwater for their main supply of water. This leaves the entire Silicon Valley area dependent on proper industry practices by the many semiconductor manufacturers in the area. If these companies allow chemical contaminants to enter the groundwater system, the entire region suffers. Businesses raise troubling environmental questions on a global scale as well. Some say that allowing free trade—in which countries produce and sell products anywhere in the world—is exporting pollution to less developed countries. Are companies moving “dirty industries”—those that have a high risk of pollution, danger to workers, or toxic damage of the environment—to countries where environmental regulations are lacking? It is increasingly important for industry leaders to have some structured ethical system to make such complex, long-reaching decisions. ECONOMIC EFFECTS As an individual, CSR affects you as well. Financially, the

long-term consequences of businesses implementing a strong CSR plan have an impact on the prices you pay for products, the products that are available to you, and the quality of those products. Industries that act in ways that jeopardize their own long-term sustainability can create economic ripples that affect the bottom line of individual consumers.

EFFECTS ON EMPLOyEE MORALE Think of your own career. Your potential for advancement, day-to-day work environment, and overall sense of purpose are affected by the degree to which the company you work for is socially responsible. The ethical culture of a company and its leadership has effects on its workers every day. Sometimes, this effect is a positive one. Consider the Publicis Kaplan Thaler advertising agency, the fastest-growing advertising firm in the country, started by Linda Kaplan Thaler and Robin Koval. The billion-dollar company, which began as a one-client startup, prides itself on creating unique ad campaigns, such as the Aflac duck campaign, that grab viewers’ attention. Yet for all of its success, the core philosophy of the company, as Thaler and Koval describe in their book The Power of Nice, is that being nice pays. After spending years at high-powered, high-pressure firms where “those who eat their young get raises,” Thaler and Koval instead founded a firm dedicated to the principles of being empathetic.22 They assume that the people you work with are there to help you, and remember that emotionally, well-adjusted people earn higher incomes, live longer, and have more satisfying lives.23 The company founders’ beliefs affect the employees at the firm each and every day. Even from the initial interview, aspects of a company’s CSR plan may be apparent. For example, it’s becoming increasingly common for companies that practice CSR to try to attract job candidates and hire employees who match their own corporate values. Doing so results in a workforce that’s more dedicated and performs better, firms are finding. Human resources management professionals refer to this practice as value-based recruiting and hiring.

The Effects of Individuals on CSR How can I affect how businesses operate ethically? There are many ways that individuals can work toward a more ethical world filled with more ethical businesses. In addition to contributing by means of your own personal conduct, both at the workplace and outside of it, your choices about where and on what to spend your money greatly influence corporate behavior. Companies survive only because consumers buy their products or use their services. If you don’t believe in a company’s ethics, you can take your business elsewhere. Meanwhile, if you choose to invest money in mutual funds and the stock market, you have another opportunity to make a statement about corporate ethics. Socially responsible investing (SRI) is the practice of investing only in companies that have met a certain standard of CSR. Investment-fund managers who practice SRI look at the social and environmental behavior of companies to decide which of them to include

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and exclude from their investment portfolios. As a shareholder, you can also use your voice to encourage a company to improve or maintain a high standard of ethics. Finally, when you choose an employer, you’re making a clear statement on ethical conduct by offering the company your valuable time and energy. By agreeing to work for a company, you’re saying that you agree with its mission and ethics.

 As a boy, Starbucks founder Howard Schulz watched his father grow ill and his family lose their home and be driven into public housing as a result. Schulz was determined that any company he ran would never let such a thing happen to an employee. When he bought Starbucks in 1987, he immediately extended a company-subsidized health care package to all full- and part-time employees and their dependents. The deductibles, copays, and benefits are the same for all employees. The incredible success of Starbucks could be an accident that happened despite the company’s commitment to ethics and social responsibility, but Howard Schulz would tell you something different.

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Dangers of a Weak Ethical Focus Summarize how legal compliance affects ethical conduct, and describe some strategies a company can use to recover from ethical lapses.

 “To me, it was stealing, and, bottom line, stealing is wrong.” The software firm Lana Phillips worked for had finished developing a program to deliver movie content on demand to people’s mobile devices. Before the company could break into the market, however, it needed to test its product and make appearances at big electronics trade shows. To test the program, the company needed movies. But movies are copyrighted, and DVDs of them are encrypted so they cannot be copied onto a computer hard drive. As the testing phase approached, word came down from management: purchase some DVDs, break the encryption, and rip them to hard drives to use as testing. After all, the managers reasoned, the company was not going to make money from violating DVD copyrights; it was just using it to test its software. And if it worked well, it would then run demos for clients and at trade shows using those DVDs. What was the harm? The company consulted its attorneys, and half felt the use of the DVDs might be illegal and half felt it could be defended. Lana suggested some other solutions: The company could use Hollywood films that were older and not covered by copyright protection or public domain documentaries, which were freely available for public use. Company managers worried what the impact on business would be. Would a product shown running a 30-year-old movie or an unknown documentary grab the attention of buyers at a busy Las Vegas trade show? The danger on the other side was that a successful product launch by the company might not save it from facing future legal action for copyright infringement. How could Lana and her boss resolve the issue when it wasn’t even clear what the correct legal path was?

Source: kaprikfoto/Fotolia

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Depending on the industry, there may be significant legal consequences to business behavior that ignores agreed-on ethical standards. Companies are responsible for following complex sets of laws, and if they violate them, even unknowingly, their businesses may be in jeopardy. Next we’ll examine legal compliance and how a business can recover if they ignore ethical conduct.

legal Regulations and legal Compliance How is a company regulated legally? Legal regulations are the specific laws governing the products or processes of a specific industry. When enough people feel that a particular ethical standard is important, it eventually becomes law. For example, in 1962, the Consumer Bill of Rights was passed in Congress. This bill made the following ethical standards legal rights: the right to safety, the consumer’s right to choose, their right to information, and their right to be heard.24 Another example is the Organic Seal of the U.S. Department of Agriculture (USDA), which assures consumers of the quality and integrity of organic products. To certify a product as organic, a company must meet stringent conditions set by the USDA, including annual and random inspections to check on standards. Legal compliance refers to conducting a business within the boundaries of all the legal regulations of an industry. Various government agencies, such as the Equal Employment Opportunity Commission (EEOC) and the Securities and Exchange Commission (SEC), provide guidance to companies to help them maintain legal compliance. The EEOC monitors their compliance by investigating complaints about discrimination, sexual harassment, or violations of the Americans with Disabilities Act (ADA) in the workplace. The ADA of 1990 requires companies to make a reasonable accommodation to the known disabilities of an applicant or employee, as long as it doesn’t require undue hardship for the employer. The SEC governs the securities industry to ensure that all investors are treated fairly and have the same access to information about companies. Violations of federal laws can severely damage a company. We mentioned previously how ADM, the agriculture giant, was involved in a large price-fixing scheme in which it bilked its own customers out of millions of dollars. The company was later fined $100 million for its role in the price fixing. Likewise, in 2010, British Petroleum agreed to establish a fund of $20 billion to begin to meet claims of damage resulting from the Deepwater Horizon oil spill.25 Don’t companies often break the law and still make money? There are plenty of cases in which companies have broken the law and seemed to benefit—for a time. Take the case of Enron. Enron had grown to become the seventh-largest company in the United States. The company was lauded by Fortune magazine as the Most Innovative Company in America many times and was in the top 25 of Fortune’s 100 Best Companies to Work For. Enron had published its social and environmental positions, noting that the company made decisions based on three values:26 • Respect. Mutual respect with communities and stakeholders affected by the company’s operations • Integrity. Examining the impacts, positive and negative, of the business on the environment and society and integrating human health, social, and environmental considerations into the company’s management and value system • Excellence. Continuing to improve performance and encouraging business partners and suppliers to adhere to the same standards However, by 2001, it was discovered that Enron’s success had been based largely on fraudulent activities. The company had hidden debts totaling more than $1 billion to inflate its own stock price; manipulated the Texas and California power markets, causing enormous hardship; and bribed foreign governments to win contracts abroad. A few months later, the company filed bankruptcy, and founder

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Kenneth Lay was convicted on 10 counts of fraud and conspiracy. Helater died while awaiting sentencing. CEO Jeffrey Skilling was convicted of 18 counts of fraud and is now serving a 14-year prison sentence. The global accounting firm that Enron had hired, Arthur Andersen, was convicted of obstruction of justice for destroying thousands of documents relating to its work with Enron and its knowledge of the fraud. The fraud ultimately led to the internal collapse of both companies. Thousands of employees who did not know their managers were participating in illegal activities lost their jobs and pensions as a result. To avoid future occurrences such as these, the Sarbanes-Oxley Act of 2002 was enacted. Under this act, CEOs are required to verify their companies’ financial statements and vouch for their accuracy with the SEC. The act didn’t put an end to financial fraud though. In 2008, one of the largest financial scandals of all time was exposed: a massive Ponzi scheme led by New York financier Bernie Madoff. A Ponzi scheme is a swindle whereby investors believe their money is being invested and earning returns for them but is instead being siphoned off by the schemer. A Ponzi scheme works as long as there are not as many investors wanting to withdraw their money from the investment fund. When too many of them do, there is not enough to pay them all, and the scheme is exposed. For decades, Madoff had been collecting billions of dollars in funds from his many prestigious clients, including celebrities, pension funds, and not-for-profit charities. But then it was revealed that more than $65 billion was missing from his clients’ accounts.27 He was ultimately convicted and is serving a 150-year prison sentence.

Recovering from Weak Ethical Conduct What if your company is breaking the law and you want it to stop? Some people risk their positions and future careers to stop corporate abuse when they see it in the workplace. A whistle-blower is an employee who reports misconduct, most often to an authority outside the firm. Famous examples include Jeffrey Wigand, a vice president of a tobacco company who, in 1996, revealed on the television show 60 Minutes that his company was deliberately upping the nicotine in its cigarettes to make them more addictive. Another example is Sergeant Joseph Darby, who sent to the U.S. Army Criminal Investigation Command an anonymous note and photos of prisoners being abused at the U.S. prison Abu Ghraib in Iraq. The information sparked an investigation that eventually revealed to the public the abuses at the prison. Darby later received a John F. Kennedy Profile in Courage Award, but he and his wife were forced to live in protective custody in an undisclosed location because of threats made against them. Legal protection for whistle-blowers varies from state to state and industry to industry. For the people who take such a step, the pressure of the conflict between what they see and their own ethical standards forces them to make tremendous sacrifices. Can a company really recover from an ethical lapse? Companies that try to recover from highly publicized ethical lapses often face a long road. Recovering from a scandal almost certainly requires pervasive change. Usually, employees who were not involved in the wrongdoing work to forge a new image. If the corruption is bad enough, sometimes a company goes so far as to “clean house”—that is, terminate all of its current managers and maybe even its employees to try “save face” with the public. That’s what happened at Tyco International when it was discovered in 2003 that the firm’s president and chief financial officer had ripped off the company by hundreds of millions of dollars. The money was siphoned off via illegal corporate loans and by manipulating the company’s stock price. Both men were convicted of fraud and later sentenced to up to 25 years in prison. Within a few months of being hired, Tyco’s new CEO replaced all of the members of the company’s board of directors as well all of the firm’s 290 employees. Companies that are attempting to recover from scandal often follow some common strategies: • They work to find a leader who will set an example of the new ethical image of the company.

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• They restructure their internal operations to empower all employees to consider the ethical implications of their decisions and feel free to speak up when they spot a concern. • They redesign internal rewards, for example, restructuring their incentive packages for sales employees so that they are financially rewarded for building ongoing relationships with their clients rather than just closing one-time sales. By using creative thinking and adhering to clearly stated ethical principles, a company can actually turn a scandal into something good. For example, when many shoppers boycotted Target because the chain had a policy of not allowing solicitors to collect money outside its doors, they managed to turn the incident into positive publicity. It began with Target not allowing volunteers collecting for the Salvation Army. The Salvation Army reported the ban cost the charity more than $9 million in possible donations. Target could have responded with a defensive attack on the Salvation Army or by pointing out that the retailer already was investing 5 percent of its profit in local communities. Instead, the company chose to work with the Salvation Army, first donating the lost $9 million directly and then creating an online “wish list” shoppers could use to donate toys, clothes, and household items to needy families during the holiday season. By acting together with the Salvation Army in new ways, Target was able to turn a negative situation into something beneficial for both itself and the community.

 Now

think back to Lana Phillips’s company copying movies from DVDs. Even though the firm wasn’t committing fraud on the scale of the Enron scandal, many of the same principles are at play. The temptation to ignore existing laws to make a profit—or even the chance for profit—lies at the heart of both stories. Enron’s misdeeds devastated thousands, if not millions, of people. At Lana’s firm, future penalties could cripple the company, but simply knowingly violating her own personal code of ethics was the driving force for Lana. She was forced to decide whether she would refuse to work on the project and potentially lose her job, knowing that her manager would assign the work to another employee who would then be breaking the law. Lana decided to urge her company to not use the copyrighted DVDs. Ultimately, executives agreed with her. They felt that the risk of future copyright infringement lawsuits was too great. Lana’s persistence paid off, and she was able to maintain both her job security and her personal code of ethics.

Objective 3-5

Business Opportunities created by Ethical Needs Identify ways in which companies can apply ethical standards to create new business opportunities.

 In

the early 1980s, Mary Stephenson lost her battle with cancer. After her death, her son, Richard Stephenson, tried to explore what options the family might have pursued that would have made his mother’s final days with her family of higher quality. He found facilities that were

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equipped to provide top-notch technical care but none that provided compassion and nurturing for the whole person who was ill as well as for his or her entire family. How could he give his mother’s death meaning and positively affect the lives of others? Was there a way that the business of health care could be both successful and compassionate? So far, we’ve addressed the extra work and the difficult decisions that have to be made to conduct business ethically. But there are also opportunities and potential for gains for doing so. Like Richard Stephenson, some companies focus on creating new markets with an ethical focus. Others redesign their businesses so that they no longer have a negative impact on the environment. Still others use ethical challenges as a tool to unite and empower employees. So let’s explore what new opportunities can be created by keeping strong ethical standards. Source: Fuse/Getty images

Creating new Markets with an Ethical Focus How can firms create business by acting ethically? By examining the world with an eye toward social responsibility, many firms have created opportunities with new types of products and services. Let’s examine a few. OFFERING CLEAN FUEL Solar City is a company that is finding ways to create profit from the residential and commercial use of solar energy. They did not invent a new solar panel or a new technology but focus on creative ways to help homes and businesses afford the up-front installation costs of switching their energy needs to solar. This approach to making solar energy an affordable option for millions may be more important than even inventing a new type of solar battery itself. CREATING MEDICAL vACCINES Other companies have created business opportunities by addressing the world’s most serious medical needs. Malaria kills up to 3million people a year, mostly children, and is the leading cause of death in children worldwide, mostly in Africa. The disease is transmitted easily, whereas the drugs currently used to treat it are becoming increasingly ineffective. Many businesses haven’t found a way to balance the tremendous research costs associated with creating a malaria vaccine with the anticipated meager profits from it. Enter Sanaria, a pharmaceutical company founded by Dr. Stephen Hoffman, whose mission is to create a malaria vaccine. Hoffman remarks, “Ihaven’t spent 25 years working on diseases of the most disadvantaged and neglected people in the world to start a company that’s just here to make money.”28 The malaria vaccine the company has developed has completed its first phase of clinical trials. FIGHTING CENSORSHIP Still other companies are creating business opportunities by fighting censorship. The Chinese government maintains a tight rein on the flow of information to its citizens, including controlling the accessibility of certain Internet sites. This policy of censorship garnered the attention of the international business community when, in 2010, after four years of complying with

Mosquito nets work to reduce the risk of malaria. A malaria vaccine, though, would eliminate the risk for millions. Source: j R Ripper/brazil Photos/Getty images

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China’s system of censorship so that search results were edited before being presented to users, Google did an about-face and announced it would no longer censor search results for China.29 Google’s announcement was met by an announcement from Microsoft that its Bing search engine would continue to abide by Chinese censorship laws. The Bing search engine has even been charged with censoring information for Chinese language users in the United States in the same way.30 This censorship left the founder of Dynamic Internet Technology (DIT), Bill Xia, with a skewed view of the world when he arrived in the United States from China. DIT and similar companies provide a paid service that counteracts the impact of censorship. When a site is placed on the list of censored sites by the Chinese government, DIT quickly creates a new, uncensored web address that points users to the same material. A list of the new accessible sites is then e-mailed to web surfers who want full Internet access. Chinese censors often stamp out the new site within a few days, at which point DIT starts the process again, determined to override China’s censorship. DIT and other companies are showing there are ways to fight censorship and profit from it. The service DIT provides may continue to be important because other countries, including India, are now requiring Google to restrict content their governments feel are “antisocial” or “antireligious.”31

businesses Going Green

Starbucks discounts coffee if customers bring their own recyclable tumblers. Customers bring in tumblers more than 35 million times a year. Source: bloomberg/Getty images

How can businesses benefit by going green? Increasingly, companies are attempting to reduce the impact they have on the environment. Take Interface, Inc., the world’s largest commercial carpet manufacturer. The company was careful to follow all laws and regulations related to its industry, but it made no special commitment to stewardship of the environment beyond that. Then CEO Ray Anderson read The Ecology of Commerce.32 Anderson was so inspired by the book’s message that he began reorganizing his $1.4 billion company around the principles of sustainability. Sustainability is the practice of improving the quality of people’s lives in ways that simultaneously protect and enhance the earth’s life support systems. Interface is rethinking all aspects of its business in an effort to meet its sustainability goal. It is eliminating waste and toxic substances from its products, using renewable energy, and finding how to route its trucks along more efficient transportation routes.33 Cool Carpet is one product that demonstrates how Interface now operates. The “cool” part of Cool Carpet is that Interface makes sure that all carbon dioxide emissions over the full life cycle of Cool Carpet—from its manufacture through its delivery—are offset so as to minimize global warming. Actions like purchasing energy from wind farms and choosing suppliers that are ecologically friendly balance out the necessary carbon dioxide produced in other stages of carpet production. Anderson recognized the choices Interface makes today will ultimately affect future generations and hoped his customers would see the value in these choices and go green themselves. Another large international company that has worked for over a decade to reduce its environmental footprint is Starbucks. Its “Shared Planet” progress plan sets clear objectives for the company in terms of its recycling, energy and water usage, building, and efforts to reduce climate change.34 Starbucks also held a summit with local governments, cup manufacturers, and recyclers to identify the steps required to make its cups recyclable. Stores are being designed with recycling bins in the front, and customers are given $0.10 off each cup of coffee served in a reusable tumbler. Today, more than 35 million Starbucks customers bring their personal tumblers to the firm’s stores to have them refilled.

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 So sometimes new business opportunities are created by recognizing the need for ethical standards. Richard Stephenson responded to his mother’s death by founding a network of hospitals called the Cancer Treatment Centers of America (CTCA). At CTCA, providers are guided to treat patients with the “Mother Standard of care,” the level of compassion and support that you would want for your own family members. CTCA treats patients with the latest conventional therapies but also provides a full range of complementary treatment options and access to multidisciplinary team support. Hospital staff members are available for nutritional consultations, spiritual support, mind–body counseling, and the latest treatments in chemotherapy, radiation, and surgery. The hospital policies are centered on a model called “Patient Empowerment Medicine,”35 in which both the patient and caregivers play an active role in treatment options. From the pain of his mother’s illness and the lack of compassionate, integrated care available for her, Stephenson recognized the opportunity for a more ethical and humane medical system. Objective 3-6

How Businesses Develop an Ethical Environment List some approaches that a company can use to develop and maintain an ethical environment.

 Rashid

Divecha has seen it all as a project manager for a major clinical laboratory: samples left on the dock over the Fourth of July weekend (thawed beyond repair), tests done with old chemicals, and reports delivered late and incomplete. But Divecha knew he’d really be in hot water with a client when a lab technician walked in on Friday and announced that three key samples from the testing for a major client were missing. The results for those samples were critical to the report that was being delivered to the client on Monday—but now there was no proof for the U.S. Food and Drug Administration (FDA) that the samples and the data they contained had ever really existed. As Rashid pondered how to handle the situation, his e-mail in-box was filling up with demands from his supervisors not to say anything to the client until a complete “story” had been developed that would make the lab appear blameless. Some even suggested covering up the whole episode with false data. What would Rashid do? Almost every business wants to promote an ethical environment, but sometimes managers find it difficult to know how to implement this successfully. Let’s look at some different ways businesses are creating workplaces that value ethical conduct. Source: angellodeco/Shutterstock

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Looking at the Business Environment

Ethical Focus from the Start How can a business improve its own culture of ethical and responsible conduct? There are steps that businesses can take to make sure employees get off to an ethical start: • Managers can make sure a strict code of ethics and a meaningful and current mission statement are in place and that both are clearly communicated to employees when they start working at an organization. The code of ethics and mission statement should be posted throughout the workplace. • A company can offer orientation programs to new employees to inform them of the ethical standards in place and the conduct expected of them from the beginning of their careers at a company. Companies should set the right tone at the beginning—show how serious they are about ethics and act with the highest regard to ethical behavior.

Ethical Focus Every Day How can a business maintain its policy of ethical conduct in the workplace? When employees are faced with unethical situations on a daily basis, adhering to a company’s code of ethics can be difficult. Business leaders must take steps to make sure that all employees are making ethical decisions. This becomes even more of a challenge during tough economic times. Companies often report trying many things to promote ethical conduct within their organizations. These efforts include having managers talk regularly with employees about acceptable and unacceptable business practices and check to determine that the code of ethics is being followed. Good managers focus on ethics themselves, setting clear examples for the behavior expected at all levels of the organization. Often, companies create a hotline for employees to anonymously report violations of the ethics code and make sure the allegations are followed up. Companies also employ ongoing ethics training programs designed to boost the awareness of their employees about ethics issues. Such training occurs at all levels of the organization. From top management that makes strategic and far-reaching decisions, to frontline managers who use their decision-making skills to put out fires, to salespeople who work with vendors and must navigate ethics questions, to lower-level employees who make decisions regarding whether to follow the advice of their leaders, all levels of employees are involved in ethics training.

Playing the Ethics Game

unique approach to ethics training is emerging in the corporate world: games. For example, Cadbury Schweppes, an international confectionery and beverage company, has created a board game called “Ethical Risk” its employees play to help bridge the gap between the values the company wants to achieve and the day-to-day decision making and practices of its managers.36 Lockheed Martin uses a computer game called “Gray Matters,” which presents a series of ethical dilemmas. Group discussion with a facilitator leads to a better understanding of how to

on TARGET

resolve complex ethical issues.37 A school in Norway is even using the video game “The Walking Dead” to teach ethics because the characters in the zombie-filled postapocalyptic world depicted in the game often find themselves faced with ethical decisions.38 Many other companies offer selfpaced online training in ethics awareness issues. The use of multimedia and a gaming environment promotes a stronger dialogue and builds insight into the practical ways to address the complex issues of corporate ethics and social responsibility.

ChAPTER 3

Of course, private-sector businesses are not alone in wanting ethics training programs for their employees. State and government organizations face similar challenges. Many law enforcement agencies—including local police, state police, and the FBI—have ethics training programs to help officers deal with cases in which there may be no clear ethical response.39 For example, when an officer responds to a domestic disturbance call but decides no crime has been committed, does he or she have a responsibility to try to prevent a potential escalation into a future criminal incident? By discussing, role-playing, and writing about these scenarios, the officers are more prepared for the ethical dilemmas facing them on the job.

 Developing an ethical environment involves implementing several components and often requires a concentrated investment of time and resources. However, it remains a priority for most businesses. Think back at Rashid’s story. What did he decide to do? Although he was pressured by his supervisors not to say anything to the client until a complete “story” had been developed, Rashid knew how he would want to be treated and was willing to live up to his personal ethical beliefs even in this crisis. In doing so, he set an example for his own employees to emulate. Next, he went looking for the company’s stated procedure for the ethical handling of a corrective action like this. It turned out there was no such document at his facility, but the company’s Salt Lake City lab had a corrective procedures document, so Rashid obtained a copy of it. He then began a series of interviews with all the employees involved, not as a hunt to place blame but with a clear message of improving lab performance. Some practices were identified that needed to be changed—for example, scientists often just walked into the lab and took samples they wanted for their own research. It also became clear there was one employee who had been involved in several instances of sample mishandling. It was never proven whether this was as a result of incompetence or unethical conduct, but the employee was given a performance-improvement plan to help train him and monitor and improve the situation. As these results were communicated to the client, its trust in the lab began to grow again. Rashid’s supervisors saw the value of being of honest and up front with the client, and the firm’s policies were modified formally.

Ethics in Business

Chapter 3

summary 3-1

Describe ethics and the systems of ethical conduct, and illustrate how someone can create a personal code of ethics.

• Ethics are the moral choices people make. • Ethical systems include the following: • Moral relativism, a perspective that holds that there is no universal moral truth but instead only individuals’ beliefs, perspectives, and values • Situational ethics, which encourages people to make ethical decisions based on the circumstances of a particular situation, not on fixed laws • Systems defined by religious traditions, such as Judeo-Christian ethics, which refers to the common set of basic values shared across both Jewish and Christian religious traditions

3-2

Explain how personal ethics might play a role in the workplace and what resources one may use to evaluate a company’s ethical code.

• Determine your base character.

• A strong CSR plan allows a company to serve its local and global communities well. It also benefits a corporation in direct and indirect ways. • Companies must balance their moral and ethical obligations to consumers with their need to respond to investors and produce a profit. • It’s also important for companies to show a strong commitment to their employees (by ensuring workplace safety), the local community (by responding to community needs), and all the countries in which they operate (by upholding human rights policies). At times, it can be difficult to balance these commitments with the need to ensure that the business remains financially successful.

3-4

Summarize how legal compliance affects ethical conduct, and describe some strategies a company can use to recover from ethical lapses.

• Think about how your behavior reflects these beliefs.

• Legal compliance refers to conducting a business within the boundaries of all the legal regulations of that industry.

• Now think about where your beliefs and view of your character come from. Why do you hold these beliefs?

• Companies that establish and adhere to high ethical standards are more likely to maintain legal compliance.

• Having a strong ethical foundation can help you achieve success in business and greater happiness in life.

• A company can work to find a leader who will set an example of the new ethical image of the company.

• In the modern workplace, there is less distinction made between how you conduct yourself inside and outside the office. Telecommuting is one instance when a person’s employer may influence how an employee behaves at home. Conduct on social media sites can also influence a person’s workplace, even though it happens outside of work.

• A company can restructure its internal operations to empower all employees to consider the ethical implications of decisions and feel free to speak up when they have concerns.

• List all the beliefs that influence your decision making.

• Conflicts can emerge when your personal ethics are different from those of your company.

3-3

• Some companies may have a written code of ethics, or a statement of their commitment to certain ethical practices. • Many companies have a public mission statement that defines the core purpose of the organization and often describes its values, goals, and aspirations.

• Corporate social responsibility (CSR) consists of five major areas: employment standards, ethical sourcing, marketing issues, environmental concerns, and community policies.

• A company can redesign its internal rewards.

3-5

Identify ways in which companies can apply ethical standards to create new business opportunities.

• While some businesses are tackling ethical issues and offering consumers more ethical choices through their businesses, others are attempting to reduce the impact they have on the environment.

3-6

List some approaches that a company can use to develop and maintain an ethical environment.

• Managers can make sure a mission statement is in place and set clear examples for the standards of behavior expected at all levels of the organization. • Companies can offer orientation programs to new employees to inform them of the ethical standards in place. • Ethics training programs can boost the awareness of employees about ethics issues.

ChAPTER 3

Ethics in Business

Key terms amoral behavior code of ethics corporate philanthropy corporate social responsibility ethics ethics training program Judeo-Christian ethics

legal compliance legal regulations mission statement moral relativism personal ethics price fixing situational ethics

social audit socially responsible investing sustainability unethical behavior whistle-blower

MyBizLab To complete the problems with the

, go to EOC Discussion Questions in the MyBizLab.

self test Multiple Choice You can find the answers on the last page of this text. 3-1 The study of moral principles is

3-5 A business is in legal compliance if

a. Christianity.

a. it follows all the laws of which it is aware.

b. ethics.

b. it cannot be proven guilty of violating any laws.

c. CSR.

c. it meets all local, state, and federal regulations.

d. philanthropy.

d. it hires only employees who do not have criminal records.

3-2 A corporation can behave in a socially responsible way by

a. having strong policies in place to help the community. b. acting to reduce the negative impact a company has on the environment.

3-6 Amoral behavior is a. any illegal activity. b. not caring about the moral consequences of your action.

c. being truthful with consumers in its market.

c. when a person has a strong conviction behind their actions.

d. All of the above

d. a part of most religious traditions.

3-3 Employees can be sure their behavior out of the office

a. has no impact on stockholders. b. cannot impact their career if they blog under a fake name. c. matters to employers only during the hours they are officially telecommuting. d. None of the above

3-4 CSR can be measured by

3-7 Socially responsible investing (SRI) means that you are investing in

a. companies making the largest gains in profit for the past three years. b. only companies that meet a certain standard of CSR. c. only nonprofit companies. d. companies that sponsor food banks.

3-8 Ethical sourcing means that

a. a company’s rate of growth.

a. people should make ethical decisions based on a particular situation.

b. organizations that monitor and rank performance on social issues.

b. there is one accepted source for guiding ethical decision making.

c. the happiness level of employees in a company.

c. a company follows accepted conduct when acquiring raw materials from suppliers.

d. businesses that have high profit margins and gross sales.

d. companies will not work with international suppliers.

PART onE

Looking at the Business Environment

3-9 Which of the following strategies is not designed to help a company recover from an ethical lapse? a. Ensuring whistle-blowers face legal consequences b. Working to find a leader who will set an example of the new ethical image of the company

True/False You can find the answers on the last page of this text. 3-11 A mission statement details the plans of how a company will achieve profitability.

True or

False

c. Restructuring internal operations to empower all employees to consider ethical implications of decisions and allowing them to feel free to speak up when they have ethical concerns

3-12 Minimizing a company’s carbon footprint is part

d. Redesigning a firm’s internal rewards—for example, restructuring the incentive package for sales employees so there’s a financial reward for building relationships with clients rather than just closing a sale

3-13 Ethics is the study of the general nature of morals

3-10 The practice of corporate philanthropy a. is only a marketing strategy. b. can build stronger relationships with employees and the community at large. c. states that success can be found by competing fiercely to provide the lowest price. d. is a strategy that works only in certain segments of industry where there is a lot of media attention.

of a plan to increase corporate philanthropy.

True or

False

and the specific moral choices a person makes.

True or

False

3-14 Price fixing is when a group of companies get together and decide to drop prices to make up for scarcity in the market.

True or

False

3-15 A weak ethical focus in a company allows it to

compete more aggressively and guarantees higher profits.

True or

False

Critical Thinking Questions 3-16 Do you believe being ethical will lead to a better quality of life for you? Do cheaters win in the real world, or does ethical conduct lead to a more satisfying outcome? Are there times you would be willing to compromise your ethics for business gain? 3-17 Which of the five pillars of CSR seems the most important to you? How do the five areas relate to each other?

3-18 How should companies respond to government request to break their own security systems. Apple has had numerous requests from law enforcement to break into iPhones confiscated in criminal and terrorism cases. Can Apple be forced to provide a “backdoor” allowing government agencies to defeat the security they have designed into their products?

team time ONE ISSUE, THREE SIDES Divide into three teams, one to represent each of the following: a. Pharmaceutical company executives b. People with a catastrophic but treatable illness c. People identified as having “unique” DNA

Scenario Are there some things that can’t be owned? Leukemia patient John Moore would answer yes. After Moore had his cancerous spleen removed at the University of California–Los Angeles, the university kept the spleen and was eventually granted a patent for DNA removed from the organ. The value of the DNA was estimated to be more than $1 billion. When Moore demanded his cells from his spleen be returned, the California Supreme Court ruled against him, saying that

ChAPTER 3

Ethics in Business

team time (continued) he had no right to his own cells after they had been removed from his body. Pharmaceutical researchers, like those at the University of California, often hope to later license the DNA patterns or sell them to other companies so they may use them to develop drugs or tests for the presence of disease. Does a person or a group of people who have a specific, perhaps unique gene have ownership of that genetic information? Do they deserve payment? Do they have a right to a voice in the use of their genetic material? Or are their interests trumped by the value of such discoveries to the greater good?

Process Step 1. Record your ideas and opinions about the issue presented in this sce-

nario. Be sure to consider the issue from your assigned perspective.

Step 2. Meet as a team and review the issue from multiple perspectives. Discuss

together what one best policy could be developed to address the concerns of all three groups.

Ethics and corporate social Responsibility PERSONAL AND BUSINESS ETHICS As you’ve learned, sometimes a person’s personal code of ethics does not fall within the code of ethics used in his or her profession. What is your personal code of ethics? What profession do you hope to have in the future? How does your personal code of ethics match the code of ethics used in that profession? Would you be willing to ignore your personal ethical code for business?

Process Step 1. Draft your personal code of ethics. Use the steps for analyzing one’s own

ethical system outlined at the beginning of this chapter.

Step 2. Think about a profession you’d like to have in the future. Visit a website

describing the code of ethics employed in this profession.

Step 3. Compare your personal code of ethics to the profession’s code of ethics.

Then write a paragraph explaining how the two codes compare.

Web Exercises 3-19

Government’s Role in Happiness The country of Bhutan is the only country that measures its progress by the level of happiness of its citizens, a metric named the gross national happiness (GNH). Examine www.grossnationalhappiness.com and see if you think the idea of a GNH measurement can be incorporated into organizational decision making.

3-20

Identifying Your Strengths Visit the website of Martin Seligman, a psychologist who promotes the field of positive psychology, at www .authentichappiness.sas.upenn.edu. Complete the VIA Survey of Character Strengths. Consider how you can use your strengths each day in the work schedule you have right now.

86 3-21

3-22

PART onE

Looking at the Business Environment

Socially Conscious: How Do Your Investments Measure Up? When you invest in mutual funds, you can make decisions in different ways. You may want to just put money into funds that had the greatest gain last year, or you may want to invest in funds that are collections of socially responsible companies. Find several socially conscious mutual funds. What restrictions do they make on the companies they include? What is their average rate of return? Whistle-Blower or Traitor? Worldwide repercussions were felt when Edward Snowden released thousands of classified documents showing that the National Security Agency was running an international surveillance program. Snowden was charged with espionage and theft and fled the country. Find supporting evidence for both points of

view—that Snowden committed espionage and endangered the country and that his actions were in the interest of the citizens of the United States. Does whistle-blowing include illegal behavior? Should he be convicted or pardoned? 3-23

Corporate Social Responsibility with Your Prescription CVS Pharmacy has made the decision to stop selling cigarettes and other tobacco products, even though it earns an estimated $2 billion a year from these products. Visit the CVS Caremark website and examine its Code of Conduct and statements on corporate responsibility. Discuss how this decision could be presented to customers, to stockholders, and to employees. How should a pharmacy balance the health needs of its customers with the business demands of its stockholders? In what ways could this decision increase profitibility?

MyBizLab Go to the Assignments section of your MyBizLab to complete these writing exercises. 3-24 How do your personal ethics impact your business decisions? How do they influence what products you decide to purchase? How do they influence your decisions around employment? How do you evaluate the ethical behavior of companies to compare them to your personal ethics? 3-25 How does a corporation’s responsibility to shareholders to produce a profit interact with its social responsibility? Name several areas of possible conflict and analyze them from both a short-term and a long-term view.

References 1. “Ethics,” The Oxford Dictionary (Oxford: Oxford University Press, 2016), www.oxforddictionaries.com/us/definition/ american_english/ethics. 2. University of Pennsylvania Positive Psychology Center, “Authentic Happiness,” www.authentichappiness.sas. upenn.edu/. 3. Ann Pomeroy, “The Ethics Squeeze,” HR Magazine, March 2006, 53. 4. Renae Merle, “Boeing CEO Resigns over Affair with Subordinate,” Washington Post, March 8, 2005, www.washingtonpost.com/wp-dyn/articles/A13173-2005Mar7 .html?nav=rss_topnews. 5. From Pomeroy, “The Ethics Squeeze,” 53. 6. From Pomeroy, “The Ethics Squeeze,” 53. 7. “Once a Whistleblower,” March 11, 2014, www.wcpo.com/ news/local-news/once-a-whistleblower-embezzler-theman-who-inspired-the-informant-talks-redemption-in-cincy. 8. Fetzer Vineyards, “Fetzer Vineyards Philosophy,” March 14, 2016, www.fetzer.com/committment, reprinted with permission of Fetzer Vineyards. 9. Boston College Center for Corporate Citizenship, March15, 2016.

10. Miller, Chance. “New Investigation Claims Apple’s Battery Suppliers Use Cobalt Mined by Child Labor.” 9to5Mac. AAPL Company, 18 Jan. 2016. Web. 15 Mar. 2016. 11. T. Webb, “Case Study: Chiquita,” May 23, 2013, www.slideshare.net/Tobiaswebb/ chiquita-case-study-from-octopus-to-csr-pioneer. 12. Brave New Films, “Citations of Statistics Used in the Film,” www.walmartmovie.com/. 13. The Corporation, “Who’s Who,” www.thecorporation .com. 14. Chroma Technology Group, “Chroma Wins Worldwide Award for Democracy in the Workplace,” www.chroma.com/newsevents/articles/ chroma-wins-worldwide-award-democracy-workplace. 15. Chroma Technology Group, “Being Their Own Bosses,” www.chroma.com/newsevents/articles/ being-their-own-bosses. 16. Time Warner, “Citizenship,” www.timewarner.com/corp/ citizenship/index.html. 17. Target, “Community Outreach,” http://sites.target. com/site/en/company/page.jsp?contentId=WCMP04031700&ref=sr_shorturl_community.

ChAPTER 3 18. Suzanne Vranica, “Twitter Crowns Wendy’s Promo as ‘Most Retweeted,’” Wall Street Journal, December 8, 2011, http://blogs.wsj.com/digits/2011/12/08/ twitter-crowns-wendys-promo-as-most-retweeted. 19. World Health Organization, “Global Health Observatory,” January 2015, www.who.int/gho/hiv/epidemic_status/ deaths_text/en. 20. World Health Organization, “World Malaria Report 2015,” http://www.who.int/malaria/publications/ world-malaria-report-2015/report/en/. 21. Intel, “Corporate Responsibility Report,” www.intel.com/ intel/corpresponsibility/awards.htm. 22. Linda Kaplan and Robin Koval, The Power of Nice: How to Conquer the World with Kindness (Crows Nest: Allen & Unwin, 2007). 23. Kaplan and Koval, The Power of Nice. 24. Val Lush, “Consumer Bill of Rights,” www.bookrags.com/ research/consumer-bill-of-rights-ebf-01. 25. British Petroleum, “BP Establishes $20 Billion Claims Fund for Deepwater Horizon Spill and Outlines Dividend Decisions,” June 16, 2010, www.bp.com/genericarticle .do? categoryId=2012968&contentId=7062966. 26. Data from Enron’s Corporate Responsibility Annual Report, 2000, www.corporateregister.com/a10723/enr00-cr-usa.pdf. 27. “Ponzi Scheme,” www.merriam-webster.com/dictionary/ ponzi%20scheme. 28. “Malaria Prevention,” The Medical News, © 2007. All rights reserved. Used with permission. 29. Steven Musil, “Week in Review: Google Slams China Censorship,” http://news.cnet.com/8301-1001_310435702-92.html.

Ethics in Business

30. D. Rushe, “Bing Censoring Chinese Language Search Results for Users in the U.S.,” February 11, 2014, www.theguardian.com/technology/2014/feb/11/ bing-censors-chinese-language-search-results. 31. Alex Fitzpatrick, “Google, Facebook Censor Themselves in India after Court Order.” Mashable. Web. 15 Mar. 2016. 32. Interface, Inc., “Our Progress,” www.interfaceglobal.com/ Sustainability/. 33. Interface, Inc., “Groups,” http://www.interfaceglobal .com/company/mission-vision.aspx, 16 Mar. 2016. 34. Starbucks, “Being a Responsible Company,” www .starbucks.com/responsibility. 35. Cancer Treatment Centers of America, “CTCA Quality Story,” www.cancercenter.com. 36. Mark Young, “HR as the Guardian of Corporate Values at Cadbury Schweppes,” Strategic HR Review 5, issue 2 (2006),: 10–11. 37. “Lockheed Martin Gray Matters Ethics Game,” http:// www.lockheedmartin.com/us/who-we-are/ethics/ training.html, 16 Mar. 2016. 38. K. Akash, “Walking Dead Video Game Used in Norway to Teach Ethics and Morality,” January 18, 2014, www .ibtimes.co.uk/walking-dead-video-game-used-bynorwegian-school-teach-students-ethics-morality-1432832. 39. International Association of Chiefs of Police, “Ethics Training in Law Enforcement,”www .theiacp.org/PoliceServices/ExecutiveServices/ ProfessionalAssistance/Ethics/ReportsResources/ EthicsTraininginLawEnforcement/tabid/194/Default .aspx.

Chapter 4

Business in a Global Economy OBjEctivEs 4-1 What Is Globalization?

Identify the implications of the globalization of markets and production, and explain why globalization has accelerated so rapidly. Devin Kay always “buys American”—but what does that mean in the new global marketplace?

4-2 International Trade

Discuss the costs and benefits of international trade. As foreign companies begin to compete in U.S. markets, there is more competition and more pressure on U.S. businesses. What are the benefits of international trade? What are the costs?

4-3 Free Trade and Protectionism Describe the different types of trade barriers.

Trying to compete in the world marketplace means using every resource available. So when the members of the family who operate the Miller farm found that genetically modified organisms (GMOs) helped boost the farm’s crop output, they were thrilled. Now, however, they have discovered they can’t sell their crops in 28 countries because they used GMOs. How do free-trade agreements affect businesses and members of a community?

4-4 Conducting Business Internationally

Explain the three basic strategies of international business, and describe how international firms successfully enter foreign markets. When you’re conducting business internationally, many factors come into play. What are the

strategies of international business? How can you enter a foreign market? Which entry mode is best? Hachimo Isu needs some answers before he expands his business.

4-5 International Business: Economic Factors and Challenges Define exchange rates, explain how they affect international business, and discuss the economic factors that play a role in conducting global business.

Economic factors affect what products get imported and exported. Exchange rates both encourage and deter countries from trading with one another and therefore have a big impact on imports and exports. Business owners like Rachel Gao, who sells jewelry, want to import goods from countries with favorable exchange rates. How do exchange rates affect the bottom line of Rachel’s business, and how do they affect a nation’s economy overall?

4-6 Creating Successful International Businesses

List sociocultural, political, legal, and ethical challenges to conducting business in a global marketplace. How would you feel if a potential client from Venezuela wouldn’t sign a contract with you because you didn’t pat him on the shoulder when you first met? Joe Stein lost one account that way. He now thinks he may lose another by accepting and opening a gift from a client in India. What challenges does Joe face there? Is there a problem accepting and opening a gift when it’s received? Knowing the answers to such questions is vital to running a successful global business.

CHAPTER 4

Objective 4-1

What is Globalization? Identify the implications of the globalization of markets and production, and explain why globalization has accelerated so rapidly.

 Devin Kay is a worldly guy who has traveled globally. But he is loyal to U.S. products and tries to buy American whenever he can. For example, Devin wouldn’t dream of buying a car like an Italian Maserati. “Italian car? Never! I’d rather buy a good ol’ American Jeep,” he says. When he vacations, he chooses to take a weekend getaway in Manhattan rather than spending money to vacation abroad. He believes high tariffs on foreign products sold in the United States are a good idea because they make products more expensive relative to U.S. products, which then sell better. “The world is a tough place, and we should do whatever we can to give American companies an edge,” he tells his friends.

Source: vege/Fotolia

Former President Bill Clinton once said, “Globalization is not something we can hold off or turn off … it is the economic equivalent of a force of nature—like wind or water.”1 In recent years, the rise of globalization has made a dramatic impact on the lives of people around the world. The United States and other nations are increasingly importing, or buying products from other countries, and exporting, or selling domestically produced products to other countries. People from the United States to Taiwan to Argentina are interconnected and dependent on one another for a variety of goods and services.

Many products we own were made in countries other than the United States. If you inspect the items you buy, such as laptop computers, clothes, and cars, you will see that many of them and their parts are manufactured in other countries. ◼ FIGURE 4.1 shows how Ford cars, which many people think are made in the United States, are comprised of components manufactured in other countries or are assembled outside the United States. Even relatively small companies are marketing their products to the United States and vice versa. What can people do to enhance their country’s ability to compete in the global economy? What can a country do to provide good-paying jobs for its citizens? How can U.S. companies increase their profitability in the face of foreign competition at home or enhance their market share overseas? When the U.S. dollar

ThE LIST

Powerful People to Know

Do you know every name on this list? 1. Hu Jintao

6. Dilma Rousseff

2. Angela Merkel

7. Abdullah bin Abdu Aziz al Saud

3. Jim Yong Kim

8. Tenzin Gyatso

4. Sergey Brin and Larry Page

9. Narendra Modi

5. Carlos Slim Helu

10. Christine Lagarde

PART one

Looking at the Business Environment Stereo and other key electrical components manufactured in Japan

is stronger or weaker than the currencies of other countries, how does it affect business in the United States? After studying this chapter, you’ll be able to answer these questions.

The effects of Globalization How does globalization affect the United States? The old saying “No man is an island” can be used to describe globalization. Globalization, the movement toward a more interconnected and interdependent world economy, may be one of the most profound factors affecting people in the United States and around theglobe. Why is this? Whatever Ford car happens today in the U.S. economy—the assembled world’s largest economy—will have a in Canada Transmission significant impact on people not only in the Engine made in produced in Mexico Unites States but also worldwide. Meanwhile, Detroit, Michigan economic conditions in other countries also affect the U.S. economy, producing changes and challenges for U.S. consumers, businesses, and workers. One example of this can be seen in the booming economies of India and China. Their growth is a major reason for the increasing global demand for energy. Increased energy demand is a major cause of the Seats made in Dash and other plastic world’s rising oil prices, which have created Great Britain components manufactured higher prices at the gas pump for people in China around the world. As a result, people have less money to spend on other things, such as eating out. Local restaurants and ◼ FIGURE 4.1 businesses feel the pinch, so their sales fall, and they must curtail their production Made in the USA? Many brand-name products are comand lay off employees. Higher energy prices can also drive up production costs, posites of components manufactured which, in turn, drive up the prices businesses must charge for products. around the world. For example, most people think that Ford cars are made in the United States. But is it really “made in the USA” if most of its components are manufactured in other countries or it is assembled outside the United States? Images sources, clockwise from top, then middle: Daboost/Fotolia; Mrr/Fotolia; Daboost/Fotolia; Daboost/Fotolia; Daboost/Fotolia; Daboost/Fotolia

How does globalization offer more marketing opportunities to businesses? Globalization has two main components: • The globalization of markets • The globalization of production The globalization of markets refers to the movement away from thinking of the market for your products as being local or national and the entire world instead. This offers incredible new opportunities for businesses. Companies such as General Electric (GE), Dell, and Toyota are not just selling to customers in Dallas or Atlanta, or Japan or Europe; they’re selling to customers all over the globe. For example, all auto manufacturers are looking to sell their vehicles in China. Why China? Because more than 1.3 billion consumers live there. That’s more than quadruple the number of consumers who live in the United States. When it comes to doing business abroad, most marketing experts advise firms to “think globally and act locally.” In other words, companies should adjust their products or marketing campaigns to suit the unique tastes and preferences of their local customers, wherever they may be. For example, Coca-Cola often must tweak its recipes to appeal to the tastes of consumers in different parts of the world. In India, Coca-Cola adapted its Minute Maid orange soda recipe to suit the tastes of people there, most of whom prefer a sweeter version of the drink than the version sold in the United States.2 Similarly, many foreign-owned companies advertise or adapt their products for sale in the United States to attract consumers here.

ChAPTeR 4

How does globalization make it easier to manufacture products? The globalization of production refers to the trend of moving a firm’s production to different locations around the globe to take advantage of lower costs or enhance the quality of products. Outsourcing is often part of the globalization of production. Outsourcing is the assignment of certain tasks, such as production or accounting, to an outside company or organization. Currently, much outsourcing is offshore outsourcing (or offshoring), which involves moving production from a domestic site to a foreign location. In addition, companies may decide to relocate at least some of their own production facilities to other countries where production costs are lower.

Reasons for the Rise in Globalization Why has globalization accelerated so rapidly? Two main factors underlie the trend toward greater globalization: • A dramatic decline in trade and investment barriers. Trade and investment barriers are government restrictions that prevent the flow of goods, services, and financial capital across countries. Lowering trade barriers makes global business cheaper and easier to conduct and allows a firm to move its different production activities to the lowest-cost locations. For example, a firm might design its product in one country, produce parts for it in two or three other countries, assemble the product in yet another country, and then export it around the world. • Technological innovations. Advances in technology, communications, and transportation have made it possible to better manage the global production and marketing of products. Using web conferencing tools, a business manager in New York can meet with contacts at a firm’s European and Asian operations centers without ever leaving the office. This has significantly reduced the cost of doing business. Technological advancements are a great equalizer for small companies, enabling them to inexpensively access customers worldwide through their websites and effectively compete with huge global corporations. The globalization of production has resulted in some international firms becoming so large that they actually generate more revenue than the gross domestic product of many nations. As you can see in ◼ FIGURE 4.2, several U.S. companies rank above many countries in the world in terms of the total revenue they generate.

Global Business Trends Where will trends in global business take us? Some noteworthy global business trends likely to continue are as follows: • A growing role for developing nations. Over the last several decades, developing countries, including China, India, and Brazil, have been expanding rapidly. This trend is expected to continue as countries like these increase their presence on the world economic stage. • A rise in non-U.S. foreign direct investment. Previously, the United States was the world’s leader in terms of foreign direct investment, which is the purchasing of property and businesses in foreign nations. Now many other countries are investing in businesses abroad, including businesses and property located in the United States. You might think of Budweiser as a U.S. company, but did you realize that it was purchased by the Dutch firm In-Bev? Not only is more foreign direct investment flowing into the United States than ever before, but more and more foreign direct investment is flowing into developing nations. • A rise in multinational enterprises. Over the last several decades, there has been a rise in the importance of multinational enterprises, businesses that manufacture and market products in two or more countries. Moreover, mini-multinationals (small- and medium-sized multinational enterprises) have

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◼ FIGURE 4.2 Company Revenue versus National Incomes Today some international businesses are larger than entire countries in terms of the revenue they generate. Source: Data from vincent trivett, “25 Mega corporations: Where they Rank if they Were countries,” Business Insider, june 27, 2011. www.businessinsider.com. © Michael R. Solomon. Image sources, clockwise from top left: © General electric inc.; © costco Wholesale corporation; Logo of Walmart Stores, inc.; © Apple inc.

SUDAN

NEW ZEALAND

Costco is bigger than the Sudan

GE is larger than New Zealand

NORWAY

ECUADOR Walmart outperforms Norway

Apple is bigger than Ecuador

become prominent on the world stage. Consider Transferwise, a company that allows people to electronically transfer money between accounts in different countries quickly and at much lower rates than what banks offer. By using technology to change how international banking is done, Transferwise has been able to expand its services abroad rapidly. • Increasing democratization. With the movement toward democratization and the adoption of free-market economies around the globe, many more nations are becoming involved in the global economy. If this trend continues, the opportunities for international business will be enormous as the global marketplace expands and more locations open as potential production sites.

 Remember Devin? Because of globalization, he is probably finding it difficult to buy “only American” products. Today, the Maserati he would never buy is owned by the Italian carmaker Fiat, which owns part of the Chrysler Group, which produces U.S. Jeeps. And his vacation in New York City? More than one-tenth of all the goods and services produced in New York and 1 in 20 jobs are supplied by companies controlled by foreign investors.3 And although Devin argues that tariffs will protect U.S. products, most economists today believe that tariffs reduce a nation’s trade and hamper its economy, which can lead to the loss of domestic jobs.

ThE LIST

Countries in Which It Is Easy to Start a Business

1. New Zealand

6. Hong Kong

2. Australia

7. Georgia

3. Canada

8. Rwanda

4. Singapore 5. Macedonia

9. Belarus 10. Ireland

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Objective 4-2

international trade Discuss the costs and benefits of international trade.

 Thom McGovern runs a successful textile manufacturing firm. The business was started by his father and has grown every year since Thom took over. The firm creates high-quality clothing products sold to retail stores. Thom’s company is a dependable supplier with many satisfied customers. Over the past several years, though, high-quality foreign clothing has been showing up in the U.S. market in greater numbers and selling at prices far below anything Thom can match. Slowly, his customers are switching to other suppliers. Thom could drop prices to his customers and increase his company’s profits if he offshored his production. But that would mean he would have to lay off his employees. What should he do? Economists argue that international trade flourishes because it is in the best interest of the country as a whole. However, competition in the international market often puts new pressures on domestic businesses like Thom McGovern’s firm unless they find ways to keep up with the high-quality and low-cost products that international trade provides. Let’s take a closer look at why countries participate in international trade, how trade affects a firm’s competitiveness, and what costs and benefits are associated with international trade. Source: wavebreakpremium/Alamy Stock Photo

International Competition What is the theory of comparative advantage? Many theories apply to international trade. The most popular theory is the theory of comparative advantage, which states that specialization and trade between countries benefit all who are involved. If this method is practiced, each nation will have a greater quantity and variety of higher-quality products to consume at lower prices. For this mutually beneficial system to work, each country must specialize in the production of those products for which it possesses a comparative advantage—that is, produce the goods and services it can produce relatively more efficiently compared to other countries. A comparative advantage should not be confused with an absolute advantage, which is the ability to produce more of a good or a service than any other country. Just because a large country can produce more of a good than a small country can doesn’t necessarily mean it is relatively more efficient at producing that good. What matters is relative efficiency, or comparative advantage—not absolute advantage. When all countries focus on producing products for which they have a comparative advantage, collectively they all have more production to share. This, in turn, creates higher standards of living for these countries. As you’ve probably guessed, countries export products for which they have a comparative advantage and import products for which they do not have a comparative advantage.

Fostering Competitiveness What can a country do to have an edge in world markets? Governments often focus on improving their nations’ competitiveness by improving their resources— natural resources, labor, capital (plant, equipment, and infrastructure), technology, innovation, and entrepreneurialism. A nation can only do so much to improve its natural resources, however; it has to work with the natural resources with

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which it is endowed. Nations with abundant natural resources will likely have a comparative advantage in the production of goods that require these raw materials. For example, big-leaf mahogany trees are found in only a few countries, including Mexico and Belize. So, these countries have a comparative advantage in the production of mahogany furniture and musical instruments made from mahogany. However, governments can and do invest in health, education, and training designed to increase the productivity of their labor forces. All international businesses are constantly looking for good workers, and each country wants to attract businesses to enhance the employment opportunities for its citizens. Investing in education programs, entrepreneurial classes as well as vocational training and apprenticeships develops an attractive workforce. As well, countries compete to attract foreign students, many of whom choose to stay in the country where they finish their education. Many governments try to create incentives to attract the investments made by private companies, such as investments in plant and equipment. One way to do this is for a government to try to keep interest rates low so that private companies will invest in the latest state-of-the-art equipment, thereby giving them an edge over foreign competition. Governments also invest in public capital, which is sometimes called infrastructure. Infrastructure includes roads, bridges, dams, electric grid lines, and telecommunication satellites that enhance productivity. Governments also try to promote technological advances to give their nations a competitive edge. This can include investments in basic and applied research at state-funded higher-educational institutions. Finally, governments also promote innovation and entrepreneurialism. In countries like Korea, France, and Norway, there are few women entrepreneurs.4 To close the gap in Norway, the government there created an action plan to increase grant accessibility for female entrepreneurs. The objective is to have women own at least 40 percent of entrepreneurial businesses.5 On the flip side, sometimes governments use trade restrictions and added tariffs on goods from other countries to create an artificial competitive advantage. We’ll discuss these practices later in the chapter.

When foreign imports arrive in the United States, they increase the supply of a product, pushing its price down. Consumers welcome competition and lower prices, but domestic competitors aren’t pleased. Source: Universal images Group/Universal images Group/Getty images

What can businesses do to be more competitive? To be competitive, businesses must grapple with many of the same issues nations trying to be more competitive do. That is, successful companies try to gain access to cheap raw materials, invest in their workers’ training and productivity, and purchase state-of-the-art plants and equipment that will give them an edge. Successful companies also invest in cutting-edge technology in their research-and-development departments. Finally, they promote innovativeness throughout their organizations. Conversely, if a company, an entire industry, or even a nation has lost its competitive advantage, then it probably failed in one or more of these areas. For example, at one time, the U.S. steel and textile industries had a competitive advantage in the world. Today, however, those industries have fallen behind their international competitors. It is the joint job of government and private businesses to determine the ways to improve to compete more effectively.

The Benefits and Costs of International Trade What are the benefits and costs of international trade? The theory of comparative advantage indicates that countries that participate in international trade will experience higher standards of living because of the greater quantity and variety of higher-quality products offered at lower prices. These results stem from the increased competition associated with more open trade. But these benefits are not without their costs. The costs of international trade are borne by those businesses and their workers whose livelihoods

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are threatened by foreign competition. Some domestic businesses may lose market share to foreign companies, stunting their profitability and ability to create jobs. Other firms may face so much foreign competition that they’re driven out of business entirely. Do the benefits of international trade outweigh the costs? This is a difficult question to answer. The costs of increased international trade—including lost jobs to foreign competitors—are often easy to identify. The benefits are not always easily seen, however, as they are spread out among millions of consumers. One measure used to quantify a country’s international trade is the balance of payments (BOP). The BOP summarizes all of the transactions—payments, financial aid, and gifts— that take place between residents of a country and the external world. However, one number does not express the complexities of international trade. For example, a greater quantity and variety of higher-quality products to purchase may not be easily traced to increased international trade because these benefits are often slow and subtle. Price reductions may save people only a nickel here and a dime there. But the sum of these lower prices for the public as a whole can be dramatic—especially over time. As we’ll see in the next section, governments play a large role in determining how much international trade they will support, for example, by choosing to impose restrictions on the quantity and types of goods that can cross their nations’ borders.

 We

started this section by discussing Thom McGovern’s textile business, which was struggling to compete against foreign competition. Did Thom just close up shop, or did he adapt to the pressures and take advantage of the opportunities of globalization? As company president, Thom chose to invest in new equipment and training for his workers to try to gain a competitive advantage. He also began acquiring lower-cost raw materials from foreign suppliers, a process the Internet has made easier to coordinate. Finally, he investigated new markets for his specialty products and is expanding into countries like India and China. Thom is not sure what his company will look like in five years, but he is sure that the globalization of the world marketplace will result in both challenges and opportunities.

Objective 4-3

Free trade and Protectionism Describe the different types of trade barriers.

 Farming

has changed, and the Miller farm has always changed with the times. A few years ago, the Millers began using genetically modified organisms (GMOs) to grow crops that are more resistant to frost and improve their farm’s output. But recently, the European Union (EU)—a major group of European countries—issued a new health directive: To be eligible for sale in the EU, any product meant for human consumption could not contain any GMOs. The Millers worry that the manufacturers they sell to in these countries will no longer do business with them. Countries implement trade barriers for a variety of reasons. Sometimes, trade barriers are implemented to protect consumers. Other times, trade barriers are established to protect domestic businesses from international competition. Many people believe that such protectionist trade barriers are the best way to

Source: Dvarg/Fotolia

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defend a nation’s economy; others are in favor of free trade. Free trade refers to the unencumbered flow of goods and services across national borders. That is, free trade is free from government intervention or other impediments that can block the flow of goods across borders. The vast majority of economists recognize that the benefits of free trade far outweigh the costs for a nation. However, some people—especially those who feel their livelihoods are threatened by free trade—are not convinced. In this section, we’ll examine both sides of this debate.

Types of Trade Barriers What trade barriers can governments put in place? As ◼ FIGURE 4.3 shows, there are three types of trade barriers:

◼ FIGURE 4.3 Trade Barriers Countries use these strategies to make it more difficult for foreign firms to sell their products competitively. © Kendall Martin

• Tariffs and subsidies. The most common trade barrier is a tariff, a tax imposed on an imported good or service, such as a U.S. tariff on imported French wine. Governments prefer to impose tariffs because they raise tax revenues. The opposite of a tariff is a subsidy, in which a government makes payments to domestic producers. In the United States, subsidies are provided to a wide variety of businesses, including many agricultural businesses. A subsidy can take many forms. It can be a direct cash grant or a tax concession or a low-interest loan. • Quotas and embargoes. A quota is a limitation on the amount of an import allowed to enter a country. For example, a U.S.-imposed quota on French wine might limit the quantity of it that can be imported to 10,000 cases per day. The most heavy-handed government trade barrier is an embargo, a total restriction on an import (or an export). For example, the United States has imposed an embargo on most goods traded with Cuba. Embargoes are usually tools designed to achieve a political goal. In the case of Cuba, the U.S. embargo began in the 1960s when Fidel Castro adopted a one-party communist system. The embargo has been used as a tool to pressure Cuba to adopt a more democratic system of government. • Administrative trade barriers. Several other types of trade barriers can be lumped under the heading of administrative trade barriers—government rules designed to limit imports. One example is a local content requirement, which is a requirement that some portion of a good be produced domestically. This usually drives up the cost of an import. Administrative trade barriers might also require an import to meet some technical standard or bureaucratic rule, effectively shutting out the import from a domestic market. For example, the EU has banned the importation of all animal meats in which steroids were used to stimulate growth. This decision has heavily impacted the U.S. beef and dairy industries. Although administrative trade barriers can be legitimate, they may be designed purely to protect domestic producers from international competition.

Trade Barriers: Winners and Losers Quota or Embargo

Foreign goods trying to come in

Local Content Requirement

Tariffs

Who benefits and who suffers from trade barriers? Without a doubt, trade barriers benefit domestic producers and their workers but hurt domestic consumers. Trade barriers increase costs to foreign companies or restrict the supply of imports, driving up prices and reducing sales in the domestic market. As a result, higher-priced imports increase the demand for domestically produced substitute goods or services. This higher demand also increases the domestically produced product’s price, although it simultaneously increases domestic sales.

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Because domestic firms are selling more at higher prices, they are more profitable. This profitability also creates more job security for their employees. The undesirable outcome, however, is that both imports and domestically produced substitute products are now more expensive. Domestic consumers lose, whereas domestic producers and their workers gain. Trade barriers also hurt consumers because the overall quantity, variety, and quality of products are lower as a result of curtailing foreign competition. What are common arguments in favor of protectionist trade barriers? Four main arguments for and against trade barriers are as follows: • National security. The national security argument states that certain industries critical to national security should be protected from foreign competition. For example, the United States wouldn’t want to become dependent on another nation for a component critical to the nation’s defense. Critics of this argument point to the fact that few industries seeking protection fall into this category. • Infant industry. The infant industry argument states that an undeveloped domestic industry needs time to grow and develop to compete in the global economy. Once the industry has grown and is more competitive, protection from foreign competition will no longer be necessary. Opponents of this view argue that, in practice, it can be difficult to determine whether an industry legitimately holds the promise of becoming competitive. In addition, these people argue that rarely do infant industries ever “grow up.” Instead, governments continue to protect them at the expense of consumers. • Cheap foreign labor. The cheap foreign labor argument centers on lower wages paid to workers of foreign companies. This issue has become a growing concern. How can domestic companies compete with these low wages? Critics of protecting a nation’s workers against cheap labor argue that a company’s costs of production can be lower even when it pays its workers twice as much if the productivity of the workers is at least twice as high. If a country wants to maintain high wages in a global marketplace, it needs to find a way to increase the productivity of its labor force, not impose trade barriers. • Threat of retaliation. The threat of retaliation (or the bargaining chip) argument says that if a trading partner increases its trade barriers on your exports or fails to reduce trade barriers when you reduce yours, then an uneven playing field is created. For example, domestic companies are often adversely affected if a foreign firm is dumping its product. Dumping refers to selling a product at a price below its cost in a foreign country to drive competitors there out of business so you can take over the market. Dumping can be difficult to prove, however, and even harder to stop. One way to stop it is for a government to threaten to impose higher trade barriers on the imported product being dumped—in other words, to use trade barriers as a bargaining chip. The problem with this tactic, critics argue, is that it can result in a trade war if the exporting country raises its trade barriers in response. A trade war is likely to harm the economies of both countries. How do economists feel about protectionist trade barriers? Most economists believe that the best way to address the concerns of those industries and their workers whose livelihoods are threatened by foreign competition is not to impose protectionist trade barriers. Instead, these displaced individuals need to be equipped with the education, training, and skills necessary to smooth their transition into a line of business or work in which the nation has a comparative advantage and demand is rising. Although all governments have protectionist trade barriers in place, they have been working to reduce them because they believe the economic benefits of doing so generally outweigh the costs. This helps explain the recent trend toward freer trade and greater globalization. ◼ TABLE 4.1 summarizes the economic benefits and costs of free trade and protectionism for a nation.

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TABLe 4.1

economic Benefits and Costs of Free Trade and Protectionism for a nation Free Trade

Protectionism

Economic benefits

A greater quantity and variety of higher-quality products at lower prices

Increased sales at higher prices improves the profitability of protected domestic companies, creating greater job security for their workers

Economic costs

Reduced sales and lower prices for domestic firms that find it difficult to compete internationally, which reduces their profitability and lowers job security for their workers

A lower quantity and variety of lower-quality products at higher prices

International organizations Promoting Free Trade What groups are working to promote free trade? Countries realize that unilaterally reducing their trade barriers puts their businesses at an unfair disadvantage. The key for realizing the mutual benefits of international trade is to get all countries to lower their trade barriers simultaneously, which was the reason for creating organizations such as the General Agreement on Tariffs and Trade and the World Trade Organization. The General Agreement on Tariffs and Trade (GATT) was created in 1948 with 23 member nations and grew to 123 member nations by 1994. Although GATT was not an organization with any real enforcement powers, its eight rounds of negotiated agreements or treaties successfully reduced tariffs and other obstacles to the free trade of goods. Thereafter, the amount of global trade increased dramatically, as did world economic growth.6 However, GATT was not as successful in terms of reducing trade barriers on services, protecting intellectual property rights, or enforcing agreements among member nations. As a result, the World Trade Organization (WTO) replaced GATT in 1995. The WTO has strengthened the world trading system by extending GATT rules to services and increasing the protection for intellectual property rights. But, perhaps most significantly, the WTO has taken on the responsibility for arbitrating trade disputes and monitoring the trade policies of member countries.7 The WTO operates as GATT did—on the basis of consensus—when settling disputes. However, unlike GATT, the WTO doesn’t allow losing parties to ignore the arbitration reports of the WTO. The WTO has the power to enforce its decisions. ◼ FIGURE 4.4 shows which countries are members of the WTO. Can more be done to promote free trade? Advocates of free trade argue that much more can be done to reduce trade barriers. The first round of WTO meetings were derailed by antiglobalization protestors. The meetings were relaunched a few years later with the goal of curtailing dumping, reducing trade barriers, protecting intellectual property rights, and reducing government barriers on foreign direct investment.8 That round of talks was slated to last three years but started and stopped over the next fifteen years. It has been far more difficult than anyone imagined to reach concrete results. What problems can result from free trade? WTO protests reflect an ongoing concern that free trade encourages firms to shift their production to countries with low wages and lax labor standards and that the exploitation of workers in low-wage countries contributes to the gap between the rich and the poor. Environmentalists are also concerned that free trade encourages companies to move their production to countries that allow the firms to pollute the environment and emit unlimited amounts of greenhouse gases that contribute to global warming. Environmentalists highlight the fact that the economic benefits and

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World Trade Organization Membership status: WTO Member Observer Negotiating Accession

◼ FIGURE 4.4 Countries in the WTO © Michael R. Solomon

costs of free trade are not the only costs and benefits it results in. Important social, ethical, political, and environmental concerns also need to be considered.

Regional Free Trade Agreements What are regional free-trade agreements? Many nations have been so eager to achieve the higher standards of living associated with free trade that they have struck out on their own by creating their own regional free-trade agreements. Let’s look at some of the most powerful regional free-trade agreements.

The European Union The oldest and largest free trade area in the world is the European Union (EU). The EU can trace its roots to 1957 with the creation of the European Economic Community (or Common Market), which consisted of six founding countries. Although many obstacles had to be overcome, such as the concern over the potential loss of national sovereignty, the EU now includes 28 countries, as shown in ◼FIGURE4.5. Its success is as a result, in large part, of its demonstrated commitment to the free flow of goods, services, capital, and people across borders in Europe. The success of the European Union has not been without controversy. In 2016, after the pressures of large-scale immigration movements, the United Kingdom voted in referendum to leave the European Union. This “Brexit,” or British Exit, was a close vote with certain areas like London and Scotland firmly voting to remain in the EU. The procedure for the withdrawal from the EU and the long-term implications will be understood over the next several years. The immediate impact was a sharp drop in the value of the British pound as the world financial markets reacted. The EU accounts for approximately one-third of the world’s total production. It is the largest exporter in the world and the second-largest importer.9 In 1999, the EU also surpassed all other free-trade areas with respect to economic integration by adopting a common currency—the euro. The euro is currently used by 18 of the 28 countries in the EU and has become a major currency in global financial markets.10 The EU is likely to continue to grow as other countries, particularly those in Eastern Europe, apply to join the organization.

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Iceland

Finland Norway Sweden

Ireland

United Kingdom

Estonia

cS ea

North Sea

Denmark

Latvia

lti

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Lithuania

100

Netherlands Belgium Luxembourg

Atlantic

Poland

Germany Czech Rep.

ak Slov

Liechtenstein

Ocean

France

Austria

Switz. Slovenia

Italy

Portugal

Hungary Romania

Croatia

Ser

Albania

Tyrrhenian Sea

Greece

Malta

k Sea

Bulgaria

Montenegro

Spain

Blac

bia

Former Yugoslav Rep. Of Macedonia

Ionian Sea Cyprus

◼ FIGURE 4.5 The European Union The EU has 28 member countries. It is the most economically integrated free trade area in the world.*

The EU’s economic power and political clout has a huge influence on international businesses worldwide. For example, some international businesses have been motivated to invest in production facilities within the EU to hedge against any potential trade barriers. The EU has also established many legal, regulatory, and technical standards for imports to the EU market. In addition, the EU’s antitrust rulings have significantly affected U.S. businesses.

The North American Free Trade Agreement The North American Free Trade Agreement (NAFTA) is an ongoing agreement to move the United States, Mexico, and Canada closer to true free trade. NAFTA was established in 1994 after a considerable amount of political opposition. More than 20 years after the agreement, NAFTA has quadrupled the trade between the three countries. None of the worst fears about NAFTA have come to pass—there has been no huge loss of jobs to Mexico, nor has there been an enormous increase in immigration rates from Mexico. It has successfully created a regional market of over $19 million in trade. The United States participates in other free-trade agreements as well, such as the Dominican Republic–Central American Free Trade Area (DR-CAFTA) as well as agreements with Israel, Korea, and Australia.

Other Free-Trade Areas Many other free-trade areas exist in the world. The following are some of the more noteworthy examples: *At the time of this writing, the UK was still part of the EU.

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• MERCOSUR is a regional coalition of South American countries including Brazil, Argentina, Paraguay, Uruguay, and Venezuela. • The Association of Southeast Asian Nations (ASEAN) includes Indonesia, Malaysia, the Philippines, Singapore, Thailand, Brunei, Vietnam, Laos, Myanmar, and Cambodia. ASEAN has negotiated free-trade agreements with many countries and is working to create a free trade agreement with the EU. • The Asia-Pacific Economic Cooperation (APEC) currently has 21 member countries, including economic powerhouses such as the United States, Japan, and China. Most free-trade areas haven’t had the kind of success that the EU and NAFTA have had in reducing their trade barriers. However, it is clear that most countries are eager to come together to reduce trade barriers in an attempt to realize the economic benefits of greater free trade.

 We started this section with a story about the Miller farm and its struggles to determine what to do in light of an EU decision to disallow GMO products in its member countries. Regional free-trade agreements create powerful negotiating bodies, and as the Millers have found, the EU can make decisions that ripple through many levels of government, all the way to impacting the Miller’s farm management. Now that you have reviewed both sides of the issues concerning protectionism and free trade, what is your opinion? Can a balance be struck between protecting domestic businesses and consumers and opening markets up to more free trade?

Objective 4-4

conducting Business internationally Explain the three basic strategies of international business, and describe how international firms successfully enter foreign markets.

 hachimo

Isu worked as a professional translator for many years before opening his own successful translation business in the United States. Over the years, Hachimo has hired additional translators, and his company has grown. Now he thinks it would grow more if he were to open some offices in other countries. To which countries should he expand and how?

All business operations are undertaken within economic, sociocultural, political, and legal environments that change over time. Even the savviest managers can have trouble keeping up with the changes. Managing an international business is even more complex because a firm has to stay abreast of changes occurring in multiple countries. The rest of this chapter will explore some of the numerous important economic, sociocultural, political, and legal differences among nations. An understanding of these differences is critical for successfully conducting global business. First we’ll discuss the strategies of international businesses and how firms enter foreign markets.

Source: thanapol Marattana/Moment/ Getty images

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International Business Strategies What types of strategies can an international business pursue? There are different types of strategies companies can use to expand abroad. Let’s look at them. • Global strategy. Companies that pursue a global strategy sell a standardized (or homogeneous) product across the globe. Standardized products are basic products that meet universal needs. Examples of standardized products include agricultural products, oil, and raw material commodities. These goods are essentially the same from company to company and have the same appeal to consumers across many cultures. When selling standardized products, firms compete aggressively on the basis of price. The company with the lowest price usually captures the most market share. • Multidomestic strategy. Companies that pursue a multidomestic strategy customize or differentiate their products to meet unique local needs, tastes, or preferences. For example, in Asian countries, McDonald’s offers seaweedflavored fries. Firms pursuing a multidomestic strategy face relatively low pressures for cost reduction because price is often of secondary concern to buyers. Instead, what is important to customers is whether a product meets their needs or is distinct from a competitor’s product. • Transnational strategy. Companies that pursue a transnational strategy offer a product globally, to many countries, working simultaneously to sell it at the lowest possible price. An example of the pursuit of this type of strategy is a product like Coca-Cola soda or a computer model from Dell. Although the language on the packaging will be changed country to country, the product is the same.

entering Foreign Markets How do firms enter foreign markets? In addition to determining a business strategy, businesses must determine how they will serve foreign customers. Companies may undertake one of six strategies: • • • • • •

Export their products Implement turnkey projects Sell franchises Enter into licensing agreements, joint ventures, or strategic alliances Engage in contract manufacturing Establish wholly owned subsidiaries

Let’s look briefly at each strategy.

Exporting Many firms initially enter foreign markets by exporting their products. Exporting is relatively easy and inexpensive compared with establishing a physical presence in a foreign market. In addition, exporting may help a firm realize lower costs because companies can move production to an inexpensive location and then export its product from that location around the world. Exporting also has a few disadvantages. It is not economical for heavy or bulky products with high transportation costs. Exporting may also become uneconomical if foreign trade barriers are unexpectedly imposed.

Turnkey Projects When firms export their technological know-how in exchange for a fee, they have implemented a turnkey project. Turnkey projects are common in the production of sophisticated and complex manufacturing facilities, such as those involved in petroleum refining, steel, and hydroelectric energy production. Once a facility is up and running and the locals are trained, the keys are turned over to the new foreign owners. For example, the largest traffic control system in China is the Wuhan

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Urban traffic control system, delivered by the German electronics firm Siemens.11 Turnkey projects allow firms with specialized know-how, like Siemens, to earn higher profits from their technical expertise. The drawback is that a firm may create a viable competitor if their technological expertise is easily accessible.

Franchising Franchising involves selling a well-known brand name or a proven method of doing business to an investor in exchange for a fee and a percentage of sales or profits. The seller is the franchisor, and the buyer is the franchisee. Franchising is popular both domestically and internationally. Examples of franchising abound. McDonald’s and Kentucky Fried Chicken (KFC) restaurants are now found all over the world.12 In India, the Walt Disney Company has sold more than 100 franchises for its stores.13 Undoubtedly, all of these franchises must be careful to adapt their goods and services to appeal to their different global customers. The main advantage of franchising is that the franchisor shifts to the franchisee the costs and risks of opening a foreign market. The disadvantages include enforcing franchise contracts that ensure quality control over distant franchisees and ensuring that the franchised product is properly adapted to appeal to customers abroad.

Licensing Licensing is an agreement in which the licensor’s intangible property—patents, trademarks, service marks, copyrights, trade secrets, or other intellectual property— may be sold or made available to a licensee in exchange for a royalty fee. The licensor holds the original patent or copyright, and the licensee is paying a fee to be allowed to use that property. The advantage of licensing is the speed with which the licensor can enter a foreign market and the assumption of risks and costs by the licensee. The disadvantage is the loss of technological expertise to the licensee and the creation of a potential competitor. SRI International is a company that holds patents in the areas of biosciences, computing, and chemistry-related materials.14 They license their vast array of intellectual property around the world.

Joint Ventures Joint ventures are formed when two firms team up to better take advantage of a business opportunity than either one of them could alone. Frequently, a company wishing to expand abroad will partner with a local firm that has knowledge of how business is done in the foreign country. The two companies will then share the costs and risks of developing and selling the product the joint venture has to offer. Sometimes the only way a company can enter a market is via joint venture. India’s market for consumer goods, things like such as soap, detergent, and shampoos, is more than 1.2 billion people. However, to protect small Indian businesses, the country restricts the entry of foreign businesses. So, Walmart

Because of international franchising, you can eat at Kentucky Fried Chicken in India, China, and Egypt, among other countries. Sources, top to bottom: bloomberg/ Getty images; Stephen Shaver/AFP/Getty images; Dana Smillie/bloomberg/Getty images

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has had to enter India through a joint venture with the Indian company Bharti Enterprises, an expansion that proved to be difficult because of the cultural and other differences between the firms and was abandoned after seven years.15 Entering into a joint venture, like entering into a marriage, requires considerable thought in the selection of a complementary partner. The disadvantage of joint ventures is losing control over a company because compromise with the partner is inevitable. The risk of losing proprietary technology in the event of dissolution or divorce of the joint venture is also a major drawback.

Strategic Alliances Strategic alliances are cooperative arrangements between actual or potential competitors. Unlike a joint venture, in a strategic alliance each partner retains its business independence. Typically, strategic alliances are agreements for a specific period of time or the duration of a particular project. The advantages of strategic alliances include the pooling of unique talents and expertise and the sharing of the costs and risks of a project for mutual benefit. The disadvantages include a loss of technology and initial difficulty in finding a compatible partner. Microsoft has a strategic alliance with Japanese mobile phone manufacturer Nokia. The companies work together to optimize the mobile phone experience for Microsoft’s Windows software and Nokia’s phone hardware. Together they joined their workforces of talented engineers and their financial clout; now they have the power to compete more effectively.16

Contract Manufacturing Contract manufacturing occurs when a firm subcontracts part or all of its goods to an outside firm as an alternative to owning and operating its own production facility. When doing international business, the subcontractor is a foreign firm. Therefore, contract manufacturing is really a form of offshore outsourcing. Dell, Apple, and Hewlett Packard all use contract manufacturing to produce their computer products. Although the design for Apple computers is done in the United States, for example, many are shipped directly from Asian manufacturers to customers.17 Contract manufacturing allows business to enter a foreign market by placing its label on the good and selling it in the foreign market where it was produced. Contract manufacturing also enables a firm to test-market its product in a foreign market with little expense compared with the high start-up costs of building its own facility on foreign shores. The disadvantage centers on the lack of quality control over the subcontractor. For example, when the toy maker Mattel used a contract manufacturer in China to produce Hot Wheels cars and Barbie dolls, Mattel ended up recalling the toys and paying millions of dollars in fines imposed by the U.S. Consumer Product Safety Commission. Why? Because the Chinese manufacturer had used lead paint on the toys, a practice that is banned in the United States.18

Wholly Owned Subsidiaries A wholly owned subsidiary is a facility owned entirely by the investing firm. For example, Hyundai, a South Korean automotive manufacturer, entered the Russian market by establishing Hyundai Motor Manufacturing Russia, a wholly owned subsidiary.19 The advantages of this entry choice include total control over foreign operations and technological know-how. The disadvantage is that the parent company must bear all the costs and risks of entering a foreign market.

The Advantages and Disadvantages of each entry Mode Which mode of entering foreign markets is optimal? The optimal entry mode depends on many factors, including a firm’s strategy. ◼ TABLE 4.2 summarizes the advantages and disadvantages of the various entry modes.

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TABLe 4.2

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Advantages and Disadvantages of Foreign Market entry Modes Advantages

Disadvantages

Exporting

• Speed of entry • Production site in lowest-cost location

• High transportation costs • Threat of trade barriers, such as tariffs • Lack of access to local information

Turnkey project

• Increased profits for high-tech firms

• Loss of technical know-how to potential competitors

Franchising

• Costs and risks of opening the foreign market fall on the franchisee

• Difficulty in maintaining quality control over distant franchises

Licensing

• Speed of entry

• Licensee may become competitor • Loss of knowledge to potential competitor

Joint venture

• High potential for learning • Benefit of combined resources

• Shared control of business • Risk of losing specialized technology to partner

Strategic alliance

• Pooled talents and expertise • Shared costs and risks

• Risk of losing specialized technology to partner • Difficulty in finding a compatible partner

Contract manufacturing

• Speed of entry • Low test-marketing costs

• Lack of quality control over distant subcontractor

Wholly owned subsidiary

• Total control over all operations • Preservation of proprietary technology

• Risks and costs of entering a foreign market

 We started this section with a story about Hachimo Isu, who was considering expanding his business abroad. After spending more time reviewing the idea of going global, he is thinking of two different target countries: Saudi Arabia or Belgium. For each, he needs to consider how he would modify the services he offers to reflect the needs of these countries. For example, Brussels, Belgium, is the headquarters of the EU and has specific political and legal translation needs. Saudi Arabia is experiencing a construction boom and requires the translation of engineering and legal documents. Hachimo needs to review the different ways these markets can be entered and the pros and cons of each and decide which mode has the most benefits for his company. It is an exciting time, and there are a lot of frequent-flyer miles in his immediate future! Objective 4-5

international Business: Economic Factors and challenges Define exchange rates, explain how they affect international business, and discuss the economic factors and challenges that play a role in conducting business on a global scale.

 When Rachel Gao decided to expand her jewelry business to include handbags, she thought importing them would be cheaper than purchasing them from a domestic company. Initially, she thought she would purchase the handbags from a small European designer, but after she saw the exchange rate for the euro, she changed her mind. Because of the high exchange rate of the euro relative to the U.S. dollar, to make a profit, Rachel

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would have to charge her customers extremely high prices for the bags. She didn’t think her customers would pay prices so high. What other options would still allow her to expand into the handbag business? Businesses are impacted by fluctuating exchange rates every day. Transactions between international companies not only have to specify what each side will be paid but also in which curency. In addition, multinational enterprises use foreign currency to pay foreign workers or to invest spare cash in other nations where interest rates may be more attractive. In this seciton, we’ll look at exchange rates and how fluctuations in the value of currency affect the global economy. We’ll also explore other economic factors and challenges that affect global business. Source: bloomberg/Getty images

The Role of exchange Rates What are exchange rates? Foreign exchange markets determine exchange rates, the rates at which currencies are converted into another country’s currency. A strong dollar means that the U.S. dollar exchanges for a relatively large amount of foreign currency. A weak dollar does not, and you will get many fewer Mexican pesos for a dollar, for example. Depending on a firm’s perspective, it may prefer a strong dollar or a weak dollar. U.S. exporters prefer a weak dollar because their products will be more affordable to foreigners. However, U.S. importers prefer a strong dollar because the cost of importing foreign goods is cheaper. If goods are imported cheaply, then those savings can be either passed on to the consumer or kept as higher profits. How do exchange rates affect international business? Changes in exchange rates have a huge impact on firms doing international business. Let’s look at the reasons why.

Export and Import Prices Suppose the value of the dollar rises or gets stronger against the yen (the currency of Japan). What impact will this have on U.S. and Japanese businesses? Goods exported from the United States will become more expensive because people in Japan will now need more yen to purchase each dollar. This means, for example, that the cost of a $40 pair of jeans made in the United States will become more expensive for the Japanese consumer. Japanese consumers will buy fewer U.S. goods, like jeans, and U.S. exports to Japan will fall. Of course, this will hurt U.S. businesses selling their products in Japan. At the same time, however, the stronger dollar will cause a decline in the relative price of Japanese goods for U.S. consumers because fewer dollars will be needed to purchase each yen. Thus, resulting from the change in currency exchange rate, the United States will import more Japanese goods, and U.S. businesses will lose market share to Japanese companies. This example of Japanese and U.S. trade shows how a currency appreciation—an increase in the exchange rate of a nation’s currency—causes the relative price of imports to fall and the relative price of exports to rise. When currency appreciates, the currency becomes stronger. By contrast, a currency depreciation—a decrease in the exchange rate of a nation’s currency—has the opposite effect on the relative prices of exports and imports: Exports become cheaper and imports become more expensive. Sometimes the government issuing the currency decides to devalue its currency. This deliberate adjustment of the value is different than depreciation, where the change is happening as a result of outside forces.

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Fluctuating exchange rates also affect multinational firms in other ways. Many companies feel pressured to shift their production to countries with weak or low-valued currencies to take advantage of lower costs of production. For example, a weak Chinese currency reduces labor costs in China. If a firm doesn’t shift more of its production to China but its competitors do, then its costs will be higher, and the company will lose global market share.

Trade Deficits and Trade Surpluses Exchange rate changes can also create trade deficits and trade surpluses for a country. A trade deficit exists when the value of a country’s imports exceeds the value of its exports. For example, a stronger dollar can create a trade deficit for the United States because it can cause export prices to rise and import prices to fall. A trade surplus occurs when the value of a country’s exports exceeds the value of its imports. What do countries do when they experience a trade surplus? Often countries that trade in raw materials, such as oil or diamonds, find the commodity price fluctuates a great amount from year to year. So, taking the pool of money that exists in the year of a trade surplus and investing it would be a good strategy. Sovereign wealth funds (SWFs) are government investment funds that do just that. They are managed separately from the official currency reserves of a country. In 1953, Kuwait established the first SWF, which is now worth almost $300 billion. Many countries now have SWFs, including Norway, China, Saudi Arabia, and Singapore. The amount held by all SWFs is currently more than $6 trillion.20 SWFs can invest in anything they want, and sometimes the investments of SWFs stabilize and allow foreign companies to expand. But during the recent credit crisis, many SWFs invested in collapsing banks in Europe and the United States. In fact, more than $69 billion was invested in a range of struggling banks and financial institutions.21 The oil-rich emirate of Abu Dhabi made a $7.5 billion investment in the U.S. banking firm Citigroup. The political implications of this level of investment make some uneasy about the rapid growth of SWFs. China’s fund has made significant investments in major U.S. financial firms. How might that impact the political tensions between the two countries? What if an Arabian SWF invested in a shipping company, giving it control of U.S. ports?

ThE LIST Rank

Top U.S. Trading Partners

Country

Percent of Total Trade

China

16.0%

Canada

15.4%

Mexico

14.2%

Japan

5.2%

Germany

4.6%

Korea, South

3.1%

United Kingdom

3.0%

France

2.1%

Taiwan

1.8%

10.

India

1.6%

11.

Brazil

1.6%

12.

India

1.5%

13.

Netherlands

1.4%

14.

Belgium

1.4%

15.

Switzerland

1.4%

Data from “Foreign trade,” U.S. top trading Partners, U.S. Department of commerce, 12/2015, www.census.gov.

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Fixed and Freely Floating Exchange Rate Systems Exchange rates can be manipulated or fixed by governments. For example, China has fixed its currency to a rate that is weak compared to the dollar. This means Chinese exports to the United States are cheap and imports from the United States to China are expensive. As a result, the United States faces a huge trade deficit with China. The U.S. government has been trying to persuade China for years to allow its currency to “float,” or change in response to changing market conditions. Indeed, most countries operate under a freely floating (or flexible) exchange rate system, a system in which the global supply and demand for currencies determine exchange rates. Many specific factors affect the demand and supply of a nation’s currency, such as changing interest rates, tax rates, and inflation rates. Generally, however, changes in exchange rates in a freely floating exchange rate system reflect a country’s current economic health and its outlook for growth and investment potential. The problems with floating exchange rates are that they can create relative price changes outside the control of international businesses and engender risks of losses because of rapid and unexpected changes in exchange rates. For example, in the 1980s, Japan Airlines purchased several 747 airplanes from Boeing and agreed to pay in U.S. dollars. In the interim period between signing the contract and the delivery of the planes for payment, the value of the dollar rose dramatically. The airline company had to pay a lot more money than anticipated for the airplanes, and it almost went bankrupt. This example illustrates that unanticipated exchange rate changes can pose huge risks for international businesses.

Nonconvertible Currency and Countertrade Governments also reserve the right to restrict the convertibility of their currency. It’s not uncommon for a developing country to have a nonconvertible currency— currency that can’t be exchanged for another currency. For example, the national currency in Morocco is the dirham. It cannot be converted outside Morocco’s borders, so visitors want to spend every dirham they have before ending their Moroccan vacations. Governments with nonconvertible currencies often fear that allowing convertibility will result in capital flight, the transfer of domestic funds into a foreign currency held outside the country. Capital flight would deprive the nation of much-needed funds for investment and development. Global companies can still do business with countries that have nonconvertible currencies through the use of countertrade. Countertrade is a form of international barter, the swapping of goods and services for other goods and services. Currently, countertrade may account for as much as 10 to 15 percent of total world trade. Companies engage in countertrade because of necessity and profitability. Examples of companies that have undertaken countertrade include Goodyear, GE, Westinghouse, 3M, General Motors (GM), Ford Motor Company, Coca-Cola, and PepsiCo.22

other economic Challenges to Conducting International Business What are some other economic challenges to conducting international business? Changing exchange rates and nonconvertible currencies are not the only economic challenges to conducting international business. Companies must also consider how to adapt their products for sale in developing nations, how certain government policies might affect their business, and how the socioeconomic factors of an area impact the types of products they sell.

Economic Growth and Development Many developing countries are experiencing more rapid growth than advanced economies are, and they have hundreds of millions of eager new customers ready to put their money into the global market. However, some developing countries

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Which Is Better—A Strong Dollar or a Weak Dollar?

he answer to this question depends on the type of business a firm undertakes. Companies that do a lot of exporting—such as vehicle manufacturers, chemical manufacturers, and farmers—prefer a weak dollar because it makes the prices of their products lower in the global marketplace, so their sales and profits will be higher. However, companies that import components or finished goods for resale in the domestic market prefer a strong dollar because the relative price of their imports is lower. From a consumer’s perspective, a strong dollar is typically preferred because import prices are lower, which has a tendency to keep domestic competitors’ prices low as well. As an employee, if you work for a company that exports much of its

product, you would prefer a weak dollar to stimulate sales and ensure your job security. The benefits of a strong dollar for a nation as a whole are that it results in lower-priced imports. However, a strong dollar can create a trade deficit. A weak dollar, on the other hand, is good for domestic international businesses because it stimulates employment and raises standards of living. The drawback of a weak dollar is that it can lead to higher costs of energy and other imported products. If the costs of these products increase significantly, they can increase a nation’s inflation rate. So, which is better—a strong dollar or a weak dollar? Like most real-world issues, the answer depends on your perspective.

still lack the basic infrastructure necessary for the effective transportation of goods or lack access to dependable electricity. They may also be lacking in modern communication systems. The implications for companies doing business with these nations are clear. For example, the types of food products offered for sale would have to be altered and packaged differently. The modes of advertising would shift from television to radio, and marketing a product via the Internet wouldn’t be effective because few customers would own a computer. Advertising delivered via mobile phones would be critical in these countries. African countries are an example.

Government Economic Policies International businesses prefer free market economies to state-run or socialized economies because the bureaucratic red tape drives costs up. Other economic factors include the debt load of a nation (the amount of debt a country has), its unemployment and inflation rates, and its fiscal and monetary policies. A country with high unemployment rates and runaway inflation can signal that the nation is unstable and risky to do business in.

Socioeconomic Factors Several socioeconomic factors also need to be taken into account, such as the demographics of population density and age distribution. The birthrates of many developing countries are high and offer exciting opportunities to toy manufacturers such as Mattel. Other socioeconomic factors that firms must consider include income distribution, ethnicity, and the cultural behaviors of a community.

 Remember Rachel Gao? She decided to expand her jewelry business to include handbags and thought importing goods would be cheaper than purchasing them from a domestic company. Although she wanted to buy from a small European designer, she quickly realized that based on the exchange rate for the euro, the goods would be too expensive. After looking at the exchange rates of various countries, she found she would be able to import a variety of handbags from China at inexpensive prices. Not only would her customers appreciate the low prices, she would also be able to make a substantial profit on the sale of the handbags. Do you see any risks related to her decision?

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creating successful international Businesses List sociocultural, political, legal, and ethical challenges to conducting business in a global marketplace.

Source: Paylessimages/Fotolia

 International sales is the dream job for Joe Stein. He loves travel and is fluent in several languages. He prides himself on being good with people and loves to negotiate. The part of the job that is the most challenging for him is to understand the unwritten rules that are so different from country to country. In Venezuela, businesspeople want a firm handshake and a pat on the shoulder when they first meet. In Japan, he needs to be sure to immediately read the business cards people hand him and not just put the cards in his pocket. Recently, he traveled to India and was given a gift by an Indian business partner. After opening the gift, Joe thanked him profusely, but he sensed that he had done something wrong. Was this going to cost him the deal? What should he have done differently? When a business expands into an international market and lacks cross-cultural awareness, it is destined to fail. Along with cultural norms, political, legal, and ethical norms vary from country to country. Understanding how the different policies of different governments can affect your business is also critical. And because there is no global court to settle differences and disputes, businesses need to thoroughly study what is acceptable legally and ethically in each country. In this section, we’ll review the sociocultural, political, legal, and ethical concerns that can make or break a company working in the global marketplace.

Sociocultural Challenges How does culture affect business? Culture is the complex set of values, behaviors, lifestyles, arts, beliefs, and institutions of a population that are passed on from generation to generation. Culture impacts all aspects of business: management, production, marketing, and more. Most international businesses fail because they suffer from a lack of cross-cultural awareness. Cross-cultural awareness is an understanding, appreciation, and sensitivity to foreign cultures. Ethnocentrism, a belief that one’s own culture is superior to all other cultures, makes succeeding in international business difficult. Why do aesthetics matter when it comes to international business? Aesthetics refers to what is considered beautiful or in good taste. Aesthetics affect a culture’s etiquette, customs, and protocols. Few things are more embarrassing than violating a sense of good taste. For example, a company advertised eyeglasses in Thailand by featuring a variety of cute animals wearing glasses. The ad was a poor choice in Thailand because animals are considered a low form of life there, so no self-respecting Thai would wear anything worn by animals. Likewise, former president George H. W. Bush, former Chrysler chairman Lee Iacocca, and other U.S. business magnates violated Japanese etiquette in the 1990s when they went to Japan and made direct demands on the country’s leaders.

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The Japanese considered this assertiveness rude and a sign of ignorance or desperation. Japanese businessmen don’t “lower themselves” by making direct demands. Some analysts believe this violation of cultural aesthetics doomed the trade agreements the countries were trying negotiate and confirmed to the Japanese that U.S. citizens are barbarians.23 What other cultural prejudices must be examined for success in other countries? Attitudes toward time vary considerably across the world. Time is paramount to those in the United States. People are expected to be prompt. Some cultures view this as pushy and impersonal. In addition, the U.S. time horizon differs markedly from, for example, the Japanese perspective. A long-term view to a U.S. citizen might be four to seven years in the future, whereas to a Japanese citizen, the long term is likely to be decades in the future. Attitudes toward work also vary. For example, the Germans argue that people in the United States live to work, whereas Germans work to live. Germans and other Europeans expect four to six weeks of vacation per year. Compare this to the two weeks on average a person in the United States gets, and it is clear which country values vacation time more. Religion plays a profound role in shaping a culture. International businesses are well advised to educate themselves on varying religious value systems, customs, and practices if they don’t wish to offend customers in marketing campaigns. For example, a soft drink was introduced into Arab countries with an attractive label that had stars on it—six-pointed stars. The Arabs interpreted the product as being pro-Israeli and refused to buy it. Why is knowing the native language not enough? Language, both spoken and unspoken, is extremely important. Consider a few more examples of international business blunders as a result of a lack of cross-cultural awareness. A U.S. oil rig supervisor in Indonesia shouted at an employee to take a boat to shore. Because berating a person in public is abhorred in Indonesia, a mob of outraged workers chased the supervisor with axes. Unspoken language, or body language, also differs significantly around the world. A U.S. telephone company aired an ad in Saudi Arabia that portrayed an executive talking on the phone with his feet propped up on the desk. The problem? The soles of his shoes were showing—something an Arab would never do. Although the world is getting smaller and a global culture is emerging, significant cultural differences still abound.

International Business Blunders

ompanies must research the cultural norms and languages of the places in which they plan to do business. Not doing so can be disastrous, as the following examples illustrate.24

oFF The MARk

tell her they would be late for dinner, the commercial bombed.

• Translation difficulties can cause a fine slogan to fail miserably in another language. The Pepsi slogan “Come alive with the Pepsi Generation!” was translated into Mandarin Chinese as “Pepsi will bring your ancestors back from the dead!”

• P&G could not imagine the backlash it would receive when it ran a popular European television commercial in Japan. The ad showed a man entering a bathroom and touching his wife while she bathed. The Japanese disapproved of this ad because the man’s behavior did not adhere to the nation’s cultural norms.

• In many Latin American cultures, women do not order their husbands around, and people are not usually concerned with punctuality. A popular U.S. telephone company didn’t know this. When the company showed a commercial in which a Latino wife tells her husband to call a friend and

• When a manufacturer tried selling its golf balls in packs of four in Japan, the campaign was unsuccessful. Why? Because the pronunciation of the word four in Japanese sounds like the word death in Japanese, so items packaged in fours are unpopular in the country.

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Political Challenges

Should you bow or shake hands when you visit a Japanese client in Japan? Source: Rawpixel.com/Fotolia

What are the political challenges to conducting international business? International businesses look for nations that have stable governments because political upheaval can severely disrupt commerce and jeopardize the success of their firms. The political differences among nations can also pose a challenge for companies doing business internationally. China, although politically stable, has a questionable record on human rights issues and privacy. When Google wanted to enter China, the government demanded it abide by the nation’s Internet censorship laws. Google complied and became the numbertwo search engine in the country. Then Google experienced a cyberattack originating from China that targeted the Gmail accounts of dozens of human rights activists in China. That action, along with an increase in the government blocking of sites such as Facebook, Twitter, and Google Docs, led Google to reverse its decision. It decided to stop censoring results, forcing a standoff with the Chinese government. The “Great Firewall of China” is a nickname for the Chinese government project to filter and block Internet content. This is an example of how the pressure from an international business giant can be at odds with political forces in a foreign country. Government intervention in the process of determining which goods are undesirable and whether goods should be regulated, taxed, or banned also varies from country to country. Many products that pollute the environment are deemed undesirable and have been regulated in one form or another by most governments around the world. The differences in these regulatory standards can impose big differences in costs of production for global businesses. There are also growing pressures on governments to address global climate change issues that will affect international business.

Legal Challenges What are the legal challenges to conducting international business? Laws, regulatory standards, and access to unbiased judicial systems differ considerably around the world. No universal laws, regulatory standards, or global courts exist to settle disputes in the global economy. The different laws governing contracts, product safety and liability standards, and property rights are of particular importance when conducting global business. Property rights violations, including violations of patents and copyrights in the software, music, and publishing businesses, have cost businesses billions of dollars a year. Without adequate protection of intellectual property, technological developments would be too expensive and risky for companies to continue to fund. Different laws also govern the use of bribery throughout the world. The United States passed the Foreign Corrupt Practice Act in the 1970s to prevent U.S. companies from making illegal payments to foreign government officials to secure contracts or other favors. The act was designed to restore public confidence in the business community in the United States. But Congress became concerned that U.S. businesses were being put at a disadvantage by the law. Many foreign companies routinely paid bribes and were even able to deduct the cost of bribes from their taxes as legitimate business expenses. The United States therefore pushed for the creation of the Organisation of Economic Co-operation and Development, which currently consists of 30 member nations committed to combating bribery. In many places in the world, however, bribes are common and may even be necessary for doing business.25

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ethical Challenges What are some ethical challenges faced by international business? Bribery is just one of the many ethical dilemmas global businesses face in different countries. For example, should a firm conform to its home country’s environmental, workplace, and product safety standards—even though it’s not legally required to do so—while operating in another country? Should a company do business with a repressive totalitarian regime such as North Korea? When conducting international business, companies must determine whether they are willing to defy ethical codes to enhance their profits.

 We started this section by introducing Joe Stein, who works in international sales and must deal with a variety of cultures. Joe has learned a lot about the world and about himself by working in international sales. When his Indian business supplier offered him that gift, he politely said thank you and opened it. But he saw Sheshadri’s face wince, and others in the group began to look uncomfortable. Joe quickly apologized and asked Sheshadri privately whether he had done something inappropriate. “In India you should never open a gift before the person has left. It shocked a few of us that you would be so rude.” Joe thanked him for the insight and made sure to apologize to the people there. Understanding and respecting the differences in cultures around the world will help Joe succeed in international business.

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Chapter 4

summary 4-1

Identify the implications of the globalization markets and production, and explain why globalization has accelerated so rapidly.

• The globalization of markets refers to the movement away from thinking of the market as being local or national to being the entire world. Businesses need to “think globally but act locally,” which means that companies must market their products so that they appeal to their local customers. • The globalization of production refers to the trend of individual firms to disperse parts of their production processes to different locations around the world to take advantage of lower costs or enhance the quality of products. The globalization of production often involves outsourcing, which is contracting with another firm to produce part of a product that formerly was produced in-house. Offshore outsourcing (offshoring) has become a significant concern for U.S. workers. • The decline in trade and investment barriers, which are government barriers that inhibit the free flow of goods, services, and financial capital across national boundaries, is one factor that has led to increased globalization. This decline has encouraged developing nations to become involved in international trade and allowed companies to base production facilities at the lowestcost locations.

4-3

• The different types of trade barriers are tariffs, subsidies, quotas, and administrative trade barriers: • Tariffs are taxes imposed on a foreign good or service. • Subsidies are government payments to domestic producers in the form of a cash grants, tax concessions, or low-cost loans. • Quotas are quantity limitations on the amount of an export allowed to enter a country. • Administrative trade barriers are government bureaucratic rules designed to limit imports. One example is a local content requirement, which is a requirement that some portion of a good be produced domestically.

4-4

• There are eight common ways for a company to enter foreign markets, as follows: • Exporting, the sale of domestically produced goods in a foreign market • Turnkey projects, exporting a firm’s technological know-how in exchange for a fee • Franchising, selling a well-known brand name or business method in exchange for a fee and percentage of the profits

• Teleconferencing, which allows businesspeople to conduct meetings with contacts around the world

• Licensing, an agreement in which the licensor’s intangible property may be sold or made available to a licensee for a fee

• Information technology, such as the Internet and cable and satellite television systems, which allow companies to advertise and sell products on a globalscale

• The costs of international trade are borne by those businesses and their workers whose livelihoods are threatened by foreign competition. Businesses may lose market share to foreign companies and have to lay off workers as a result.

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• Joint ventures, the shared ownership in a subsidiary firm • Strategic alliances, cooperative agreements between competitors

Discuss the costs and benefits of international trade.

• The theory of comparative advantage states that specialization and trade between countries benefit all who are involved. This is true because countries that participate in international trade experience higher standards of living because of the greater quantity and variety of higher-quality products sold at lower prices.

Explain the three basic strategies of international business, and describe how international firms successfully enter foreign markets.

• The three basic strategies of international business are the global strategy, the multidomestic strategy, and the transnational strategy.

• Technological changes that have also contributed to the rise in globalization include the following:

4-2

Describe the different types of trade barriers.

• Contract manufacturing, subcontracting part or all of the manufacturing of goods to an outside firm • Wholly owned subsidiary, establishing a foreign facility owned entirely by the investing firm

4-5

Define exchange rates, explain how they affect international business, and discuss the economic factors that play a role in conducting global business.

• An exchange rate is the rate at which one currency is converted into another.

ChAPTeR 4 • Currency appreciation is the increase in the exchange rate of a nation’s currency, which causes the price of imports to fall and the cost of exports to rise. Currency depreciation is the decrease in the exchange rate of a nation’s currency and creates the opposite effect.

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• International businesses prefer stable governments. However, many countries do not offer this kind of political and economic environment. Government decisions about taxation, infrastructure investments, and antitrust law enforcement can all affect global business.

• Economic growth and development present a challenge because some countries lack the infrastructure necessary to transport goods effectively.

4-6

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• From a legal standpoint, the differences in laws and regulations around the world provide challenges for conducting business. There are no universal laws or policies for governing contracts, product safety and liability standards, or property rights.

List sociocultural, political, legal, and ethical challenges to conducting business in a global marketplace.

• Bribery is an ethical challenge facing international businesses. Decisions about whether to conform to a home country’s environmental, workplace, and product-safety standards while operating in a foreign country are other ethical dilemmas.

• Ethnocentrism the belief that one’s own culture is superior to all others, can lead to conflict when conducting business globally. Other sociocultural challenges include differences in aesthetics, religion, and attitudes toward time and work.

Key terms absolute advantage balance of payments comparative advantage competitive advantage contract manufacturing currency appreciation currency depreciation devalue dumping embargo ethnocentrism exchange rate exporting foreign direct investment franchising

free trade General Agreement on Tariffs and Trade global strategy globalization globalization of markets globalization of production importing joint venture licensing local content requirement multidomestic strategy multinational enterprises North American Free Trade Agreement

offshore outsourcing (offshoring) outsourcing quota regional free trade agreement sovereign wealth funds strategic alliances subsidy tariff theory of comparative advantage trade deficit trade surplus transnational strategy turnkey projects wholly owned subsidiary World Trade Organization

MyBizLab To complete the problems with the

, go to EOC Discussion Questions in the MyBizLab.

self test Multiple Choice You can find the answers on the last page of this text. 4-1 The globalization of markets refers to moving away from thinking

4-2 The globalization of markets and the globalization of production means that

a. the market for your product is local.

a. people are no longer in control of their own lives.

b. that other countries are interested in trade.

b. we are all connected by the Web.

c. that every component of a product must be produced in this country.

c. companies can take one product to international markets without having to adapt it.

d. investment in foreign countries is a good idea.

d. companies design products for global markets and can produce them offshore.

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4-3 The theory that states that specialization and

trade are mutually beneficial to all economies involved in trade is called the

b. can impact the trade deficits and trade surpluses of a country.

a. theory of comparative advantage.

c. can be manipulated by governments and can cause price changes outside the control of businesses.

b. theory of beneficial trade.

d. all of the above.

c. theory of absolute advantage. d. theory of relative trade.

4-4 Ethnocentrism is a belief that a. ethics are central to doing well in business. b. the value of commerce changes in different societies. c. all cultures should be respected equally. d. can lead to conflict when conducting business globally.

4-5 The theory of comparative advantage indicates that

a. a country should sell to other countries the products it produces most efficiently and buy from other countries the products that it cannot produce as efficiently. b. international trade will force domestic businesses to lose market share to foreign competitors. c. countries that participate in international trade will have a higher standard of living. d. a limit is placed on the amount of goods and services that can be traded.

4-6 Which of the following are examples of regional free-trade agreements?

a. European Union, NAFTA, and APEC b. The Euro, the IMF, and GATT c. WTO and GMO d. SWF, EU and KFC

4-7 A mini-multinational is a company that a. is small but still does international sales. b. is a large international firm. c. is a small local business. d. is now illegal because of trade barriers.

4-8 Exchange rates affect international businesses because the exchange rate

a. impacts the relative costs of imports and exports.

4-9 Which method of entering foreign markets has theadvantage of allowing for test-marketing a product in a foreign market at the lowest cost? a. Joint ventures b. Wholly owned subsidiaries c. Exporting d. Contract manufacturing

4-10 A local content requirement is one kind of government rule meant to a. reduce foreign exports. b. limit imports. c. tax foreign goods. d. subsidize domestic producers.

True/False

You can find the answers on the last page of this text.

4-11 A free-floating exchange rate system uses global supply and demand to set exchange rates.

True or

False

4-12 Dumping refers to selling a product below what it cost to make.

True or

False

4-13 Increasing U.S. dominance of foreign direct

investments has helped accelerate globalization.

True or

False

4-14 Entering a foreign market through a joint venture means you will eventually be operating independently in that market.

True or

False

4-15 A transnational business strategy is used when a

product is sold in many regions of a country at the same time.

True or

False

Critical Thinking Questions 4-16 Governments invest in education and infrastructure for their citizens, in part to gain a competitive advantage in world markets. Could a government invest too much in education? Could a government invest too heavily in technology? What are the key technologies or services that would give a country more of a competitive advantage in today’s markets? 4-17

Review the three basic strategies of international business. Discuss the type of companies

that would most likely pursue a global strategy, a multidomestic strategy, and a transnational strategy. 4-18 Organizations to promote free trade, like the EU, have had difficulty creating a common currency. Why do you think not all EU countries use the euro? Why do some countries that are not part of the EU choose to use the euro?

ChAPTeR 4

team time The Devil’s Advocate Read the following issues and questions. Which side of the issue do you believe is correct? Form a group with other students in the class who share your belief. As a group, play devil’s advocate by creating a case for the opposing side of the issue. Now that you’ve considered both sides, you’re ready to debate the opposition. 1. In the recent wave of globalization, developing countries have become the focus for many international businesses. Is this process of globalization the best way to strengthen developing countries and establish a level playing field, or does it keep them under the control of wealthy industries and increase income inequality? 2. Free trade versus protectionism is a heated debate in today’s fragile economy. Which is better for the health of the U.S. economy over the next 10years—free trade or protectionism? 3. Currently, the minimum age for a child to work in Indonesia is 12 years old. The minimum age for a child to work in the United States is 14 years old. If a garment company from the United States decides to outsource production to Indonesia, would it be ethical for the company to hire 12- or 13-year-old workers in the factory?

Process Step 1. Meet as a group to discuss the issue. Remember that you must build a

case for the side you chose. Look for problems with your own personal beliefs to develop a case for your side.

Step 2. Prepare an individual response that supports your side of the issue. Step 3. Share your response with your group. Think of possible rebuttals for each

response. Then alter any responses that can produce a strong rebuttal.

Step 4. Determine who will be the group’s primary spokesperson for the debate. Step 5. Each group will be given five minutes to present its side of the issue. After

each group has presented its argument, each team will be given five minutes to prepare a rebuttal and then three minutes to present the rebuttal.

Step 6. Repeat with other groups. Step 7. After each group has debated, discuss whether anyone’s personal views

have changed after this assignment.

Ethics and corporate social Responsibility OFFShORE OUTSOURCING Workers in the United States often view offshore outsourcing in a negative light. Many people believe that this practice is a way for companies to make more money by eliminating U.S. jobs. However, offshore outsourcing sometimes seems necessary for the survival of a company. Review the following scenario.

Scenario You are the owner of a company that makes industrial sewing machines. Currently, your company’s profits are decreasing because your competitors have lower prices. You cannot lower the price of your machines without losing

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a significant amount of money. The majority of your costs come from labor. You have 2,000 employees in your factory, and your company is the primary employer in the community. You could sell your product for a third of the price if you outsourced half your production to a foreign country. However, this would eliminate 1,000 jobs and devastate the community. Also, the country that you would be outsourcing to has a reputation for unsafe working conditions and practices. If you don’t outsource some of your production, over time your company may be unable to compete, possibly forcing you to shut down your company.

Questions for Discussion 4-19

As a business owner, what are the costs and benefits of moving half your production abroad?

4-20

Do the benefits of offshore outsourcing outweigh the costs? Why or why not?

4-21

Are there any possible alternatives to consider? What other decision could you make so that each side (domestic and international) benefits?

Web Exercises 4-22

4-23

4-24

The Complexity of the European Union Watch the YouTube video “The European Union Explained.” Can you describe the differences between the EU, the Eurozone, and the European Economic Area (EEA)? Why would there be the need for these different agreements? How do these tie to past history of EU member countries? Same Company, Different Products Go to the website of the Swedish furniture maker IKEA (www.ikea.com). Under the “select a location” option, choose the United States. Review the site and note the products and the design of the page. Then go back to the home page and choose a different country. Look for differences in the appearance of the website and the products offered. Why do you think these sites are different for each county? Go State! Have you ever considered a career with the U.S. State Department? At www.state.gov, under “Youth and Education,” select “Student Career Programs.” What aspects of these careers appeal to you? Visit the Fulbright

Scholar program. What information in the Fulbright Fellow Orientation Handbook is new to you? 4-25

Cultural Guidelines Knowing how to behave in a variety of countries is critical with increased globalization. Go to www.kwintessential .co.uk to find business etiquette materials on the site. Select three different countries from different regions of the world. Review the “Etiquette, Customs and Protocol” guides for each country. Create a pamphlet for business travelers on the business dos and don’ts for each country.

4-26

You’re the Trader Imagine you’re in charge of trading goods for a country. Would you focus on building wealth by selling commodities or on developing an industry by purchasing raw materials? Type “IMF trading around the world” into your Internet browser. This should pull up a link to the page of the International Monetary Fund where you can play a game in which you become an international trader. Measure your success on the global economics conditions scale.

MyBizLab Go to the Assignments section of your MyBizLab to complete these writing exercises. 4-27 How has globalization progressed in your lifetime? How has it affected your educational plans in terms of where you study, the number of foreign students on your campus, or the curriculum? How has it affected your purchasing decisions and your employment plans? 4-28 What are the advantages of increased competition in the global market? What are the disadvantages? Is foreign competition always good for the consumer? Is foreign competition always bad for local businesses?

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References 1. President Bill Clinton, “Remarks by the President to Vietnam National University,” Embassy of the United States, Hanoi, Vietnam, November 17, 2000. 2. Govindkrishna Seshan, “Fruit Punch,” Business Standard, February 26, 2008, www.business-standard.com/india/ storypage.php?autono. 3. Patrick McGeehan, “Foreign Investment in City Is Growing, Report Finds,” www.mitchellmoss.com/ mentions/NYTimes-27-June-08.pdf. 4. Ayala Pines, Miri Lerner, and Dafna Schwartz, “Gender Differences among Social vs. Business Entrepreneurs,” http://cdn.intechopen.com/pdfs/31886/InTech-Gender_ differences_among_social_vs_business_entrepreneurs.pdf. 5. Ministry of Trade and Industry, “Promoting Entrepreneurialship,” www.regjeringen.no/en/dep/nhd/ selected-topics/innovation/promoting-entrepreneurship .html?id=582899. 6. World Trade Organization, “The GATT Years: From Havana to Marrakesh,” www.wto.org/english/thewto_e/ whatis_e/tif_e/fact4_e.htm. 7. World Trade Organization, “Understanding the WTO,” www.wto.org/english/thewto_e/whatis_e/tif_e/tif_e .htm. 8. World Trade Organization, “Doha Development Agenda: Negotiations, Implementation, and Development,” www .wto.org/english/tratop_e/dda_e/dda_e.htm. 9. Central Intelligence Agency, “Rank Order: Exports,” World Factbook, www.cia.gov/library/publications/theworld-factbook/rankorder/2078rank.html, and “Rank Order: Imports,” World Factbook, www.cia.gov/library/ publications/the-world-factbook/rankorder/2087rank. 10. Matt Rosenberg, “Euro Countries,” http://geography .about.com/od/lists/a/euro.htm. 11. M. Jing, “Siemens Provides the “Brain” for Wuhan’s Traffic Control System,” October 23, 2013, http://usa.chinadaily. com.cn/epaper/2013-10/23/content_17053310.htm. 12. “Subway Timeline,” March 18, 2013, http://www.subway .com/subwayroot/about_us/TimeLine.aspx.

13. Franchise International, “Disney Signs India Master,” www.franchise-international.net/franchise/ Walt-Disney-Company/Disney-signs-India-Master/1554. 14. SRI International, “Intellectual Property and Licensing,” www.sri.com/rd/hot.html. 15. “The Bharti-Walmart Breakup: Where Does FDI in India Go Next?” KnowledgeWharton, University of Pennsylvania, 1 Nov. 2013. Web. 18 Mar. 2016. 16. Warren, Tom. “Microsoft Writes off $7.6 Billion from Nokia Deal, Announces 7,800 Job Cuts.” The Verge. N.p., 08 July 2015. Web. 18 Mar. 2016. 17. M. Kan, “Foxconn Mulls Building TVs, Display Panels in Arizona,” www.computerworld.com/s/article/9243931/ Foxconn_mulls_building_TVs_display_panels_in_Arizona. 18. Parija B. Kavilanz, “Mattel Fined $2.3 Million over Lead in Toys,” June 5, 2009, http://money.cnn.com/2009/06/05/ news/companies/cpsc. 19. “Hyundai Is First Foreign Automaker to Install a Stamping Shop in Russia,” http://news.infibeam.com/ blog/news/2010/05/20/hyundai_is_first_foreign_ automaker_to_install_a_stamping_shop_in_russia.html. 20. K. Armadeo, “Sovereign Wealth Fund,” http://useconomy .about.com/od/glossary/g/wealth_fund.htm. 21. Elena Logutenkova and Yalman Onaran, “Singapore, Abu Dhabi Face Losses on UBS, Citigroup (Update2),” BusinessWeek, March 2, 2010, www.bloomberg.com/apps/ news? pid=newsarchive&sid=aeS1DdEYqj_Q. 22. C. G. Alex and Barbara Bowers, “The American Way to Countertrade,” BarterNews 17 (1988), www.barternews .com/american_way.htm. 23. “Results of Poor Cross Cultural Awareness,” www .kwintessential.co.uk/cultural-services/articles/ Results%20 of%20Poor%20Cross%20Cultural% 20Awareness.html. 24. Quoted in “Cross Cultural Business Blunders,” www .kwintessential.co.uk/cultural-services/articles/ crosscultural-blunders.html. 25. U.S. Department of Justice, “Foreign Corrupt Practices Act,” www.justice.gov/criminal/fraud/fcpa.

Mini Chapter

Chapter 1

Business Law Every business, whether it is a large multinational corporation, or a small, sole proprietorship, has laws and regulations that govern how business is conducted. You should have a basic understanding of the laws of the U.S. legal system that pertain to your business and industry to be sure you are functioning within the law.

the U.S. Legal System The United States is a federalist system, meaning there is government authority at both Administrative Statutory/Administrative national and state levels. The Common Law Law Law national government has specific powers, and the 50 U.S. Executive Judicial Branch Legislative Branch Branch states retain substantial autonCreates the Law Interprets and Applies the Law Enforces the Law omy and authority. Both the federal government and state President/ Supreme Court of District House of Senate Governor Court Appeals Courts Representatives governments are divided into executive, legislative, and judicial branches. Written constitutions, both federal and state, ◼ FIGURE M1.1 form a system of separated powers, checks, and balances among the branches The Legislative System (see ◼ FIGURE M1.1 ). © Mary Anne Poatsy Constitution

Sources of Law There are four sources of law: constitutional law, statutory law, administrative regulations, and common law. Constitutional law, the written text in the U.S. Constitution and the Bill of Rights, is the foundation of the laws of the United States. All other laws are subordinate to the laws in these two documents. Statutory laws are laws passed by the legislative branches of the government. The executive and legislative branches of the federal or state government also establish regulatory bodies. The Securities and Exchange Commission, the Federal Trade Commission (FTC), and the Food and Drug Administration (FDA) are examples. These regulatory bodies have the power to pass administrative laws—rules and regulations within their area of authority. The judicial branches of the government not only apply established constitutional and statutory laws when deciding cases but also create law when their decisions become precedents for future case decisions. This type of unwritten but applied law is referred to as common law, or case law.

how Laws affect Businesses In addition to the laws that govern all citizens of the United States, there are specific laws that pertain more directly to businesses. Business law consists of

MINI 1

laws that directly affect business activities. Once a legal business structure is determined (see Chapter 6), a wide variety of laws affect how the business is run as well as how it treats its employees and consumers. Finally, there are laws that determine what happens when a business needs to stop operating.

Running a Business: Essential Concepts of Business Law Even before a business opens its doors, various business laws affect it. There are laws that regulate how the business are to be established and how it interacts with other businesses, its employees, and its customers. Laws also dictate the consequences when a business acts in a wrongful way. Laws are in place to govern commercial transactions, and laws exist to help protect ideas, inventions, and artistic works as well as designs and images used by businesses. In addition, laws are in place to protect consumers from fraud or deceit and to ensure competition between businesses remains fair and vibrant. Finally, laws are in place to ensure that businesses do not threaten the environment. Let’s look at these laws in greater detail.

Contract Law Contracts form the basis for many personal and business transactions. A contract is an agreement between two parties. In our personal lives, contracts are used in marriage and divorce, as well as when you buy and sell a house. In business, contracts are used when a company hires another company or individual, when property is bought or sold, and when services are exchanged (see ◼ FIGURE M1.2).

Green Thumb Landscape Services 3156 Funks Road * Lansdale, PA 19464 * 610-555-4326

An offer is made.

THIS AGREEMENT made April 12, 2013, by and between Green Thumb Lawn Services and Mr. and Mrs. Charles Moyer at 1032 Skippack Lane, Lansdale, PA 19464.

Work to be done is legal. legal

Scope of Work Green Thumb Lawn Services shall furnish all materials and perform all of the work on the property at 1032 Skippack Lane, Lansdale, PA 19464 as specified below:

Terms of offer outlined.

Work to Be Performed 1. Remove all existing plant material as specified on plan provided. 2. Install landscape rock accent wall as per design provided. 3. Install new plant material as per design provided with fertilizer and a one (1) year warranty upon completion of work. 4. Install brown bark mulch throughout to completion. 5. Return any areas disturbed during the installation to acceptable standard, with grass seed, starter fertilizer, lime, and mulch, as needed.

Consideration determined: services in exchange for payment.

Contract Price The Owner shall pay the contractor for material and labor to be performed under the sum of $4,500 Progress Payments Payments of Contract Price shall be made as follows: 1/3 of contract price ($1,500) upon acceptance of proposal, 2/3 of contract price ($3,000) upon completion of project. Net 10 days, interest charged after 30 days.

Signatures imply offer is accepted and valid. Signers are deemed competent.

Owner Signature

Charles Moyer

Contractor Signature

Justin Clark, Green Thumb

Date 4/12/13 Date

4/12/13

◼ FIGURE M1.2 A Valid Contract © Mary Anne Poatsy

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ELEMEnTS oF A ConTRACT For a contract to be valid, an offer must be made, the parties must understand and agree on the terms of the contract, consideration must be given, and the offer must be accepted.

• An offer is made and accepted by competent parties. The offer (what is given in exchange for goods or services, generally a price) can be spoken or written and must be accepted (generally by a signed contact, oral agreement, or simple handshake). Offers can also be made to the general public in the form of advertisements. For a contract to be valid, all parties entering into it must have the capacity to understand its terms and conditions. Therefore, minors, mentally incompetent individuals, and those who are under the influence of drugs or alcohol are considered to not have the capacity to execute valid contracts. Finally, all parties must enter into the contractual agreement voluntarily without duress resulting from fraud or undue influence. • The terms of the offer must be defined and understood and of legal purpose. Although contracts can be casually created—either verbally or scribbled on a napkin or on the back of an envelope—most are formally drafted. In any contract, however, the terms of the offer must be clearly defined and understood. The underlying purpose of the contract must be legal; otherwise, the contract is void (invalid). • Consideration is defined and exchanged. Something of real value—what lawyers refer to as consideration—must be exchanged by both parties to a contract, whether it entails an exchange of services or goods (trading or bartering) or payment for services or goods. BREACh oF ConTRACT Most contractual arrangements are fulfilled to completion,

with the terms of the contract being satisfactorily met. However, there are situations in which a party will fail to uphold his or her stated obligation because of a dispute over the quality of goods or services provided or as a result of a failure to complete the contractual obligation. When a contract is not fulfilled a breach of contract occurs. Some breaches are resolved in lawsuits, but many can be resolved in a less formal manner.

Tort Law Another common business law concept is torts. Atortis a wrongful act, resulting in injury or damages. A tort differs from a breach of contract in that a tort is a violation of a right given by law, whereas a breach of contract occurs when there has been a violation of a right acquired by contract. In some instances, a circumstance can be both a tort and a breach of contract. There are different types of torts: intentional, negligence, and strict liability. • Intentional torts are actions meant to injure another person or person’s property, such as battery, assault, fraud, misrepresentation, trespass, slander, and defamation. • Negligence is a failure to exercise reasonable care to avoid causing harm to others. Because negligence is not intentional, it cannot result in an intentional tort. • Strict liability (or absolute liability) is the legal responsibility for damages or injury, even if the person found strictly liable was not at fault or negligent. Strict liability is usually associated with defectively manufactured or designed products and is often referred to as product liability. In product liability cases, the injured party needs to prove only that the item was defective and that the defect caused some type of harm, rather than proving that the producer of an item was somehow negligent. Failing to warn buyers about the incorrect use of products or their inherent dangers can also result in product liability lawsuits. A case in which a 79-year-old woman incurred third-degree burns after spilling McDonald’s coffee on her lap is a classic example of not only a failure to warn

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but also a product defect. The woman sued McDonald’s for knowingly serving coffee so hot it could cause third-degree burns in two to seven seconds if spilled. Even though McDonald’s had a printed warning on its coffee cups that its coffee was hot, the print was small and hard to read. The case went to trial and was settled in the woman’s favor. McDonald’s subsequently reduced the serving temperature of its coffee and increased the size of the warning on its cups. No doubt you can recall other cases in which companies were held liable for damages associated with faulty products. Bridgestone/Firestone recalled nearly 6.5 million Firestone tires after defective products caused death and serious injuries to the owners of Ford Explorers, some of whom filed lawsuits against the company. Mattel settled product liability claims for toys made in China containing high levels of lead paint. And Toyota recalled millions of automobiles in response to product liability claims of unintended acceleration and braking problems. Sometimes, when product deficiencies affect many individuals, the individuals will form a group and together file a class-action lawsuit. In these situations, the group of injured individuals (referred to as the class) is jointly represented and acts as one claimant. Class-action lawsuits are usually more powerful than individuals filing separate lawsuits and are often less costly for the individual. If the lawsuit is decided in favor of the class, then the award is split among the group members. Tort reform—proposals to limit tort filings and proceedings and to cap damage awards—is an ongoing source of debate and discussion. The economic effects of the current tort system are the biggest driver of the debate. Manufacturers argue that the cost of litigation and the multibillion-dollar awards raise the cost of insurance and force companies to increase product prices. Some people feel society has become too litigious and that frivolous lawsuits are out of control. Other people argue that tort reform makes it more difficult for those who are legitimately injured by products to file lawsuits and be fairly compensated. What are your thoughts?

Intellectual Property Laws Intellectual property laws are put in place to protect intellectual property—creations of the mind, such as ideas, inventions, and literary and artistic works as well as symbols, names, images, and designs used in commerce. Intellectual property laws cover patents, trademarks, copyrights, trade secrets, and digital rights. Intellectual property protection encourages innovation, research and development, and cultural exploration by ensuring that the resulting output is protected, and the creator is fully compensated. • Patents. A patent is a property right on a new and useful invention granted by the U.S. Patent and Trademark Office (USPTO). A patent grants the patent holder the exclusive right to his or her invention, excluding others from using, making, or selling the same invention for 14 or 20 years, depending on the type of patent issued. There are three types of patents: utility patents, design patents, and plant patents. Utility patents protect inventions for processes, machinery, manufactures, or composites of matter (such as a newly synthesized chemical compound or molecule). Design patents protect the appearance of an object rather than its functionality (which is covered by the utility patent). Plant patents protect new, reproducible plants (organic matter). A person who owns a patent can assign, or sell, it for a lump-sum payment to another party. More often, though, the owner licenses the patent to a company that markets the invention. The inventor still owns the patent but receives a license fee and royalty payments based on the revenues generated from the invention.

Patents are property rights on new and useful inventions. Source: Don Farrall/DigitalVision/Getty Images

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• Trademarks. A trademark is any word, name, symbol, or device (or any combination of these) used to identify and distinguish a good. A service mark is used to identify a service. Trademarks and service marks are often referred to as “brands” or “brand names.” Generally, consumers associate products bearing trademarks with certain standards of quality (see ◼ FIGURE M1.3). What reactions do you have when you see the Nike swoosh, McDonald’s golden arches, or Apple’s apple? Trademark rights exclude others from using a similar mark, thus protecting the trademark owner against any potential fraud. Only those trademarks registered with the USPTO bear the symbol ®, but anyone can use the TM or SM to identify a mark, even though it might not be registered with the USPTO. Trademarks can be licensed, which is generally the case with franchising arrangements. • Copyrights. A copyright is a form of protection provided to creators of original works for a limited period of time. Copyrights protect works such as books, music, photographs, art, movies, and computer programs and apply to both published and unpublished works. A copyright makes it illegal for anyone other than the creator to reproduce, distribute, or make a derivative of the work (such as a movie from a novel), publicly perform it (such as music or plays), or publicly display it (such as paintings). • Trade secrets. A trade secret is undisclosed information that provide a competitive advantage. Trade secrets can be any formula, pattern, physical device, idea, process, or compilation of information. Unlike trademarks and patents, trade secrets are not protected under federal statutes; they are protected only under state laws. Another distinction from trademarks and patents is that trade secrets are protected only when the secret is not disclosed. Employees of companies who, by the nature of their positions within their firms, have firsthand knowledge of trade secrets usually are asked to sign a nondisclosure agreement—an agreement not to reveal his or her employer’s proprietary information. Violation of such an agreement can lead to imprisonment. For example, two employees of Coca-Cola were sentenced to fiveand eight-year federal prison terms for conspiring to steal and sell company trade secrets to Pepsi. • Digital rights. Digital intellectual property is the digital (or electronic) representation of an individual’s intellect that holds value on the commercial market. Unlike other intellectual property protected by patents, trademarks, and copyrights, protecting digital intellectual property is much more difficult because it is often easy to electronically copy and distribute quickly and inexpensively to a vast number of individuals. In 1998, the United States passed the Digital Millennium Copyright Act (DMCA) to try to prevent

◼ FIGURE M1.3 Corporate Logos Can you identify these corporate logos? Image sources, clockwise, from top left: Q-Images/Alamy Stock Photo; LunaseeStudios/Shutterstock; Howard Harrison/Alamy Stock Photo; Bloomberg/ Getty Images; dailin/Shutterstock; Kristoffer Tripplaar/Alamy Stock Photo

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digitized works from being illegally reproduced and distributed, thereby enforcing two 1996 treaties of the World Intellectual Property Organization. The DMCA extends the reach of a copyright by criminalizing the creation and distribution of technology, devices, or services that control access to copyrighted works and tightening the penalties for copyright infringement in the digital environment. Some believe, however, that the DMCA does little to really reduce the confusion that still surrounds the protection of digital works. There are ongoing debates as to whether the works are indeed protected or whether the current copyright laws, as they apply to digital media, become a detriment to consumers and impair the evolution of the technology.1

Sales Law Many laws govern the sales of goods. The most comprehensive of these laws is the Uniform Commercial Code (UCC), a set of model laws that govern businesses selling goods within the United States and its territories. The UCC covers the sale of goods, transfer of ownership, leases, contracts, securities, as well as how money can be borrowed. The UCC laws are “model laws” because they first must be adopted by a state—either verbatim or in a modified form. Once adopted, they become state law. All 50 states and territories have adopted some version of the UCC. ◼ TABLE M1.1 outlines the articles and general provisions of each article in the UCC. Everyday business transactions involve provisions in Articles 3, 4, and 5. Article 3 involves negotiable instruments, such as checks, paper money, and commercial paper (short-term debt issued to finance short-term credit needs). The debt for these instruments is unsecured, that is, issued without any form of collateral. Article 4 pertains to banking matters, and Article 5 applies to letters of credit. A letter of credit is a letter from a bank that guarantees payment to a seller will be made, regardless of the buyer’s current financial situation.

Antitrust Laws A healthy economy depends on businesses being able to compete with each other in free and open markets. Competition benefits consumers by providing more choices, keeping prices low and the quality of products high, and fostering

TABLE M1.1

Description of Articles in the Uniform Commercial Code

Article

Title

Contents

General Provisions

Principles of interpretation, general definitions

2 and 2A

Sales and Leases

Applies to all contracts for the sale and lease of goods

Negotiable Instruments

Checks, banknotes (paper money), and commercial paper

Bank Deposits

Bank collections, deposits, and customer relations

Funds Transfers

Corporate to corporate electronic fund transfers and payments such as wire transfers and automated clearinghouse credit transfers

Letters of Credit

Laws that address promises by a bank to pay the purchases of a buyer quickly and without reference to the buyer’s financial condition

Bulk Transfers and Bulk Sales

Imposes an obligation on buyers who order the major part of the inventory for certain types of businesses

Warehouse Receipts, Bills of Lading, and Other Documents of Title

Applies generally to trucking companies; includes rules on the relationships between buyers and sellers and any transporters of goods

Investment Securities

Rules pertaining to the issuance of stocks, bonds, and other investment securities

Secured Transactions

Security interests in real property

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innovation. Antitrust laws are designed to promote fair competition between companies and to prevent actions that might hurt consumers or unfairly harm other businesses. The first American antitrust law, the Sherman Act of 1890, was created to prevent large, powerful companies from coming together as “trusts” and dominating industries. The Clayton Antitrust Act of 1914 added further substance to antitrust legislation, addressing specific practices such as mergers, that the Sherman Act did not clearly prohibit. The Robinson-Patman Act made it illegal for some companies to purchase products at more favorable prices than other businesses. Today, the FTC’s Bureau of Competition reviews and analyzes agreements between businesses to prevent anticompetitive conduct and to ensure that competition is maintained. Through such scrutiny of competitive business practices, the FTC strives to ensure that consumers have choices in price, selection, quality, and innovation. Antitrust laws are designed to prevent companies from unfairly stifling competition through the formation of monopolies, certain mergers, and illegal cooperation between competing businesses.

The FTC allowed the merger between Office Depot and Office Max after denying a similar merger between Office Depot and Staples nearly a decade earlier. Sources, left to right: Tom Carter/Alamy Stock Photo; Justin Sullivan/Getty Images News/Getty Images

• Monopolies: Competition between businesses is usually beneficial to the consumer. Competition often fosters innovation and encourages businesses to provide high-quality products at reasonable prices. Companies that are dominant in their industry lack the benefit of competition and are often able to charge consumers higher prices and offer inferior products. Antitrust laws strive to prevent companies from becoming too large or eliminating competition. • Mergers: The FTC monitors mergers to ensure that a combination of two or more businesses will not result in market dominance by the larger, newly formed company. Not all mergers result in monopolies, and many mergers are beneficial. Mergers can create more efficient and competitive organizations by combining operations and eliminating duplicate functions (two sales departments, two human resources departments, and so on). When Staples tried to buy Office Depot in 1997, the FTC blocked the merger of the two large office supply retail stores. Why? At the time, the FTC reasoned that the merger would reduce the number of competing stores in some parts of the country. By 2013, however, the competitive environment had changed. In reviewing the proposed merger of Office Depot and Office Max in 2013, the FTC allowed the merger, concluding that because of the availability of office products through online sites such as Amazon and retailers such as Walmart, the merger of Office Depot and Office Max would not severely limit competition in the office supplies market.2 • Price collusion: The FTC also watches out for companies that work together on price-related matters that then might either make it difficult for competitors to enter a market or artificially inflate the prices consumers pay. For example, the FTC concluded that Apple and five large U.S. publishers had conspired to increase the prices of electronic books.3 The U.S. Justice Department

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filed suit against Apple and the five companies, and in 2013, they were found guilty. Apple agreed to pay $450 million to settle the case. • Manufacturer/dealer agreements: The FTC monitors any agreements between manufacturers and product dealers. Often these agreements make sense and benefit consumers, such as when a computer manufacturer arranges works with software developer to install certain application on new computers before their sale. But the FTC watches for instances when a manufacturer forces an unwanted associated product onto a dealer. This is what happened when Microsoft bundled its web browser Internet Explorer with its Windows operating system in the early 1990s. Doing so gave Microsoft an unfair advantage in the web browser market, the FTC concluded. There are also many federal and state regulatory agencies, such as the Federal Communications Commission, the FDA, and the Federal Aviation Agency, to name a few, that are in place to protect the public. However, in the late 1970s and 1980s, many felt some regulated industries were being artificially held back from competition and economic growth, so a trend toward deregulation—breaking up the government regulatory controls on some industries—ensued. Deregulation started with the Railroad Revitalization and Regulatory Reform Act of 1976 and the Staggers Rail Act of 1980. These acts enabled railroads to better compete against the growing trucking and airplane industries. Similarly, the Airline Deregulation Act of 1978 was passed to promote broader competition among air carriers. And the breakup of AT&T in 1984 began deregulation of the telephone industries and was followed by the Telecommunications Act of 1996 to ease the oversight and regulation on cable and Internet communication industries.

Environmental Laws The rapid growth of business and industry can have a significant negative impact on the environment. To protect the environment for future generations, in the 1960s and 1970s, U.S. laws were passed to regulate air and water quality, and the Environmental Protection Agency (EPA) was established.4 The EPA is responsible for maintaining and enforcing national environmental standards as well as conducting research and providing education on environmental issues. Additional regulations have been passed to control the disposal of hazardous waste. More recently, it has been debated whether regulations should be passed to help curb global warming.

Laws for Consumers and Employees Various commerce-related laws are designed protect the employees of firms and their customers. Advertising laws, employee safety laws, and food and drug laws are examples.

Advertising Laws Consumers are inundated with advertisements that tout product features and benefits. Companies engage in advertising, some of which is expensive, with the hopes of enticing us to purchase their products. Advertising accounts for nearly 20 percent of U.S. economic activity.5 The FTC regulates all forms of business advertising. • Truth-in-advertising rules help to ensure advertisements are truthful and nondeceptive, that there is sufficient evidence to support the claims they make, and that the advertisements are not unfair (and subsequently cause unavoidable consumer injury that is not outweighed by the benefit).

The U.S. Environmental Protection Agency (EPA) is responsible for maintaining and enforcing environmental standards and controlling air and water pollution, among other things. Source: Snap Happy/Fotolia

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• Product labeling laws include laws that mandate that food products have specific nutritional and product information on their labels, cigarette packages must include warning labels, and any products that might be hazardous to children must contain warnings. In addition, there are specific product advertisements that the government regulates, including advertisements for cigarettes, alcoholic beverages, automobiles, Internet services, health and fitness products, housing and real estate, and telephone services.

Employment and Labor Law There are hundreds of laws in place that regulate how companies hire and treat employees. Employment laws mandate that companies in their hiring practices do not discriminate against a job applicant or candidate based on his or her disabilities, age, race, religion, sexual orientation, or nationality. These laws include Equal Employment Opportunity laws, the Civil Rights Act, the Americans with Disabilities Act, and the Age Discrimination in Employment Act. See Chapter 9 for more details on employment laws. Employee laws ensure that all workers and employees are treated fairly with respect to their wages, working conditions, medical care resulting from a workplace injury, and employee benefits, to name a few. ◼ TABLE M1.2 lists some of the major employee laws.

Laws That Govern Closing a Business Truth-in-advertising laws ensure that advertisements are not deceptive and support the claims they make. Source: Laura Gangi Pond/Shutterstock

At some point, businesses close their doors and cease operating. Sometimes, especially with family-owned businesses, sole proprietorships, or partnerships, businesses close because the current leader of the business leaves and there is no further succession in business ownership. Sometimes, through a merger or acquisition, a business is incorporated into another business. In those instances, regulations and processes ensure that all financial obligations (taxes and business debts) have been successfully met, that employees have been notified and paid appropriately, and that all aspects of the business operations, including permits, licenses, and trade names, are canceled. In some instances, businesses are forced to file for bankruptcy because they can no longer meet their financial obligations.

Bankruptcy Bankruptcy is the legal status of an insolvent person or organization by which their debts are relieved through court action. Bankruptcy can be filed voluntarily or involuntarily; and after all debts have been paid, the debtor is free to begin anew. The source of funds from which creditors can collect is first determined by how the business is structured. For example, when a sole proprietorship files for bankruptcy, the business’s assets are first used to pay off its debts. Once business assets are exhausted, the business owner’ personal assets (such as homes, cars, and bank accounts) can also be used to pay off any remaining debts. Corporations, limited liability companies, and some forms of partnerships protect personal assets, allowing only business assets to be used to pay off debts incurred by the entity. There are three types of bankruptcy, and they are named for the specific chapter of the U.S. Bankruptcy Code: • Chapter 7. All business (and sometimes personal) assets are liquidated, and outstanding debts are paid off in a Chapter 7 bankruptcy. Any outstanding debts remaining after all assets are used are discharged. The business ceases operation. • Chapter 11. A business under Chapter 11 bankruptcy is allowed to continue operating and develops a reorganization plan to pay its creditors over time.

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Examples of Laws That Govern how Businesses Should Treat Employees

Law/Regulation

Description

Fair Labor Standards Act

Regulates standards for wages and overtime pay.

Occupational Safety and Health Act (OSHA)

Regulates safety and health conditions for employees.

Workers Compensation

Provides for the compensation and medical care for employees injured on the job or who develop diseases as a result of doing their jobs.

Employee Retirement Income Security Act (ERISA)

Regulates the administration of retirement, pension, and welfare benefits.

Labor-Management Reporting and Disclosure Act

Regulates the fiduciary responsibilities of unions to its members.

Family and Medical Leave Act

Regulates the amount of leave employers must give their employees upon the birth or adoption of a child or for the serious illness of a direct family member.

Lilly Ledbetter Fair Pay Act

Individuals subjected to unlawful pay discrimination are able to seek justice under the federal antidiscrimination laws.

Worker Adjustment and Retraining Notification Act (WARN)

Requires employers to notify all employees 60 days in advance of plant closings or mass layoffs.

• Chapter 13. Chapter 13 is the most common form of bankruptcy for individuals. Chapter 13 allows an individual to use proceeds from the sale of some assets and pay off remaining debts with operating income by following a three- to five-year repayment plan. This enables an individual to keep his or her home and potentially a car and other productive assets. Although bankruptcy can be a solution to insolvency, it should be only a last resort. Companies and individuals who survive bankruptcy often find it hard to reestablish good credit ratings. As a result, banks and other lenders may not extend credit or will do so only with high interest rates.

Key terms administrative law antitrust laws bankruptcy breach of contract business law class-action lawsuit Clayton Antitrust Act of 1914 common law (case law)

constitutional law contract copyright digital right employee laws employment laws intellectual property mergers

patents product liability Sherman Act of 1890 statutory law trade secret trademarks tort Uniform Commercial Code

references 1. Michael Rappa, “Managing the Digital Enterprise: Intellectual Property,” May 31, 2009, http://digitalenterprise.org/ip/ ip.html, accessed March 30, 2016. 2. David McLaughlin and Matt Townsend, “Office Depot Merger with Office Max Wins U.S. Approval,” November 1, 2013, http://www.bloomberg.com/news/ articles/2013-11-01/office-depot-merger-with-officemaxwins-u-s-approval, accessed March 30, 2016. 3. Adi Robertson, “Apple Guilty of Ebook Price Fixing, Rules Federal Court,” July 10, 2013, http://www.theverge

.com/2013/7/10/4510338/apple-found-guilty-of-ebookprice-fixing, accessed March 30, 2016. 4. Environmental Protection Agency, “Our Mission and What We Do,” https://www.epa.gov/aboutepa/our-missionand-what-we-do, accessed March 20, 2016. 5. IHS Global Insight, Inc., “The Economic Impact of Advertising Expenditures in the United States 2012–2017,” January 2014.

Part 2

Starting and Structuring a BuSinESS

Chapter 5

Small Business and the Entrepreneur OBjEctivES 5-1 Small Business: The Mainstream of the American Economy Describe the role and structure of small business within the American economy.

Allison Juarez left a secure position in a good company to start her own personal organizing business. For Allison, the financial risks of leaving a set salary and retirement plan were offset by independence and flexibility. What exactly is a small business? And why are they so important to the American economy?

5-2 Entrepreneurs and the American Dream

Explain what the traits of an effective entrepreneur are, and differentiate the types of entrepreneurs. The Wahoo brothers took the concept of a fish taco and created a multimillion-dollar business with several locations. Their success is not based just on their delicious food. What else about these brothers and their business makes them successful entrepreneurs? Do you have what it takes to be an entrepreneur?

5-3 Buying Franchises and Existing Businesses Summarize the advantages and disadvantages of franchising and buying existing businesses.

Have you ever thought of owning your own business but didn’t know where to start? Naomi Lawrence had always dreamed of running a restaurant. Should she start her own restaurant, buy

an established one, or purchase a franchise for a restaurant?

5-4 The Risks of Small Businesses and Where to Get Help

Discuss the factors that can lead to small business failure and the steps and resources available to diminish the potential of small business failure. What resources are available to provide assistance and guidance to small business owners? There’s a good reason why entrepreneurs are known for being risk takers: Starting a small business is risky! Having left a failing company to start his own business, Roger Sherman knew the pressures and risks he was facing as an entrepreneur. After making a good start with his business, Roger needed some assistance. Where could he go to get some short-term financial assistance?

5-5 Financing Considerations

Compare the potential benefits and drawbacks of each major source of small business financing. All that stands between a would-be entrepreneur and a pot of gold at the end of the rainbow is a way to finance his or her dream business. Although operating a sandwich shop was not Fred DeLuca’s dream, it did become his pot of gold because it turned into one of the world’s top franchise opportunities and largest privately held businesses. And it all started with a $1,000 investment from a friend. How do small businesses obtain financing and choose between different types of financing available to them?

CHAPTER 5

Objective 5-1

Small Business: the Mainstream of the american Economy Describe the role and structure of small business within the American economy.

 Allison Juarez thought she was set for life. Right after college she joined a large, secure company; she received a regular paycheck, had a 401(k) plan, and had already been promoted twice. Still, she felt something was missing. She fantasized about owning her own business, making her own decisions, having some flexibility in her schedule, and hopefully not having someone else set her earning potential. But she never could gather enough courage to leave the stable paycheck. Finally, when it looked like she could end up being downsized, Allison jumped the corporate ship and started her own professional organizing business. She had helped to organize many garages, closets, and offices for friends and family, but she had never considered charging for her time. It was just fun for her. Now, she was actively seeking clients, marketing her services, and enjoying the results. Business has been steady but not overwhelming. Allison is glad that she has a nest egg to rely on during slow times, but she is not regretting her decision to start her own company. Like Allison’s business, many small businesses are founded to provide innovative solutions to unique problems or to offer a different lifestyle. Small businesses often fill a niche that large companies do not. As a whole, small businesses in the United States play a major role in the economy. In this section, you’ll learn about the role small businesses play in the American economy, and the many reasons why many people start small businesses.

Source: bobo/Fotolia

Small Business and the Economy What is a small business? The Small Business Administration (SBA) is an independent agency of the federal government that was formed to aid, counsel, assist, and protect the interests of small businesses. The SBA defines a small business as one that is independently owned and operated and not dominant in its field of operation.1 To qualify for governmental programs and benefits specifically targeted for small businesses, a small business must also meet employee and sales standards established by the SBA. In general, most small businesses must have fewer than 500 employees. However, as ◼ FIGURE 5.1 shows, nearly 90 percent of all small businesses have 20 or fewer employees.2

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◼ FIGURE 5.1 U.S. Small Businesses by Number of Employees

503,033 9%

Source: Data from “Statistics about Small business from the census bureau,” U.S. census bureau, retrieved from http://www.census.gov/econ/smallbus .html#empSize. © Mary Anne Poatsy

85,264 2%

600,551 10% 1 to 4 employees 5 to 9 employees

992,281 17%

3,575,290 62%

10 to 19 employees 20 to 99 employees 100 to 499 employees

THE LIST

Ten Great Industries for Starting a Business

1. Healthy fast foods

6. Pet care and grooming

2. Internet marketing

7. App development

3. Elderly home care

8. Home and building services

4. Home fitness trainers

9. Small business services

5. Green contracting

10. Retirement recreation

The SBA also places restrictions on how much annual revenue a small business can earn to qualify for its programs. The limits on average annual revenue vary significantly by industry, but for most industries the standard annual revenue ranges between $7.5 million and $38.5 million.3 ◼ FIGURE 5.2 U.S. Small Businesses versus World Economies GDP

Why are small businesses important to the economy? Small businesses are important to the U.S. economy and job market. Small businesses create nearly 65 percent of all new jobs in the United Sates and generate nearly one-half of the nation’s gross domestic product.4 As ◼ FIGURE 5.2 shows, if U.S. small businesses made up their own economy, it would be one of the world’s largest.5,6 Small businesses also export about one-third of the total goods exported from the United States.7

Source: Data from “Statistics about Small business from the census bureau,” U.S. census bureau. Web. http://www.census .gov/econ/smallbus.html#empSize. © Mary Anne Poatsy $20,000 $18,000 $16,000

$12,000 $10,000 $8,000 $6,000 $4,000 $2,000

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How do small businesses foster innovation? Small companies often introduce new products or procedures that many large businesses do not have the flexibility, the time, or the inclination to produce or offer. In fact, small businesses create more patents per employee than do large firms.8 The impact of small business innovations is well known in the computer, information technology, and communications industries. Legendary entrepreneurs include Mark Zuckerberg, who created Facebook from his Harvard dorm room at the age of 19, and two Stanford students, Larry Page and Sergey Brin, who began Google as part of a graduate project. Many years earlier, Michael Dell shook up the computer retail industry by being the first to market computers directly to customers via the Internet rather than through retail stores.

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Other industries besides the technology field also have benefited from the innovative contributions of small businesses. For example, in the biotechnology industry, many small businesses have found innovative solutions to medical issues. The flexibility small businesses have allows them to react more quickly than larger companies to changing market trends and needs. As such, small businesses play an important role in maintaining a healthy economy. The “green industry”—businesses that provide environmentally friendly products and services—are a hotbed for small start-up businesses. Entrants into this new industry seem to be one of two types: Someone either takes an existing product and makes a business out of making it green or has an idea for a green product and creates a business to produce it. Wind turbines, solar panels, recycling, and recycled products have spurred many business initiatives. GigaBiter is a small business that benefits the environment as well as people’s security and privacy by safely grinding old computer equipment into dust that is 100 percent recyclable.9 The outdoor clothing and gear maker Patagonia was the first company to use recycled plastic bottles—and later recycled polyester—to create Polartec fleece.10 How do small businesses help bigger companies? Small businesses often operate in cooperative relationships with bigger businesses. In the automotive industry, for example, small businesses are important because they make and supply the parts needed to manufacture cars. In fact, many of the parts that go into automobiles, such as seats, engine blocks, and bumpers, are provided by independent suppliers. Small businesses also provide larger companies with new and better product designs. For example, heated seats and intermittent windshield wipers were first developed by small companies and later sold to large car manufacturers. How do small businesses help consumers? Small businesses directly provide us with many of the specialized products and services we use every day. Service businesses, such as hair salons, landscapers, and dry cleaners, as well as local restaurants, auto repair, and many other mom-and-pop stores, provide the services and goods larger businesses can’t or don’t want to provide. ◼ FIGURE 5.3 Small Business Ethnic Ownership

Small Business and the workforce What kind of workers do small businesses employ? Almost all new businesses are small and account for most of the new jobs created in the economy. In addition, small businesses hire a larger proportion of younger workers, older workers, and part-time workers, so they help employ millions of people who do not fit into a traditional corporate structure. Do small businesses provide opportunities for minorities? Many individuals see owning and operating their own businesses as a means of achieving the American dream. To that end, women, minorities, and immigrants are becoming more important players in the small business arena. According to the SBA Office of Advocacy, more than one-third of all U.S. small businesses are owned by minorities, with the largest growth and ownership occurring in Hispanic-owned businesses (see ◼ FIGURE 5.3). Hispanic-owned businesses account for 12 percent of all U.S. firms, African American-owned businesses account for 9 percent, and Asian-owned firms account for 7 percent of all U.S. firms. Women, who own 5.3 million businesses, make up approximately one-third of all small business owners.

Source: Data from Minority business Development Agency, U.S. business Fact Sheets, january 2016. Retrieved from http://www.mbda.gov/sites/default/ files/2012SbO_MbeFactSheet020216.pdf. © Mary Anne Poatsy

Native Hawaiian & Pacific Islander 1%

Black/African American 32%

Hispanic 41%

Asian 23%

American Indian & Alaska Native 3%

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Opportunity & Innovation New ideas and needs bring new businesses.

Control

More control of business decisions; do not want to work for someone else.

Financial Independence

Owners feel they can make more money operating their own business.

Schedule Flexibility Looking for a better work/life balance.

Unemployment

Seeking income due to job loss.

◼ FIGURE 5.4 Reasons to Start a Small Business Image sources, clockwise from top left: carsten Reisinger/Shutterstock; alphaspirit/Fotolia; Al-Ma-Ga-Mi/Fotolia; alphaspirit/Fotolia; tiero/Fotolia

Reasons for Starting a Small Business Why would I want to start my own business? Bill McNeely, a logistics operations manager at a training camp for the Afghan National Police, left his job to start a business so he would not have to be away from his family in Texas. But people start small businesses for many different reasons (see ◼ FIGURE 5.4): 1. Opportunity knocks. As the proverb goes, “Necessity is the mother of all invention.” An idea for a new company often starts when someone envisions a product or a service that isn’t being offered yet. Just listen to any episode of ABC’s entrepreneurial showcase, Shark Tank, to understand that many new businesses are formed to solve a problem, to offer a product that improves on an existing idea, or that helps to overcome a personal obstacle. For example, Ava the Elephant is a talking medicine dropper that helps children take their medicine and Unshrinkit is a laundry solution that was developed when a borrowed sweater was mistakenly washed and shrunk. Similarly, Anthony Casalena created Squarespace, an online tool for building and publishing websites, because at the time, the existing tools were fragmented and rudimentary. Initially Casalena didn’t think he was building a business. He was merely fixing his own problem. Today, Squarespace supports more than 1 million websites. 2. Financial independence. Many people launch small businesses to achieve financial independence, although this should not be the sole reason you start a business. Why? Because most small businesses don’t start out as profitable ventures. Traditionally, it takes three to five years for new businesses to become profitable. 3. Control. Being in control and making more business decisions than their current positions allow is another reason why people start their own businesses. With fewer channels to go through when decisions need to be made, small business owners can often react more quickly to take advantage of immediate opportunities. This can be rewarding. Other people simply aren’t satisfied working for someone else. 4. Flexibility. Running their own businesses gives people the flexibility to adjust their work schedules. Many small business owners appreciate the work– life balance that owning their own businesses affords. 5. Unemployment. It is not uncommon for people to start their own businesses because they have no other employment opportunities. “Life begins when you get fired” was exactly the case for Bruce Freeman, owner of ProLine Communications, Inc. Three months after being fired, he couldn’t think of what

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what’s in a Name?

aming a business should be fun, but it can be stressful, especially if you make some of the more common mistakes:

MISTAkE 1 Involving friends, family, employees, or clients in the naming decision. The name should communicate the key elements of your business, not the combined efforts of your friends and family. MISTAkE 2 Combining description with product name. Although it might seem catchy at the time, the result of company names that try to marry description with product is forced and often trite. A service franchise named QualiServe or a day spa named TranquiSpa ultimately aren’t the right choices. MISTAkE 3 Using generic names. Gone are the days when ACME Foods works as a corporate name. Similarly, using

names such as Joe’s Bar or Smith’s Hardware is inadequate. In such highly competitive times, when new products or services are fighting for attention, it is best to choose a more unique name. MISTAkE 4 Making up a name. Although using generic names may not be good, be careful to avoid names that are obscure, hard to pronounce, or hard to spell unless there is solid market research behind it. MISTAkE 5 Using geographic names. Unless you plan to stay local, including a specific geographic name may imply that you won’t go beyond that regional territory. TIP: You might need to hire a company to create a name for you. Acura, Flixx, and Compaq are all names that were created by experts.

to do next. Then, encouraged by a friend, Bruce started his own business. His first client was a company he worked with in his previous job. Now, more than 10 years later, he’s making more money than he ever could have in his old job.11

The Impact of Technology on Small Businesses How has technology affected small businesses? Technology creates new business opportunities and new ways to conduct business. Entrepreneurial success stories, such as YouTube, Facebook, and Google, have had a big impact on small businesses. Consider entrepreneur Evan Spiegel who eventually created Snapchat in response to a conversation with a fraternity brother who regretted sending a photo to someone. Although it took several years for Snapchat (originally named Picaboo) to gain acceptance and popularity, its rapid growth fostered a $3 billion acquisition offer from Facebook, which Spiegel turned down.

Social Media and Mobile Marketing Small businesses are finding that social networks, blogs, and mobile devices are more cost-effective ways than traditional advertising to interact with, market to, and keep abreast of their customers. This is what Sprinkles Cupcakes, a bakery chain based in Beverly Hills, California, does. Each day the company posts a secret word on its Facebook page. Customers who retrieve the word and mention it at any one of the bakery’s stores get a free cupcake. The company also uses Facebook to pretest flavor ideas and upcoming promotions in an effort to increase its interaction with its customers. Facebook is not the only social media tool being used by small businesses. Twitter, Yelp, Foursquare, and LinkedIn are also popular ways to connect with

Businesses in this Grapevine, Texas, mall use social media and mobile devices to communicate with their customers as they shop. Source: joyce Marshall/Mct/Newscom

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off ThE MARk

iSmell

ot all technology-related businesses end up being a successful. One example was the iSmell, a product that plugged into a computer’s USB port and promised to enhance a user’s web surfing experience by generating different scents. Using the iSmell, you could smell

a new perfume before buying it or conjure up the smell of a ballpark while playing a baseball video game. Unfortunately, iSmell never made it beyond the prototype stage. Its parent company, DigiScents, pulled the plug on it.12

customers and prospective employees. Using mobile-device apps consumers can access coupons, discounts, and special offers from small businesses. To help visitors with their shopping, the Grapevine Mall in Grapevine, Texas, posts signs throughout the mall to remind shoppers how to use their mobile devices to navigate the mall and find deals. Small business owners are also using devices that fit onto smartphones to process credit cards, which is a perfect solution for businesses that do transactions primarily at trade shows, flea markets, and craft shows. However, social media can also become problematic if not managed well. Creating a fan page on Facebook without monitoring what people are saying about your business can be hazardous to its reputation. Although most consumers report that they use social media to communicate with businesses, only a few are satisfied with businesses’ responsiveness on social media. Similarly, writing a blog may help get out your message, but if no one reads the blog, it is not effective. A well-thought-out technology and social media plan is an important aspect of any business’s overall strategy.

 Starting a small business is a sizable challenge, as Allison can attest to.

Source: Newscom

It didn’t solve all her problems; in fact, it might have created a few more, but she is glad to be in control of her own situation. It is a challenge to which many entrepreneurs, looking for their piece of the American dream, enthusiastically rise. For Allison, having a flexible schedule, doing what she loves to do, and making money doing it made the risks of starting her homeorganizing business worth taking. Objective 5-2

Entrepreneurs and the american dream Explain what the traits of an effective entrepreneur are, and differentiate the types of entrepreneurs.

 Who would ever have thought that blending Mexican, Brazilian, and Asian cuisines and $30,000 would lead to more than 50 restaurants in seven states as well as Japan 20 years later? Certainly not the Wahoo brothers. If you ask them, it just kind of happened. The Wahoo brothers—Wing, Ed, and Mingo—grew up above their parents’ Chinese restaurant in southern California. They took the concept of a fish taco—a staple they had grown to love while surfing in Mexico—and

ChAPTER 5

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enhanced it with their favorite Brazilian and Asian dishes. Combined with a casual, surf-inspired decor, their restaurant concept was well received by the local southern California crowd. The brothers brought in another partner to help manage their second location, and the business quickly took off from there.13 So, what qualities do the Wahoo brothers have to take their small fish taco eatery and turn it into a multimillion-dollar business? What makes them entrepreneurs? We’ve all heard of Starbucks, Under Armour, and Amazon.com, but you probably don’t associate these big-name companies with small business. At one point, however, each of these companies originated as a small business. Each was started by an entrepreneur—someone who assumes the risk of creating, organizing, and operating a business. Not all small businesses, however, are entrepreneurial. What makes a new venture entrepreneurial is that the business is innovative, change-oriented, or that it fills an opportunity niche by satisfying a need in the market that is not being adequately met.

The Traits of Successful Entrepreneurs What are the traits of successful entrepreneurs? Businessman Wayne Huizenga started Waste Management, Inc., a leader in the waste and environmental services industry, by buying a single garbage truck in 1968. He expanded the company by buying other trash collection services, and by 1983 the company had grown into the largest of its kind in the United States. But Huizenga didn’t stop there. He also started Blockbuster Video, the video rental company, as well as AutoNation, the behemoth automotive dealer.14 How can some entrepreneurs like Wayne Huizenga begin successful businesses, whereas others have a difficult time getting their ideas off the ground? How do successful entrepreneurs see an opportunity niche and know exactly what they need to do to seize the opportunity and succeed? Although luck and timing play a large role in entrepreneurial success, research has also shown that successful entrepreneurs have the following characteristics: 1. 2. 3. 4. 5. 6.

Are innovative and have a vision Take risks Are motivated to succeed Are flexible and self-directed Work well with others and possess good leadership skills Are “system thinkers”—view the whole process rather than just its individual pieces

How are entrepreneurs innovative? Successful entrepreneurs see problems to be solved or opportunities that aren’t being addressed in the marketplace; they recognize opportunity niches. They also make improvements to existing products or systems, or they introduce something new and make profitable solutions out of problems. Renowned management and business thinker Peter Drucker noted that successful entrepreneurs “exploit change as an opportunity for a different business or a different service.” For example, Henry Ford turned his knowledge of engines into the first “horseless carriage,” which he later improved to become the Model T. His improvement was not only in creating a new machine but also in developing an assembly-line process by which his company could make multiple automobiles more efficiently. Ford’s innovative assembly process became the standard for efficient manufacturing. Think about other entrepreneurs and the innovation behind their success. Mark Zuckerberg changed how we communicate and network with others by launching Facebook. Steve Jobs, arguably one of the greatest innovators of

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◼ FIGURE 5.5 Entrepreneurial Innovations

FM radio

Polaroid camera

Super computer

Portable computer

Digital X-ray

Portable MP3 player

Consumer GPS devices

Apple iPhone

Apple iPad

1933

1947

1958

1981

1983

1998

2000

2007

2010

modern times, helped to bring personal computing to the home with the introduction of the Apple computer and more recently changed how we listen to music with the iPod and iTunes, how we use mobile phones with the iPhone and mobile apps, and how we access media information and entertainment with the iPad. Entrepreneurial doesn’t just mean that you start from scratch. Obviously, Jobs had the powerful resources of Apple behind him to launch some of these innovations, but nonetheless his products were innovative and radically changed many traditional processes. ◼ FIGURE 5.5 lists some other important innovations by entrepreneurs. What other innovations would you add to this list? How do entrepreneurs take risks? Because entrepreneurs are often creating new and innovative products, the processes they develop often are untried and therefore subject to many risks: The risk of failure, the risk of losing one’s career or reputation, and, of course, financial risks. Successful entrepreneurs are aware of the risks, recognize they can influence events but do not have complete control over them, and know they may fail. Successful entrepreneurs therefore take calculated risks—that is, they consider the likelihood of success before deciding whether to take a particular risk. In addition, successful entrepreneurs are not daunted by failure or bad outcomes. Most see setbacks as part of the process, deal with them, and move on. What makes entrepreneurs motivated to succeed? Entrepreneurs are motivated by many different factors. Some entrepreneurs are motivated to provide for themselves or their families. These individuals may be driven to pursue multiple ventures before uncovering a successful idea. Other entrepreneurs are motivated to succeed by the personal fulfillment they feel after successfully launching a business. The keen desire to tackle challenges and achieve success led one entrepreneur, Ted Kennedy (not the former Massachusetts senator), to start a company. Kennedy noticed that many participants in the Ironman Triathlon Challenge were corporate executives. He also noticed that they wanted above-average accommodations and enjoyed meeting and socializing with other CEOs before and during their competition. So, Kennedy formed CEO Challenges, a company that puts on sporting competitions specifically for CEOs. Although CEO Challenges initially only offered triathlons, it now offers cycling, hockey, fishing, golf, sailing, tennis, and other competitive adventures to executives and holds challenges in Canada and Europe. Why do successful entrepreneurs need to be flexible and self-directed? Because new ventures are risky, entrepreneurs need to be able to react quickly to unexpected situations and downturns. Moreover, an entrepreneur must be able to wear many hats, acting not only as executive but also as sales manager, financial director, secretary, and mailroom person. Entrepreneurs also need to know when to sell or exit a business. Why are people skills and leadership skills important to entrepreneurs? They may come up with the initial ideas behind their businesses, but entrepreneurs rarely work by themselves. As much as they have the capacity to wear many hats, at some point most entrepreneurs need other people with complementary skills to join them in their ventures. If their businesses expand, they must hire employees and other managers to help them run it, just as the Wahoo Brothers did when they decided to expand their restaurant business. Leadership and communication skills are therefore important traits of successful entrepreneurs who must motivate others to feel as passionately about the entrepreneurial enterprise as they do.

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What does it mean for entrepreneurs to be “system” thinkers? Although entrepreneurs develop companies from an idea, they must focus on the entire process of turning their idea into a business to succeed. Successful entrepreneurs are able to see the whole picture when they establish their businesses. They determine how to resolve a problem or capitalize on an opportunity by developing a solid plan, including producing, financing, marketing, and distributing the service or the product. Realizing that the hamburger was the best seller in their California restaurant, the McDonald brothers, who started the McDonald’s restaurant chain, created an assembly line that allowed them to produce burgers quickly and inexpensively. Business boomed. It expanded even more when businessman and entrepreneur Ray Kroc, who was selling milkshake machines in California, convinced the brothers not only to use his milkshake machines but also to let him open another McDonald’s restaurant in Chicago. Seeing the opportunity niche in fast-food franchising, Kroc later bought the McDonald’s restaurants from the McDonald brothers, and has since turned it into a global, multibillion dollar operation.

Types of Entrepreneurs Are there different types of entrepreneurs? Beyond traditional entrepreneurs described in the previous sections, other entrepreneurial categories exist: 1. 2. 3. 4. 5. 6. 7. 8.

Lifestyle entrepreneurs Micropreneurs Home-based entrepreneurs Internet entrepreneurs Growth entrepreneurs Intrapreneurs Social entrepreneurs and social intrapreneurs Serial entrepreneurs

Although each category has its own unique characteristics, entrepreneurs don’t necessarily fit into just one. For example, there are home-based entrepreneurs who are also lifestyle entrepreneurs and Internet entrepreneurs. Let’s take a look at each of these types of entrepreneurs. What are lifestyle entrepreneurs? Lifestyle entrepreneurs look for more than profit potential when they begin their businesses. Some lifestyle entrepreneurs are seeking freedom from corporate bureaucracy or the opportunity to work at home or in a location other than an office. Others want more flexibility in work hours or travel schedules. Take Richard Dahl, for example. He is traveling around the country in a travel trailer selling more than 300 items, including his flagship water filter system at trailer parks, campgrounds, and motor home shows.15 His business, The RV Water Filter Store, allows him to fulfill his passion of traveling around the country with this wife. Gary Veynerchuk started WineLibrary.com, a multimillion-dollar online wine store that married his passion for wine with his entrepreneurial spirit. Gary has since started several other businesses in addition to investing in other start-ups. What are micropreneurs? Micropreneurs start their own businesses but are satisfied with keeping their businesses small in an effort to achieve a balanced lifestyle. For example, a micropreneur might open a new type of restaurant and be satisfied with running only that one restaurant instead of expanding as Ray Kroc did with the McDonald brothers’ restaurant. Micropreneurs have no aspirations of growing large or hiring hundreds or thousands of employees. Businesses such as dog-walking services, painters,

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and special-occasion cake bakers would all be considered micropreneurial opportunities. What are home-based entrepreneurs? As the name suggests, home-based entrepreneurs are entrepreneurs who run their businesses out of their homes. Home-based entrepreneurs are often parents who like being able to stay home with their children while running a business. In addition to offering lifestyle advantages, such as being able to stay at home with children, home-based businesses offer several financial advantages. Staying at home eliminates commuting time and costs as well as office rent and other overhead expenses. Also, home-based entrepreneurs can take advantage of deducting from their taxes a part of their rent or mortgage payment, as well as other expenses such as depreciation, property taxes, insurance, utilities, household maintenance, and home repairs and improvements. P. J. Jonas is a home-based entrepreneur. Jonas launched Goat Milk Stuff on her family’s farm after she started making natural soap so she could avoid using chemicals on her children’s skin. Jonas, her husband, and all eight of their children work in the business. In 2013, Goat Milk Soap won StartUpNation’s “Leading Moms in Business” competition.

Catherine Cook, at the age of 17, cocreated the successful website MeetMe with her older brothers Dave and Geoff during spring break. Source: Newscom

What are Internet entrepreneurs? Advances in technology have spawned another type of entrepreneur, the Internet entrepreneur, who creates businesses that operate solely online. The early 1990s saw the first group of Internet entrepreneurs, but most did not survive the dot-com bubble and bust. Now, however, with the advent of Web 2.0 technologies (such as blogging and social networking), smartphone apps, contextual web-based advertising (such as Google Ads) that help to provide revenue, along with faster broadband connections, a greater number of successful online businesses are being established. Some of the most famous Internet entrepreneurs include Mark Zuckerberg (Facebook), Jeff Bezos (Amazon), Pierre Omidyar and John Donahoe (eBay), Sergey Brin and Larry Page (Google), and Jimmy Wales (Wikipedia). Youth may have an advantage in this entrepreneurial genre because success requires little investment, some spare time, and a good understanding of what their peers are looking for. For example, David and Catherine Cook and their older brother Geoff started MeetMe (formerly myYearbook.com) over spring break in 2005. The social networking site invites members to meet new people through playing games, chatting, and sending virtual gifts purchased with Lunch Money, the site’s virtual currency. Members are also given the opportunity to donate Lunch Money to their favorite charity through their charity application. In 2013, MeetMe launched two new dating apps, Choosy, which quickly became the top new app in the social category of the Google play store, and Charm, which uses videos rather than photos, like the social networking site Vine does. A simple homework assignment for a class at Stanford University, referred to as the “Facebook Class,” spawned many successful companies and ideas. Student teams were to create applications for Facebook, the popular social networking site. Many of the apps had a short life span, but their creators went on to create other apps for the newly released iPhone or to begin other Internet businesses, such as the social networking site Friend.ly, or have sold their businesses to companies like Zynga. The class, now called “Startup Engineering,” can be taken for free on Coursera.org. What are growth entrepreneurs? Growth entrepreneurs strive to create fast-growing businesses and look forward to expansion. The companies that these

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types of entrepreneurs create are known as gazelles. Typically, a gazelle business starts with a base revenue of at least $100,000 and experiences at least 20 percent sales growth every year for five years. In other words, over the course of the five years, the firm doubles its revenues. It is hard to recognize a gazelle business during its rapid growth period, though companies such as eBay, Google, and more recently, Tesla, can clearly be identified in retrospect as having been gazelles in their early years. Gazelle companies also help the economy. Although they only represent approximately 15 percent of all businesses, they have been credited with generating about 50 percent of all new jobs.16 What are intrapreneurs? You don’t necessarily have to leave your company to have an entrepreneurial experience. Some companies are good at fostering intrapreneurs—employees who work in an entrepreneurial way within an organizational environment. Because its success depends on its ability to develop creative solutions to household problems, developing intrapreneurs has been important to the home appliance company Whirlpool. Instead of relying solely on the traditional research-and-development process, Whirlpool taps the creative juices of its employees by encouraging them to generate ideas that will enhance the company’s existing products. Although employees are not separately compensated for their ideas, they are pleased that the company asks for their ideas and have responded enthusiastically. Technology companies are well known for fostering intrapreneurial creativity. Microsoft encourages employees to work on their own projects in the company’s “Garage,” a facility with various tools such as three-dimensional (3D) printers they can tinker with. At Google, employees are encouraged to spend 20 percent of their time working on their pet projects. Gmail and GoogleAds are two products that were developed as a result of this policy. Other examples of products generated from employee innovation include Post-It Notes, the Sony PlayStation, the Java programming language, and ELIXIR guitar strings.17 What are social entrepreneurs and social intrapreneurs? Just as a business entrepreneur tries to create innovative solutions that satisfy an unfulfilled corporate or consumer need, the idea can be extended to society at large. Social entrepreneurs are entrepreneurs who create innovative solutions designed to solve social problems. For example, Mimi Silbert founded Delancey Street Foundation, a residential education center that teaches substance abusers, former felons, and the homeless the skills necessary to lead productive lives. The foundation runs on income generated by businesses created by the foundation that act as the training ground for program participants. It has been called the most successful rehabilitation project in the United States.18 Similarly, social intrapreneurs build and develop ventures within a company that are designed to identify and solve large-scale social problems. In an effort to create a “social corporate enterprise,” eBay, for example, gathered 40 employees to discuss ways to make the company more environmentally aware. What resulted were a myriad of projects, ranging from ride-sharing programs and community gardens to the largest installation of solar-power generators in San Jose, California, at the company’s corporate headquarters.19 Previously we mentioned Wayne Huizenga, the entrepreneur who started Waste Management, Blockbuster Video, and Auto Nation. Wayne, like other serial entrepreneurs, seems to like the process of building and growing a business and doing it over and over again. Other successful serial entrepreneurs include Ted Turner (Turner Broadcasting System, CNN, and Ted’s Montana Grill), Richard Branson (Virgin Records, Virgin Airways, and Virgin Mobile), and even Oprah Winfrey (O, The Oprah Magazine, OWN network, and Harpo Productions). Some might even consider Ben Franklin and Thomas Edison as our earliest serial entrepreneurs. Would you agree?

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oN TARgET

origami owl

ella Weems desperately wanted a car for her sixteenth birthday. But her parents had other ideas. They wanted Bella to go to work to so she could buy her own car. And that’s just what Bella did. At age 14, she started a business with $350 of her own money, an amount her parents matched. Bella ultimately ended up buying herself a

white Jeep, but that’s only part of the story. The business she created, Origami Owl, uses private home parties to sell Living Lockets, which are mini-shadow boxes filled with charms of your choice to tell your own story. In just two years, the business generated $24 million and has been growing exponentially since.

Entrepreneurial Teams What if I don’t have all the skills to be an entrepreneur? Look at the list of entrepreneurial traits described in this section. In addition to being innovative, motivated, and self-directed, an entrepreneur initially may need to fill the role of executive, sales manager, financial director, secretary, and mailroom person. If you don’t possess all of these traits, it doesn’t preclude you from starting your own business and becoming a successful entrepreneur. If you have an idea and really want to make it happen, you might want to reach out to others who can do what you can’t or don’t want to do and assemble an entrepreneurial team. What is an entrepreneurial team? An entrepreneurial team is a group of qualified individuals with varied experiences and skills who come together to form a new venture. The skills of the entrepreneurial team members complement one another so that as a group the team has the necessary skills and traits to manage a successful project. For example, brothers Lucas and Lee Brown along with Lin Miao and Andrew Bachman, came together to form Tatto Media, a successful Internet marketing company that changes how advertisers pay for display advertising. After selling Tatto Media, the Brown brothers went on to form HasOffers, an advertising performance analytics group. Entrepreneurial teams are also great for those who want to run their own businesses but perhaps lack the personal experience. For example, college and business school students often form entrepreneurial teams to get their first projects launched. Students from Stanford University have come together to create well-known companies such as Google, HP, Cisco, Imagen, and Yahoo! Many schools run entrepreneurial challenges, such as the Big Bang competition at the University of California–Davis. During the yearlong competition, students, alumni, staff, and faculty join forces to construct and test their business plans, which serve as the springboards for new companies.

 Perhaps you are a part of an entrepreneurial team or an employee in an intrapreneurial company or prefer to go it alone. Maybe you want to keep your business small or expand it like the Wahoo brothers or McDonald’s. Whatever the case, being an entrepreneur is more than just being in business for yourself. Taking advantage of an opportunity niche, riding the bumps along the way, and being a system thinker all describe successful entrepreneurs. Do you have what it takes to be an entrepreneur? Entrepreneurial opportunities exist if you are up to the challenge.

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Objective 5-3

Buying Franchises and Existing Businesses Summarize the advantages and disadvantages of franchising and buying existing businesses.

 It

was a desired change in lifestyle that prompted Naomi Lawrence to think about starting her own business. She had always dreamed of running her own restaurant, but she didn’t have much business background or restaurant experience. What she did have was a lot of tenacity and knowledge of marketing. Additionally, she was a people person—a necessity for restaurant owners. Still, she was unsure of where to begin. Naomi was uncomfortable starting from scratch because she knew that the risks were way too high to start a restaurant on her own.She felt that she needed the support of someone who had been through the process before. What are her options? What would be the best route for Naomi to take? For those who want the opportunity of owning their own business but, like Naomi, want to avoid the stress of starting it completely from scratch, buying an existing business or purchasing a franchise may be a viable alternative. Franchises are a popular way to enter the world of business ownership. Alternatively, there are definite advantages to buying an existing business, especially if it has previously enjoyed a good reputation and has an existing customer base. In this section, we’ll look at what it means to buy a franchise. We’ll also discuss buying an existing business and molding it into your own.

franchising Basics What is a franchise? Franchises have been around for centuries. In the United States, Singer Sewing Machines, one of the first franchises, started in 1851. A franchise is a method of doing business whereby the business (the franchisor) sells its products or services under the company’s name to an independent thirdparty operator (the franchisee). Naomi would be a franchisee using a franchisor’s marketing methods and trademarked goods under the name of the business. In exchange, she would make monthly payments to the franchise. What kinds of business opportunities are available as franchises? Franchises play an important role in our economy. There are nearly 780,000 franchised businesses in the United States. They employ approximately 8.9 million people and generate nearly $890 billion annually.20 Franchises in the business-services, retail products and services, as well as lodging and personal services are expected to experience the greatest growth and have the most employment opportunities in the coming years.21 But franchise opportunities exist in nearly every industry, and many can be run from home, which lowers a business owner’s start-up costs because there is no need to purchase

Source: Kzenon/Shutterstock

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web-Based Resources for Potential franchisees

The SBA and FranNet sponsor a site with information about franchising, how to determine if franchising is right for you, and how to select the right franchise. The American Franchisee Association offers advice on buying a franchise, legal resources, and opportunities to network with other franchisees. The Federal Trade Commission provides consumer information on franchise and business opportunities. The publication A Consumer Guide to Buying a Franchise outlines the steps to take before selecting a particular franchise, how to shop at a franchise exhibition, and what you should know before signing the franchisor’s disclosure document. Entrepreneur.com’s Franchise Zone allows users to search a directory of franchising opportunities and provides tips on buying a franchise. This site also ranks the top franchises in terms of growth, cost, global appeal, and other aspects. The International Franchise Association provides answers to frequently asked questions about franchising and resources for potential and current franchisees. This website also hosts a directory of franchising opportunities in various industries.

or rent real estate. Home-based franchises, such as Jan-Pro, Snap-on Tools, and Cruise Planners, are among today’s top home-based franchises.22 If you are thinking of purchasing a franchise, you will need to do your homework. There are several sources of helpful information about franchises that you should study before taking the leap. ◼ TABLE 5.1 lists several helpful web-based resources that you can begin with.

Pros and Cons of franchising What are the advantages of franchising? For many, franchising is an easier, less risky means of starting a business because of the immediate effects of owning a business with an established brand and name. In addition, because the franchisor provides much of the marketing and financial tools needed to run the business, all the franchisee is expected to bring to the table are management and marketing skills, time, and money. Other advantages of owning a franchise include: • A proven system of operation. Instead of wading through the muddy waters of new business ownership by themselves, franchisees benefit from the collective experience of the franchising company. The franchisor has determined, through trial and error, the best way to open and operate the business. New franchisees can avoid many of the common start-up mistakes made by new business owners because they will be working with standardized products, systems, and financial and accounting systems. • There is strength in numbers. You are not alone when you buy a franchise. Because you belong to a group, you might benefit from economies of scale achieved by purchasing materials, supplies, and services at discounted group rates. In addition, it is often easier to get approved for business loans when running a franchise because lending institutions often view that there is less risk associated with franchises. • Initial training is part of the deal. The beauty of franchising is that you are in business for yourself but not by yourself. The franchisor offers initial training to ensure that you have a successful opening. They might offer ongoing training if new products or services are being incorporated into the franchise line. • Marketing support is provided. As a franchisee, you are often given marketing materials generated at the corporate level and have the benefit of any national advertising programs that are created. Although you are expected to run your own local marketing efforts, you have the support of other franchisees in the area to help you in your efforts. • Market research is often provided. Good franchisors do considerable market research and can generally conclude whether there is demand for the product or service in the area before selling a franchise. The franchisor should also help

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to identify the competition and offer strategies to differentiate the franchise from them.

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6QVCN+PXGUVOGPVs r(TCPEJKUG(GG r1PIQKPI4Q[CNV[(GG r6GTOQH#ITGGOGPV[GCTU

What are the disadvantages of franchising? Although buying a franchise provides the franchisee with many benefits, there are some disadvantages:

• Lack of control. There is not much opportunity to 6QVCN+PXGUVOGPVs r(TCPEJKUG(GG contribute creatively to the franchise because the r1PIQKPI4Q[CNV[(GG franchisor often controls the look of the store and r6GTOQH#ITGGOGPV[GCTU the product or the service. The franchisee, however, is expected to bring the necessary drive and spirit to make the franchise a success. 6QVCN+PXGUVOGPVs • Start-up and ongoing costs. You don’t have to have r (TCPEJKUG(GG a lot of money to purchase a franchise. Many franr1PIQKPI4Q[CNV[(GG chises can be purchased with a small initial investr6GTOQH#ITGGOGPV[GCTU ment. The initial investment includes the franchise fee (the initial fee paid to a franchisor to join their system), along with other startup expenses such as real estate, equipment, ◼ FIGURE 5.6 supplies, licenses, and working capital. Franchises such as Cruise Planners, Franchise Costs and Fees Vanguard Cleaning Systems, and Coverall Health-Based Cleaning Systems Image sources, top to bottom: bloomberg/ can be purchased with less than $50,000.23 (See ◼FIGURE 5.6.) Getty images; Ulrich baumgarten/Getty In addition, franchisees must pay a monthly royalty fee to the franchisor, which is typically 6 to 10 percent of the business’s gross revenues. The royalty fees are due regardless of how the franchisee’s business is doing—in other words, whether it is making a profit or not.

images; the Washington Post/Getty images

• Workload. As with any new business, new franchisees shouldn’t expect easy hours. Naomi spends a lot more time running her franchise than she thought she would. However, because she can hire employees to run the day-to-day operations, her time is spent more on the business development and management end of the business. • Competition. Some franchises do not restrict the number of their franchise locations. In those instances, franchisees could experience serious competition not only from other companies but also from other franchisees in the same organization. In addition, some franchises do not offer geographic or demographic studies of the best locations in which to open new stores and instead may expect the franchisee to do a market analysis of the surrounding competition. • Share common problems. If the franchisor or another franchisee is having problems, all franchisees will feel their pain. For example, when a Wendy’s res◼ FIGURE 5.7 taurant was falsely accused of serving chili with a human thumb mixed in, all Pros and Cons of Franchising of Wendy’s restaurants suffered from the fallout. Franchising ◼ FIGURE 5.7

cons of franchising.

summarizes the pros and

Advantages

Disadvantages

franchising Considerations

Proven system of operation

Lack of complete control

What are things to watch out for when considering buying a franchise? The most common piece of advice offered to anyone interested in buying a franchise is to do your homework up front. Although much of the start-up process is done for you, you are still buying a business that will require your time

Strength in numbers

Start-up and ongoing costs can be overwhelming

Training is part of the deal

Work load is no less with a franchise

Marketing support is provided

Competition and cannibalizing can occur within the franchise

Market research is provided

Individual problems can become group problems

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Questions to Ask before Buying a franchise Questions to Ask the Franchisor

Questions to Ask Other Franchisees

Competition

• What is the competitive advantage of the good or service? • What makes the business more attractive to an owner and more attractive to a customer?

• How is your system better than that of competitors? • How does your business match up? • Who are your competitors?

Franchise system

• How time tested and standardized is the franchise system? • What franchise system is used, and how does it work? • How long has the franchise been in business, and what improvements have the franchise company made recently?

• How long have you been in business? • Does your location meet your customers’ needs? • Who selected the site?

Support and training

• How much support does the franchisor give the franchisee? • What initial and ongoing training are provided? • Are there toll-free help lines, field support, annual meetings, local meetings, purchasing programs, and marketing promotions?

• How is the relationship with the franchisor? • How were the initial and ongoing training and ongoing support? • How are the marketing, advertising, and promotional programs handled?

Financial strength

• What are the financial strengths of the company and the experience of its managers? • How much revenue comes from franchise fees, and how much revenue comes from royalties? • How has the stock performed?

• Are you pleased with earnings? • Is volume growing?

Franchise relationships

• How important is the franchisee to the franchise? • How can they describe the relationship with the franchisor?

• Have there been lawsuits or arbitration? • If so, how have they been resolved? • Do you have second thoughts (would you do this again)? • Would you own more units?

Source: based on “A checklist of Questions to Answer before You buy a Franchise” (PowerHomebiz.com). © Michael R. Solomon

and money, and it is not guaranteed to succeed. ◼ TABLE 5.2 shows suggested questions to ask the company from which you are buying the franchise and other people who have bought franchise before you take the plunge.

Buying an Existing Business Is there another way to start a business besides starting new or buying a franchise? Another option is to buy an existing business. However, just like buying a franchise or starting a business from scratch, the decision must be well thought out. What are the advantages of buying an existing business? Buying an existing business has the following advantages: • Ease of start-up. Like a franchise, it is often simpler to buy an existing business than to start one from scratch. If you are purchasing a business that is operational and does not have serious problems, your suppliers, existing staff and management, and equipment and inventory will already be in place to help facilitate the transition. • Existing customer base. An existing business may have a satisfied customer base already in place. If no significant changes are made to drive away current customers, the business can continue to run and provide immediate cash flow. • Financing opportunities. If the business has had a positive track record, it might be easier to obtain financing to purchase it.

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What are the disadvantages of buying an existing business? There are also disadvantages to buying an existing business: • High purchase price. If you need to buy the owner out of the business, the initial purchase price may be high. The purchase price may be more than the immediate up-front costs associated with starting a business from scratch and in some cases purchasing a franchise. Although you can determine the value of the physical business and its assets, it is more difficult to determine the true value of the previous owner’s goodwill—the intangible assets represented by a business’s name, customer service, employee morale, and other factors— that might be lost with a change in ownership. Often the intangible assets are overvalued, making the business cost more than it is worth. • Inheriting the previous owner’s mistakes. In addition, with a preexisting business, you are sometimes stuck with the previous owner’s mistakes. This means you might inherit dissatisfied customers, bad debt, and unhappy distributors or purchasing agents. You may need to work to change the minds of people who have had a bad experience with the previous ownership. • Unknowns in transition. There is no guarantee that the firm’s existing employees, managers, customers, suppliers, or distributors will continue to do business with you once you own the company. If the staff does stay, you may inherit unanticipated employee problems. What do I need to do before I buy a business? Existing businesses are sold for many reasons. Before buying an existing business, make sure you perform due diligence—which is conducting a reasonable investigation into the business’s history, operating and financial records, contracts, and the valuation of the business. You want to know if you are buying a company with a dissatisfied customer base or with a large amount of unpaid bills or with unfavorable contracts that cannot be renegotiated. ◼ TABLE 5.3 provides a brief checklist of things you should look into before buying a business.

 We started this section with a story about Naomi Lawrence, who had a dream of owning a restaurant. What did she decide? Naomi knew that the risks were way too high to start a restaurant on her own. She considered buying an existing restaurant but still felt that she didn’t have enough experience to handle the demands of a full-service restaurant. Instead, she felt that she

TABlE 5.3

Things to Consider before Buying a Business

Initial Considerations • Why is the business for sale? • What do current customers say—in person and via social media? • Are there opportunities for growth? How much time does the current owner put into the business? • Who is the competition? Due Diligence Checklist • Get an independent valuation of inventory and equipment. • Have an accountant review the financial statements for the past three years. • Have a lawyer analyze pertinent business documents—property leases, employment contracts, and so on. • Talk to suppliers to see if they will continue to supply the business when ownership changes hands. • Check for lingering or festering hazardous waste problems. They’ll become your responsibility as the new owner.

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could run a small, single-product food business, such as a coffee bar or an ice cream shop, to give her the experience she would need to run her own fullservice restaurant someday. Ultimately, Naomi decided to open an ice cream franchise. There were many to choose from, so she spent months doing product research, visiting and tasting the various frozen treats offered by most of the ice cream franchises. Whether you buy an existing business or franchise or begin a business of your own, you’ll be joining a large group of small business owners who make a significant contribution to the U.S. economy. Objective 5-4

the risks of Small Businesses and Where to get Help

Source: alphaspirit/Fotolia

Discuss the factors that can lead to small business failure and the steps and resources available to diminish the potential of small business failure.

 When

Roger Sherman heard rumors that the company he was working for was considering filing bankruptcy, he felt he would be better off on his own. Roger took advantage of an early retirement package and, using his life savings, started a business selling energy-efficient, solar-powered scooters and bicycles. But his well-thought-out business was hampered by a massive downturn in the economy. Roger is concerned he might not be able to make payroll or keep all his employees. What should he do?

Starting a business is a lot of hard work and comes with no guarantee for success. Nearly one-fourth of all start-ups fail in the first year, and two-thirds survive only two years. Just slightly more than onehalf make it through five years of operation. However, resources are available to small business owners to help mitigate the risks of failure. In this section, we’ll talk about the risks facing small businesses and where owners can go for help.

why So Many Small Businesses fail What are the risks of owning my own business? Although anything can happen to threaten the survival of a small business, most small businesses fail for one of a few common reasons. Some reasons why businesses fail include: • • • •

Too much accumulation of debt Inadequate management Poor planning Unanticipated personal sacrifices Let’s examine each risk in more detail.

What causes excessive debt accumulation? One reason many new businesses fail is that they accumulate too much debt early on. Most begin a new business

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by borrowing funds. Regardless of whether the loan comes from a bank, an outside investor, or a credit card company, if the new business does not generate revenue quickly enough to begin to pay back the loans, the burden of paying the debt balance plus additional interest as well as normal operating expenses can cause an owner to become further entrenched in a potentially unrecoverable situation. The situation might also tempt the owner to take out more loans to keep the business running. What’s worse is that some business owners borrow against their personal assets. This puts the owners at risk of not only losing their businesses but also potentially forcing them to file personal bankruptcy as well. How does poor fiscal management lead to failure? Although entrepreneurs and small business owners are good at coming up with ideas, they may not be great at managing the books. The fact that so many businesses fail as a result of high levels of debt can be a sign of poor financial and business management. Financial statements and budgets need to be created honestly and adhered to each month, accounts receivable religiously collected, and accounts payable aggressively managed. Take Jodi Gallagher, for example. Jodi owns a business that designs and creates lingerie. In an effort to get her product into as many stores as possible, Jodi was lenient on the collection terms of her accounts receivable. Rather than insisting on immediate payment, she extended stores credit, and, as a result, it took her months to collect. Realizing that her mistake almost cost her business, Jodi no longer extends credit.24 What other types of improper management lead to failure? For some new owners, an early surge in sales proves to be overwhelming. This is what happened to many dot-com companies that went bust in the late 1990s. They did not plan for rapid growth and therefore did not have sufficient inventory to fulfill orders when they came in. They also did not take into consideration the subsequent impact this would have on dealers and retailers who were a part of their distribution channels. Similarly, unexpectedly high demands can lead to expanding the business too soon or moving into areas that are less profitable—both of which can cause the business to stray from its original course and set it up for failure. Many business owners ignore the initial signs of business failure or attribute the failure to the wrong reasons. Good managers stay on top of all aspects of the business, remain objective, and make tough decisions when necessary. How important is planning to a business’s success or failure? Large debt accumulation and poor business management happen after the business is established. One of the biggest reasons businesses fail is that there was no formal plan in place to begin with. The old adage “failing to plan is planning to fail” certainly applies to starting a business. Many budding business owners, in the excitement of starting something new, neglect to take the boring and difficult but necessary steps of building an effective business plan. A business plan is a formal document that states the goals of the business as well as the plan for reaching those goals. As ◼ FIGURE 5.8 shows, a business plan includes the company’s mission statement, history, and the qualifications of the owners and management team and any resources they might have to contribute to the business. It includes a marketing plan, an operational plan, a financial plan, and a risk analysis. A business plan also identifies the competition and highlights opportunities for success. (You will find more information about creating successful business plans in Mini Chapter 2.) Neglecting to consider any of these factors can doom a business from the start. Writing a business plan forces you to think through some of the more difficult aspects of the business up front. Poor planning can lead to unnecessary spending. Equally, a well-written and well-thought-out business plan can lead to greater financing options as lenders are more likely to invest in a business that has a solid plan. Success is a lot more difficult without adequate funding. New businesses also may fail when their new owners do not adequately anticipate the many personal sacrifices—financial, time, and otherwise—they are forced to make. For example, the cost of health insurance and retirement accounts for the owner and employees falls solely on the shoulders of the new business owner.

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◼ FIGURE 5.8 A Business Plan Outlines a Company’s Goals and Strategies

Company Information • Mission Statement • Current Status • History • Management Team

Marketing Plan

Risk Analysis

• Competitive Analysis • Pricing • Distribution • Promotion and Brand Development

• Risk Evaluation • Risk Management Plan

Financial Plan

Operational Plan

• Current Financing • Funding Needs and Plan • Financial History • Financial Forecasts • Valuation

• Staffing • Research and Development • Manufacturing Plan • IT Plan

Forbusinesses with more than 50 employees, providing health care is mandated by the government. For smaller businesses, however, to keep the business running, sometimes the expense of health insurance and long-term retirement funding for the owner gets postponed. Additionally, the amount of time and effort owners must invest in the business, as well as the necessity to take on multiple responsibilities, makes running your own business not for the faint of heart.

getting help Where do small business owners go for advice? Most new business owners are just that—new. Because they haven’t experienced much of what they will encounter, knowing when and where to go for help, a second opinion, or just advice can make all the difference. There are several sources of help and advice that a small business owner can turn to (see ◼ FIGURE 5.9): ◼ FIGURE 5.9 Small Business Support Websites

SBA

SCORE

• www.sba.org • Sole purpose is to cater to the needs of small businesses. Provides counseling, workshops, small loans.

• www.score.org • Volunteer organization of retired executives who offer workshops and counseling to small businesses at no cost.

Entrepreneurs Organization • www.eonetwork.org • Offers industry-related conferences and seminars and help to connect business owners with industry experts for individual mentoring.

National Business Incubators Association • www.nbia.org • Provides start-ups with information, education, advocacy, and networking resources.

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• The Small Business Administration. In addition to financial assistance the SBA offers help with the legalities needed to start and operate a business as well as education and training, disaster assistance, and counseling for small business owners. The SBA holds events in major cities in all states, such as workshops in financial analysis, creating a business plan, and launching a business. It also offers free online courses and coordinates links to academic institutions that offer private online training. The SBA also acts as an advocate for small business owners to national and state policymakers. It works to reduce regulatory requirements and maximize benefits that small businesses receive from the government. • SCORE. The nearly 11,000 volunteers who make up the SBA’s Service Corps of Retired Executives (SCORE) offer workshops and counseling to small businesses at no cost. The volunteers are currently working in or have been in the field and can therefore provide advice to new or existing small business owners. They review business plans, help with tax planning, and offer new ideas and fresh insights. Some SCORE success stories include Vermont Teddy Bear, Vera Bradley Designs, and Jelly Belly Candy. • Other mentoring sources. SCORE is not the only resource new business owners can turn to for mentors. Industry-related conferences or seminars often present new business owners with opportunities to find others who can serve as sounding boards and guides. In addition, other organizations, such as the Entrepreneurs Organization (EO), connect business owners with experts in their industry for individual mentoring. Although the EO is for those who are currently in a viable operation (its requirements are that you must be a founder, cofounder, owner, or controlling shareholder of a business with a minimum of $1 million in annual gross sales and younger than 50 years old), such mentoring services can nonetheless be helpful to small business owners who have already launched their businesses. What kind of training is appropriate for small business owners? Before jumping into any endeavor, it is always good to have some experience or training. Although many entrepreneurs have advanced degrees in business, that level of formal education is often not necessary. If you are currently in college, look for internship opportunities in your industry of interest. Both large and small companies use interns. Most community colleges offer business classes for credit or noncredit community education classes that are taught by industry professionals. In addition to formal classroom training, you can also obtain hands-on experience by interning or working part-time for a company in a related field; if no opportunities exist in a related field, working for any start-up company can give you experience that can help you run a small company. Where can small business owners go for support services? One of the biggest overhead costs for many new businesses is the support services required to run the business. Business incubators are organizations that support start-up businesses by offering administrative services, technical support, business networking, sources of financing, and more that a group of start-up companies share. Business incubators can be either private organizations or public services. Over the past few decades, many cities, as well as developed and developing countries, have started public business incubators, often in conjunction with universities and research institutions, to promote new business development. For example, the National Science Foundation has created Innovation Corps (I-Corps)—a $5 million incubator for student entrepreneurs—and Rensselaer Polytechnic Institute runs one of the oldest incubator programs in the country. The primary goal of a business incubator is to produce successful businesses that are able to operate independently and become financially viable in the early years when they are most vulnerable to failure. Incubators also create a synergistic

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environment where companies can act as peer-to-peer mentors, sharing both successes and failures. Incubators also lend legitimacy to a beginning company as well as a more professional atmosphere than someone’s home office. Eventually, participants must leave the incubator, but beginning in an incubation program can increase the success rate of many start-ups. What other options exist for small business advice and assistance? As noted previously, starting up a small business requires a business owner to fulfill many roles. Many owners quickly realize that their strengths lie in only one or a few of these roles and therefore seek assistance from other people. One option is to team up with partners who offer the company strengths that the new owner does not possess. The partners in turn share the business’s profits and liabilities. Forming an advisory board is another option. An advisory board is a group of individuals who offer guidance to the new business owner. It is similar to a board of directors in a publicly held company except it generally does not have the authority to make decisions. Does my business location make a difference in the type of help I can get? In most cases, new business owners look for a location that is suitable for their business, has good traffic flow, is safe, and so on. However, in an effort to build up and even resuscitate communities throughout the United States, federal and state governments have established enterprise zones, geographic areas targeted for economic revitalizing, based on various criteria, such as their population, poverty rates, and amount of economic stress they are experiencing. Businesses receive generous tax benefits for locating and hiring in these enterprise zones. Almost every state has some form of enterprise zone program. In addition, the federal government has enterprise communities and empowerment zones across the United States. The economic benefits companies receive when they locate in an enterprise zone often outweigh the risk of locating in a distressed area.

 Remember Roger Sherman? When he found he had troubles with his Source: Newscom

small business, Roger decided to consult a SCORE volunteer. Many new business owners think they can’t afford professional advice, so they rely on their own efforts, advice from friends and family, and trial and error. Often, they find that it takes more than a good idea and hard work to make a business successful. Knowing all the resources available to fledgling businesses can help entrepreneurs avoid making the mistakes that eventually lead to the demise of their businesses. Careful financial decision making, savvy management, meticulous planning, and the willingness to make significant personal sacrifices are all needed to create a successful business. Knowing when, where, and how to ask for help is also a critical factor to success. Objective 5-5

Financing considerations Compare the potential benefits and drawbacks of each major source of small business financing.

 Fred DeLuca began his sandwich shop in 1965 when he was 17. He had just graduated from high school and was concerned about his ability to pay for college with his $1.25-per-hour minimum-wage job at a local hardware store. A family friend, Dr. Peter

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Buck, suggested that Fred open a sandwich shop. All he needed to do was to rent a shop, build a counter, buy some food, and make the sandwiches. Customers would come in and pay. Then Fred could pay his suppliers and still have enough money to pay for college. Dr. Buck was so sure this would work that he gave Fred $1,000 to begin. Four decades later, Subway is one of the largest privately held businesses, with restaurants around the world.25 Although Fred started with a loan from a family friend, there are other ways for entrepreneurs to finance their new ventures before seeking more formal financing arrangements. In this section, we’ll present the many sources of funding available to small business owners, and we’ll discuss the pros and cons associated with each.

Cash and Credit Where can I get the money to start a business? Most new ventures require capital to purchase inventory, secure a physical location, and begin some modest marketing efforts. Often, new business owners must make do with whatever sources of financing are available to them, including their own funds. When entrepreneurs start a business with little capital, they are said to be using bootstrap financing. This includes using your own money, borrowing funds from family and friends, and possibly trading services and products with vendors or clients. Friends and family are generally go-to financing options for new business owners because, unlike banks, family and friends often do not require high rates of return on the money they have invested or demand the business turn a quick profit. However, it is important when borrowing from friends and family that you treat them as professionally as possible. Make sure you give them documents that indicate how you intend to pay them back and outline a contingency plan if things go wrong. In addition, you should inform them up front and during the project of any risks related to the venture. Other means of bootstrap financing include using trade credit, factoring, and leasing. We will discuss these options in Chapter 15. Is it reasonable to use crowdfunding sites to raise capital? Sites like Kickstarter and Indiegogo have popularized a new type of start-up funding known as crowdfunding. Entrepreneurs put together a detailed explanation of their projects or businesses on these sites and ask for funding. People who fund projects on these sites typically donate small amounts of money and are offered free products from the startups they contribute to—perhaps the chance to purchase a product in a special edition or color or meet with the product’s designer. People supporting a Kickstarter business do not own any part of the new business and are not guaranteed that it will be successful—they are simply making a donation. Crowdfunding might sound like a poor way to launch a product, but that’s not necessarily the case. There are many amazing stories of super successfully crowdfunded projects. Pebble Watch was one of the first projects with extraordinary funding success. The developer of the watch was hoping to raise $100,000 in one month on Kickstarter and ended up raising more than $10 million. More recently, the Coolest Cooler reached its goal in less than 36 hours, and ultimately received more than $13 million in pledges. Crowdfunding will be discussed in more detail in Chapter 15 as well. Should I use credit cards to finance my business? Credit cards offer a convenient way to obtain funds quickly, especially with some of the 0 percent financing options available. If used wisely, a credit card can be a convenient

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way to finance a business’s short-term needs but only if you can pay the balance off completely every month. If not, the interest charged on the unpaid balances can grow quickly because the interest rates on credit cards are extremely high compared to other types of financing. Over time, you are paying interest on any unpaid balances as well as interest on any carryover interest, which quickly can become a huge financial burden.

Small Business loans and grants What if I need more money than what I can provide myself? For larger amounts, new business owners sometimes borrow against their own assets, such as the equity in their homes or against their retirement accounts. However, this is a risky practice because the consequences of the business failing are personally devastating. Bailing out a failing business with your life savings or equity in your home has caused many a person to lose both. If you are purchasing an existing business or a franchise, banks and savings and loans will often offer loans to help you buy the business, equipment, and machinery and lines of credit (sources of credit that can be drawn on at the borrower’s discretion) to help you make your payroll during slower periods. Roughly half of all small businesses use bank loans and lines of credit as part of their financing strategies. Can I apply for grants to help start my business? Grants are financial awards offered by federal and state governments and some private organizations. Although grants do not need to be repaid, the application process is quite long and includes considerable amounts of paperwork. The biggest hurdle in applying for a grant is writing the proposal. Make sure you understand the grant-writing procedure because many a good submission has not been funded because of an oversight in the grant application. Depending on the nature of your business, federal grants are usually not available, but state governments typically offer grants to small businesses that are in industries that the states are trying to nurture to expand in their economies. Make sure, however, you read through the entire grant application and understand any requirements that may be expected of a grant recipient. Failure to comply with grant requirements will generally result in the grant proceeds being converted to a loan, with interest.

Angel and Venture Capital financing What if I need additional sources of funds through investors? There are other sources of funding if you choose not to finance your business with loans or if loans are not an option. For example, businesses can be financed by outside investors, such as angel investors, venture capital, or small business investment companies: • Angel investors. Angel investors are wealthy individuals who are willing to put up their own money in hopes of a profit return later on. Angel investors fund thousands of small companies each year, with investments that range between $25,000 and $1 million.26 Angel investors often provide funding in the earlier stages of a business and typically have industry experience in the areas in which they are investing and can provide guidance and advice. Unlike venture capitalists (discussed next), angel investors usually do not seek to manage or control the businesses they are investing in. If you don’t personally have any rich friends or connections to rich friends, it is possible to find an angel investor with a simple search on the Internet. Angel Capital Association can help locate regional angel groups. Social networking sites, such as Angel List and Investors’ Circle, match entrepreneurs to investors. • Venture capitalists. Venture capitalists are the next step in funding a startup. Venture capital funding is generally sought when the business is more

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155

Conducting a SwoT Analysis

ecently, you and a fellow engineer friend have been working to boost the performance of hybrid car batteries. As you’ve learned more about the hybrid car industry, you’ve discovered a potential unmet need for the service and replacement of these batteries. Some dealerships

offer these services, but there may be an opportunity for you to open a specialty shop in your area that focuses solely on these batteries. Can you think of strengths, weaknesses, opportunities, and threats for hybrid car battery industry?

mature and needs large sources of capital to take the business to the next step. Venture capitalists are corporate entities that use funds from other investors and manage that money by investing it in businesses with prospects for high growth. In return for the investments, venture capitalists get some form of equity—a piece of ownership—in the businesses. Venture capitalists are picky about the projects in which they invest because they want to minimize the risk of failure. Generally, the financing they offer is available only to businesses that have been operating for several years and have the potential to become larger, publicly owned, regional or national companies. To protect their investments, venture capitalists sometimes demand to play an active role in the management of the company. So, business owners must be open to the idea of relinquishing control when they seek venture capital funding. Shark Tank, the ABC reality television show, offers a peek into the venture capital arena. The show features high-profile investors who listen to several new business pitches every week. • The small business investment company program. If venture capital is not available or suitable, an alternative is a small business investment company (SBIC) program. SBICs are private venture capital firms licensed by the SBA to make equity capital or long-term loans available to small companies. The size of the financing provided by SBICs is generally in the $250,000 to $5 million range. As mentioned, a downside of using outside investors is that, to protect their investments, these investors often are looking for some controlling or managerial role in the business. However, it is the investor’s level of business acumen that is often necessary to take a business to the next stage of growth, so generally it is a win–win for both owner and investor.

 Funding a business is a task fraught with challenges and difficult decisions, as Fred DeLuca would attest. Beginning with just the money offered by a family friend and his own savings, Fred turned a simple sandwich shop into a global franchise operation. But whether the money comes from your own pocket, a friend, or an outside investor, the stakes—personal, professional, and financial—are quite high. Thorough research and careful planning are essential to navigating these tricky issues. By understanding the available options and being prepared to deal with financial predicaments, business owners give themselves the best chance at success.

Chapter 5

Summary 5-1

Describe the role and structure of small business within the U.S. economy.

• A small business is a business that is independently owned and operated, is not dominant in its field, and has fewer than 500 employees. To qualify for government programs from the U.S. Small Business Administration (SBA), revenue restrictions are also put in place and vary by industry. Many small businesses are limited to $7 million in annual revenues. • Small businesses are important to the economy for several reasons. They account for more than one-half of America’s economic output, help foster innovation, supply larger companies with products and services that larger companies do not or cannot supply themselves, supply products and services to consumers that large companies cannot or will not provide, and employ approximately 50 percent of the private workforce.

5-2

Explain what the traits of an effective entrepreneur are, and differentiate the types of entrepreneurs.

• An entrepreneur is someone who assumes the risk of creating, organizing, and operating a business.

• The disadvantages of franchising include a lack of control over the look of the store and the product or service being offered, start-up costs and monthly fees that must be paid to the franchisor, and a heavy workload. In addition, franchises will be affected by negative news involving the franchisor or another franchisee of the same company.

5-4

Discuss the factors that can lead to small business failure and the steps and resources available to diminish the potential of small business failure.

• A business plan outlines the goals and strategies of a company, including its marketing plans, financial forecasts, a risk analysis, and an operational plan. Neglecting to consider any of these options can doom a business from the start. • The reasons new businesses fail include accumulating too much debt, inadequate management, poor planning, and unanticipated personal sacrifices.

• Entrepreneurs are innovative, risk-taking individuals who are motivated to succeed and who are flexible and self-directed. They work well with people, possess good leadership skills, and are “system thinkers.”

• The SBA offers assistance in the legalities associated with starting and operating a business as well as education and training, financial assistance, disaster assistance, and counseling.

• Not all entrepreneurs are the same: lifestyle entrepreneurs look for a business that matches their desired lifestyle, micropreneurs are satisfied with keeping the business small to achieve a balanced lifestyle, homebased entrepreneurs run their businesses out of their homes, and Internet entrepreneurs run their businesses strictly online. Growth entrepreneurs strive to create fast-growing businesses and look forward to expansion, and social entrepreneurs start businesses with a social mission in mind. Intrapreneurs are entrepreneurs who work in an entrepreneurial way within organizations owned by other people. Finally, serial entrepreneurs create and grow many different businesses over their business career.

• Business owners can receive formal classroom training at two- and four-year colleges and participate in internships with companies in similar industries for hands-on training.

5-3

Summarize the advantages and disadvantages of franchising and buying existing businesses.

• A franchise is a method of doing business whereby the business sells a company’s products or services under the company’s name to independent third-party operators.

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• The advantages of franchising include that the business is a proven system of operation, franchises benefit from economies of scale, and the franchisor often offers training and marketing support as well as market research.

• SCORE volunteers provide free assistance by reviewing business plans, helping with tax planning, and offering new ideas and fresh insights. Other mentoring sources include industry-related conferences and other organizations, such as the EO.

• Business incubators support start-up businesses by offering resources such as administrative services, technical support, business networking, and sources of financing that a group of start-up companies share. • Advisory boards offer guidance to new business owners, but they generally do not have authority to make decisions. • Enterprise zones are geographic areas targeted for economic revitalizing by state and federal governments. Businesses receive generous tax benefits for locating and hiring in these enterprise zones.

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5-5

• The benefit of credit cards is that they are a convenient means of acquiring short-term cash. However, the risk associated with using credit cards for initial business financing is the high rate of interest charged on unpaid balances. • When more money is needed than credit cards, friends, or family can provide, another source of financing are small business loans from banks and savings-and-loan

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institutions. Lines of credit or start-up loans are also available and can be used to bridge short-term capital needs. Federal and state grants may also be available, depending on the nature of the business.

Compare the potential benefits and drawbacks of each major source of small business financing.

• The benefit of using cash borrowed from friends and family members is that, unlike banks or other lending institutions, these contacts often do not require high rates of return on their investments or demand to see the business turn a quick profit. However, the potential drawback is that these types of personal loans can sometimes be handled unprofessionally.

Small Business and the Entrepreneur

• Angel investors are wealthy individuals who are looking to invest in interesting businesses with good prospects for growth and returns. Generally, angel investors do not seek managerial roles in the businesses they invest in and often have a longer time frame to receive a return on their investment. • Venture capitalists invest in a business in return for some form of equity or ownership in the business. Venture capitalists usually want to play an active role in the management of the companies they invest in. Consequently, this funding option may not be attractive to business owners who aren’t open to the idea of relinquishing control of their businesses.

Key terms advisory board angel investors bootstrap financing business incubator business plan due diligence enterprise zones entrepreneur entrepreneurial team franchise

franchisee franchisor goodwill grants growth entrepreneur home-based entrepreneur Internet entrepreneur intrapreneur lifestyle entrepreneur micropreneur

opportunity niche SCORE (Service Corps of Retired Executives) Serial enterpreneur small business Small Business Administration small business investment company (SBIC) program social entrepreneur social intrapreneur venture capitalists

MyBizLab To complete the problems with the

, go to EOC Discussion Questions in the MyBizLab.

Self test Multiple Choice You can find the answers on the last page of this text. 5-1 Which is a key trait of an entrepreneur? a. Flexibility b. Risk taking c. Creative thinking d. All of the above

5-2 Sally started her new business venture five years

ago. The business brings excess organic produce to food banks and has grown 15 percent every year. Which type of entrepreneur best describes Sally? a. Social entrepreneur b. Lifestyle entrepreneur c. Growth entrepreneur d. Gazelle

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5-3 One of the first things someone needs to do before starting a business is to write which of the following? a. A business plan b. A loan application c. A partnership statement d. A franchise agreement

5-4 Which of the following is not a characteristic of a small business?

more efficient but needs about $125,000 to take the idea further and perhaps sell it to other pet groomers. Which is the most likely source of financing that Rebecca could use? a. Credit cards b. New business grant c. Funds from an angel investor d. Venture capital financing

5-9 Which of the following factors commonly leads to

a. They have less than 500 employees.

the failure of a small business?

b. On average, the annual revenue is no more than $7million.

a. Not enough planning b. Too much accumulated debt

c. It is independently owned and operated.

c. Unanticipated personal sacrifices

d. It is considered a dominant player in its industry.

d. All of the above

5-5 Steven Ye wants to start a company. He has a

5-10 Rashid is starting a consulting business. He needs

rough draft of his business plan and some tentative funding but needs some additional advice and guidance to help him through the start-up process. The best source for Steve is

a receptionist, a place to meet clients, and other aspects of an office. A good solution for Rashid to consider would be a(n)

a. an angel investor.

b. advisory board.

b. a SCORE volunteer.

c. business incubator.

c. his parents.

d. entrepreneurial team.

a. mentoring group.

d. a bank loan officer.

5-6 Kazuto is interested in starting a new business.

Which is a reason Kazuto should consider buying an existing business versus starting one from scratch? a. He will operate a tried and tested business. b. He will need to work fewer hours. c. He will need less capital up front. d. All of the above

5-7 Wayland wants to buy a deli that is for sale, but the owner has put too high a value on the business’s goodwill. Goodwill is

a. the value of the leftover products the deli gives to the local food pantry. b. the value of the donations the deli gives to charity. c. the value of the business’s reputation with the current owner. d. All of the above

5-8 Rebecca has been operating a pet grooming busi-

ness for several years and has already maxed out her personal credit and savings. She has designed a device that will make the pet grooming process

True/False You can find the answers on the last page of this text. 5-11 Small businesses can have a positive impact on large businesses.

True or

False

5-12 A social intrapreneur is someone who provides

funding for those in Third World countries who want to begin their own businesses but have no capital with which to do so.

True or

False

5-13 Although most small businesses have annual rev-

enues less than $39 million, there is no specific revenue limit set by the SBA for small businesses.

True or

False

5-14 A franchisee is usually required to pay the franchiser an ongoing fee.

True or

False

5-15 Crowdfunding is putting a request for funds on your Facebook page.

True or

False

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Critical Thinking Questions 5-16 Companies that encouraged their employees to pursue entrepreneurial activities within an existing business created products such as Post-It Notes and Sony PlayStation. What aspects of the corporate environment promote intrapreneurial activities?

5-18 Compare the different sources of funding available to small business owners. What types of funding are better at the beginning stages of a business? What types of funding may be better once the business is better established and is looking to expand?

5-17 Discuss how social media has affected small businesses at all stages of their development, such as financing, marketing, and communications.

team time STARTING A BUSINESS: BRAINSTORMING Assemble into groups of four or five. 5-19

Before meeting as a group, think about what you are passionate about and whether there is a potential market involving your interests. Develop one or two ideas for potential businesses based on your passions. a. Consider if there is unfulfilled demand for what your business will sell. For example, are you passionate about locally grown organic vegetables but frustrated that there isn’t a place nearby to purchase them? If so, you’ve developed an idea for a local farmers’ market. b. Consider community service ideas. When school has a half day or full day off, consider having high school students form a daytime child care service for elementary students. c. Consider business ideas that have potential but aren’t doing well now. Are there ways to make them better? Gather your group and go over each other’s ideas. Refine the list to two or three ideas. Have each group member refine an idea even further, identifying the target market and outlining the business goals and objectives. Meet as a team one more time to pick one business idea. If time permits, the group can develop this idea further by using the Business Plan project template. See Mini Chapter 2 for more information.

Ethics and corporate Social responsibility SOCIAL ENTREPRENEURSHIP: START SOME GOOD Alex Budak and Tom Dawkins created StartSomeGood to help raise money for social entrepreneurs. Similar to the crowdfunding sites Kickstarter and IndieGoGo, people who invest in the projects on StartSomeGood are rewarded with products and other incentives.

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Ethics and corporate Social responsibility (continued) Step 1. Visit StartSomeGood.com to see the types of projects that are being pro-

posed. Read through the “How it Works” section to learn more about how to submit an idea on StartSomeGood.

Step 2. In groups, discuss the needs your school or community has and cre-

ate a list of ideas that your group feels would be good candidates for a StartSomeGood campaign. Decide on the levels of support required and appropriate rewards to be given to funders.

Step 3. Each group should present their idea to the class; as a class, vote on the

best idea to send to StartSomeGood.

Web Exercises 5-20

5-21

5-22

Do You Have What It Takes to Be an Entrepreneur? In this chapter, you learned that there are several personality traits common to successful entrepreneurs. Do you possess any of these traits? Using a search engine, find an entrepreneurial quiz that will help you determine if you have what it takes to be an entrepreneur. What aspects of your personality make you a good candidate to be an entrepreneur? What is holding you back? Franchise Owner You want to start a business but not from scratch. Go to Entrepreneur.com and research three franchise opportunities you would consider pursuing. Make sure these franchises are within your financial reach. Write up a brief summary of each franchise, noting the pros and cons of owning or operating each one. Angel Investor for a Day Congratulations! You just won the lottery! You are looking for some start-up businesses in which to invest some of your winnings. Go to Angel List (https://

angel.co) and research the types of businesses that have received funding or are looking for funding. Pick three different businesses and discuss why you would or would not invest in them. 5-23

Build a Business with a Conscience What does it take to create a socially conscious business? Play The New Heroes game on PBS to see if you have what it takes. Go to PBS.org and click on “The New Heroes” under the “Programs” link. To play the game, click “Engage.”

5-24

Small Business Owners: Where to Go for Help If you were a new small business owner, where would you go for help? Many colleges have a small business development center (SBDC). These centers, which are affiliated with the SBA, provide information and guidance to current and prospective small business owners. Go to the SBA’s site and use the “SBDC Locator” link to identify the nearest SBDC in your area. Then research the services your area’s SBDC can provide.

MyBizLab Go to the Assignments section of your MyBizLab to complete these writing exercises. 5-25 Why would someone want to buy an existing business rather than start a business from scratch? What are the drawbacks of buying an existing business? 5-26 Micka is starting a new business and needs to raise about $500,000. Consider all the financing mechanisms available to Micka, and choose two options that you think would best fit Micka’s situation. Include the pros and cons of each financing option, as well as your ultimate recommendation. You may include any business assumptions for Micka’s new venture in your answer.

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references 1. From U.S. Small Business Administration, “Small Business Size Standards,” https://www.sba.gov/contracting /getting-started-contractor/qualifying-small-business (accessed April 17, 2016). 2. U.S. Census Bureau, “Statistics about Small Business from the Census Bureau,” http://www.census.gov/econ/susb (accessed April 18, 2016). 3. U.S. Small Business Administration, “Summary of Size Standards by Industry Sector,” www.sba.gov/content /summary-size-standards-industry (accessed April 18, 2016). 4. John Tozzi, “Small Business’s Shrinking GDP Contribution,” Bloomberg Businessweek, February 16, 2012, www.businessweek.com/articles/2012-02-16 /small-businesss-shrinking-gdp-contribution. 5. Small Business Economic Council, “Small Business % of US Economy”: http://www.sbecouncil.org/about-us /facts-and-data/ 6. International Monetary Fund, “World Economic Outlook Database April 2016,” www.imf.org/external/pubs/ft /weo/2011/02/weodata/index.aspx (accessed April 18, 2016). 7. Small Business Administration, “United States Small Business Profile, 2016,” https://www.sba.gov/sites /default/files/advocacy/United_States.pdf. 8. Small Business Administration, Office of Advocacy, “Frequently Asked Questions,” https://www.sba.gov/sites /default/files/FAQ_Sept_2012.pdf (accessed April 23, 2016). 9. GigaBiter, “Our Company and Mission,” www.gigabiter .com/about/index.aspx. 10. “Fabric: Recycled Polyester,” www.patagonia.com/us /patagonia.go?assetid=2791. 11. Bruce Freeman, “Fired? Start a Business!” www.prolinepr .com/Fired.html (accessed April 24, 2016.) 12. Dan Tynan, “The 25 Worst Tech Products of All Time,” May 26, 2006, www.pcworld.com/article/id,125772 -page,6/article.html. 13. Jake Kilroy, “Wahoo’s Has a Birthday Party (and I Get Invited),” Entrepreneur Daily Dose, February 27, 2009,

14. 15. 16.

17. 18. 19. 20. 21. 22. 23. 24.

25. 26.

https://www.entrepreneur.com/article/218380 (accessed April 24, 2016). “Citizen Wayne—The Unauthorized Biography,” Miami New Times 9, no. 33 (December 1–7, 1994), www .corporations.org/ wmi/huizenga.html. “Lifestyle Entrepreneurs: RV-Based Businesses Can Be Going Concerns,” www.entrepreneur.com/franchises /franchisezone/startupjournal/article64548.html. Ryan Decker, John Haltiwanger, Ron Jarmin, and Javier Miranda, “The Role of Entrepreneurship in US Job Creation and Economic Dynamism,” Journal of Economic Perspectives, Summer 2014, https://www.aeaweb.org /articles?id=10.1257/jep.28.3.3 (accessed April 22, 2016). Jake Swearingen, “Great Intrapreneurs in Business History,” www.bnet.com/2403-13070_23-196888. html?tag+content;col1. “Meet the New Heroes: Mimi Silbert,” www.pbs.org /opb/thenewheroes/meet/silbert.html. Josh Cleveland, “Creating a Company Culture That Engages Social Intrapreneurs,” June 29, 2009, www .greenbiz.com. International Franchise Association, “About the IFA,” http://www.franchise.org/about-ifa. “Franchise Business Economic Outlook for 2016,” http:// emarket.franchise.org/FranchiseOutlookJan2016.pdf. “Home-Based Franchises for 2016,” https://www .entrepreneur.com/franchises/homebased. “2015 Top Low Cost Franchises,” https://www .entrepreneur.com/franchises/lowcost. Stacy Perman, Jeffrey Gangemi, and Douglas MacMillan, “Entrepreneurs’ Favorite Mistakes,” BusinessWeek, http:// images.businessweek.com/ss/06/09/favorite_mistake /source/1.htm. “About Us: History,” www.subway.com/subwayroot /about_us/history.aspx. “Financing Options for a Small Business: Finding the Right Funding,” www.startupnation.com/articles /financing-options-for-a-small-business-finding-the-right -funding.

Chapter 6

Forms of business Ownership Objectives 6-1 Sole Proprietorships

Discuss the advantages and disadvantages of a sole proprietorship. When an entrepreneur starts a business, choosing the proper business structure is vital to the company’s success. When Patty Jacobs decided to start her own cleaning business, she became a sole proprietor. Her business began growing so fast, and she now does not know if being a sole proprietor is the right business structure for her new venture. Do you know when it is best to operate as a sole proprietorship?

6-2 Partnerships

Discuss the advantages and disadvantages of a partnership and a partnership agreement. Trying to do a job alone can sometimes be overwhelming. Because of this, entrepreneurs may partner together to share resources and talents for the benefit of everyone involved. Partners Daniel Ramirez and Stefan Brown brought their skills and finances together to begin a new venture. Why might a partnership be a good business structure for a business? What difficulties should new partners prepare for?

6-3 Corporations

Explain how a corporation is formed, and compare a corporation to other forms of business. Brandon Jacobson and his sister, Sonya, found themselves unexpected landlords when they inherited properties that were owned and operated

by their mother. Their mom reported the rental income on her personal income taxes as a sole proprietor. Brandon and Sonya were looking into creating a partnership, but they were advised that a partnership may not be the best corporate structure for them to operate under. Why is not a partnership a good choice for Sonya and Brandon? What are their other options?

6-4 Not-for-Profits and Cooperatives

Explain the characteristics of not-for-profit organizations and cooperatives. Darrell Hammond knew he could make a difference in the life of inner-city children by giving them safe places to play. He quickly outgrew his modest volunteer activities and knew he wanted to expand to help more children. He needed a corporate structure that would allow him to take his profits and put them back into communities nationwide. What type of alternative business structure would work best for him?

6-5 Mergers and Acquisitions

Compare the different types of mergers and acquisitions, and explain why each occurs. Companies constantly search for opportunities to expand by adding to their product lines, to enter into different geographic areas, or to gain a competitive advantage. The rationale behind mergers and acquisitions is that the resulting combined firm will be more valuable than the individual companies on their own. What is the difference between a merger and an acquisition? When do they occur?

Chapter 6

Objective 6-1

sole Proprietorships Discuss the advantages and disadvantages of a sole proprietorship.

 Patty

Jacobs runs a small cleaning business from her home. She has no employees, and she reports the business’s income and expenses on her personal income taxes. However, the business has begun to grow quickly, and she is considering hiring a few employees. She is concerned about the added liability she faces with an expanded business and new employees. As a sole proprietor, she knows that she is held responsible for any and all damages her company commits. In addition, now that Patty’s small business is becoming successful, it may make more sense to report its earnings on a separate tax return rather than running them through her personal tax return. She realizes that being the owner of a growing company requires more decisions than she had anticipated.

Source: tatyana Gladskih/Fotolia

Patty Jacobs chose to begin her company as a sole proprietorship because it was quick and easy to establish. No legal paperwork is required to begin a sole proprietorship, and all the financial information related to it can be reported on the owner’s personal tax returns. Because of these advantages, a sole proprietorship is a common form of business ownership for start-up businesses. Many businesses also start out as sole proprietorships simply because their owners are unfamiliar with other forms of business ownership. Choosing the right legal structure for Patty’s business may have initially been a simple decision, but has her fast business growth outgrown a sole proprietorship? How do you know which form is best for your company? Choosing a form of ownership depends on many factors, including the personal liability you face, the amount you pay in taxes, your ability to borrow money, and the amount of paperwork your business is required to file. The U.S. economy—as well as the global economy—is based on a variety of enterprises, including sole proprietorships (businesses owned by one person), partnerships (where two or more people legally share ownership of a business), and corporations (businesses that are formed as separate legal entities). More businesses in the United States are structured as a sole proprietorship. On the other hand, corporations, while fewer in number, generate the most revenue. Besides sole proprietorships, partnerships, and corporations, there are other classifications of corporations to consider, such as limited liability companies and S corporations. In this chapter, we’ll explore each of these forms of business ownership in greater detail, beginning with sole proprietorships in this section.

Starting a Sole Proprietorship Why is a sole proprietorship a popular form of business ownership? A sole proprietorship is an unincorporated business owned (and usually controlled) by a single individual. Because no legal paperwork is necessary to establish 163

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◼ FIGURE 6.1 Characteristics of a Sole Proprietorship

Preliminary Paperwork Period of Existence Liability Operational Requirements Management Taxation Raising Capital

• No special forms required • Ends when proprietor dies or leaves business • Unlimited liability • Minimal legal requirements • Full control of management and operations • Not a separate taxable entity; taxes paid through owner’s personal tax return • Funding mostly derived from owner; outside funding difﬁcult to obtain

a business as a sole proprietorship, many small business owners are sole proprietors without even knowing it. Although a sole proprietorship has only one owner, it can have any number of employees. For example, you can be the owner of a plumbing business with several other plumbers working for you and still operate as a sole proprietorship. Other characteristics of a sole proprietorship are listed in ◼ FIGURE 6.1. How do I start a sole proprietorship? The minute you begin doing business by yourself—that is, collecting income as a result of performing a service or selling a good—you are operating as a sole proprietor. There are no special forms to fill out, and there are no special filing requirements with state and federal governments. At a minimum, you might need to obtain a local license or permit, or you might have to ensure that you’re operating in an area zoned for the type of business you are running. If you’re hiring employees, you will need to register your company name and obtain an employer identification number (EIN) from the Internal Revenue Service (IRS).

Advantages and Disadvantages Are there advantages to being a sole proprietor? There are several advantages of forming your business as a sole proprietorship—one of which we have already discussed: ease of formation. With only one person making all the decisions and no need to consult other owners or interested parties, sole proprietors also have great control and considerable flexibility to act quickly. Another advantage is that there are no specific corporate records to keep or reports to file, including tax reporting. Because there is no legal distinction between the owner and the business, no separate tax return is required. As a result, the income and expenses of a sole proprietorship flow through the owner’s personal tax return. This can be an advantage, especially in the start-up phase of the business when it is likely that the operating costs of the business are greater than the incoming revenues. In this case, the excess expenses (or net loss) can help offset the taxes you owe on any other sources of income you might have. For example, imagine you run a landscaping business during the summer in addition to your regular job. If the lawn mower breaks down and needs to be replaced, that expense could be more than all the earnings you collected, generating a loss for your lawn-mowing business. You can subtract that loss from the income earned from your regular job, reducing your income tax obligation. ◼ TABLE 6.1 and ◼ FIGURE 6.2 show how a business loss can reduce your tax payment. In this example, a business loss of $3,000 reduces by $450 the federal taxes you would have to pay.

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Why wouldn’t I want to run my business TAble 6.1 Personal Income and Taxes Due as a sole proprietorship? One of the biggest with and without a business loss disadvantages of a sole proprietorship is that from a Sole Proprietorship it leaves you exposed to personal liability. A liability is the obligation to pay a debt, such as With Business Loss Without Business Loss an account payable or a loan. Liabilities can also include a breach of contract or losses associated Wage income $14,500 $14,500 from damages. Unlimited liability means that if Business loss 2$3,000 business assets aren’t enough to pay business debts, Net income $11,500 $14,500 then personal assets, such as the sole proprietor’s house, personal investments, or retirement funds, Taxes due $2,437 $2,887 can be used to pay the balance. In other words, the Difference: $450 proprietor can lose an unlimited amount of personal assets. As a sole proprietorship, the business is not a separate legal entity, and all business debts and liabilities are the owner’s personal obligations. As a sole proprietor, you are personally responsible for the business’s contracts, taxes, and the misconduct of employees who create legal liabilities while acting within their employment. Therefore, if the type of business you’re running has the potential for someone

Working for someone else throughout the year

Running a lawn-mowing business yourself during the summer

Lawn-mowing revenue

Working as a waiter

Cash collected from customers

Income Expenses Profit

$3,500 $6,500 ($3,000)

Wages earned from working as a waiter

Simplified Payment 1040 Tax Form to IRS Wages $14,500 $2,887 Profit/loss from summer business ($3,000) Total taxable income $11,500 $2,437

New mower, gasoline, oil, and other expenses ◼ FIGURE 6.2 The Effect of a Business Loss on Personal Income Sole proprietors can deduct business losses from their personal taxes, reducing their overall tax burden. Image sources, clockwise from top: Kirsty Pargeter/Fotolia; shock/Fotolia; carlos caetano/Fotolia

Summer job (loss) results in $450 tax savings

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to sue you because of damages caused by your business, you may not want to operate as a sole proprietorship. Imagine that you own a catering business. While you are preparing food in someone’s house, the oven catches fire because you forgot to take the egg rolls off the paper tray. You are personally responsible, or liable, for paying for any damages if the assets of your business (or your insurance) are not sufficient to cover the damages. If the damages are severe enough—perhaps your client’s entire house burns down—you could lose all your assets, including your own home and savings. If you decide that a sole proprietorship is the right business form for you for other reasons, buying insurance—such as errors or omissions insurance, disability insurance, and insurance to protect your assets—will help protect you against unforeseen situations. Are there other things to consider when operating as a sole proprietorship? Unlimited liability is perhaps the most critical reason for not operating as a sole proprietorship. However, there are other reasons why you might not want to operate your business as a sole proprietorship. • Financing/investment. A drawback of a sole proprietorship is that it can make it more difficult for you to borrow money to help your business grow. Banks will be lending to you personally, not to your business, so they will be more reluctant to lend large amounts, and the loan will be limited to the amount of your personal assets. Structuring the business as a separate entity may mean more financing options are available to you. In addition, if you decide to bring in investors who want some type of ownership in the company, the form of the business would need to be changed. • Taxes. As a sole proprietorship, your business income and expenses are included on your personal tax return. The costs you pay for your health care, retirement, and other benefits are not tax deductible for the sole proprietorship itself, although you may be able to deduct some of these expenses on your personal tax return. If your business were to be so successful that taxes became an issue, the legal structure of the business would need to change. • Selling. If you ever wanted to sell the business, it is much more difficult to sell a sole proprietorship. • Financial sacrifices. Financial control is great, but it can come with a price. Generally, after the business pays its employees, suppliers, and other creditors, the owner is often the last person to get paid. If the budget is tight, the payments for the owner’s health care and retirement sometimes get postponed, which can be problematic. It is often helpful to run a sole proprietorship as a part-time business and still work for someone else until the business is earning enough money to pay you a salary as well as provide you with benefits. • Spreading yourself thin. Most importantly, running a sole proprietorship means that all the management duties fall on one person—you! Many a sole proprietor neglect to consider that there are other responsibilities to running a business besides performing the services or making the goods sold to customers. There is a lot of paperwork and time involved to ensure that invoices are created, payments are collected, and salaries and benefits are paid (if there are other employees), as well as generating new business, following up on prior jobs, and performing the marketing tasks. These additional tasks are timeconsuming, and ones that proprietors do not anticipate and can undo many new businesses quickly.

 Remember Patty Jacobs? When she first started her business, running it as a sole proprietorship worked for her. The structure was simple, and there was little paperwork. But now Patty is realizing that a sole proprietorship is not the best form of ownership for her because she does not want to risk losing her personal

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assets in the event of an employee error. Patty, like many other small business owners, is realizing that making decisions about choosing the correct corporate structure is complex. After getting advice from other business owners, Patty decided that her business needed to undergo some corporate restructuring so that the company’s business form would be more conducive to her needs.

Objective 6-2

Partnerships Discuss the advantages and disadvantages of a partnership and a partnership agreement.

 Daniel Ramirez had his eye on a piece of property for a storefront in an up-and-coming neighborhood. The property was affordable but still slightly out of his reach. It also needed some renovations—skills that Daniel did not have. Stefan Brown, a friend of Daniel’s college roommate, had some construction and carpentry experience and was also looking for a business opportunity but didn’t have as much capital. After much thought and conversation, Daniel and Stefan agreed to form a partnership, buy the property, and embark on the renovations together. What contributions did Daniel and Stefan each bring to the partnership? What difficulties should the two new partners prepare for? The saying that two brains are better than one may explain why many small businesses have two or more owners working together. There are some distinct advantages to these types of business arrangements, but there are also some potential disadvantages to be aware of. In this section, we look at the advantages and disadvantages of partnerships, and what you need to be aware of should you engage in a partnership.

Advantages and Disadvantages of Partnerships When is it good to bring in a partner? A partnership is a type of business structure in which two or more entities (or partners) share the ownership and the profits and losses of the business. Joining forces with someone else can help a businessperson share the costs of starting and running a business as well as the managerial responsibilities and workload associated with it. Having a partner whose skills complement your own can be quite advantageous. For example, if you are great at numbers but hate making sales calls, bringing in a partner who loves to knock on doors would be beneficial for your business. Another advantage of a partnership relates to time: Because more owners are involved in the business, there is more time available for the owners to increase the firm’s marketing and sales efforts to generate more income. A partner can also help come up with new ideas and projects for the business as well discuss major decisions with you and help you make them. And because partners have a stake in the business, unlike employees, they are more likely to work long hours and go the extra mile.

Source: Ljupco Smokovski/Fotolia

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Preliminary Paperwork

• No special forms required; partnership agreement recommended

Period of Existence

• Ends upon death or withdrawal of a partner unless otherwise provided for in partnership agreement

Liability Operational Requirements Management Taxation Raising Capital

• Unlimited liability • Minimal legal requirements • Roles speciﬁed in partnership agreement; partners generally have equal voice • Not a separate taxable entity; taxes paid through owner’s personal tax return • Funding raised through partner contributions

◼ FIGURE 6.3 Characteristics of a Partnership

Are there disadvantages to adding partners? For every advantage a partner can bring, adding the wrong partner can be equally problematic. Obviously, adding partners means sharing profits and control, so if you don’t want to give these up, a partnership may not be the right structure for you. Your partner may also have different work habits and styles than you. If the person’s style does not complement your own, the differences can be challenging. In addition, as the business begins to grow and change, your partner might want to take the business in a different direction than you had envisioned. Like entering into marriage, you want to consider carefully the person(s) with whom you will be sharing your business.

As a business form, how does a partnership compare to a sole proprietorship? Partnerships and sole proprietorships are similar; in fact, the biggest difference between the two is the number of people contributing resources and sharing the profits and the liabilities. It is just as easy to form a partnership as to form a sole proprietorship. The government does not require any special forms or reports, although some local restrictions may apply for licenses and permits. For example, suppose you and your brother-in-law form a small partnership called “All in the Family Electricians.” Before you are able to do business, you might have to apply for a license, but you do not need any special papers to create the partnership itself. Also, like a sole proprietorship, partnerships do not file a separate tax return. All profits and losses of the partnership flow directly through each partner’s individual tax return. ◼ FIGURE 6.3 outlines other characteristics of a partnership.

elements of a Partnership Agreement What goes into a partnership agreement? A partnership can begin with a handshake, and many of them do. Although no formal documents are required to form a partnership, it is a good idea to draw up a partnership agreement that formalizes the relationship between partners. Think of a partnership agreement as a prenuptial agreement. It helps settle conflicts when they arise and may prevent small misunderstandings from erupting into larger disagreements. Many points can be included in a partnership agreement; however, the following items should always be included: • Capital contributions. The amount of capital (money), equipment, supplies, technology, and other tangible things of value each partner contributes to begin the business should be noted in the partnership agreement. In addition, the agreement should also address how additional capital can be added to the business—who will contribute it and whether there will be a limit to a partner’s overall capital contribution. • Responsibilities of each partner. To avoid the possibility of one partner doing more or less work than others or a conflict arising over one partner assuming a more controlling role than the other partner desires, it is best to outline the responsibilities of each partner from the beginning. Unless otherwise specified, any partner can bind the partnership to any debt or contract without the consent of the other partners. Therefore, it is especially important to spell out the policy regarding who assumes responsibility for entering into key financial or contractual arrangements. • Decision-making process. How will decisions be made? Knowing whether decisions will be the result of mutual consent of all or several partners or

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how Do You Find the Right business Partner?

usiness partners are like spouses: Finding each other is often through circumstance and happenstance. Because of the high financial stakes, many look to partner with those whom they trust most: spouses, friends, or relatives. Hiring friends or relatives can have its benefits, but what do you do if your best friend does not do the job well? You might instead want to turn to your casual acquaintance network—your gym buddy, a parent of your child’s friend, or a classmate—to

find a business partner. If your network is not turning up any promising leads, turn to others’ networks. Similar to finding a job, write a description of the “perfect partner” and send it to as many people as you can. Make sure you interview the candidates and look for those who have similar goals and values but complementary skills. And by all means, “date” (get to know) the prospective partner before jumping into a business marriage; there is too much at risk to proceed too quickly.

whether just one or two partners will make the key decisions will help the partners avoid disagreements. What constitutes a key decision should also be defined in the agreement. In a partnership of two, where the possibility of a deadlock is likely, some partnerships provide for a trusted associate to act as a third “partner” whose sole responsibility is to be the tiebreaker. • Shares of profits or losses. The agreement should specify not only how to divide profits and losses between the partners but also how frequently this will be done. For example, it might stipulate that the profits and losses will be proportional to each partner’s initial contribution to the partnership, as reflected in ◼ FIGURE 6.4. Or, the agreement might split the profits evenly, regardless of contribution. It is also important to detail how adjustments to the distributions will be made—if any at all—as the partnership matures and changes. • Departure of partners. Eventually, the composition of partners may change as original partners leave and new partners come onboard. The partnership agreement should have rules for a partner’s exit, whether voluntary, involuntary, or as a result of death or divorce. Provisions to remove a partner’s ownership interest are necessary so the business does not need to end (liquidate). The agreement should include how to determine the amount of ownership interest and to whom the departing partner is permitted to transfer his or her interest. It is important to consider whether a partner can transfer his or her ownership solely to the remaining partners or whether individuals outside the existing partnership can buy the departing partner’s share of the business. • Addition of partners. The partnership agreement should spell out the requirements for new partners entering the partnership. Also included should be how the profits will be allocated once a new partner is taken on and whether there will be a “junior partner” period during which the person must prove himself or herself before obtaining full partner status.

Types of Partnerships Are there different types of partnerships? There are two common types of partnerships: general partnerships and limited partnerships. The distinction between the two types involves who accepts most or all of the business liability. What is a general partnership? A general partnership is the default arrangement for a partnership and is, therefore, the simplest of all partnerships to form. For instance, if two friends, Juan and Franklin, set up an ice cream stand at the local park, sell ice cream cones, and split the profits at the end of the day, they have created a general partnership. For Juan and Franklin, this is a logical arrangement because they share the profits equally, and there is little worry

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Contributes $45,000

Contributes $30,000

Contributes $15,000 value

about liability. In a general partnership, each partner has unlimited liability for the debts and obligations of the partnership, meaning every partner is liable for his or her own actions as well as the actions of the other partners and the actions of any employees.

What is a limited partnership? Sometimes, a business can bring on additional “limited” partners who mostly provide capital and earn a share in the profits but who are not involved Capital Contributions 50%/50% split in operating the business. To encourage investors to contribute capital to a business without risking more capital than they have contributed, a limited partnership is created. In a limited partnership, there are two types of partners. General partners are full owners of the business, are responsible for all the day-to-day business decisions, and remain liable for all the debts and obligations of the business. Limited Partnership Responsibilities partners are involved as investors and, as such, are personally liable only up to the amount of their investment in the business. They must not actively participate in any 80% of his time spent in 20% of his time 80% of her time 20% of her time spent Financial Management spent in Sales spent in Sales in Office Management decisions of the business. To continue our example, suppose Juan and Franklin don’t have enough money to purchase a new freezer for their business. So, they ask Juan’s brother Carlos to invest enough cash in the business to buy the freezer. Because Carlos is already working full-time and cannot participate in the business’s activities, he becomes a limited partner. ◼ FIGURE 6.4 Should something go wrong and the partners needed to cover the damages Share of Profit and Loss in a incurred by the business, Carlos will only lose the money he has contributed (the Partnership cost of the freezer). Limited partnerships can be much more complex to form than Partners’ shares of profits and losses can be dependent on the capital contribuour simple example, so it may be worth exploring other business structures before tion and the assumed responsibilities of deciding on this strategy. each partner. Another kind of limited partnership is a master limited partnership (MLP). Image sources, top to bottom, left to right: This business structure combines the tax benefits of a limited partnership, but Anatoly Maslennikov/Fotolia; nattstudio/ it is similar to a corporation (which we discuss next) in that it is publicly traded Fotolia; Antonio Gravante/Fotolia; WONG SZe Fei/Fotolia; Wrangler/Fotolia; on a securities exchange. MLPs are restricted mostly to certain businesses perhacohob/Fotolia; picture5479/Fotolia taining to the use of natural resources (such as petroleum or natural gas) and real estate. Will partnerships work well when liability is a concern? Although forming a general partnership for Juan and Franklin’s ice cream business makes sense for them, it is not right for every business. In some situations, especially if liability is a concern, neither a sole proprietorship nor a partnership will protect the owner(s) from unlimited risk. For instance, if Sarah and Hannah decide to form Personal Training Partners, a personal training and fitness motivation company, they know that each partner is liable—not only for her own business debts and actions but also for each other’s business debts and actions. If a client claims that Sarah mistreated him or her and the client sues the business, not only are the business assets at risk, but both Sarah’s and Hannah’s personal assets are also at risk. Sarah and Hannah would prefer to only be responsible for their own mistakes. In this case, a

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partnership is not the best business structure because a partnership has unlimited liability. So, neither partner is protected against the losses of their personal property. Instead, Sarah and Hannah should consider forming a limited liability partnership (LLP). An LLP protects the partners not only from any debt or liability incurred by the business but also from the liability of another partner. A partner in an LLP is personally liable only for his or her own negligence. An LLP would protect Hannah’s assets from being used to pay for claims against Sarah’s negligence. Sarah would be solely responsible for damages caused by her own mistakes. If Sarah and Hannah aren’t concerned about being protected from each other’s possible negligence, then a limited liability company is another option. We’ll discuss this and different types of corporations next.

 Daniel and Stefan’s partnership benefited from the complementary skills and resources each partner brought to the table. Because Daniel had more financial exposure, it was important to him that he and Stefan sign a partnership agreement. After the renovations were complete and the space was ready for commercial use, Daniel and Stefan brought in one more partner, Lily Ye, who has extensive retail and marketing experience—just what they needed to move forward with their venture. But Lily suggested the partnership look into a corporate structure. Why does she think a corporation is the best structure for their business? We’ll discuss corporations next. Objective 6-3

corporations Explain how a corporation is formed, and compare a corporation to other forms of business. Source: vlam1/Fotolia

 Brandon

Jacobson and his sister, Sonya, found themselves unexpected landlords when they inherited a couple of rental properties owned by their mother. Their mother reported on her personal income taxes the rental income she received as a sole proprietor from the properties. Now, as co-owners, Brandon and Sonya were looking into creating a partnership, but they were worried about liability issues and realized that a partnership might not be their best option. They would still like to report the income on their own personal tax returns if possible. Why will a simple partnership not work? What are their other choices?

The American writer Ambrose Bierce once defined a corporation as “an ingenious device for obtaining profit without individual responsibility.”1 Unlike partnerships and sole proprietorships, corporations provide business owners with better protection of their personal assets. What is a corporation, and why might a business owner choose to form one? What are the different types of corporations? In this section, you’ll find the answers to these questions and more.

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Preliminary Paperwork

• Incorporation paperwork must be ﬁled with state and federal agencies

Period of Existence

• Separate entity; existence not dependent on owners, founders; ownership transferred easily

Liability Operational Requirements Management

• • •

Taxation

•

Raising Capital

•

◼ FIGURE 6.5 Characteristics of a C Corporation

Advantages of Incorporation

What is a corporation? A corporation is a specific form of business Owners (shareholders) are not personally liable for organization that is legally formed debts of corporation under state laws. A corporation is Must have board of directors, corporate ofﬁcers, annual considered a separate entity apart from meetings, and annual reporting its owners; therefore, a corporation Shareholders elect board of directors, which provides strategic has legal rights like an individual. management of corporation; board appoints senior management Consequently, a corporation can own property, assume liability, pay taxes, Separate taxable entity. Corporation ﬁles its own tax return. enter into contracts, and sue and be sued—just like any other individual. Capital is raised through sale of stock and debt issue Most of the time, a corporation is structured as a C corporation, which refers to Subchapter C of the Internal Revenue Code by which it is governed. Sometimes a corporation can be structured as an S corporation (which we discuss next). Some characteristics of a C corporation are listed in ◼ FIGURE 6.5. When does it make sense to form a corporation? Some business owners incorporate just to be able to end a business’s name with “Company,” “Co.,” “Incorporated,” or “Inc.” Having such corporate nomenclature can give a start-up business an air of legitimacy, which can be a perceived benefit to prospective clients and lenders and potentially a greater threat to the competition. More important, forming under a corporate structure provides many advantages not available with other business structures such as protecting against personal liability, perpetual existence, and raising capital. How can a business owner protect his or her personal assets? Corporations are not just for big businesses. A C corporation can be the right choice for many small entities because it is a separate legal entity and is responsible for its own debts, obligations, and liabilities. It also can sue and be sued. This is one of the main reasons owners incorporate their business. When a corporation runs into problems, only the corporation’s assets can be used to remedy the situation; the owners are not personally liable for the business’s debts. What happens to a corporation when an owner leaves? Sole proprietorships and partnerships, by their nature, are dependent on their founding owners. When an owner dies or otherwise leaves the business, a partnership or sole proprietorship is usually terminated. On the other hand, corporations can theoretically live forever because their ownership can be transferred to different shareholders. Shares of ownership are easily exchanged, so the corporation will continue to exist should an owner die or wish to sell his or her interest in the business. As long as it is financially viable, a corporation is capable of continuing forever. Is it easier for corporations to get funding and to raise capital? Corporations can raise money by selling shares of ownership to a specified group of individuals. Or, when a corporation has reached a significant size, it can extend its ownership by “going public”—selling shares of ownership in the corporation to the general public. A stock certificate is the tangible evidence of investment and ownership. And, as we noted previously, lenders are more likely to loan money to an incorporated business because they are not limited to the credit profile of a sole proprietor or general partners. Are corporations taxed the same as other types of businesses? Because sole proprietors and partners run their business income through their personal

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income tax statements, these two types of business structures pay taxes at the owner’s or partners’ tax rates. Corporations have separate tax rates. The corporate tax rate is 15 percent for the first $50,000 of net income a business earns, whereas the same amount of profits from a sole proprietorship or partnership would be taxed at a rate of 25 percent. However, most corporations will generate more than $50,000 in net income. Businesses generating more than $50,000 in taxable income will pay taxes at an equal or higher tax rate than individuals. Does it matter where a business is incorporated? The answer to this questions is more complex than it seems, but there are some general considerations that should be evaluated. If you have a corporation with fewer than five shareholders or members, it is usually much easier and often less expensive to incorporate in the state where your business has a physical presence. For some larger businesses, however, it may be more advantageous to incorporate in a state that is historically more favorable to businesses, such as Delaware, Nevada, and Wyoming. Delaware offers some of the most flexible and business-friendly statutes in the country. Nevada offers low filing fees and has no state corporate income, franchise, and personal income taxes. For similar reasons, Wyoming is also becoming a popular state in which to incorporate.

Structure of a Corporation How is a corporation structured? In its simplest configuration, a corporation’s organizational structure is comprised of shareholders, a board of directors, corporate officers, first-line managers, and employees, as ◼ FIGURE 6.6 shows. Each group has different responsibilities.

Shareholders Whether or not a corporation is privately owned or publicly owned, it has shareholders. Shareholders (or stockholders) have an ownership interest in the company. For their investment, the corporation provides them with stock certificates identifying the number of shares (called apportioned ownership interest) they own. A publicly owned corporation is a corporation regulated ◼ FIGURE 6.6 by the U.S. Securities and Exchange Commission (SEC) because the shares of Organizational Structure of a ownership can be traded on public stock exchanges. Although shareholders C Corporation of a publicly owned corporation serve as the owners of the corporation, they Shareholders have the power to elect have no involvement in the direct management of the corporation. Instead, the board of directors of a C corporathey can influence corporate decisions by electing directors, overseeing the tion. The board, in turn, has the ability laws and rules that govern the organization, and voting on major corporate to hire (or fire) the company’s corporate officers. issues. In privately held (or closed) corShareholders porations, in most cases, the company’s founders, a management team, or a group of private investors own Board of Directors the company. These owners are generally involved in the management Chief Executive Officer and daily operations of the business and have more decision-making responsibilities than do shareholdChief Financial Officer Chief Operating Officer Chief Sales Manager Corporate Officers ers of publicly owned corporations. The owners of privately held corpoFinancial Payroll & Buildings & Information Inside Sales Outside Sales Line Managers Management Benefits Maintenance Services rations are generally the sole shareholders. Any shares of privately held corporations are not traded on Employees Employees public stock exchanges.

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Directors The shareholders of a corporation elect its board of directors, and the members of the board select and hire the business’s management team of corporate officers. Major financing and business decisions for the corporation are also made by the board of directors. For example, in addition to setting the corporation’s policies, the board authorizes the issuance of stock, approves loans to or from the corporation, and decides on major real estate transactions. Consequently, because they vote for the board members, the firm’s shareholders can influence the nature of a corporation and how it is run. Not only is a business’s board of directors responsible for hiring the corporation’s major executives, it is also responsible for ensuring they do their jobs. Not all boards are effective in doing so. Following a rash of corporate scandals, in 2002, the Sarbanes-Oxley Act was enacted. The act provides a new set of regulations designed to make boards of directors more accountable. If the members of a board of directors ignore their responsibility to manage the internal controls of a company, they risk going to prison and face huge fines.

Officers and Line Managers The primary lineup of officers elected by a corporation’s board of directors include the firm’s CEO, CFO, and COO. The chief executive officer (CEO) is typically responsible for the entire operations of the corporation and reports directly to the board of directors. Sometimes the CEO is a member of the board of directors as well. The chief financial officer (CFO) reports directly to the CEO and is responsible for analyzing and reviewing the business’s financial data, reporting its financial performance, preparing budgets, and monitoring the firm’s expenditures and costs. The chief operating officer (COO) is responsible for the day-to-day operations of the organization and reports directly to the CEO. Often, there is a chief legal officer or general council, and depending on the needs of the company, there might also be a chief information officer (CIO). In actuality, any “officer” position can be formed if it makes sense for the company. In smaller companies, only one or two people might play the roles of several different officers. For example, the CEO might also serve as the CFO. In large companies, the responsibilities of each officer are demanding enough that firstline managers, people who directly supervise lower-level employees, help run the business.

Disadvantages of Incorporation

◼ FIGURE 6.7 Steps in Forming a Corporation Corporations provide owners with more protection than other business structures, although forming a corporation is a more complex process.

Choose a Name

Appoint Directors

Are there any disadvantages of structuring a business as a corporation? Forming a corporation is a much more cumbersome process than forming a sole proprietorship or a partnership. ◼ FIGURE 6.7 shows the steps involved in forming a corporation. Because a corporation is a separate legal entity, there are many more filing and process requirements that must be fulfilled to maintain corporate status. All public companies must file an annual report, and all corporations, both private and public, must maintain written minutes of annual and other periodic board of director and shareholder meetings. Major decisions must be recorded, including decisions about whether to issue stock, purchase real estate, approve leases,

File Articles of Incorporation

Draft Bylaws

Hold a Meeting of the Board

Issue Stock

Obtain Licenses and Permits

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loans, or lines of credit and make changes to the stock options and retirement plans employees receive. A corporation must also record financial transactions in a double-entry bookkeeping system and file taxes on a regular basis (quarterly or annually). Because it is considered its own legal entity, a corporation files its own tax return. This results in the disadvantage of double taxation. Double taxation occurs when taxes are paid on the same income twice. The classic business example of double taxation is the distribution of dividends. A corporation is first taxed on its net income, or profit, and then distributes that net income to its shareholders in the form of dividends. The individual shareholder must then pay taxes on the dividends (which have already been taxed at the corporate level). Therefore, the same pool of money—corporate profits—has been taxed twice: once in the form of corporate profits and again as dividends received by the shareholders. Although this is a commonly mentioned disadvantage of corporations, it affects only those corporations that pay dividends to their shareholders. Can a business have the protection of a corporation but not pay corporate taxes? When choosing a legal structure for their businesses, most entrepreneurs want to achieve two goals: protect themselves from personal liability and have the tax advantages of their business income flow through to their individual tax returns. A corporate structure protects an owner’s personal assets from being touched if the corporation is in financial difficulty, but the corporation is taxed as a separate entity without flow-through to the owner’s returns. Fortunately, there are other forms of business structures in which both goals can be met: the Scorporation and the limited liability company.

S Corporations What is an S corporation? An S corporation is a regular corporation (a C corporation) that has elected to be taxed under a special section of the Internal Revenue Code called Subchapter S. Like C corporations, S corporations have shareholders, and they must comply with all the other regulations involving traditional C corporations. How is an S corporation different from a C corporation? Unlike C corporations, S corporations do not pay corporate income taxes. Instead, as with a partnership or a sole proprietorship, shareholders in an S corporation owe income taxes based on their proportionate share of the business profits they receive and pay taxes through their own individual tax returns. Passing ◼ FIGURE 6.8 taxes through personal tax returns is one of the primary advantages of Characteristics of an forming a business as an S S Corporation corporation. However, even though S corporations do not pay corporate • Incorporation paperwork must be ﬁled with state and Preliminary Paperwork federal agencies taxes like C corporations, they still must file a corporate tax • Separate entity; existence not dependent on owners, Period of Existence founders; ownership transferred easily return every year. In addition, S corporations must comply • Owners (shareholders) are not personally liable for Liability debts of corporation with the meeting and reporting requirements established for C • Must have board of directors, corporate ofﬁcers, annual Operational Requirements corporations. Other characteristics meetings, and annual reporting of an S corporation are shown in ◼ • Shareholders elect board of directors, which provides strategic Management FIGURE 6.8. management of corporation; board appoints senior management How does an S corporation handle personal liability? The beauty of an S corporation is that it offers the best of both worlds: Profits and losses pass through to

Taxation Raising Capital

• Proﬁts and losses pass through owner’s personal tax return. • Capital can be raised through sale of stock and debt; only common stock can be issued.

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the shareholders, and the corporate structure provides some limitations on the personal liability of the owners. Although an owner’s personal assets will be protected in case of a large claim against the corporation, the S corporation does not assume liability for an owner’s personal wrongdoings. This is true for any corporate structure—whether it is a C corporation, an S corporation, or a limited liability company (discussed later). So, if an owner directly injures someone or intentionally does something fraudulent, illegal, or reckless that causes harm to the company or someone else, he or she will be held personally responsible and is not protected under the corporate umbrella. For example, suppose William is the owner of a boating business that offers day cruises in the San Francisco Bay. Unfortunately, one foggy day, William’s boat collides with another boat, causing his boat to capsize. Before leaving the dock, William knew there were not enough life jackets for each passenger. If any of his passengers were harmed because there were not enough life preservers, William most likely would be held personally liable for his negligent actions, even though he had structured his company as an S corporation. William not only would be in danger of losing the business but also may be forced into personal bankruptcy if his personal assets were needed to help satisfy the claims on the company. Can any business elect to be an S corporation? There are certain qualification requirements a business must meet to elect an S corporation status. According to the Internal Revenue Code, an S corporation must have the following characteristics: • The company must not have more than 100 shareholders. • Shareholders must be U.S. citizens or residents. • The company must issue only one class of stock. S corporations are an appropriate business structure for small business owners who want the legal protection of a corporation but also want to flow business income and losses on their personal tax returns. However, if a business does not meet the IRS requirements for an S corporation but the owner stills wants personal liability protection along with pass-through tax benefits, a limited liability company might be a suitable alternative corporate structure.

limited liability Companies What is a limited liability company? A limited liability company (LLC) combines the corporate advantages of limited liability with the tax advantages inherent in sole proprietorships and partnerships. Similar to creating an S or a C corporation, an LLC requires articles of organization, so it is a separate legal entity (thus providing limited liability). But an LLC is free of many of the annual meetings and reporting requirements imposed on C and S corporations, so it is simpler to maintain. LLCs do not issue stock. Rather, each member’s ownership is determined by the value of his or her capital account. A capital account tracks the member’s capital contributions to the LLC. Profit and loss distributions also flow through the capital accounts in proportion to the ownership percentage each member has. Because there are fewer corporate formalities, limited liability provisions, and the reporting of taxes at the individual level, an LLC is a popular business structure choice for many new businesses. Some states restrict the types of businesses that can form as LLCs. Other characteristics of an LLC are outlined in ◼ FIGURE 6.9.

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What’s the difference between an LLC and an S corporation? Although LLCs and S corporations share certain similarities, there are several differences between the two: • Ownership. S corporations are restricted as to the number of owners the company can have, but LLCs can have an unlimited number of owners (called members). In addition, LLC members are not limited to just U.S. residents and are not subject to other ownership restrictions imposed on S corporations.

Preliminary Paperwork Period of Existence Liability Operational Requirements Management

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• Organizational paperwork must be ﬁled with state and federal agencies • Ongoing existence is determined by requirements imposed by the state of formation; transferability is determined by the operating agreement • Members are not personally liable for debts of the LLC • Some reporting/operating requirements, but far fewer than for corporations • Management details are described in an operating agreement

Taxation

• Taxes as a partnership, although it can elect to be taxed as a corporation

Raising Capital

• Members may sell interests to raise capital; there may be operating agreement restrictions

• Perpetual life. When a member leaves an LLC, the LLC must dissolve, unless all remaining members agree to continue the business. Some states require a dissolution date be listed in an LLC’s articles of organization. Consequently, an LLC has a limited life span.

• Stock transfer. Stock in an S corporation, like a C corporation, is freely transferable, whereas the ownership interest in an LLC is not, and the transfer generally requires the approval of other members. • Profit and loss distributions. An LLC can allocate its profits in whatever way its owners agree on, but the profits of an S corporation are allocated in proportion to a shareholder’s interest. So, if two members own a business and one contributes 75 percent of the capital but does only 25 percent of the work whereas the other member contributes 25 percent of the capital but does 75 percent of the work, the two members can decide that a fair allocation of profits is 50/50. This arrangement would be possible with an LLC, but with an S corporation, the profits would need to be distributed based on the 75/25 ownership interest in the business. • Owner and employee benefits. An S corporation can offer fringe benefits to its owners, such as qualified retirement plans, employee-provided vehicles, and educational expenses related to the job. Because S corporations have stock, they can also offer their employees stock options and other stock bonus incentives. LLCs are limited in the benefits their members can be offered, and because LLCs do not issue stock, they cannot offer stock benefits to their employees. What kinds of businesses are best suited as an LLC? There are many types of businesses in which an LLC structure is appropriate. LLCs may be a good choice for start-up businesses, not only for the tax benefits but also because it is easier to obtain financing because the number of investors (owners) is not restricted.

Comparing Forms of Ownership Which form of ownership is best? There is no one entity that works for everyone. A certified public accountant or a tax attorney should be able to help you choose the right structure for your business. The important considerations are the operational, legal, and tax aspects of each structure as they apply to your unique situation. ◼ FIGURE 6.10 shows how the most common forms of ownership stack up to one another.

◼ FIGURE 6.9 Characteristics of an LLC

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C Corp

S Corp

LLC

Preliminary paperwork required for business startup Business ceases after owners, departure or death Owners have limited liability for business debts and obligations May have an unlimited number of owners Must have board of directors, corporate officers, annual meetings, and annual reporting Owners can report business profit and loss on their personal tax returns May issue shares of stock ◼ FIGURE 6.10 Comparing the Forms of Business Ownership

 Brandon

and Sonya were looking to form a partnership structure around their inherited real estate properties, but they have been advised that a partnership will not protect their personal assets if something terrible goes wrong and they are sued by a tenant. The siblings decided an LLC would be the best choice, as it would give them the protection of a corporation but the ability to report the business income through personal tax returns.

Source: nuwatphoto/Fotolia

Objective 6-4

Not-for-Profit and cooperatives Explain the characteristics of not-for-profit organizations and cooperatives.

 While attending college, Darrell Hammond had volunteered to make playgrounds. Several years later, he read about two inner-city children who had suffocated while playing in an abandoned car and realized that if

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the children had had a safe place to play, the tragedy could have been avoided. Shortly afterward, Darrell and his friend Dawn Hutchinson built a community playground for a day of service they led, and a year later they founded KaBOOM!, a not-for-profit organization that helps communities build playgrounds.2 How should Darrell structure KaBOOM! to protect himself financially, gain credibility, and continue to serve the community? The goal of some business ventures is not to generate a profit but rather to make a difference in people’s lives and their communities. These businesses can be educational, scientific, religious, or charitable. What forms of businesses do organizations such as these use, and what are their benefits and drawbacks? We’ll answer these questions next.

Not-for-Profit Organizations What is a not-for-profit organization? Legally, a not-for-profit organization (or nonprofit organization) is a business that does not seek a profit. Not-for-profit organizations generate their revenues primarily through fund-raising and donations. After paying normal operating expenses— such as salaries, rent, and purchases of inventory, supplies, materials, and equipment—a not-for-profit organization uses the remaining revenue for the business’s declared cause and mission rather than paying stockholders. Notfor-profit organizations must apply for tax-exempt status with the federal government and sometimes with the states in which they operate. To maintain their tax-exempt status, not-for-profit organizations must demonstrate that a substantial portion of their income or revenue is spent on services to achieve their goals.

THE LIST

Largest Not-for-Profit Organizations3

1. The Y

6. American Red Cross

2. Goodwill Industries International

7. Easter Seals

3. Catholic Charities USA

8. Feeding America

4. United Way 5. The Salvation Army

9. Task Force for Global Health 10. Boys and Girls Clubs of America

Can not-for-profit organizations act like corporations? Not-forprofit organizations are incorporated and, as such, are subject to most of the laws that govern for-profit corporations. Not-for-profit organizations receive limited liability protection when they become incorporated and are established as a separate legal entity. Similar to a for-profit corporation, a not-for-profit is required to hold board meetings and keep complete books and records. Not-for-profit organizations do not issue shares of stock, and their members (or owners) may not receive personal financial benefit from the organization’s profits (other than salary as an employee). However, some not-for-profit organizations do provide employee benefits, such as health insurance. In addition, should the not-for-profit organization dissolve, the organization’s assets must go to another not-for-profit organization with a similar mission.

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Are there advantages to being tax exempt? An organization that has met the qualifications in section 501(c)(3) of the IRS code is considered a not-for-profit. It is therefore exempt from paying most federal and/or state corporate income taxes. It may also be exempt from state sales and property taxes. Not-for-profit organizations are also able to apply for grants and other public or private distributions and get discounts on postal rates and other services. People who donate to not-for-profits can deduct their donations on their tax returns. This encourages people to contribute to not-for-profits.

Cooperatives What structure would be best for groups of businesses with common goals? A cooperative is a business not owned by investors but rather governed by members who use or benefit from the products or services provided by the organization. The members of a cooperative have common interests and needs and can be individuals, such as individual farmers in an agricultural cooperative, or businesses, such as individual hardware stores, florists, or hotels that come together to form it. For example, Florida’s Natural Growers is a cooperative of citrus growers who own their own groves in Florida. How are cooperatives structured? Members are the most important part of a cooperative. They buy shares to help finance the cooperative, elect directors to manage the cooperative, and create and amend the bylaws that govern the cooperative. Cooperatives depend on their members to volunteer for projects supported by the cooperative and serve on boards and committees. The board of directors in a cooperative appoints committees for specific purposes, such as member relations and special audits. The board of directors also hires the cooperative manager who handles the daily affairs. Are cooperatives not-for-profits? Although their members may be motivated by profits, the cooperatives themselves are not. Any profits made by a cooperative are reinvested in the organization to continue to maintain it and improve its functioning. Or, the profits are returned to members in proportion to their use of the cooperative, not their investment or their ownership share. Cooperatives are incorporated under state co-op statutes as businesses organized to serve their members. The status of a cooperative is also recognized by state and federal tax codes. Consequently, any distributed profits to its memberowners are taxed at the owner’s level. What are the advantages of cooperatives? Cooperatives form because a group of individuals or businesses become dissatisfied with how the marketplace is providing the goods or services they need, the prices at which they are being sold, or their quality. By uniting, the members have more bargaining power to negotiate within the marketplace and enjoy reduced costs.

 Some businesses don’t fit the mold of a sole proprietorship, partnership, or corporation because of the underlying cause or purpose of the business. When this occur.s, the business’s owners might form not-for-profit organizations or cooperatives. Darrell Hammond did not care about his personal profit; he just wanted to create an organization that would help improve communities, so he found that forming a not-for-profit organization was best for him.

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Objective 6-5

Mergers and Acquisitions Compare the different types of mergers and acquisitions, and explain why each occurs.

 Google

began in 1998 as a search engine, but nearly two decades later, the company, now formally known as Alphabet, Inc., has expanded to include many other businesses. Today, Alphabet includes Google (the search engine) as well as a collection of companies that include a web browser (Google Chrome), mapping and directional service (Google Maps and Google Earth), online productivity and communications center (Google Docs and Gmail), and social media facilitator (Google+). Alphabet also includes the Android mobile platform, Picasa image manager, Blogger, and YouTube as well as bunch of companies that are not well formulated yet that are dabbling in more conceptual products. How did Alphabet, formerly Google, expand into all these products and services?

Sometimes, in the evolution of a business or in response to market forces, companies seek opportunities to expand by adding new product lines, spreading out into different geographic areas, or growing the company to increase their competitive advantage. Often product or market expansion is done gradually by slowly adding new product lines or penetrating new areas. However, it takes time and money to research and develop new products or to locate and build in new areas. Sometimes, especially to remain competitive, a business needs to expand more quickly. In that case, it may be easier to integrate another established business through the process of mergers or acquisitions. Acquiring or merging with another company are strategies companies can use to gain synergy and increase their competitiveness.

Mergers versus Acquisitions What is the difference between a merger and an acquisition? The terms merger and acquisition are often used interchangeably, but there is a difference. When two companies come together cooperatively to form one company, a merger takes place. Generally, a merger implies that the companies involved are about the same size and have mutually agreed to form a new combined company. An acquisition, on the other hand, occurs when one company completely buys out another company. In some instances, companies claim a merger has occurred, but in reality, one company has acquired the other. The term merger has a better connotation than acquisition and therefore is used to allow the acquired company to “save face.” Often, the combined organization reflects the names of the individual companies, such as when Chase Manhattan Corp. acquired JPMorgan

Source: bas121/Fotolia

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to form JPMorganChase & Company. In other situations, just one company name is kept. For example, when American Airlines and USAirways merged, the combined airline decided to operate under American Airlines. Sometimes, a completely new name is derived, such as when Bell Atlantic acquired GTE to form Verizon Communications. Are all mergers and acquisitions mutually desired by both companies? Often, acquisitions are friendly, as was the case when Google purchased Android in 2005. At the time, Android was just a start-up but had demonstrated its ability to produce a working operating system for mobile devices. Post merger, Android continues to be run by its cofounder Andy Rubin but benefits from the significant resources that Google offers. In turn, Google benefits by having a viable mobile operating system that it uses to challenge industry giants Apple and Microsoft. Some acquisitions are “unfriendly.” An unfriendly acquisition occurs when one company tries to purchase another company against the wishes of its shareholders or managers. Unfriendly acquisitions are referred to as hostile takeovers. In an unfriendly acquisition or hostile takeover, the acquiring firm makes a tender offer, which is an offer to buy the target company’s stock at a price higher than its current value. The higher price is offered to persuade the shareholders of the target company to sell their stock. Another method of acquiring a company against its wishes is through a proxy fight in which the acquiring company tries to persuade the shareholders of the target company to vote out the firm’s existing managers and replace them with managers who are sympathetic to the goals of the acquiring company. This is the strategy Microsoft pursued when it unsuccessfully tried to take over Yahoo! in 2008.4 Some takeovers that are initiated by an outside group of investors, employees, or management are financed with debt. The acquiring group borrows as much as 90 percent of the funds necessary for the acquisition, using the assets of the acquired company as collateral. This type of transaction is called a leveraged buyout (LBO). LBOs can be either friendly or hostile, and companies of all sizes have been the targets of LBO transactions. Some of the more recent and largest LBOs involved the Hertz Corporation, Metro-Goldwyn-Mayer, and Toys “R” Us. Although LBOs may be a good strategy in some instances, the practice has received much criticism because jobs are often lost as a result of LBOs, and the companies often fail because of the high debt loads resulting from the LBO.

Advantages of Mergers and Acquisitions Why do mergers and acquisitions occur? Synergy is the business buzzword often used to justify a merger or an acquisition. Synergy is the effect achieved when two companies combine and the result is better than each company could achieve individually. Synergistic value is created when the new company can realize operating or financial economies of scale. Combined firms often lower costs by trimming redundancies in staff, sharing resources, and obtaining discounts accessible only to a larger firm. In other instances, synergy is achieved by combining resources that could not have been created independently by either party. Such was the case with the merger of satellite radio providers Sirius and XM. Each satellite radio provider had exclusive contracts with different sports programmers. Customers were having a hard time choosing between one and the other. The merger gives customers the benefit of both.

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AOl–Time Warner Merger lthough it took place more than a decade ago, the merger between America Online (AOL), an Internet services company, and Time Warner, a media and communications company, is still viewed as one of the worst mergers in U.S. history. Valued at $164 billion, the merger also was (and still is) the largest merger in the United States. At the time, it was believed that the combination of an Internet giant and a media behemoth would, in the words of Gerald Levin, then the CEO of Time Warner, “create unprecedented and instantaneous access to every form of media and to unleash immense possibilities for economic growth, human understanding and creative expression.”5 According

Forms of Business Ownership

to AOL cofounder Stephen Case, the merger was “a historic moment in which new media has truly come of age.”6 However, the deal began to sour almost immediately because it was soon quite apparent that the two companies had different cultures. In addition, AOL, “the crown jewel of the transaction,” ran into great financial difficulty when the dot-com bubble burst only months after the merger.7 Moreover, investigations by the SEC and the Department of Justice revealed that AOL had been improperly inflating its advertising revenue. In 2009, Time Warner spun off AOL as an independent company.

Is competition a driving force for mergers and acquisitions? Achieving a greater competitive advantage is another reason mergers and acquisitions take place. Often, companies join to become a more dominant force in their market. For example, the merger between Office Depot and Office Max improves the new company’s ability to compete with Staples, the market leader, as well as with online and discount stores, such as Amazon.com and Walmart.8 Do companies add value to their product lines by merging? Many times, larger companies acquire smaller companies for their innovativeness, and a smaller company will agree to merge or be acquired if it feels it wouldn’t have the opportunity to go public and couldn’t survive alone otherwise. Much of Google’s growth can be attributed to their innovative creativity within the company, but some has also come from its acquisitions of small, innovative companies, such as Feedburner, Like.com, Applied Semantics, Postini,9 and drone maker Titan Aerospace.10

Types of Mergers Are there different types of mergers? The rationale and strategy behind every merger is different. However, as ◼ FIGURE 6.11 shows, mergers fall into a number of categories that are distinguished by the relationship between the two companies merging: • Horizontal merger. A merger in which two companies sell the same types of products and are in direct competition with each other. The merger between Exxon and Mobil and the merger between USAirways and American Airlines are examples. • Vertical merger. A merger between two companies that have a company/ customer relationship or a company/supplier relationship, such as Walt Disney and Pixar or eBay and PayPal. • Product extension merger. A merger between two companies selling different but related products in the same market, such as the merger between Adobe and Macromedia.

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Horizontal Merger

Vertical Merger

Companies that share same product lines and markets

Companies that have company/supplier or company/customer relationship

Market Extension Merger

◼ FIGURE 6.11 Different Types of Mergers Image sources, left to right, top to bottom: Natika/Fotolia; m.u.ozmen/Fotolia; Sean Gladwell/ Fotolia; Maksim Shebeko/Fotolia; Scanrail/Fotolia; Stian Olsen/ Fotolia

Companies selling same products to different markets

Product Extension Merger

Companies selling different but related products in the same market

Conglomeration

Companies that have no direct common business areas merge to obtain diversification

• Market extension merger. A merger between two companies that sell the same products in different markets, such as when NationsBank, which had operations primarily on the East Coast and in southern areas of the United States, merged with Bank of America, whose prime business was on the West Coast. • Conglomeration. A merger between two companies that have no common business areas but instead merge to obtain diversification. For example, Citicorp, a banking services firm, and Travelers Group Inc., an insurance underwriting company, combined to form one of the world’s largest financial services group, Citigroup Inc.

Disadvantages of Mergers Are there disadvantages with mergers? Despite the perceived advantages of mergers, more than one-half of all mergers fail completely or don’t live up to their financial expectations.11 The primary culprit of a failed merger is poor integration following the transaction. After an exhausting process that may cause top executives to take their eyes off business, little energy or motivation may be left to plan and manage how the two companies will come together to work as one. Although cost cutting may be the initial primary focus of some mergers, revenues and profits may ultimately suffer if day-to-day activities are

ChAPTeR 6

neglected. Additionally, the corporate cultures of the organizations may clash, and communications may break down if the new division of responsibilities is vague. Conflicts may also arise as a result of divided loyalties, hidden agendas, or power struggles within the newly combined management team. Employees may be nervous because most mergers result in the elimination of jobs; this may also cause other employees whose jobs are not being eliminated to seek employment in more stable organizations.

 Alphabet,

like many technology companies, acquired other companies, helping to extend and complement Google’s existing product line. Some acquisitions didn’t work out, but others did. Google, once just a company with a great search engine, now is striving to maintain its market dominance by continuing to acquire firms and develop products in different markets.

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Chapter 6

summary 6-1

Discuss the advantages and disadvantages of a sole proprietorship.

• A sole proprietorship is a business owned and usually operated by a single individual. • The sole proprietorship is a common form of business ownership because it is the easiest to establish, but there are both strengths and weaknesses inherent in this business form. • The advantage of establishing a business as a sole proprietorship is that there are no formal, legal requirements for starting the business, and the revenues and expenses are reported directly on the business owner’s personal income tax return.

6-3

• Corporations are businesses structured as separate legal entities. Corporations are structured with different levels of managers, including shareholders, board of directors, and corporate officers, such as the chief executive officer (CEO), the chief financial officer (CFO), the chief operating officer (COO), and first-line managers. • Corporations differ from sole proprietorships and partnerships in the following ways: • Corporations are difficult to set up. • Corporations require much ongoing paperwork, including annual reports, corporate minutes, and formal financial records.

• The primary disadvantage of a sole proprietorship is that the owner’s personal and business assets are at risk in the event of a business catastrophe.

6-2

Discuss the advantages and disadvantages of a partnership and a partnership agreement.

• A partnership is a business structure that is easy to establish and has no formal, legal requirements. • In a partnership, two or more individuals share aspects of the business, including its financial management and sales and marketing responsibilities. Income and expenses flow directly through each partner’s individual tax return. • People entering into a partnership should create a partnership agreement, which is a formal document that outlines the responsibilities of each partner and how the business’s profits will be divided and disputes among the partners settled. • Problems can occur when partners do not agree on the nature of the business or have different work ethics. • Partners’ personal and business assets are at risk, with each partner being solely liable for any part of the business. Responsibility is not limited to each partner’s financial contribution to the business.

186

Explain how a corporation is formed, and compare a corporation to other forms of business.

• Corporations must file separate tax returns. • Corporations can sue and be sued. • Corporations protect an owner’s personal assets. • Both S corporations and C corporations offer the protection of limited liability, but S corporations allow their shareholders to flow the corporate revenues and expenses through their personal tax returns so they don’t face double taxation. • S corporations face certain restrictions, including having no more than 100 shareholders, requiring shareholders to be residents of the United States, allowing for the issuance of only one class of stock, and basing profits and losses on the proportional interest of each shareholder. • The corporate structure a limited liability company (LLC) offers the protection of limited liability like an S corporation does. LLCs differ from S corporations because they can have unlimited members, they must dissolve when any member leaves, and profits do not have to be distributed in direct proportion to a member’s financial contribution.

6-4

Explain the characteristics of not-for-profit organizations and cooperatives.

• A general partnership is an arrangement in which all partners have equal liability. In a limited partnership, some partners do not participate in the daily operations of the business, and their liability is limited to the amount of capital they contributed to the business.

• Not-for-profit organizations are corporations whose purpose is to serve the public interest rather than to seek to make a profit. Not-for-profit organizations are tax exempt, and donors to the organization can deduct their contributions on their tax returns.

• A limited liability partnership (LLP) protects the partners from any debt or liability incurred by the business as well as each partner from the liability of another partner. A partner in an LLP is only personally liable for his or her own negligence.

• Cooperatives are motivated to provide services or goods to people with common interests or needs.

• Cooperatives are businesses that are owned not by outside investors but are governed by members who use its products and services.

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the other against the wishes of the management and/or the owners).

• All profits generated by the cooperative are returned to the members in direct proportion to their share of ownership.

• A merger occurs when two companies of similar size mutually agree to combine to form a new company. Some types of mergers are as follows:

• Cooperatives use the benefit of the power of their groups’ to negotiate within the marketplace.

6-5

Forms of Business Ownership

• Horizontal mergers: Two companies that share the same product lines and are in direct competition with each other merge.

Compare the different types of mergers and acquisitions, and explain why each occurs.

• Firms sometimes use mergers and acquisitions to legally combine their companies for the purposes of achieving synergy and economies of scale, expanding their product lines and geographic areas they serve, or gaining a competitive advantage.

• Vertical merger: Two companies that have a company/customer relationship or a company/supplier relationship merge. • Product extension merger: Two companies selling different but related products in the same market merge.

• An acquisition occurs when one company buys another company outright. The purchased company ceases to exist and starts to operate under the buying company’s name and management. Acquisitions can be friendly (mutually agreed on) or unfriendly (one company buys

• Market extension merger: Two companies that sell the same products in different markets merge. • Conglomeration: Two companies that have no common business areas merge to obtain diversification.

Key terms acquisition board of directors C corporation capital chief executive officer chief financial officer chief operating officer conglomeration cooperatives corporation double taxation

first-line managers general partners general partnership horizontal merger liability limited liability company limited partner limited partnership market extension merger merger not-for-profit organization

partnership partnership agreement product extension merger publicly owned corporation S corporation shareholder sole proprietorship stockholder synergy unlimited liability vertical merger

MyBizLab To complete the problems with the

, go to EOC Discussion Questions in the MyBizLab.

self-test Multiple Choice

You can find the answers on the last page of this text.

6-1 Omar and Sam are physical therapists who work

together. Their office is on the first floor of a building Omar owns. They need protection of their personal assets as well as to protect themselves from any errors their partner makes. Which business structure would best suit their company? a. A general partnership b. A sole proprietorship c. A not-for-profit organization d. An LLC

6-2 Why might a potential business owner want to establish a business as a sole proprietorship?

a. The owner can use personal assets to satisfy any business liabilities. b. The owner can take into consideration the opinions of other business owners. c. The owner can generate a separate tax return for business expenses. d. The owner is not required to file legal paperwork to start up the business.

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6-3 Trudy and Yvonne have come together to run Salford

Children’s Center. The center receives state and federal grants, and whatever is left over is put back into the center to improve and expand its services. Salford Children’s Center would best be described as a(n) a. partnership. b. LLC. c. not-for-profit organization. d. sole proprietorship.

6-4 Jackson Eats is a partnership owned by Jesse and

Robert Jackson. They need additional capital to expand to a new location, so they have decided to bring in Sean, who will only contribute capital. Sean would best be considered as a(n) a. general partner. b. limited partner. c. owner. d. None of the above

6-5 Which of the following is not an advantage of a C corporation?

a. The owner’s personal assets are protected. b. The owner can raise greater sources of funds by selling shares of ownership. c. The corporation can continue to exist even if the owner leaves the business. d. There is little paperwork involved.

6-6 Warren Buffet runs Berkshire Hathaway, which

owns companies such as GEICO insurance, Dairy Queen, Fruit of the Loom, and Helzberg Diamonds. Berkshire Hathaway is considered to be which of the following? a. A conglomeration b. An acquisition c. A merger d. A cooperative

6-7 A group of people elected by a firm’s shareholders to oversee the operation of a corporation are a. the firm’s CEO, CFO and COO. b. the firm’s board of directors. c. the firm’s line managers. d. All of the above

6-8 Which is a benefit of cooperatives? a. The power of the group enables them to negotiate for goods and services at favorable prices. b. They are exempt from paying federal and state taxes.

c. They are established to serve the public interest rather than make a profit. d. They provide services to people with a variety of interests and needs.

6-9 Dad’s Camping Equipment Co. buys tents from

Son’s Outdoor Tent Co. If Dad’s company merges with Son’s company to form Family Outdoor Equipment Store, which of the following best describes the type of transaction that occurred between the two companies? a. A vertical merger b. A product extension merger c. A horizontal merger d. A conglomeration

6-10 The management team of Company A has con-

tacted the shareholders of Company B encouraging them to replace their current managers with a new group who are more in line with the goals of Company A. Company A is launching a a. proxy fight. b. tender offer. c. friendly acquisition. d. friendly takeover.

True/False

You can find the answers on the last page of this text.

6-11 Any business can elect to be an S corporation. True or False 6-12 Liabilities include losses associated with breaches of contract or from damages.

True or

False

6-13 A small, privately owned company can be structured as a corporation.

True or

False

6-14 A significant disadvantage of forming a partner-

ship is the amount of paperwork and reporting it requires.

True or

False

6-15 A partnership agreement should include proce-

dures that outline how a partner’s departure from the business will be handled as well as how new partners are to be brought in.

True or

False

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Critical Thinking Questions 6-16 Why might it be important to structure your business as a C corporation, even if you are the only person running the business? 6-17 What are the similarities and differences between a general partnership and a limited partnership?

6-18 Approximately 70 percent of all businesses are sole proprietorships. Why is sole proprietorship a popular form of business ownership? What are the circumstances when it might be important to consider a different form of ownership?

team time WHAT’S THE PLAN? Imagine that you work for the U.S. Small Business Administration and have the opportunity to advise new business owners on the form of ownership their businesses should take. Form groups of three to five people and choose one of the business ideas below. Work as a group to create an outline of a business plan for each business idea (see Mini Chapter 2 for some sample outlines). What kind of business forms would you suggest for each idea and why? Be sure to consider the potential risks and liabilities, the potential income tax situations, and the current and future investment needs of each business. Assume that in five years, the business needed additional capital to expand by adding a new building in a different location. Would your business structure support raising the necessary capital? Why or why not?

Business Ideas • • • • •

Roofing and siding company Ice cream parlor Yoga instruction Lawn mowing company Clothing donation company

Process Meet as a group to discuss your business idea. Remember that you must prepare an outline of a business plan. Use what you know about the forms of business ownership to create the business plan. Step 1. Prepare an individual report that explains the form of ownership your

business should take and why.

Step 2. Determine who will be the group’s primary spokesperson for your busi-

ness plan.

Step 3. Your group will have five minutes to present your recommendations. Step 4. After each group has presented, discuss any differences of opinion about

the proposed business structures.

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ethics and corporate social Responsibility CODE OF ETHICS Many companies establish a code of ethics or a code of values. These codes are used to communicate to all the company’s stakeholders—directors, management, employees, suppliers, and customers—a company’s values and business style. Kraft, for example, has 10 rules of ethical behavior that all employees must follow. Verizon’s code of ethics is a lengthy document outlining a variety of rules and guidelines.

Questions for Discussion 6-19

Research other codes of ethics from three different organizations. List any common values sited in these codes. Note any differences between organizations and comment on why you think the unique codes are necessary for that particular organization.

6-20

Do you think establishing a code of ethics is sufficient to ensure ethical behavior in an organization? What other forms of action or behavior might be necessary to ensure ethical business behavior?

Web exercises 6-21

6-22

6-23

Business Combinations Look on the Internet for a current example of a business merger, takeover, or acquisition. Explain the circumstances of the event. What companies are involved? Was the event friendly or unfriendly? What are the reasons given for the combination? What is your opinion of this business combination? Do you think it is a good business decision? Why or why not? Student-Friendly Businesses You have decided to start your own business. You want it to be something you can do while you’re still a student. Research on the Web ideas for small businesses for students. Describe at least three different ideas and include what form of business ownership you would use to structure each business. The Perfect Partner Search the Web for information on how to pick the perfect business partner. Write a list of rules for

picking the perfect business partner based on what you have learned. What factors should be taken into account? What can you do to avoid trouble in the future? 6-24

Plan with the End in Mind Beginning a business requires a lot of planning, but even still, the business often fails. However, most business owners do not have an “exit plan” in mind when they start the venture. Research the main causes of business failures and what kind of exit strategies can be set in place at the beginning to ease the pain if the business needs to close.

6-25

Cooperatives and You! Can you identify and or manage a cooperative? Go to www.coops.wisc.edu and play the “Find the Co-op” and “You’re the Boss!” games. Write a brief summary of what you learned while playing both games.

MyBizLab Go to the Assignments section of your MyBizLab to complete these writing exercises: 6-26 Discuss the various types of mergers and give examples of each. 6-27 Discuss when a corporate structure may be the best structure for a small business. What aspects of the business would benefit from the corporate structure, and what are the downfalls of choosing a corporate structure for a small business?

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References 1. From Ambrose Bierce, “Corporation,” in The Devil’s Dictionary (New York: Neale Publishing, 1911). 2. “Our Story,” http://kaboom.org/about_kaboom /our_story. 3. From “The 2015 NPT Top 100,” The Non Profit Times, http://www.thenonprofittimes.com/wp-content /uploads/2015/11/Top100_Charts-2.pdf. 4. Intology, “Intology—Intelligent Technology NewsComputers Technology Internet Arts Business Science Sports,” April 29, 2008, www.intology.com/business-finance /microsoft-vs-yahoo-hostile-take-over-explained. 5. Gerald Levin, quoted in “AOL & Time Warner Will Merge to Create the World’s First Internet-Age Media & Communications Company,” January 10, 2000, http://www.timewarner.com/newsroom/press -releases/2000/01/10/aol-time-warner-will-merge -to-create-world-s-first-internet-age (accessed May 5, 2016). 6. Stephen Case, quoted in “AOL & Time Warner Will Merge to Create the World’s First Internet-Age Media & Communications Company,” Time Warner Inc., http://www.timewarner.com/newsroom/press-releases /2000/01/10/aol-time-warner-will-merge-to-create

10.

11.

-world-s-first-internet-age, 1/10/2000, accessed August 15, 2016. Ted Leoniss, quoted in Tim Arango, “How the AOL-Time Warner Merger Went So Wrong,” CNET, January 18, 2010, http://www.cnet.com/news/how-the-aol-time-warner -merger-went-so-wrong/#!(accessed May 5, 2016). “Office Depot and OfficeMax Complete Merger,” http://news.officedepot.com /press-release/corporatefinancial-news /office-depot-and-officemax-complete-merger. Matt Rosoff, “Google’s 15 Biggest Acquisitions and What Happened to Them,” Business Insider, March 2011, www .businessinsider.com/googles-15-biggest-acquisitions-and -what-happened-to-them-2011-3?op=1. McNeal, Greg. “Google’s Acquisition of Drone Maker Titan Is about Imagery and Internet,” Forbes, 14 April 2014. Retrieved from http://www.forbes.com/sites /gregorymcneal/2014/04/14/fight-for-internet-drones -heats-up-as-google-buys-drone-company-originally -sought-by-facebook. Susan Cartwright, Why Mergers Fail and How to Prevent It, QFinance.com. Retrieved from www .qfinance.com/mergers-and-acquisitions-best-practice /why-mergers-fail-and-how-to-prevent-it?page=1.

MINI ChaPTEr

Chapter 2

Constructing an Effective Business Plan From the moment you received money for mowing your neighbor’s lawn or babysitting your neighbor’s child, you’ve been interested in starting your own business. But where do you begin? Do you purchase business cards? Do you create and distribute flyers? Although these might be good ways to get your business moving, they are not the first things you should do when starting a business. The Small Business Association (SBA) suggests that the first step in starting a business is planning. Writing a business plan is usually the first step in that planning process. A business plan is a written document that details a proposed or existing venture, describing the vision, current status, the markets in which it operates, and the current and projected results of a business. Traditionally, a potential business owner writes a business plan before a business is launched, but it can be written after a business has been established. In some instances, and especially in industries in which change occurs rapidly, a business opportunity might be lost if you do not start operations immediately; you may not have time to take the weeks or months often required to write a business plan. In this situation, you should still begin by answering a few discrete and pointed questions, such as those shown in ◼ Figure M2.1. This will help you determine whether the business you’re pursuing will be worth the effort. Eventually, a formal business plan should be written to more thoroughly define the goals and objectives of the business and the means to achieve them.

Planning—It’s Never Too Late

Source: Feng Yu/Alamy Stock Photo

 In 1958, college-aged brothers Dan and Frank Carney borrowed $600 from their mother to open a pizza parlor in Wichita, Kansas. This venture marked the inception of the Pizza Hut empire. The brothers had neither a formal business plan nor a clear vision of the path their business would take. In fact, the Carneys simply gave away pizza on their opening night to garner the public’s interest. Although their gimmick was impulsive, it worked. Less than a year later, the boys incorporated and opened their first franchise unit in Topeka, Kansas. Within the next 10 years, more than 150 franchises opened nationwide, and one international franchise opened in Canada. However, in 1970, the company’s growth became explosive. Pizza Hut went public, and the brothers quickly became overwhelmed. “We about lost control of the operations,” Frank Carney said. “Then we figured out that we had to learn how to plan.”1 Ultimately, Frank and Dan developed a plan that kept operations constant and under control. They also created a corporate strategy that enticed PepsiCo to purchase Pizza Hut in 1977. At that time, Pizza Hut sales had reached $436 million a year.2 The Carneys’ story is a success; however, if they had developed a clear business plan from the beginning, they may have been better prepared to handle their company’s incredible growth.

CHAPTER MINI 2 1

Step One: Write a mission statement. To help explain the purpose of your business answer the following questions: • Why should this business exist? • Who will be the target customer? • How will the customer beneﬁt from the business?

Step Two: Find the key to your success. To help figure out how your business will be successful, answer the following questions: • Where will your operations take place? • What three or four critical factors will be essential to your business s survival? • What obstacles will you have to overcome? Step Three: Perform a simple market analysis. To help determine how many potential customers your business will have, answer the following questions: • At which businesses are your customers current patrons? • Who are your main competitors? • Are there enough potential customers? Step Four: Perform a simple breakeven analysis. To help figure out how much money your business must produce to cover your costs, answer the following questions: • What is the total cost of your operations? • How many units of sales will you need to cover your costs? • Are your sales goals realistic? Step Five: Really think about it. To help decide if you are prepared to start a business, answer the following questions: • Do you feel ready to start a business? • Are you willing to commit long hours to making your business work? • Have you discussed your idea with a business counselor or coach? Considering your answers to these questions, do you still feel prepared to start a business? If so, get started, but find time to create a thorough business plan to use as a guide as your business develops.

The Purpose of a Plan A business plan is your “business story”—a story that you will tell to a wide variety of people, from personal friends and casual acquaintances to potential partners, suppliers, customers, and investors. There are three purposes to writing a business plan: development, management, and communication. • Development. Writing down your business plan solidifies and defines your intentions. It forces you to think through many aspects of a business that might otherwise be overlooked, identify roadblocks and obstacles, and determine ways to resolve or avoid them. Business plans can be used to get the entire management team and perhaps the employees of the company to understand where the company is and where it is heading. • Management. Of course, the goal of most businesses is to make money, so a business plan should summarize how a business opportunity will translate into profits. A business plan also helps in the management of a company. Because it is a living document, it should be modified as the business changes and reaches certain milestones. It can be used to track and monitor the progress of the company as well as evaluate projections with respect to the actual performance.

Source: Glyn Thomas Photography/Alamy Stock Photo

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• Communication. A business plan is often used to attract investors or obtain loans. It can also be used to attract strategic business partners, additions to the management team, or high-quality employees. As such, the plan needs to communicate that you have taken an objective and realistic view of your company and thought through all the potential problems and determined reasonable alternatives. Although some business plans are lengthy, formal documents that can take weeks or months to prepare, others are short, informal outlines. Regardless of when or how it is written, a business plan is a crucial part of a successful business operation.

Business Plan Competitions

The Massachusetts Institute of Technology is the site of one of the most famous and lucrative business plan competitions. Source: Philip Scalia/Alamy Stock Photo

A business plan can help you determine whether your idea is feasible, to pitch your idea to others, and, in some cases, help you win a bit of necessary start-up cash. Many top business schools and colleges in the United States offer business plan competitions, with cash prizes that can help you move from creating a business plan to creating a business. Business plan competitions, once deemed as the culmination of an academic exercise, are now sources of serious money. Rice University hosts at business plan competition that offers more than $1 million in prizes. The Massachusetts Institute of Technology $100K Entrepreneurship Competition has launched over 160 companies. By bringing together new thinkers who are armed with a detailed business plan and venture capitalists, these competitive events can be win–win for all.

Before the Business Plan: Finding the right Fit Before you begin to think about writing a business plan, you should do some soulsearching to determine your own goals and objectives and whether they match those of the business that you’ve imagined. You might want to visit the SBA’s website to find questionnaires and quizzes that can help you focus your ideas. Not everyone wants to be (or can be) the next Bill Gates. Some individuals are quite content running a successful business that consists of a few employees and that never sees revenues in the millions. However, some ambitious entrepreneurs would like to have their ideas realized on a much larger scale. Regardless of the size of business you would like to own, it is important to articulate your own personal business plan by answering questions like the following: • Do you want to have a balance between your business life and your personal life? Or is it okay for your business to be your life? • How do you define success? Is it a monetary goal, a production goal, or a lifestyle goal? • What is your time line for success? Do you want to achieve it quickly, or is it acceptable to work slowly toward graduated markers of success?

MINI ChAPTeR 2

Cover Sheet and Table of Contents

Executive Summary

The Company and Management Team

Market Analysis

Product

Constructing an Effective Business Plan

Sales and Promotion

Determining the answers to these questions will help to crystallize your focus, realize what your priorities are, and clarify your business goals and objectives. Once this preparation is complete, you’re poised to begin writing your business plan.

Financials

Appendices

Components of a Business Plan There is no one right way to write a business plan. Each business is unique, so business plans can be drawn up in a variety of ways. Still, most business plans share a few basic components. A typical business plan for a start-up company is about 35–60 pages in length and contains eight key elements, as illustrated in ◼Figure M2.2. The order in which the key elements are included is not random; they should be in the order of importance to the person reading the document. Therefore, although a complete description of your product may be of utmost importance to you, your investors and key contributors first need to know about the market before the specifics of your product. Let’s look at each of the basic components of a business plan in more detail.

The Cover Sheet and Table of Contents The cover sheet of a business plan is like the cover of a book; it provides the first impression of your plan and your business. This component is crucial, but many business planners don’t include the right information on the cover sheet, turning off potential investors. As shown in ◼ Figure M2.3, the cover sheet should include the following: • Basic company information (name, address, phone number, and web address) • The company logo (if applicable) • Contact information of the owner(s) and any officers (name, titles, addresses, phone numbers, and e-mail addresses) • The month and year the business plan was created • The name(s) of those who prepared the plan • A unique record number so that you can track who received which copy so you can easily follow up with him or her The table of contents follows the cover sheet. It should be well organized so that the reader can quickly find information on any aspect of the business. It should also include the page number of the first page of each section, and all pages in the document should be numbered.

AB Environmental Consulting 21 N. LaSalle Street Chicago, IL 60611 (312) 555-6439 www.abenvironmentalconsulting.com

Business Plan

Prepared by: Adam Bernard President & Owner (312) 555-6438 [emailprotected] January 2017 #AB5336

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The executive Summary An executive summary is a clear and concise (abbreviated) form of the entire business plan, generally no more than two or three pages long. After reading the executive summary, a person should understand the business’s purpose, value, operating methods, and profitability outlook. An executive summary should contain information about the company’s unique competitive advantage and projections for future sales, growth, and profits. If the business plan is to be presented to potential investors, the executive summary should also include a statement regarding the amount of and uses for capital as well as plans and a timetable for repaying investors. Ultimately, the executive summary should convey excitement and entice the reader to want to read more. Because this is often the only part of a business plan that is read completely, it is the most critical and, as a result, requires more of your time, thought, and attention than the rest of the business plan. Executive summaries are especially important when presenting your business plan to potential investors. If investors don’t get excited about your business and the prospects of success after reading the executive summary, they’ll stop reading and most likely file your plan in the trash. Because the executive summary is meant to condense the entire plan into a few pages, many people often write the summary as the last step in the business plan process. Writing your summary after completing the rest of your plan ensures that you’ve worked out all the kinks and made sure the other sections of the plan are sound.

The Company and Management Team The next section of the business plan presents the “big picture” and defines the company and its purpose. The company section should include the following elements: • Mission and vision statements. As discussed in Chapter 7, the mission and vision statements should spell out what the founder ultimately envisions the business to be with respect to growth, values, and contributions to society. They may also offer the company’s business strategy that defines the business, identifies the intended customer, and explains how the business will benefit them. • Industry profile. The industry profile describes the context in which the business will operate. This section discusses economic trends that affect the business and provides background on the industry, the current outlook for the industry, and future growth potential. • Company profile and strategy. The company profile provides details regarding how the business works and why it has a unique chance to impact the industry. The company strategy summarizes the company’s plans for growth and profits. It is important to be optimistic while also being realistic in discussing goals and strategy. It is even more important to back up the strategy with details of the company’s past and present conditions so that the strategy is convincing. • Anticipated challenges and planned responses. This section discusses potential vulnerabilities from competition, suppliers, resources, industry, or economic situations. It also discusses legal factors that might affect the business—either positively or negatively—including changes to legal restrictions, pending lawsuits, expiring patents, copyrights, and the like. This section should also state possible resources the company could make available should the need arise. Finally, the section should mention any protection from copyrights, trademarks, or patents. • Management team. This section should list the members of the management team—finance, marketing, and production specialists—and the pertinent

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experience, knowledge, or creative ability that each member brings to the team. If your company is large enough to have a board of directors, those members should be listed in this section as well. Because résumés of key personnel will be attached to the back of the business plan, keep this section brief and dedicate only a paragraph or two to each individual.

Market Analysis The market analysis section identifies who your customers are and explains how you will reach them. The main purpose of this section is to explain the benefits of your product. It should answer the question “What is it about your product that creates a competitive advantage?” For example, your product might be homemade pasta. Your customers might benefit from an authentic Italian taste at a price that is lower than the competition’s price. Or, your product could be made with all organic ingredients, which benefits health-conscious consumers. Consumer benefits are those things that do something better for the customer. They affect a person’s feelings, pocketbook, or both. The market analysis section should include an assessment of the general market and, more specifically, the competition, as follows: • Market research. This section should contain an analysis of the market to determine whether enough customers exist and will continue to exist to make your business profitable now and in the future. First, you need to describe exactly what you see as the target market for your product—that is, identify your customer. For example, is your ideal customer teenagers heading off to college, owners of pets with little time to walk them, or those needing a great meal in a relaxing location? Once you’ve identified and described your customer, you need to determine whether the market is growing or shrinking. Your analysis should reach the conclusion that the market is big enough for your business to enter with adequate growth potential to make your time and investment worthwhile. • Assess the competition. It is important to show that you have a clear understanding of your competition. Therefore, you should list your main competitors and their perceived strengths and weaknesses. You should then clearly articulate your plan to take advantage of their weaknesses and respond to their strengths.

The Product In the next section of the business plan, you describe your product and list its important details. Your product’s description should include any testing you’ve conducted and approvals you’ve received as well as trademarks, copyrights, or patents to protect your product. It is also important to discuss ongoing service aspects that are provided with the product, such as warranties and repairs. Your business plan should articulate how the product will be produced. If part of your product is dependent on outside suppliers, you should list those suppliers and verify their reliability. If your business is a service, you should discuss how you intend to find and train personnel who will deliver your service.

Market analysis is the section of your business plan that details whether customers exist for your product—and who they are. Source: Zoonar GmbH/Alamy Stock Photo

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Most important, whether for a good or a service, this section should cover your pricing strategy. In your pricing discussion, detail any aspects of the product that require a higher price, such as using premium materials. Additionally, you must conduct a thorough analysis of what the competition is charging for a similar product, noting the differences in their product or your product that justify a price differential. Finally, the section should list what you expect customers will be willing to pay for your product.

Sales and Promotion

How will you promote your business? A business plan will help you decide whether to host a free webinar or hand out coupons on a busy street corner. Source: Art Kowalsky/Alamy Stock Photo

The sales and promotion section of the business plan explains how you intend to implement the marketing plan. It should describe the approaches you’ll take to promote the product. This should include promotional avenues beyond basic advertising. Include your social media strategy, such as using blogs, Facebook, Twitter, Instagram, and YouTube. Remember to explain how you are monitoring the feedback derived from your social media strategy. This section should also describe your selling approach. For example, are you selling the product with a sales force, over the Internet, through direct mail, via retail outlets, or simply by word of mouth? Include evidence of promotional success, such as current newspaper articles, customer referrals, or letters of satisfaction.

Financials This section includes several pages of financial statements: the income statement, the balance sheet, and the cash flow statement. In addition, you should cover the financial history of the company to date and have several different forecasts and scenarios projecting the anticipated performance of the business in the next several years. You should put your financials through a stress test by showing how you expect the business to perform under worst-case, expected-case, and best-case scenarios. If one of the primary purposes of this business plan is to seek outside financing assistance, then another component of this section is a statement of funding requirements indicating information such as the amount of capital needed, the type of funding, the term of loan, and how funds will be used. Investors will also want to see how you intend to pay them back—the timing, the return on investment, and an exit strategy that you might want to suggest to investors. Don’t underestimate the importance of preparing the financial information or be misled into thinking that developing the financial information will or should be easy. This exercise forces you, as a new business owner, to face up to the reality of your business’s finances beyond daily cash flow. The numbers need to show that you can be successful in the short term as well as over the long term. Oddly, more is not better in presenting the financials of a company. More important, if you use a software program to generate financials, make sure you understand and can defend and explain every number in every line. It’s not uncommon for someone who is reviewing the financials of a business plan to ask specific questions, such as “What does the figure on line 24 in the income statement mean?” If your answer is “I’m not sure, the software program generated that number,” you are not creating investor confidence in your ability to understand and manage the financial aspects of the business. If necessary, consult an

MINI ChAPTeR 2

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accountant to help you prepare or interpret the financial statements and projections included in the business plan. Including the actual financial statements, forecasts, and scenarios in the business plan is not enough. You need to explain and summarize the key information from those statements and specifically state how they relate to the marketing, sales, and production plans already discussed.

Appendices The final pages of a business plan should be devoted to appendices. Any additional information that adds to the credibility of your business, the management team, or the industry that is not included in the body of the business plan is included in the appendices. Appendices will include information such as the following: • • • • • •

Résumés of key managers Pictures of the product, facilities, production, and so on Letters of recommendations, professional references Published information Contracts and agreements; copies of patents, copyrights, trademarks Media, articles

Writing a business plan can seem like a formidable task. But if you have a clear idea and vision of your business venture, your task will become a little easier. It is also important to know that you’re not alone. The SBA and the Service Corps of Retired Executives (SCORE) provide a wealth of information and resources for the potential small business owner. Remember, your business plan should be exciting, dynamic, and compelling. The plan’s purpose is to make others as excited about your business idea as you are. If you carefully follow the steps for writing a business plan and strongly believe in your idea, you may soon have investors beating down your door to be a part of your project.

 Although Pizza Hut owners Dan and Frank Carney launched a successful business without a formal business plan, they soon found that the planning you learn in creating a business plan was necessary for their continued success. Whether you win a business plan competition or just spend time thinking though the details of your business, creating a business plan will help you succeed.

Key Terms executive summary market analysis

references 1. “Pizza Hut Inc.,” www.fundinguniverse.com/company -histories/Pizza-Hut-Inc-Company-History.html.

2. Pizza Hut, “Our History,” www.pizzahut.co.uk/aboutus.

Part 3 Managing a Business and eMplOyees

Chapter 7

Business Management and Organization OBjectives 7-1 The Foundations of Management

Identify the levels of management and the skills managers need to be successful, and explain how the strategic plan, the corporate vision, and the mission statement are defined for a business. Xerox Corporation CEO Ursula Burns started her career at Xerox in 1980 as a mechanical engineering intern. What kind of management skills did she display over the years to rise to the top of a multibillion-dollar corporation?

7-2 The Functions of Management: Planning Discuss why managers need tactical plans, operational plans, and contingency plans.

Planning is critical as a business gets off the ground, and every day after that. How does a tattoo artist

take his skills forward into a real business? What sequence of planning stages and what tools can he use to accomplish his ultimate goals?

7-3 The Functions of Management: Organizing Explain the significance of organizing, and detail how most companies are organized.

Carrie Witt and Mark Healy have the same position at competing firms, but their day-to-day experiences differ greatly. Why is this?

7-4 The Functions of Management: Controlling

Detail how managers ensure that the business is on track and is moving forward. It all sounded so good. The planned reorganization was going to push the company to the next level ofcompetition. So why was everything such a messnow?

CHAPTER 7

Objective 7-1

the Foundations of Management Identify the levels of management and the skills managers need to be successful, and explain how the strategic plan, the corporate vision, and the mission statement are defined for a business.

 Ursula Burns, the current CEO of Xerox Corporation, didn’t start at the top. Instead, she rose from a position as a mechanical engineering summer intern at Xerox to assume the role of chairperson and CEO. This was a historic event: It was the first time that a female CEO of a major U.S. company, Anne Mulcahy, handed the reins of a company over to another woman. Burns’s personal story is dramatically American. She was raised by a single mother in a New York City housing project and now heads a $14 billion company.1 It hasn’t been all smooth sailing for Burns, however. Xerox Corporation faces serious challenges as business moves increasingly into electronic communication, therefore printing and copying less. But Burns has a track record for pushing forward new products. Early in her career, she helped lead Xerox into the field of color copying. Her vision moved Xerox out of the manufacturing industry and diversified the set of products it offers. She is also willing to take the company in entirely new directions. One of her early moves as the company’s CEO was to acquire Affiliated Computer Services. This led Xerox into the arena of providing full solutions to business data processing and document management problems. In addition, many people note Burns is able to effectively communicate her understanding of technology to Xerox’s board of directors and other key members of the company’s management team, which is an important trait.

Source: Paul Morigi/Getty images entertainment/Getty images

What makes Ursula Burns such a talented and effective manager? What skills does she possess, and how does she apply them? In this chapter, we’ll study what management is and discuss the skills successful managers must have.

Business Management What exactly is management? Have you ever been in a team situation in which one person has been instrumental in making the group work more effectively? That person could have been a peer or a superior, but somehow he or she knew exactly what had to be accomplished, assessed the resources available to achieve the goal, and organized and led other group members to accomplish that goal. If so, you’ve seen management in action. Management is the process of working with people and resources to accomplish the goals of an organization. An organization can be a simple working group, a corporate department, or a multibillion-dollar company. The size of the group doesn’t matter, but the skills of a manager and the process a manager goes through are similar across all management levels.

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◼ FIGURE 7.1 The Four Functions of Management © Kendall Martin Image sources, clockwise from top left: jasper james/Getty images; Henrik Sorensen/Getty images; Harry briggs/Getty images; vladimir Rys Photography/Getty images

PLANNING

ORGANIZING O

• Setting Goals • Developing Strategies • Determining Resources

• Allocating Al A Resources an Organizational • Creating Cr C Structure St S • Re Recruiting and Placing Em E Employees

CONTROLLING/ MONITORING

LEADING • Guiding and Motivating • Achieving A Results and Milestones • Maintaining Unit or Organization’s Focus on the Goal or Vision

• Measuring Results Against Goals • Monitoring Performance • Correcting, When Necessary • Rewarding

What are the four functions of management? As ◼ FIGURE 7.1 shows, a manager performs four primary functions: planning, organizing, leading, and controlling/ monitoring. In the rest of this chapter, we’ll examine three of these functions in more detail and explain how they integrate all of a company’s resources, including its human, financial, and technological resources. In Chapter 8, we’ll examine leadership as a function of management.

Levels of Management What are the different levels of management? Within a company, there are different levels of managers, each with increasing levels of responsibility. ◼ FIGURE 7.2 shows a traditional managerial pyramid with examples of jobs held by managers at each level and the tasks they perform. What do top managers do? At the peak of the pyramid are top managers, who are the corporate officers of the firm and are responsible for an organization as a whole. Most corporations have a chief executive officer (CEO) or president. Depending on the company’s size and complexity, it might also have a chief financial officer (CFO), a chief operations officer (COO), and a chief information officer (CIO). Top managers develop the “big picture” for a company. In other words, they outline its long-term goals and strategic vision. Then they create plans that will take the company in that direction. They establish the culture of an organization

POSITIONS President CEO Executive Vice President

Controller Sales Manager Marketing Manager Operations Manager

Supervisor Department Head

TASKS

Top Managers

Middle Managers

First-Line Managers

Generating strategic plans, long-term goals, mission statement, and vision for the organization

Tactical planning and coordinating specific plans with the established strategic vision

Carrying out operational planning and supervising employees involved in the daily operations of the company

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How Are Managers Responsible for Employee Behavior?

or two years, Ani Chopourian was a physician assistant on a cardiovascular team at Mercy General Hospital. During that time, Chopourian filed numerous complaints about sexually inappropriate workplace conduct by male physicians on the team. All of her complaints were ignored. After filing her eighteenth complaint, she was fired. In the legal action that followed, a jury awarded her $168million in damages.2

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Off THE MARk

The jury heard from a parade of employees who depicted a culture that allowed female employees to be humiliated and bullied, even to the extent that it put patients at risk. What responsibility do the managers of the hospital have to provide a safe workplace culture? Are they able to control cardiac surgeons, who know that they bring in the most money to the hospital? What kind of tools do managers need to be able to navigate these challenges?

and inspire employees to adopt the vision they have for the organization. In smaller corporations, especially small start-up companies, top managers may also be responsible for planning and carrying out the day-to-day tasks of a company. But as the business grows, companies such as these usually need to hire more employees and divide the work into smaller tasks and areas of responsibility, which usually requires hiring a new layer of managers. What do middle managers do? Middle managers manage individual divisions or segments of an organization and are responsible for creating the specific plans to implement the strategic vision set by the firm’s top managers. Included in this management layer are division managers of the firm’s functions, such as finance, marketing, sales, operations, and information technology (IT). Also included in this layer are team leaders who are not arranged by function but are responsible for cross-functional groups of employees who work on projects or other tasks of the organization. Are the people who supervise the day-to-day operations also managers? The bottom of the managerial pyramid includes first-line managers. These managers supervise the individual employees who carry out the day-to-day operations of a company. Does every company have all these different managers? Not all companies have all three layers of management; some have more, and some have fewer. Typically, you’ll find the extra layers are middle managers.

The Skills of Successful Managers What skills should a manager have? Because managerial tasks are so varied, a successful manager needs to possess the following types of skills: • Conceptual skills. The ability to think abstractly • Technical skills. The specific knowledge for the discipline • Time management skills. The ability to be effective and productive with one’s time • Interpersonal skills. The ability to motivate and communicate easily with others • Decision-making skills. The ability to analyze options and implement the best plan of action It is a rare person who masters all of these skills. Moreover, because they are responsible for a variety of jobs and because these jobs can change quite rapidly, managers must assess the skills that are required in any given situation. Managers must also be willing to acquire these skills if they are lacking in a specific area by studying, undergoing training, or finding mentors to help them.

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What do we mean by conceptual skills? To make good decisions, a manager must have conceptual skills—the ability to think abstractly and to picture the organization as a whole and understand its relationship to the business community. Conceptual skills also include understanding the relationships between the parts of an organization itself. Whenever new market opportunities or potential threats arise, managers rely on their conceptual skills to help analyze the impending outcomes of their decisions. Conceptual skills are extremely important for top managers and often develop with time and experience. What technical skills do managers need? Technical skills include the abilities and knowledge that enable employees to carry out the specific tasks required of a discipline or a department, such as drafting skills for an architect, programming skills for a software developer, or market analysis skills for a marketing manager. How to operate certain machinery is also a technical skill. Managers must be comfortable with technology and possess good analytical skills to interpret a variety of data. In addition to having the skills pertinent to their own jobs, managers must also know how to perform or at least have a good understanding of the skills required of the employees they supervise. What time management skills does it take to succeed as a manager? Managers who possess time management skills are able to be effective and productive with their time. As a manager, how do you do this? Eliminating time wasters, such as constant interruptions, setting aside time each day to return phone calls and e-mail, ensuring that meetings have a clear agenda, and successfully delegating work to others, can increase the productive use of your available time. Tracking how you spend your time each day can also improve your time management.

◼ FIGURE 7.3

5. Evaluate the decision

4. Choose and implement a plan of action

Why are interpersonal skills important for managers? Managers achieve their goals by working with people both inside and outside an organization. Interpersonal skills enable managers to interact with other people to motivate them and develop their trust and loyalty and get them to work together well. Top managers need good interpersonal skills to successfully communicate with the firm’s board of directors, investors, leaders in the business community, and middle managers. Middle managers need good interpersonal skills to communicate with all levels of management and act as liaisons among groups. Lower-level man1. Identify agers need good interpersonal skills to motiproblems or vate employees, build morale, and train and opportunities support those who perform the daily tasks of an organization. And all managers need good interpersonal skills to communicate with and motivate people who are different 2. Generate than themselves. Because the workplace is possible becoming more diverse, this is becoming an solution increasingly important managerial skill.

3. Evaluate the potential solution

Why do some people consistently make better decisions than other people? It is critical that managers have good decisionmaking skills—the ability to identify and analyze a challenge, identify and examine the alternatives, choose and implement the best plan of action, and evaluate the results. When making important decisions, managers often go through a formal decision-making process similar to that shown in ◼ FIGURE 7.3. Analyzing data and looking for trends allow a manager to identify unseen problems or opportunities. Examples may include poor

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205

Social Media: How Do Web-Based Tools Make Time Management Easier?

alendars have traditionally been a tool used by individuals to manage their personal schedules. But with modern social media tools, web-based calendars can be used to synchronize and manage the schedules of many people simultaneously. Multiple people can add new events to the calendars, thus making the scheduling of meetings easier and faster. For example, using Meeting Wizard, you can send out e-mail invitations that contain a poll of suggested meeting times. The application then creates a report for you with the group’s responses and sends everyone a confirmation e-mail with the final time chosen.

NeedtoMeet is another application that allows you to have everyone in the group enter their available times on a web-based calendar. Doodle (also available for iPhone or Android) is scheduling software that lets you check out the yes/no votes for suggested meeting times on your phone. Such tools have proven useful to many managers, but some people argue that web-based tools can make simple tasks more complicated and can make us actually less productive. What do you think? Do we rely too much on fancy electronic tools to manage our lives and our time?

growth in sales, an increase in customer dissatisfaction, or an opportunity to expand into a new market. Next, managers work with their teams to generate possible solutions. They can then evaluate each potential solution based on various criteria, such as cost, feasibility, and time and resources needed. Once they have evaluated the potential solutions, managers select the best plan of action. At this point, managers often seek the opinions of customers or other people in the marketplace before completely committing to this choice. If the feedback is not positive, another alternative might be pursued. When the final choice has been made, plans are established to implement the plan of action. Finally, managers evaluate the results of their decisions. If changes need to be made, the entire process begins again.



Think back to Ursula Burns, the CEO of Xerox Corporation. How did her education equip her with the technical skills she uses to achieve success? Do you think her success reflects strong interpersonal skills? What does the direction in which she is taking Xerox say about her decisionmaking and conceptual skills? How might time management skills come into play in terms of her ability to manage a giant corporation? To have Burns’s prominence and success in business, a combination of management skills is vital.

Objective 7-2

the Functions of Management: planning Discuss why managers need tactical plans, operational plans, and contingency plans.



William Lee knew his skills as a tattoo artist could lead into his own business if he did the right things. But where does he start? First, he sat down and wrote down his vision of the business and what he hoped to see it add to the world: “To inspire self-expression and creativity through fine arts tattoos.” Even though it seemed like a grandiose statement, seeing it written on a page

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helped William solidify some of his ideas. Next was the how—how could he create a business from this idea? What were his goals for the future? How would he find a space to rent, the money to set up shop, and the expertise to help him run it? What was his competitive advantage over other tattoo artists, and how would he communicate it? There was a lot of work ahead for William.

Source: Dominique Faget/AFP/Getty images

In today’s busy world, it is easy to become distracted, just as William Lee felt when beginning to plan for his business. Goals and plans focus our intentions in a way that leads to results. Planning is the process of establishing goals and objectives and determining the best ways to accomplish them. Goals are broad, long-term accomplishments an organization wants to achieve within a certain time frame—in most companies, usually about five years. Objectives are short-term targets designed to help achieve the goals. Planning happens at all levels of an organization. In this section, we’ll discuss the different levels of planning that occur in an organization.

Strategic Planning What is the highest level of planning in an organization? A strategic plan is the main course of action created by top-level managers. A strategic plan helps to answer three questions: 1. Where is the company going? 2. What should the company focus on? 3. How will the company achieve its goals? Simply put, a strategic plan points an organization to where it wants to be in the future and identifies how it will get there. Although individual goals sometimes contribute to the plan, the overall strategic plan is focused on an entire organization or an entire department.

◼ FIGURE 7.4

Establish Corporate Purpose • Mission statement • Values • Goals

How is a strategic plan developed? A good strategic plan reflects what is happening inside and outside an organization and shows how those conditions and changes will affect the organization in the future. Those making strategic plans must pay attention to the capabilities and resources of an organization as well as changes in the environment. There are several steps to the process of developing a strategic plan, as ◼ FIGURE 7.4 shows. Consider the strategic plan development for the Wikimedia Foundation (WMF). WMF supports the online collaborative encyclopedia Wikipedia as well as nine other projects with a common goal (Wikibooks, Wikiquotes, Wikiversity, and so on).3 In 2009 WMF began to modify the strategic plan it would use for the next six years.4 WMF found that only about 15 percent of the world was using Wikimedia’s products—far fewer than it wanted. Even in the United States, only about one-third of online users had ever accessed a Wikimedia product.

Perform SWOT Analysis • Internal strengths and weaknesses • External opportunities and threats

Formulate Strategy • Tactical planning

Implement Strategy • Operational planning

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One problem was that participation and contributions to WMF projects had begun to decline—in fact, more than 50 percent of the content was coming from about 1 percent of the contributors. In addition, the organization wanted to enhance the ability of the WMF community to think strategically and focus on the organization’s strategic plan long term. To develop a plan that could address these problems and challenges, WMF asked its community of contributors and asked for proposals. Every submission was available for the entire WMF community to view and comment on. Together the community created goals and decided how to achieve these through specific actions. The process was conducted primarily online and involved more than 1,000 people using over 50 different languages. The content of about 1,500 wiki pages of input was consolidated into a strategic report. Although this process wouldn’t work for every business, it seems appropriate for the tech-savvy WMF community.

Vision and Mission Statement What helps define the direction of a business? The first step in creating a strategic plan is to establish a corporate purpose through a clearly defined vision. A vision identifies what the business wants to be in the future, what you would like to see as the end result of all your work. The vision should be made clear to all employees and stakeholders. The vision statement for General Electric (GE) under the former CEO Jack Welch read as follows: “To become the most competitive enterprise in the world by being number one or number two in every business in which we compete.”5 A single clear vision worked for GE—during the 20 years Welch was CEO, the company’s market value went from $14 billion to more than $410 billion.6 What helps define the purpose of a business? People often confuse the vision of a company with its mission statement. The vision statement sets the long-term objective of a company and tells where the company is headed. A mission statement is a description of an organization’s current purpose, basic goals, and philosophies. A mission statement not only helps management remain focused but also lets employees understand the core values of the company for which they work. Mission statements reflect the personality of a company, so even companies in the same industry can have mission statements that vary greatly in design and content. Some use scientific jargon in a no-nonsense manner directed specifically to a certain target audience. Others may try to reach a larger audience by using a simple, direct statement that inspires the average consumer. You may find that a company uses its mission statement to highlight its environmental awareness or to set an abstract goal for the firm’s employees, like working to make the world better able to communicate. Other companies may discuss only their own business goals. The mission statement is a chance for consumers and employees to get a peek into the central values of a company. What makes an effective mission statement? If employees feel an owner’s passion for the business through the mission statement, it has a positive impact. Employees then incorporate the goals and objectives of the mission into their daily work and pass these on to customers and suppliers through their words and actions. An effective mission statement does not to be flowery. Even simple mission statements can be effective if they are written clearly and convincingly. Read over several mission statements at www.missionstatements.com. The Culver’s restaurant chain has a concise seven-word statement of mission, while the cosmetics firm Avon has a 240-word mission statement. But both statements are effective and reflect a passion for excellence. What are some benefits of well-defined vision and mission statements? The vision and mission statements lead to important benefits like the following: • Keeping management on track by ensuring strategies are consistent with the organization’s goals

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• Inspiring employees • Giving investors insight into the values of the organization Are mission statements only for businesses with a profit? No, mission statements are useful for not-for-profit companies as well. The mission statements of not-for-profit organizations are focused on outreach to the community or a specific public service rather than on investor return. For example, the American Cancer Society has a mission statement focused on eliminating cancer and reducing suffering with no mention of proft. This statement reflects the organization’s commitment to serving the community, the range of goals they have, and the set of avenues they use to accomplish theirgoals. Where can I find a company’s vision and mission statements? Both the vision and mission statements are usually found on an organization’s website. However, because the mission statement is directed toward customers—unlike the vision, which is directed toward employees—the mission statement is often used alone on advertising materials or on actual products.

SWOT Analysis How does the management team begin to move a company toward achieving its vision? Once a company’s vision and mission statement have been articulated, the firm’s managers must assess the company’s strengths and weaknesses as well as its position among its competitors. What changes are anticipated to occur both inside and outside the organization? Is the company poised appropriately to respond to such changes? These are questions that must be answered first. What is a SWOT analysis? The acronym SWOT stands for the following: Strengths Weaknesses Opportunities Threats A SWOT analysis is an analysis of the strengths, weaknesses, opportunities, and threats a company is facing. It helps managers determine the strategic fit between an organization’s internal, capabilities, and external possibilities relative to the business and economic environments. ◼ FIGURE 7.5 provides a brief explanation of each component of the SWOT analysis. When evaluating a company’s internal strengths and weaknesses, managers have to analyze a company’s internal resources, including such elements as its financial health, the strengths of its employees, and its marketing, operations, and technological resources. For example, a company’s strength might be its strong marketing department, but its weakness could be an unfavorable location. To evaluate the threats and opportunities facing a company, managers assess various external elements, such as the economic, political, and regulatory environments as well as social, demographic, macroeconomic, and technological factors that could affect the company. Managers also analyze the state of the firm’s industry and its market as well as its competitors. For example, a recession could threaten an alternative energy company, whereas increasing awareness of global warming may provide greater opportunity for market growth. What happens after a SWOT analysis is completed? After conducting a SWOT analysis, managers establish a set of goals and objectives based on the information. To help ensure they actually get accomplished, the acronym SMARTER is helpful when designing and wording them: Goals should be Specific, Measurable, Acceptable (to those working to achieve the goals), Realistic, Timely, Extending (the capabilities of those working to achieve the

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209

SWOT Analysis

S O

W T

Internal Strengths

Internal Weaknesses

Potential internal assets that give a company a competitive advantage Examples for Walmart: • Powerful brand • Reputation for value, convenience • Wide range of products in one store

Lack of internal capability or expertise compared to the competition Examples for Walmart: • Not as ﬂexible as competitors who sell just one type of product (clothing) • Global but still in only a few countries

External Opportunities

External Threats

Foreseeable external changes that could favorably affect a company’s competitive capability Examples for Walmart: • Expand to new locations and new types of stores • Take over or form alliances with other global retailers in Europe or China

External conditions that could negatively affect a company’s competitive capability Examples for Walmart: • Intense price competition increasing • Global retail exposes Walmart to political problems in the countries where it operates • Being Number 1 makes Walmart the target of competition

goals), and Rewarding to employees as well (see ◼ FIGURE 7.6).7 So if you are conducting a fund-raiser as a student government project, having the goal of “Collecting 500 coats before the end of December by advertising our clothing drive through social media” works better to focus action than stating “We plan to collect clothing for the needy.”

◼ FIGURE 7.5

SWOT Analysis Source: based on Walmart SWOt. Retrieved from: http://www .marketingteacher.com/walmart-swot/. © Kendall Martin

Tactical and Operational Planning How do managers decide how to execute a strategic plan? The next part of the process of creating a strategic plan is to have middle managers generate tactical plans to carry out the goals of a company. Tactical plans specifically determine the resources and the actions required to implement particular aspects of a strategic plan. Whereas strategic plans have a long-term focus, tactical plans are made with a one- to three-year horizon in mind. Determining a company’s annual budget, for example, is one function of a tactical plan. Let’s say one goal of the strategic plan of a paper supply company is to sell more products to large offices on the East Coast. One part of this company’s tactical plan might be to determine how much money should be allocated to advertising in that area. How is a tactical plan translated into instructions for employees? The specifics of carrying out tactical plans are operational plans. In an operational plan, first-line managers precisely determine the process by which tactical plans can be achieved. Operational plans depend on daily or weekly schedules and focus on specific departments or employees. For example, once the paper supply company determines how much of its budget can be allocated to advertising, specific department managers might have to determine which employees will travel to advertise the product.

◼ FIGURE 7.6

SMARTER Design of Goals

Specific

Measureable

Acceptable

Realistic

Timely

Extending

Rewarding

Clear and concise statement

Success can be defined and monitored

To those working toward the goals

Reasonable given resources available

Time frame is reasonable

Extends the capabilities of those working to achieve goals

To the employees

Source: based on carter McNamara, “Strategic Planning (in Nonprofit or ForProfit Organizations),” retrieved from: www .managementhelp .org/plan_dec/str _plan/str_plan.htm. © Kendall Martin

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◼ FIGURE 7.7

Contingency Planning: Are You Ready?

Public Relations Incident

National/Federal Crisis

Cyber Attack

Theft

Natural Disaster

Fire

10%

20%

30%

40%

50%

60%

70%

Percentage of Preparedness

Contingency Planning What if unforeseen events occur? Contingency planning is a set of plans that ensures that an organization will run as smoothly as possible during an unexpected disruption (see ◼ FIGURE 7.7). What happens if a company’s bestselling product is recalled because of a defect or if it experiences more sales of a good than it can produce? How should a company fight off an unpredictable takeover threat from a competitor or a rapidly spreading computer virus that threatens to shut down all internal and external lines of communication? Sometimes, extreme circumstances occur that force a company to alter its plans and find alternative ways to survive. For example, the massive earthquake and tsunami in 2011 that left 20,000 people dead and devastated Japan led to power shortages and disrupted supply chains and drastically impacted the output of factories worldwide that relied on Japanese parts.8 All the best corporate strategies can be negated quickly if an unexpected crisis occurs and a plan is not in place to deal with it adequately. How can planning help companies weather unexpected events? Part of contingency planning includes how a company will communicate, both internally and externally with all of its stakeholders during a crisis. Internally, employees need to be informed about how they should continue to do their jobs. Externally, an organization must have a plan in place to deal with requests for information either from employees, the families of employees, or even the media. Contingency planning also involves determining what departments within a company are vital to the immediate needs of the organization when an unexpected crisis occurs. The particulars of each plan differ depending on the size and function of a company and the magnitude of crisis for which the plan is needed. For example, the Vanguard Group, an investment management company, has in place specific, formal business contingency plans to respond to a range of incidents—from worst-case scenarios, such as the loss of a data center, buildings, or staff, to more common occurrences, such as power outages.9 As important as it is to have plans in place, it is just as important to ensure that the plans are tested and that key individuals know exactly what is expected of them. Similar to fire drills in school, companies should periodically

CHAPTER 7

review and rehearse their plans. Vanguard officials put their contingency plans through rigorous testing, including full-scale practice drills in which the company closes a building and works from a remote location. The company also conducts mock disaster drills together with local, state, and federal authorities. Because Vanguard’s business would be impacted significantly should a disruption in any of its technical systems occur, it also conducts tests to determine how quickly its IT systems can be made operational in the event of a disruption. ◼ FIGURE7.8 summarizes the types of contingency plans that companies such as Vanguard use.

Strategic Plan

Business Management and Organization

211

Top Management

• Sets the approach for achieving an organization’s long-term goals and objectives • Acts as a framework for decisions • Assists in setting corporate benchmarks

Tactical Plan

Middle Management

• Determines resources and actions necessary to implement strategic plan • Made with a one- to three-year horizon in mind

Contingency Plan

Middle Management

• Keeps an organization running in the event of a disruption • Details internal and external communication procedures for such an event • Determines which departments are most vital to an organization during a crisis

Operational Plan First-Line Management Now that a few years have passed, • Involves planning the execution of the tactical plan William Lee smiles when he thinks of the early • Depends on daily or weekly schedules • Focuses on speciﬁc department or employees planning of his business. He had to make hundreds of decisions along the way before ◼ FIGURE 7.8 opening the tattoo shop he now owns. At many points, he needed to think The Four Types of Management tactically, and he had to conduct a full SWOT analysis to determine where his Plans © Kendall Martin strengths and weaknesses were so he could set the long- and short-term goals for the shop. He also has contingency plans in place if he runs into problems in the future. “You never know what the future will bring,” he says, “but you know if you don’t plan, you won’t win.”



Objective 7-3

the Functions of Management: Organizing Explain the significance of organizing, and detail how most companies are organized.

 Carrie Witt and Mark Healy have a lot in common: Both graduated with degrees in business, and both acquired jobs as marketing associates at medium-sized firms that design solar energy panels for commercial use. Nevertheless, their professional experiences have been markedly different. At her firm, Carrie is part of the marketing department. She is undergoing training to help her firm acquire new clients within a specific region of the state. She reports directly to the department head, but her work is also overseen by several middle managers, including the marketing department supervisor and the marketing manager. They, in turn, take their orders from top managers: the executive vice president, the CEO, and the president. At his firm, Mark works on a team with individuals from a variety of areas, including marketing, research and

Source: MG/e+/Getty images

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development (R&D), finance, and operations. They work on a variety of projects as a comprehensive unit. One manager supervises his team and coordinates the team’s efforts directly with the goals and instructions from the firm’s CEO and president. Carrie’s and Mark’s jobs seem similar, yet their everyday experiences contrast significantly. Why is this? It’s all about organization structure. Which structure does Carrie’s firm use? Which one does Mark’s firm use? Why are these structures necessary, and what are the benefits of each? Every company, regardless of its size or specialty, needs a solid organizational structure. Without one, employees may have trouble making decisions and assigning responsibility. But this doesn’t mean there’s just one way to organize a company. In this section, we’ll explore different aspects of organization.

Organizational Structures How do managers put their plans into action? Once goals have been finalized and plans have been made, the next step in the management process is to put those plans into action. Organizing is the process of structuring the capital, personnel, raw materials, and other resources to carry out a company’s plans in a way that best matches the nature of the work. Part of organizing is to establish an organization structure. What structure an organization chooses depends on a variety of factors, such as the number of employees it has, the speed at which decisions need to be made, how vulnerable the business is to rapid changes, and the collaborative nature of the work. How do companies document the structure of an organization? Smaller companies tend to use simpler organizational structures compared to large companies. Regardless, to accomplish many tasks at the same time, organizations have some division of labor and allocate work into smaller units. An organizational chart, like that shown in ◼ FIGURE 7.9, shows how groups of employees fit into the larger organizational structure. The organizational chart is a visual representation of several ideas that reflect the structure of the company. The span of control of a specific position is the number of employees being supervised by a specific person. Departmentalization consists of the decisions made to structure the company into smaller groups. Sometimes this is done by function or by product and sometimes by geography or even the type of customers served. ◼ FIGURE 7.9

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CHAPTER 7

Business Management and Organization

How is power distributed in an organization? There are two common approaches: • Vertical organization (or a tall organization). The power belongs to a few, and most people are in positions in which they report to a supervisor. • Horizontal organization (or a flat organization). Power is distributed, with many people organized in teams or groups. In a vertical organization, decision making is centralized, and the power to make decisions lies with a smaller number of people. The firm’s organization chart tends to have many layers and long vertical columns showing who reports to whom. The vertical organization has been the primary structure of businesses since the industrial revolution. In a horizontal organization, the traditional managerial pyramid is flattened, and there are fewer layers of management. Decision making is decentralized and spread out across many more people than in it is in a vertical structure. A horizontally structured organization still has some of the pyramidal aspects, including a CEO and perhaps another layer of middle managers, but most of the remaining employees work in teams or groups. The organization chart for a firm such as this is flat and wide because there are many people with authority. ◼ FIGURE 7.10 illustrates the basic differences between vertically structured organizations and horizontally structured organizations. What are the pros and cons of vertical organization? In a vertical organization, a company is organized by specific functions, such as marketing, finance, purchasing, IT, and human resources. Levels of expertise within the functions are developed, and managers have direct authority and reporting responsibility for their area. Integrating the functions and divisions is not always easy because communication and decisions have to travel up and down long chain-of-command lines. This makes it difficult for a company to respond quickly to changes in a market. Nonetheless, the structure has its benefits because there

◼ FIGURE 7.10

Vertical organization (5 levels) X X 5

X XXXXX XX

X X

XXXXX recent hires, temps, interns, etc., each working for and within a specific division

Horizontal organization (3 levels) X X

XXXXXXXXXXXXXXX teams and groups of employees 3

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is ultimately one person in charge and a clear point of authority for decision making. However, in the early 1990s, vertical organization structures were criticized as being overspecialized, fragmented, and inflexible. Some businesses, such as Ford Motor Company and Barclay’s Bank, found that they were more successful when they organized differently and formed management groups around areas of specific production.10 What are the pros and cons of horizontal organization? The benefit of a horizontal organization is that each team has more responsibility for the outcome of its work. There is less of a sense of competition for power and more of a push toward collaborative work. Each employee is empowered to have more responsibility and decision-making authority. Because there are fewer layers of managers, if needed, approvals from them can be sought and received much faster. Horizontal structures have been deemed the model for the knowledge age. Because employees today have better access to information in their firms, whereas previously only their bosses did, many people argue horizontal structures are more effective. They are suitable for industries that require rapid responses to quick changes.

Changing Structures Does a company’s organization structure ever change? Yes. Sometimes companies grow so large that their product lines, geographic regions, or manufacturing processes can become difficult to manage. So, the firms restructure from a vertical organization to a horizontal one. In these situations, managers often try to reorganize by function. For example, they might structure the organization into divisions of employees who work on just one product line. Or they might divide a company into teams to specialize in one geographic region or work through one manufacturing process. In essence, these divisions work like separate mini-companies. Each division has its own set of functional expertise, so separate managers are in charge of financing for that division, marketing for that division, and so on. In today’s business environment, there are fewer and fewer organizations structured vertically by function. One company that made the shift from being a vertical organization to a horizontal one is Xerox. It was once had a traditional vertical structure, organized by function, such as R&D, manufacturing, and sales. To more closely connect with its customers, the company realigned itself in the early 1990s around individual business markets, such as small businesses, office document systems, and engineering systems. Each individual group had its own set of financial reports, and factories were focused on individual product lines. Today, the company continues to maintain a flat organizational structure organized by product category as well as by region to take into account the company’s global presence.

THE LIST

Bits of Advice for Managers

1. Keep your cool.

6. Never stop learning.

2. Accept opportunities outside your comfort zone.

7. Your success comes when those around you are successful.

3. Put your employees first.

8. Encourage creative thinking.

4. Earn loyalty from others. Give respect to others.

9. Be the change you want to see in your workplace.

5. Be able to admit when you are wrong.

10. Listen first.

CHAPTER 7

Business Management and Organization

Alternative Organizational Structures What is line and staff organization? Most companies begin with a simple organization where one position has direct control of all the departments under it. This is called line organization. A product manager may be responsible for the design and production of that item. These styles of management relationships are easy to document in a single, clean organization chart. As companies grow, they sometimes shift to an organization that creates staff departments. A staff legal department may interact with a specific product line when support is needed for addressing regulatory issues. The legal department does not have authority over all of the product design and production issues but works with the product department on specific topics. This more complex set of managerial relationships is called line and staff organization. What is a matrix organization? In vertical organizations, employees are grouped together based on their functions—all accountants are in one department, all engineers in another, and so on. A matrix organization is a type of structure in which people are pooled into groups by skills and then assigned to projects as needed. So, an engineer would report to an engineering supervisor but, after being assigned to a project, report to a project manager as well. The matrix organization is useful when the business is project-based because it promotes resource sharing. The shared authority and responsibility can mean better coordination between managers and lead to better project results. However, having two bosses can create conflicts, so the matrix style is useful only in specific settings. What is an inverted organization? A vertical hierarchy can be mated with another structure that is quite different, the inverted organization. In this structure, managers must answer, or be accountable, to their employees. The goal of an inverted organization is to enable, encourage, and empower employees to do what they do best. Empowered employees can make decisions on the ground without the delay of forwarding requests upward through layers of management. Most firms end up implementing inverted structures along with the traditional vertical structure. So, although employees still have supervisors and supervisors answer to managers, managers are equally accountable to their employees. The rationale for this approach is that the core business of the company is to create value. The value creators in the company are the frontline employees. So, managers contribute to the company’s success by empowering these people and putting them first.11 One company that has grown with this philosophy is HCL Technologies, a provider of IT services that has ranked as India’s best employer. Founded by Vineet Nayar, HCL adopted an inverted organization in 2005. Afterward, the company began growing by more than 20 percent annually, even amid the global recession.12 HCL’s Nayar believes that for a business to satisfy its customers, its employees must feel valued and must trust their managers. Managers must be held accountable to their employees and vice versa. Nayar wrote a book documenting the experience, titled Employees First, Customers Second. The result of taking care of employees was that customers were more satisfied and received better services and products. Many other companies, such as Southwest Airlines, have employed elements of the inverted organization. What organizational structure works across multiple companies? Today, a new business structure has emerged: the network organization. A network organization is a collection of independent, mostly single-function firms that together produce a product or a service instead of one company being responsible for all functions. Boeing uses a network organization to build its 787s. In the past, the company’s airplanes were built mostly by Boeing employees. With the 787, Boeing relies on the expertise of hundreds of manufacturers worldwide to independently manufacture

215

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the components of the plane. They then ship the individual subassemblies to Boeing’s main plant, where they are assembled into a single 787. Other companies that use a network organization include Nike, which owns only one manufacturing plant, and Reebok, which designs and markets but does not produce any of its products. Operating with a network structure requires that companies have the following characteristics: • Be highly flexible and innovative • Be able to respond quickly to threats and opportunities Companies that successfully operate in a network structure find that they can save time and can reduce costs and risks.



Reflect back on Carrie and Mark. Carrie works under the supervision of the marketing department head and several middle managers in the same department, who in turn report to top management. Mark works on a team with people from various departments at his company. Is it clearer now why their experiences were so different despite the seeming similarity between their jobs? Carrie’s company is a vertical, or tall, organization. The company is organized around specific business functions, and there are several levels of first-line and middle managers. Mark, however, works at a horizontal, or flat, organization. There are fewer middle managers, and employees work in groups. How would their work lives change if their companies reorganized to a matrix organization style? To an inverted organization?

Objective 7-4

the Functions of Management: controlling Detail how managers ensure that the business is on track and is moving forward.



It wasn’t supposed to end like this. Company executives had worked together to make plans for the reorganization of the company. Matt Finley remembered the excitement of it; everyone knew moving toward a horizontal organizational structure would benefit managers, employees, and customers alike. It felt like great times were ahead. That was six months ago. Now sales are down, morale is low, and no one knows quite why. Matt believed in the goals the management team had established. What went wrong?

Source: izabela Habur/e+/Getty images

The best-laid plans are meaningless if they aren’t put into place effectively. As managers form plans and carry out strategies to meet the goals of an organization, they must also determine whether their plans and strategies are generating the desired results. In this section, we’ll look at how managers control (or monitor) their organizations and why doing so is so important.

CHAPTER 7

Business Management and Organization

217

Controlling to Stay on Course Why does a company need to adapt to stay on course? Controlling (or monitoring) is the process by which managers measure performance and make sure the company’s plans and strategies are being or have been properly carried out. Through the control process, managers ensure that the direction a company is moving toward aligns with its short- and long-term plans. The controlling process also can detect errors in systems, so if a plan is not meeting its goals, it can be modified.

Set performance standards

Reevaluate performance standards

Measure performance

Control Strategies How is moving toward the corporate vision measured? Most companies have control systems that help measure how well Perform the plans they put in motion are working. corrective In general, the control system forms a cycle, action as shown in ◼ FIGURE 7.11. Performance standards are set, and actual performance is measured and compared against the standard. To measure a firm’s performance, reporting tools such as financial statements and sales reports are used. These reports help determine whether the firm’s products are competitive and being produced efficiently and whether the company is using its capital wisely. Based on this information, adjustments are made, and the cycle begins again.

Make adjustments

◼ FIGURE 7.11

Are financial, production, and sales measures the only tools for assessing performance? No. Another measure of performance is quality— the goods or services a company provides must meet and exceed customer

Pest Control Company Controls Its fleet

nchor Pest Control is a small pest control service with a fleet of 15 vans and trucks. When a van is down for repairs, the company experiences a serious loss of income. So keeping the entire fleet in top operating condition with a minimum of cost and downtime is an important business goal.13 Another key goal is customer satisfaction. This includes drivers arriving on time, driving to and from sites carefully, and completing their work in a timely manner. Initially, Anchor owner Don Wolf tried using GPS devices in each van to monitor whether these business goals were being met. But he soon realized these systems would track the vehicles but were not helping him answer the business questions he had: When did each van need to go in for maintenance? How hard was the engine working? Which driver was making the most stops in a day?

On TARgET

Wolf found a monitoring device called CarChip that he could afford to install in each vehicle. By downloading the information from CarChip to a software program, each vehicle can be sent in for maintenance at just the right moment: before it breaks down but not before it is required. CarChip can set a top speed for each vehicle so that he knows drivers are being careful on the road. Wolf is able to rank top performers by safety rating or total miles driven and give rewards accordingly. As a good manager, Wolf had to know what his goals were for Anchor and then investigate the right products and tools to monitor performance. Using data to check the business’s progress toward meeting those goals has helped the company be the most efficient and profitable it can be.

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expectations. Many managers use total quality management (TQM), which is an integrated approach that focuses on quality from the beginning of the production process up through the final monitoring to detect and correct problems. What are the basic tools managers use for monitoring quality? There are seven basic tools managers use to monitor quality-related goals: • Check sheet. A simple sheet recording the number of times certain product defects occur (◼ FIGURE 7.12A). • Control chart. A graph that shows the average and fluctuations of a process being monitored to determine whether it is behaving within the limits of proper functioning. ◼ FIGURE 7.12B shows the average weld strength (35.5) and the fluctuations around the average according to the lot number. • Histogram. A graph that displays the count of the number of times a specific event occurs (for example, the number of times the smoothness of a tube produced was in the range 5 to 10) (◼ FIGURE 7.12C). • Pareto chart. A combination bar and line graph that shows different categories of problems and the total (cumulative) number of problems. The Pareto chart in ◼ FIGURE 7.12D shows the breakdown of types of complaints leading to returned merchandise. • Scatter plot. A graph that displays the values of two variables to see if there is a relationship between them. For example, the scatter plot in ◼ FIGURE 7.12E would help a firm decide if more time in the kiln creates tiles that have a higher smoothness value. • Run chart. A graph that displays the value of some data across a specific set of dates. Managers can then identify problems that occur in a certain cycle, for example, once a month. Does the run chart in ◼ FIGURE 7.12F show there is a pattern to the production of higher-brilliance bulbs? • Cause-and-effect diagram. Also called a fishbone diagram, this illustrates all of the contributing factors in the product design that might lead to faulty production (◼ FIGURE 7.12G). For example, if the defect being analyzed is a soldering defect, the cause-and-effect diagram would show that contributing factors could be from the machinery operator, materials, or methods. There are many more advanced statistical tools available, but managers often begin their drive toward TQM with these seven basic tools.

Name of Data Recorder: Jigme Patel Location:

Bowie, AZ

Data Collection Dates:

10/1–10/15

Defect Types/ Event Occurrence Overheated

Dates Sunday

Monday

IIIIIII

Cooled too long

Tuesday

Wednesday

IIIIIII II

IIII I

Thursday

Saturday

Friday

Weak welds Misaligned

IIII

Spotting

2 0

Irregular shape

IIIII

Inaccurate measurements

◼ FIGURE 7.12A

0 0

Paint defect

TOTAL

5 3

Broken Discolored

TOTAL

CHAPTER 7

219

Business Management and Organization Distribution of Defects in Soldering

Xbar Quality Assessment of Weld Strength 41 40 39

38 Count

37 36 35 34

33 32 31 30

3 4 5

6 7 8

9 10 11 12 13 14 15 16

Lot Number

◼ FIGURE 7.12B

◼ FIGURE 7.12C

Control Chart

Histogram

Scatter Plot of Smoothness

Returned Merchandise by Complaint

300

10 Smoothness

100.0%

275

90.0%

250

80.0%

225

175

60.0%

150

50.0%

125

40.0%

100

30.0%

20.0%

Smoothness

70.0%

200

10.0%

0.0%

Broke

Did Not Function

Missing Parts

Wrong Color

Not Ordered

◼ FIGURE 7.12D

40 0

100 150 Time in Kiln

200

◼ FIGURE 7.12E

Pareto Chart

Scatter Plot

Run Chart 100

Brilliance

80 Factors Involved in Soldering Defect

Temperature

10/18/2013

10/11/2013

8/27/2013

10/04/2013

8/20/2013

8/13/2013

8/06/2013

7/29/2013

7/22/2013

7/15/2013

7/08/2013

7/01/2013

6/25/2013

6/18/2013

6/11/2013

6/04/2013

◼ FIGURE 7.12F

Shift

Alloy

Heating element

Date

Operator

Steel

Calibration

20 0

Material

Duration

Training level

New Experience compound Braced

Smith kiln Alexander kiln Environment

Molded Suspended

Method

Humidity Filter age

Particulates

◼ FIGURE 7.12G

Run Chart

Cause-and-Effect Diagram

Defect

250

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PART THREE

Managing a Business and Employees

What is the Six Sigma strategy for quality? Another well-known quality initiative is Six Sigma, a statistically based, proactive, long-term process designed to examine the overall business process and prevent problems. To achieve the “Six Sigma standard,” a business must not allow more than 3.4 defects per million opportunities. To achieve such levels, it can take years to train and implement a staff that understands the approach. The techniques of Six Sigma produce results that are consistent and repeatable, which translates into few defects and consistent high levels of customer satisfaction. GE was a huge proponent of the Six Sigma method and pushed it into every corner of the company with great success. However, there is controversy around the proper use of Six Sigma monitoring in the business community.14 For example, Robert Nardelli, who left GE to become the CEO of Home Depot, applied Six Sigma practices there with great fervor. Home Depot initially saw great growth in profits, but the huge amount of paperwork and data collection began to take a toll on store workers. It left them less time for customer interaction, causing customer satisfaction to plummet. The next CEO of Home Depot modified the Six Sigma approach to allow store managers to make more decisions independently.



The missing piece for Matt Finley’s company, which was struggling despite a promising reorganization plan, turned out to be a lack of adequate control. The company began its reorganization with well-designed goals but never chose which tools it would use to monitor the results. Matt recognized this and established a set of procedures so managers could measure both the firm’s financial progress and product quality. He had to learn about some new tools for quality reporting—Pareto charts and cause-and-effect diagrams— but once the processes for collecting and reporting data were in place, the picture became clear. The new organization structure began working once these important adjustments were made.

Chapter 7

summary 7-1

Identify the levels of management and the skills managers need to be successful, and explain how the strategic plan, the corporate vision, and the mission statement are defined for a business.

• Management is the process of working with people and resources to accomplish the goals of an organization by performing four primary functions: planning, organizing, leading, and controlling/monitoring • Top managers are the corporate officers who are responsible for the organization as a whole. Middle managers are the top managers of the major divisions or segments of an organization. First-line managers supervise the employees who carry out the day-to-day operations of a company. • Successful managers need to possess a variety of skills, including conceptual, technical, time management, interpersonal, and decision-making skills • Managers use planning, goals, and objectives to help achieve the corporate vision and stay on task. Planning is the process of establishing goals and objectives and determining the best ways to accomplish them. Goals are broad, long-term accomplishments an organization wants to achieve in about a five-year time frame. Objectives are the short-term targets that are designed to help achieve goals. • Top managers put together a strategic plan, or a main course of action, that maps out the way in which the corporation will achieve its goals. • Before the strategic plan is in place, a firm’s managers must define the organization’s purpose, basic goals, and philosophies through vision and mission statements. The corporate vision is what the business wants to be in the future. A mission statement is a description of the organization’s current purpose, basic goals, and philosophies. • Part of the strategic planning process includes conducting a SWOT analysis to help management determine the strategic fit between an organization’s internal capabilities and external possibilities. SWOT stands for strengths, weaknesses, opportunities, and threats.

7-2

Discuss why managers need tactical plans, operational plans, and contingency plans.

• Tactical plans specifically determine the resources and the actions required to implement particular aspects of a strategic plan. Tactical plans are made with a one- to three-year horizon in mind and are formulated by middle managers. • Operational plans determine the process by which tactical plans can be achieved. Operational plans depend on daily or weekly schedules and focus more on specific

departments or employees. Operational plans are formulated by first-line managers. • Contingency planning is planning that ensures that an organization will run as smoothly as possible during a crisis or disruption and determines how a firm’s managers will communicate, both internally and externally.

7-3

Explain the significance of organizing, and detail how most companies are organized.

• Organizing is the process of structuring the capital, personnel, raw materials, and other resources needed to implement a company’s plans in a way that best matches the nature of the work. An organizational chart shows how groups of employees fit into the larger organization structure and to whom they report. • A vertical organization is organized by specific functions, such as marketing, finance, purchasing, IT, and human resources. However, integrating the functions and divisions is not always easy because communication and decision making must travel up long chain-of-command lines. • A horizontal organization is flatter, and there are fewer managerial levels. Most employees work in teams or groups and have more responsibility for the outcome of their work. Because the chain of command is shorter, approvals for decisions can be sought and received much faster. • Matrix organization is type of management system in which people are pooled into groups by their skills and then assigned to projects as needed. • Network organizations are collections of independent, mostly single-function firms that collaborate with one another to produce a product or a service. • In an inverted organization, the role of managers is to empower and encourage employees to do what they do best and to be accountable to them.

7-4

Detail how managers ensure that the business is on track and is moving forward.

• Controlling (also called monitoring) is the process by which managers measure a company’s performance and ensure that its plans and strategies are working. • Performance standards are measured with reporting tools, such as financial statements and sales reports. Quality measures are also in place to ensure that products or services meet customer requirements. Total quality management (TQM) focuses on quality control throughout the entire production process. Basic mathematical and graphical tools, such as scatter plots and Pareto charts, are used to monitor quality goals. Six Sigma is a statistically based process to establish high quality production in a business and prevent future problems.

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Key terms conceptual skills contingency planning controlling (monitoring) decision-making skills departmentalization first-line manager goal horizontal organization interpersonal skills inverted organization line organization line and staff organization

management matrix organization middle managers mission statement network organization objective operational plan organizational chart organizing planning Six Sigma span of control

staff department strategic plan SWOT analysis tactical plans technical skills time management skills top managers total quality management vertical organization vision

MyBizLab To complete the problems with the

, go to EOC Discussion Questions in the MyBizLab.

self test Multiple Choice

You can find the answers on the last page of this text.

7-1 The four primary processes of management are a. planning, optimizing, leading, and controlling. b. organizing, controlling, planning, and leading. c. prioritizing, leading, controlling, and organizing. d. planning, leading, organizing, and deciding.

7-2 A SWOT analysis a. is an important part of developing a strategic plan. b. is one type of contingency planning. c. helps translate the tactical plan in instructions for employees. d. guarantees that inventory matches market demand.

7-3 A well-defined corporate vision benefits a company by

a. keeping managers focused on strategies that are consistent with the company’s goals. b. illustrating the company’s values to investors. c. inspiring employees. d. All of the above

7-4 The mission statement is a description of an organization’s

a. financial health. b. current purpose, basic goals, and philosophies.

7-5 The focus of a strategic plan is different than a tactical plan because

a. a strategic plan is has a long-term focus and a tactical plan looks just a few years ahead. b. it is not written down but changes constantly. c. concentrates only on what is going on inside an organization, not outside an organization. d. it is created by the customers instead of the management of the organization.

7-6 The controlling function of management is best described as

a. keeping employees in line. b. watching employees carefully by monitoring their e-mail and phone usage. c. measuring the firm’s performance to make sure the company’s plans are on track. d. All of the above

7-7 The span of control of a specific position is foundby

a. counting the number of employees that person supervises. b. considering how many e-mails that person receives each day.

c. philanthropy goals.

c. calculating the number of years that person has been in their role.

d. tactical plan.

d. None of the above

CHAPTER 7

7-8 The seven basic tools for monitoring a business include all of the following except a. Pareto analysis. b. Monte Carlo statistical simulations. c. scatter plots. d. cause-and-effect diagrams.

7-9 Positions that would be considered middle managers include a. sales manager. b. marketing manager. c. operations manager. d. all the above.

7-10 A corporation with a matrix organizational system a. pools people into groups by skills. b. makes sure teams have more responsibility for the outcome of their work. c. organizes based on functional area. d. collects single-function firms into a network that collaborates on a product.

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True/False

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You can find the answers on the last page of this text.

7-11 A company with a vertical organization cannot use an inverted organization.

True or

False

7-12 A SWOT analysis is used to determine the stra-

tegic fit between an organization and its internal and external environments.

True or

False

7-13 Conceptual skills mean a person has the ability to think abstractly.

True or

False

7-14 Contingency planning helps a business weather a disruption or a crisis.

True or

False

7-15 The Six Sigma initiative is focused on improving communication.

True or

False

Critical Thinking Questions 7-16 Recall your own personal working experiences and the managers with whom you have had interaction. Discuss the skills that define the best manager with whom you have worked and discuss the skills that define the worst manager with whom you have worked. 7-17 Would you prefer to work in an organization with a vertical structure or a flat, horizontal structure? Would your answer change if you

were the CEO instead of a new hire? How would you feel about working in an inverted organization as a manager? 7-18 Review the tools presented for monitoring quality. How would this kind of data-driven decision making help managers make decisions? Could too much data make it difficult to decide on a course of action? Would it depend on the type of problem? The type of manager?

team time On A MISSIOn Research and print out several mission statements. Be sure to choose statements from both not-for-profit organizations and for-profit organizations. Bring these mission statements to class.

Process Step 1. Assemble into groups of four or five. Step 2. As a group, evaluate the similar components in each mission statement,

such as the following: • The statement of the product or service being offered • The primary market it’s being offered to • An indication of the organization’s commitment to quality • An indication of the organization’s commitment to social responsibility • A declaration of organization’s philosophy

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ments and those that are included in only a few of them.

Step 4. As a group, decide which mission statement is the most inspiring. Why?

Which is the least inspiring? Why?

Step 5. As a class, compare the statements deemed most inspiring from each

group and determine which is the most effective. Finally, openly discuss with your classmates how the winning statement would affect their inclination to work for this organization.

ethics and corporate social Responsibility ASSESSInG SOCIAL RESPOnSIBILITY One of the functions of management is control, which includes measuring financial performance. But how often and with what tools does a manager assess an organization’s social responsibility?

Process Step 1. In small groups, discuss the following:

• The planning and organizational changes that might need to be implemented • The controls that a manager might use to measure and monitor the results of his or her social responsibility initiatives

Step 2. After this discussion, research companies that are known for their social

responsibility efforts. Then discuss what impact their efforts have had on management.

Web exercises 7-19

7-20

7-21

Project Oxygen Google invested a great deal of time mining its own internal data to determine what type of person makes a good Google manager. Dubbed Project Oxygen, researchers made more than 10,000 observations of managerial behaviors at Google. Find articles about Project Oxygen on the Web and read them. What were the researchers’ conclusions? Who makes a good manager, and who does not? Are the researchers right? Or are there other key factors that do not appear in the final eight qualities the researchers identified good managers as having? Are the results valid only for Google, or do you think they are general truths? Tools for TQM Using online resources like YouTube and Lynda.com see if you can teach yourself to create a Pareto chart in Excel. Can you create a histogram? A scatter plot? Can you find a PowerPoint template for a cause-andeffect diagram? How Well Do You Manage Your Time? Time management skills are important for a manager to have to work efficiently and accomplish all the tasks a manager is expected to handle on any given

day. How are your time management skills? As a student, you are your own manager and can benefit from being more in control of your time. Find an online tool to assess your ability to manage your time. Write a brief report answering the following questions: • What online assessment did you find? • What were the results? • How can you improve your time management skills? 7-22

Predictably Irrational Visit the Ted.com website and search for the 20-minute video “Are We in Control of Our Own Decisions?” by Dan Ariely, a behavioral economist. Watch the video and concentrate on the example of the doctor and the patient. Are there business decisions that managers make where factors outside their decisionmaking process influence the outcome?

7-23

Get SMARTER The acronym SMARTER reminds us that goals should be specific, measurable, acceptable, realistic, timely, extending, and rewarding. Do some research on the Web to see how other people have implemented SMARTER goals. Then create two goals for yourself for next semester. Document how they are SMARTER goals.

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MyBizLab Go to the Assignments section of your MyBizLab to complete these writing exercises. 7-24 Contingency plans are important in any business. Describe what kinds of plans your school might have in place to recover from a disaster. How would these plans differ, if at all, from those of a local business in your area? What are a few possible scenarios that would require contingency plans in your school or at a local business? 7-25 The skills of successful managers take time to build. Describe the steps you are taking today to build the conceptual skills and technical skills required. What activities develop your interpersonal skills. How are you improving your time-management and decision-making skills?

References 1. “Xerox on Forbes List.” Forbes Magazine, May 2015. Web. 20 Mar. 2016. 2. L. Bohm, Work Harassment—Ani Chopourian’s Story, www .youtube.com/watch?v=ZJMWaalwrcU. 3. Wikimedia Foundation, “Vision Statement,” http:// wikimediafoundation.org. 4. Wikimedia Strategic Plan, February 1, 2011, http://upload .wikimedia.org/wikipedia/foundation/c/c0/WMF _StrategicPlan2011_spreads.pdf. 5. Vision statement of General Electric Inc., by Jack Welch. Reprinted by permission. 6. “Our History: Our Company: GE,” www.ge.com/company /history/bios/john_welch.html. 7. Carter McNamara, “Strategic Planning (in Nonprofit or For-Profit Organizations),” www.managementhelp.org /plan_dec/str_plan/str_plan.htm. 8. Rie Ishiguro and Shinji Kitamura, “Japan Quake’s Economic Impact Worse Than First Feared,” April 12, 2011,

9. 10. 11. 12. 13. 14.

www.reuters.com/article/2011/04/12/us-japan-economy -idUSTRE73B0O320110412. The Vanguard Group, “Business Contingency Planning and Disaster Recovery Programs at Vanguard,” www .vanguard.com/pdf/ccri.pdf. Frank Ostroff, The Horizontal Organization (Oxford: Oxford University Press, 1999), 25–57, 102–150. “About Vineet.” Vineet Nayar. http://www.vineetnayar .com/. Harichandan Arakali, “HCL Tech Exceeds Expectations, Records 29% Jump in Net Profit,” www.livemint.com/ 2012/04/18085442/HCL-Tech-exceeds-expectations.html. Anchor Pest Control, “Pest Control Company Exterminates Business Problem,” www.carchip.com /Product_Docs/CS_PestControl.pdf. “Six Sigma: So Yesterday?” Bloomberg Businessweek, www .businessweek.com/magazine/content/07_24 /b4038409.htm.

Chapter 8

Motivation, Leadership, and Teamwork ObjecTives 8-1 Motivation

Understand the main theories of motivation and how these have changed the work environment. At Ana Gutierrez’s public relations firm, employees were suffering from a severe case of demotivation. Translating motivational theories into practical applications is a challenge many business managers face. How can Ana use abstract concepts about human behavior to inspire her workforce and turn around her struggling company?

8-2 Leadership

Identify the various leadership styles and traits, and explain how they affect business.

economic systems and creating the tools for space travel seems like too much for any one person. But Elon Musk is accomplishing it all with the help of his leadership skills.

8-3 Teamwork

Explain the best ways to create, manage, and participate in teams. Teamwork can bring about great success. For all teams, teamwork is important, but for some teams, it is essential. If a surgical operating team does not work together effectively, patients can suffer complications or even die. How could one surgeon make a difference worldwide by studying the dynamics of his operating room team?

Every young person dreams big—but dreaming of changing the world’s transportation systems and Objective 8-1

Motivation Understand the main theories of motivation and how these have changed the work environment.

 “All of my employees were so . . . uninspired,” Ana Gutierrez laments. “People seemed to be just ‘showing up’; the sense of apathy in the office was almost palpable. The quality of our work was suffering. I wasn’t sure what to do.” Ana, the founder and CEO of a small public relations firm, was facing a crisis of motivation within her workforce. The sales team hadn’t scored a new account in months, and existing clients were complaining about their sales representatives. “You’re not delivering on your promises,” one client, the leader of a local not-for-profit organization, blurted during a particularly tense conference call. “Our recent event was poorly advertised and poorly attended. There were errors in your latest press release. And your associates take two days to respond to my e-mails.” Ana had already tried a variety of tactics to motivate her employees. She dangled the possibility of additional bonuses and free dinners to her

CHAPTER 8 1

salespeople—to no avail. She instituted a new policy requiring all employees to work nine hours a day, plus two weekends a month. It didn’t work. She told her associates she was prepared to promote at least three of the highest-performing employees among them to more lucrative positions within six months. No one was interested. How could Ana apply what she knows about motivational theories to light a fire under her employees and save her business? We hear the word motivation often. When students seek out extra learning opportunities to go beyond a course’s general requirements, they are described as motivated learners. But what does motivation have to do with working in a business? Are all of a business owner’s actions motivated solely by profit? Does an employer who pays well always have strongly motivated employees? In this section, we’ll examine motivation in detail and look at techniques used in the past and the present to motivate employees. Source: tim Pannell/Fuse/Getty images

Personal Motivation What drives you to do your personal best? Even when pursuing their personal goals, different people retain and lose motivation for different reasons. Think of times you have pushed to be your best, whether at school, in sports, or in other activities. Is it easier for you to build enthusiasm for tasks you’re sure you can accomplish? Or do you set difficult goals and draw energy from the challenge of attaining them? Some people need immediate gratification to stay motivated. Others are able to postpone short-term success in pursuit of long-term gains. Which setting motivates you more? Now think about how hard you work when you receive positive feedback— either financial or emotional. Are you driven more by the values of the place where you work, by your beliefs, or by the rewards from doing a job well? For some people, being part of the accomplishments of a team is what motivates them. Are you one of those people? What does it feel like to be optimally motivated? Have you ever been working on a project in which you were so immersed in what you were doing that, when you looked at your watch, four hours had gone by? Psychologist Mihaly Csikszentmihalyi refers to this state of rapt attention as flow.1 A flow state happens when you are completely involved and focused on what you are doing. Often, people produce their best work, make the best use of their skills, and feel the most pleasure when they are in flow. They feel a strong match between their own abilities and the challenge of a task: It is neither too difficult, which can lead to frustration, nor too simple, which can lead to boredom. They report a sense of control over what is happening and a feeling of effortlessness in their work. How do you create this sense of flow? This is the subject of organizational psychology—the study of how to create a workplace that fosters motivation and productivity among employees.

Motivating Employees How motivated is the U.S. workforce? The Q12 is a 12-question survey of employee engagement administered by the Gallup Organization. Based on respondents’ answers to a series of questions, the survey classifies employees as

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TAblE 8.1

Motivation levels of Employees

Engaged

Not Engaged

Actively Disengaged

• Work with passion

• Work with minimal effort

• Work in a disruptive manner

• Feel connected and obligated to the company

• Are indifferent to the company

• Are unhappy with the company

• Add to the success of the company

• Make little or no contribution to the company

• Combat the efforts of engaged workers

“engaged,” “not engaged,” or “actively disengaged.” According to Q12 survey results, 68 percent of U.S. employees are not engaged or are actively disengaged in their work2 (see ◼ TABLE 8.1). Imagine a workplace in which three out of four employees are complaining or even disrupting other workers during the day. This statistic makes it clear that encouraging flow in the workplace is an important challenge. How does a work environment encourage “flow”? There is no fixed recipe, but there are companies that have succeeded in building motivated, engaged environments that support workers and support the creative experience of flow. One such company is SAS, a business software firm in North Carolina. With an incredibly low employee turnover rate of just 2 to 5 percent,3 SAS has achieved 40 straight years of record revenues.4 The company has achieved this in large part as a result of the policies of its CEO, Jim Goodnight. Goodnight lists the following as ways in which SAS works to foster a creative environment: • • • •

It keeps employees intellectually engaged. It removes distractions so employees can do their best work. It makes managers responsible for sparking creativity. It has managers eliminate the arbitrary distinctions between administrative “suits” and more abstract “creatives.” • It engages customers to be creative partners. In addition to fostering the professional lives of its employees, SAS supports their private lives as well. On the SAS campus, you’ll find medical facilities for employees and their families, a Montessori day care center, and a cafeteria where families can eat lunch together. “The corporate philosophy is, if your fifth grader is in his first school play, you should be there to see it,” says CEO Goodnight. Such a philosophy has led to SAS earning a top spot on Fortune magazine’s Best Companies to Work For list.5 What are the benefits of keeping employees motivated? Both employers and employees benefit from motivated workforces. Employers find that workers are more productive and creative when provided with a motivating environment and motivating tasks. Disengaged employees cost firms up to $300 billion a year in reduced productivity.6 What happens if you find the secret to motivated employees? Companies with high engagement levels have four-times-greater earnings growth rates compared to companies in the same industry struggling with disengaged workers. The Atlanta-based chain Chick-fil-A is an example of a company that has benefited from strong employee motivation. The company fosters employee motivation with strong monetary rewards like scholarships and free cars to the operators of strong-performing stores. The chain has never allowed any store to be open on

ChAPTER 8

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Sunday. Remaining closed on Sundays is both a practical and a spiritual decision, centered on the belief that employees should have an opportunity to rest and spend time with their families each week so they can return to work motivated on Monday mornings.7 Chick-fil-A employees respond with highly engaged behavior by going out of their way to refill customers’ drinks and watching to see if they need extra napkins delivered to their tables. The results are seen in the chain’s explosive growth, with total sales now almost $6 billion.8

Traditional Theories of Motivation What are the traditional theories describing what motivates people? Several theories have been proposed to explain how and why people are motivated: • Maslow’s hierarchy of needs • McClelland’s “three needs” theory • Herzberg’s motivator-hygiene theory What is Maslow’s hierarchy of needs? One early researcher in the area of human motivation was Abraham Maslow (1908–1970), who published the book Motivation and Personality in 1954. In his theory of motivation, Maslow suggests that humans have a hierarchy of needs and that primary needs must be met first before higher-level needs can be addressed (see ◼ FIGURE 8.1). The first needs that must be met are basic needs—termed physiological needs—such as the need for water, food, sleep, and reproduction. This means that before we as humans can think about anything else in our lives, we must ensure that these basic physiological needs are met. Once our physiological needs have been met, Maslow’s theory holds that people strive to satisfy their safety needs. This includes establishing safe and stable places to live and work. Once these needs have been met, people try to meet their social or belonging needs. These include the need to belong to a group and feel accepted by others. The next level in Maslow’s hierarchy includes esteem needs. These are satisfied by the mastery of a skill and the attention and recognition of others. Finally, self-actualization needs are at the top of the hierarchy. These needs include the desire to maximize your own potential through education and self-fulfillment as well as experiences of beauty and spirituality. Self-actualization needs cannot be met unless and until all of a person’s lowerlevel needs have been met. Maslow suggested that different people find themselves at different places in the hierarchy, and so their motivations may be different. An offer to work overtime for a higher hourly wage might motivate a person concerned with his or her safety needs but have the opposite effect on someone trying to fulfill his or her need for self-actualization. What is McClelland’s “three needs” theory? Other researchers have proposed different models to map human needs to motivation. Psychologist David McClelland’s (1917–1998) three needs theory suggests there are three main motivators: 1. The need for achievement—to accomplish something difficult on your own 2. The need for affiliation—to form close personal relationships 3. The need for power—to be able to control the behavior of others

◼ FIGURE 8.1 Maslow’s Hierarchy of Needs

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Although an individual may have multiple needs, McClelland suggests that one tends to be dominant over the others. Which need we try to satisfy depends on a variety of complex factors, including our cultural background. For example, in the workplace, a person whose main need is for affiliation may have little motivation to perform a solitary task, whereas a person with a high need for achievement may be highly motivated to perform a difficult task alone. How does Herzberg’s motivator-hygiene theory explain motivation? In 1959, psychologist Frederick Herzberg (1923–2000) proposed a theory of job satisfaction called motivator-hygiene theory (or two-factor theory). According to this theory, two factors influence a person’s motivation. Hygiene factors are factors such as a safe working environment, proper pay and benefits, and positive relationships with one’s coworkers. People rarely notice hygiene factors if they are present. However, if hygiene factors are absent or inadequate, people tend to be dissatisfied. If there suddenly is no heat in the place where you work or if your pay is cut, you may be motivated to find a way to meet these needs. But if these factors are already in place, they are taken for granted and may not serve to motivate you. Motivator factors represent the second set of factors in Herzberg’s theory. These factors include a sense of responsibility, recognition, promotion, and job growth. If there is no path for growth in your job or little recognition of your achievements, you probably would not immediately quit, but their absence would create a set of conditions that would fail to motivate you.

Motivational Theories in the Modern Workplace Do managers actually use theories of motivation? Theories of motivation can be abstract. So, how can a team leader at a software development company take what researchers know about motivation and use it to increase the productivity and satisfaction of employees? The theories of human motivation you have just read about have given rise to several different approaches for organizing and motivating people in the workplace. What can a manager do to enhance employee motivation? In the workplace, there are some external motivating factors managers can control. These motivators, called extrinsic motivators, include pay, promotion, and verbal praise. Other factors, called intrinsic motivators, are beyond a manager’s control because they are internal to each individual employee. Intrinsic motivators are based on a person’s actual interest in his or her work and stem from the sense of purpose or value the person derives from the work being done. A manager will have difficulty motivating an intrinsically motivated employee to take on unsatisfying work by using offers of just bonuses or promotions. Researchers are investigating if there are some intrinsic motivators common to all of us. At Cornell University, Evan Polman and Kyle Emich studied a large number of undergraduates to see if the motivation and the quality of their work would change depending on whom the work benefited.9 Two separate groups of students were given puzzles and creative projects. One group was told that they were solving the puzzle to save themselves and that they were illustrating a story they would later publish themselves. The second group was told that they were doing the work to benefit someone else—solving the puzzle would save the life of another person who was imprisoned—and that they were illustrating a story someone else would publish. In each case, the group working for someone else produced better results—66 percent of the altruistic group solved the puzzle versus less than 50 percent of the self-focused group, and the creative level of the work for an unknown author was of much higher quality. If work done for others is more effective and creative than work we do solely for ourselves, how can managers structure their organizations in ways that promote that?

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What other motivational models exist? In addition to the theories proposed by Maslow, McClelland, and Herzberg, several models have been developed that provide theoretical explanations of what motivates employees specifically in a business or workplace context: • Theories X, Y, and Z • The Vroom model • Strength-based management What are the Theory X and Theory Y models? In 1960, social psychologist Douglas McGregor proposed the Theory X and Theory Y models of behavior (see ◼ FIGURE 8.2). The Theory X model suggests that people inherently dislike work and want to avoid it. Managers who subscribe to this model believe employees must be coerced and controlled to be productive and therefore use an authoritarian, hardline style of management. In contrast, the Theory Y model suggests that people view work as being as natural as playing and resting. According to Theory Y, people are naturally motivated and will work to further the goals of an organization if they are satisfied with their jobs. Theory Y managers believe that, on average, people will accept and seek out responsibility and therefore have a softer, more collaborative style of management. Clearly, Theories X and Y would not work equally well in all situations. Theory X style management—which is authoritarian and hard line—is often seen in large-scale operations such as mass manufacturing. In the knowledge industry, in which a mix of professionals work together to solve complex problems, Theory Y style management is more likely to be used. How is the Theory Z model different? In 1981, William Ouchi, a professor at the University of California, Los Angeles, put forward a Theory Z model based on a

Theory X

Theory Y

Not motivated

Motivation

Naturally motivated

Must use heavy control of workers

Management

Will create their own motivation

Follow rather than solve

Leadership

Creative problem solvers

Avoid responsibility

Responsibility

Seek added responsibility

Security seeking

Needs

Need intellectual stimulation

◼ FIGURE 8.2 Comparison of Theory X and Theory Y

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Japanese management style that relied heavily on collaborative decision making. In many corporations in Japan in the 1980s, one person might be responsible for many different aspects of a single project. Employees tended to become generalists rather than specialists who were trained to do narrow sets of tasks. Theory Z style management offers long-term employment with an emphasis on individual responsibility. Workers tend to show a desire to cooperate and be loyal to an organization. As a result, companies that apply Theory Z management often reap the benefits of low turnover, high productivity, and strong morale among the workforce. Morale, a sense of purpose, and enthusiasm toward one’s work is an important factor in an employee’s level of motivation. Do any motivational models describe an individual person’s motivation? Although Maslow’s hierarchy and other theories describe human motivation, they do so in terms of an overall model for all employees. In 1964, Victor Vroom proposed a theory named expectancy theory, which has since been developed by other researchers. Expectancy theory suggests an individual’s motivation can be described by the relationship between three psychological forces. He put forward the following formula to describe the motivation a person feels in any given situation based on these three forces: Motivation = Expectancy × Instrumentality × Valence Expectancy is the idea that a person’s effort has an appreciable effect on a situation’s result—whether it is a success or failure. Does working harder lead to a more positive outcome for an employee or a company? Or does it not make a difference? Instrumentality refers to the idea that the outcome of a situation results in either reward or punishment. For those who are extrinsically motivated, instrumentality answers the question “What are the chances I’m going to be rewarded if I do a good job?” For those who are intrinsically motivated, instrumentality answers the question “How good will I feel if I can accomplish this task?” Valence is the importance that the individual places on the expected outcome of a situation. It answers questions such as “How great a reward will there be if my performance is exemplary?” and “How serious a punishment do I expect if I underperform?” In common terms, Vroom’s formulas for high and low motivations read as follows: High motivation = (My work actually affects the outcome.) × (There’s a good chance I’ll get a reward if this works out.) × (It’ll be a really big reward!) Low motivation = (Nothing I do is going to impact this situation.) × (Even if it does go well, I probably won’t see any benefit.) × (The only reward from this will be incredibly small.) The Vroom formula can be used to analyze factors such as how satisfied employees are with their jobs, how likely it is they will remain in their jobs, and how hard they will work in them. Unlike Maslow’s and McClelland’s models, which address the typical needs of groups of people, Vroom’s model, with its three independent variables, can generate a much more specialized result, attuned to the mental state of a specific individual. Closely related to expectancy is equity theory—the idea that people expect to be rewarded on par with other people they feel their performance equals or else their motivation will suffer. People in an organization want to feel their contribution is recognized in a manner that fits with how they see the other coworkers being rewarded. What is unique in strength-based management? Strength-based management is a system based on the belief that, rather than improve employees’ weak skills, the best way to help them is to determine their strengths and build on them. This system is supported by research that shows that people can learn

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the most about areas in which they already have a strong foundation. Strengthbased programs identify employees’ current talents and skills and then provide additional training and support to develop them into areas of excellence. By designing a match between an employee’s strengths and his or her daily activities and working around his or her weaknesses, the employee becomes more motivated and engaged.

Evolution of Motivational Theories How have motivational theories changed? During the industrial age, large corporations were created, and researchers like Frederick Taylor (1856–1950) began to study ways to make workers more efficient and cost effective. In 1911, Taylor published his findings in The Principles of Scientific Management. He encouraged managers to scientifically study their employees to determine the best way for them to complete tasks and then train their employees to use these methods. Many of his ideas were implemented in factories. By the 1920s and 1930s, a field of academic study called industrial psychology was created to further address these issues. Other researchers, such as Frank and Lillian Gilbreth, used photography to study employees’ work patterns. For example, they used time-motion studies to analyze factory jobs. These involved recording the actual movements and positions of workers, along with the timings, as they performed common tasks. Then workers could be trained in the precise sequence of steps that would make them most productive. Elton Mayo, a professor at Harvard University, conducted another famous study of the period at the Hawthorne plant of the Western Electric Company in Illinois. The study ran from 1927 to 1932 and examined physical influences on the workplace (such as lighting and humidity) as well as psychological aspects (such as group pressure and working hours). Mayo’s major finding, known as the Hawthorne effect, was that regardless of the experimental changes made, the production of the workers improved. Researchers concluded that the increase in productivity was based on the attention the workers were receiving. Because they knew they were being studied, the employees felt special and produced more, regardless of the conditions Hawthorne studied. The Hawthorne effect is used now as a term to describe the increase in productivity caused by workers being given special attention. After World War II, the direction of research in management theory shifted from the management of individual workers toward the management of entire organizations, their structures, and policies. What motivational theories fit the modern workplace? Research continues to be conducted in the field of organizational psychology, and new theories about motivation and management continue to emerge. A recent motivational theory has been developed as a result of examining the open-source movement—software projects that are developed, tested, and maintained for free by a worldwide network of volunteers. Wikipedia and the Linux operating system are examples of these projects. Both have been hugely successful and were created by professional people working many hours for free—outside of their regular jobs. What is causing people to behave this way? Four academic economists tried to find out by running an experiment where people were recruited to perform a range of tasks that required motor skills, creativity, or concentration. Monetary rewards were promised to people doing the tasks, depending on how well they performed on them. Top performers were promised the equivalent of five months’ pay if they did well on the creative tasks or the ones that required concentration. Surprisingly, the higher the incentives were, the worse people performed. Similar results were seen when the London School of Economics reviewed corporate payfor-performance plans.10 The researchers concluded that using economic rewards to motivate employees can actually lead to poorer performance when the work being done is creative or requires concentration. At least one additional study has

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shown that today’s knowledge workers value three things much more highly than money:11 • Autonomy. Having some control over the key decision in their work lives • Mastery. Feeling skilled and having time to develop and improve their skills • Purpose. Wanting their lives and work to have a higher meaning

For knowledge workers, autonomy, mastery of skills, and a sense of purpose in their work are key motivators. Source: keepsmiling4u/Fotolia

Companies that use knowledge workers and are able to provide them with incentives such as these will see great benefits.

 Remember Ana Gutierrez and her team of uninspired public relations professionals? “I realized that extrinsic motivators didn’t have much of an effect on my employees, nor did a hard-line management style based on the Theory X model,” she says. “So I changed my approach, and I soon saw positive results.” In an attempt to increase the level of intrinsic motivation among her employees, Ana met with her salespeople and asked them which accounts they found most meaningful and satisfying to work on. She then rearranged the salespeople’s accounts based on this information and found that they were more motivated when they worked with clients with whom they felt a personal connection. Ana also eliminated the nine-hour-day mandate but soon found that many of her newly motivated employees voluntarily worked at least that many hours—if not more! The company, once struggling, now flourishes: Sales are up, and clients are thrilled. With experimentation and careful thought, Ana achieved the goal of all business managers: translating motivational theory into business success. Objective 8-2

Leadership Identify the various leadership styles and traits, and explain how they affect business.

 Elon

Musk showed his technical talents early, selling a computer game he designed at age 12 for $500. After he finished his undergraduate education with degrees in economics and physics at the University of Pennsylvania, he made plans to attend Stanford and study physics. But his interests spanned more than one field. He wanted to impact the future of the planet through the revolution of the Internet by generating solutions to the energy crisis—and by exploring the possibility of mass space travel. How could one person hope to accomplish such lofty goals in two different industries?

Source: bloomberg/Getty images

An organization is often successful when employees have a strong leader to demonstrate what it takes for a company to achieve its goals. Leading is the process of influencing, motivating, and enabling others to contribute to the success

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235

and effectiveness of an organization. As we discussed in Chapter 7, leading is one of the four functions of management (other functions include planning, organizing, and controlling/monitoring). Are all managers leaders? Famed management researcher and author Peter Drucker once noted that “management is doing things right; leadership is doing the right things.”12 Both leaders and managers strive to motivate people, but they have different scopes. Typically, managers spend their time making sure specific tasks are done well and completed on time. The leadership of a company, on the other hand, is focused on establishing the long-term vision and strategies a company will need to survive and flourish. Truly great leaders are able to be both managers and leaders: They define a vision, foster agreement across the company, and then implement the strategy. What styles of leadership exist? Many different leadership styles exist, and leaders often employ different styles in a given situation depending on a complex mix of their own personalities, the types of companies they work in and their corporate cultures, and the employees they manage. ◼ TABLE 8.2 lists four of the most common leadership styles: • • • •

Democratic Autocratic Affiliative (laissez-faire) Visionary

What are democratic and autocratic leaders like? A democratic leader delegates authority and involves employees in the decision-making process. An autocratic leader makes decisions without consulting others.

TAblE 8.2

Styles of leadership Democratic

Autocratic

Affiliative (Laissez-Faire)

Visionary

Leader characteristics

• Listens well • Is a team worker • Collaborates • Influences

• Commands—“Do it because I say so” • Threatens • Has tight control • Monitors studiously • Creates dissonance • Contaminates everyone’s mood • Drives away talent

• Promotes harmony • Empathizes with others • Boosts morale • Solves conflicts

• Inspires • Believes in own vision • Is empathetic • Explains how and why people’s efforts contribute to the “dream”

Benefits to style

Values people’s input and gets commitment through participation

Soothes fear by giving clear direction in an emergency

Creates harmony by connecting people toone another

Moves people toward shared dreams

When style is appropriate

To build buy-in or consensus or get valuable input from employees

In a crisis, to kick-start an urgent turnaround; with problem employees; traditional military

To heal rifts in a team; to motivate during stressful times or strengthen connections

When changes require a new vision or when a clear direction is needed; radical change

Image sources: tribalium81/Fotolia; Kikkerdirk/Fotolia; NLshop/Fotolia; Lightwise/123RF

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John Lasseter, Chief Creative Officer of Pixar and Walt Disney, has been a visionary leader in the field of animation. Source: Matt Hoyle/Getty images

Consider Henry Chang, who runs the kitchen of a large restaurant. Henry allows his staff to offer opinions as he develops the menu. He also lets them experiment with different recipes and food presentations and features their work on the main menu when possible. The kitchen staff members love working with Henry because he allows them to be creative and innovative. He also encourages them to cultivate the skills they will need to run their own restaurants someday. However, Henry’s restaurant often attracts important political dignitaries and famous entertainers. Sometimes, the restaurant becomes unexpectedly busy. In these circumstances, Henry doesn’t leave anything to chance and dictates exactly what needs to be done and who should do it. Henry knows he might hurt someone’s feelings in the process, but ultimately, his staff trusts him to make the right decisions to obtain the best results for the restaurant. For the most part, Henry is a democratic leader because he knows that by involving his employees, they become more invested in the process. The trade-off, Henry recognizes, is that his democratic style of leadership requires more time and advanced planning. When such time is not available, Henry must take complete charge. In those instances, he becomes an autocratic leader. A good leader knows that such commanding leadership can be an effective style in certain circumstances when quick decisions need to be made or when it seems as if the group cannot come to a consensus. What are affiliative leaders? Some leaders take a more hands-off approach to management and act more as consultants than participants. Affiliative (or laissez-faire) leaders are more advisory in style, encouraging employees to contribute ideas rather than specifically directing their tasks. This style of leadership is often best used with groups and teams. Affiliative leadership implemented properly can give employees a sense of challenge, commitment, and renewed energy as they are left to handle tasks on their own. As businesses continue to reduce the layers of management, affiliative and democratic styles are becoming the leadership styles of choice. However, it is possible for affiliative leaders to lose too much involvement in the group’s processes. If the group or team members feel that management is virtually absent, the members may choose actions and strategies that are easy and not in line with the goals of a company. What makes a leader a visionary? Visionary leaders are able to inspire others, believe in their own vision, and move people toward a shared dream. John Lasseter was an animator in Disney’s computer animation department when George Lucas’s company Lucasfilm opened a computer animation division. Intrigued by the advances in technology he saw in use at Lucasfilm, Lasseter left Disney in 1984 to spend a month at Industrial Light and Magic (ILM), a division of Lucasfilm. The division was later purchased by Steve Jobs and became its own company, Pixar. Lasseter is currently Pixar’s chief creative officer. He has assembled a uniquely creative group of employees who have produced animatedfilm classics such as Toy Story, The Incredibles, and Frozen. As a visionary leader, Lasseter had to create the special environment giving creative people the freedom to be inventive but also the structure to meet the deadlines required to produce a multimillion-dollar film on schedule. His leadership came into play in the production of Toy Story. At that time, Pixar had never produced anything longer than a short, five-minute film. It wasn’t clear whether the company could actually produce a full-length film. Toy Story was being produced and distributed by Disney (in a partnership with Pixar), which called a meeting to see a segment of the film to check its quality. Lasseter remembers the meeting: “I was pretty much embarrassed by what was on the screen. I had made it. I directed everybody to do this . . . but it was a story filled with the most unhappy, mean people.” Disney wanted to shut down production and fire the staff. But Lasseter negotiated a twoweek reprieve and returned to lead his team of cowriters and animators. “Let’s

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make the movie we wanted to make,” he told them, and the story took on a gentler, sweeter tone. The team had to work nonstop during the two-week reprieve, with the threat of massive layoffs hanging over their heads. The ending of the story is well known: Toy Story went on to achieve $190 million in domestic box office receipts, and Lasseter earned an Honorary Oscar for the achievement.13

Traits of leadership What are the traits of great leaders? As illustrated in leaders share some common traits:

◼ FIGURE 8.3,

the best

• Great leaders challenge the process by not always accepting conventional beliefs and practices as the only way to accomplish tasks. Leaders are not afraid to alter their methods or plans if the situation calls for change. They continually brainstorm for solutions to problems and more effective ways of reaching goals. • Great leaders inspire a shared vision and motivate people to care about the mission and goals of an organization. Leaders influence in a positive and moral way (rather than in a selfish and destructive way) and garner trust, respect, and commitment to the vision. • Great leaders model the way by serving as a living example of the ideals they are asking their employees to emulate. Leaders have a good handle on their businesses and industries. They are willing to admit mistakes and constantly seek more information to make informed and reasoned decisions. Good leaders base their decisions on facts. They are well organized and detail oriented and through their speech and action choices set the ethical tone for their firms. • Great leaders exhibit emotional intelligence. Most successful leaders possess a high degree of emotional intelligence—the ability to understand both one’s own and others’ emotions. It is a term for a set of skills that includes self-awareness, self-management, social awareness, and relationship man◼ FIGURE 8.3 agement. Leaders can use their awareness of others’ emotional states to Traits of Effective Leadership inspire people to feel more positive and connect with others by being honest and open about their own ideals, concerns, and goals. In working with these types Model the of leaders, people tend to feel secure and way free to explore and share their creative ideas. • Great leaders enable others to act by giving people access to information and empowering them to perform to their fullInspire a Challenge est potential.14 Leaders need to achieve shared the and have high energy levels. However, vision process successful leaders also delegate authority Effective and responsibility to others so they are Leadership successful as well. These traits are essential to effective leadership and are common to most good leaders. Are there systems for measuring leadership potential? There are many personality tests that can provide information to assess people’s leadership potential and improve their leadership skills. Popular personality assessments include the Big Five, the Cattell 16 PF, and the Thematic Apperception Test.

Enable others to act

Exhibit emotional intelligence

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Off ThE MARk

Masataka Shimizu

asataka Shimizu, the head of the Tokyo Electric Power Company (Tepco), faced a horrible situation when an earthquake rocked the company’s Fukushima nuclear reactor complex in Japan in 2011. The subsequent meltdown of three of the complex’s reactors resulted in a massive release of radiation and more than $100 billion in damages. Japan’s economy was disrupted for over a year, and plans to increase the role of nuclear power in the country were derailed. It is hard to rise to such a challenging set of events, but in the investigations that followed, much troubling information

came to light. The amount of radiation released was more than twice what had initially been reported by the company. Moreover, senior Tepco engineers had known for years that half of the reactors had a dangerous design flaw, but the company failed to make upgrades to them.15 After the disaster struck, Shimizu disappeared for days, and his communication about it with the government created confusion. At stake was a complete evacuation of Tokyo if all six of the reactors at the Fukushima were to melt down. Although that did not occur, Shimizu resigned amid scandal within the year.

Although no one personality test is recognized as the perfect tool, all of them strive to provide us with a better understanding of the traits that are the foundation of successful leadership.

leadership and Corporate Culture Masataka Shimizu, formerly the president of the Tokyo Electric Power Company, kneels and bows in apology to the people who had to evacuate the Fukushima region after the company experienced a power plant disaster there following an earthquake and tsunami. Source: Sankei/Getty images

How does the leadership style of a firm’s managers affect the work environment? The collection of values, norms, and behavior shared by managers and workers in a firm defines the character, or corporate culture, of an organization. What style of dress is appropriate at work, the work environment itself, rules for getting ahead and being promoted, what is valued, who is valued, and even what kind of work–life balance is expected are all aspects of a firm’s corporate culture. Typically, this information isn’t written down anywhere. Instead, it is communicated via an attitude of “this is how we do things here.” Employees aren’t explicitly told how to behave, but nonetheless they generally conform to the norms of the corporate culture. This is why it is important that your personal goals and style match the corporate culture of the organization you choose to work for. In a corporation in which the culture is not well defined—or, even worse, one that supports questionable behavior—problems result. This was the case for the natural gas giant Enron. A significant lack of control and poor ethical behavior on the part of the firm’s top managers resulted in an accounting scandal at the firm. The scandal came to light in 2001, and the company later collapsed. On the other hand, when the corporate culture is strong and all employees accept the culture as their own, they are motivated to maintain it and monitor their own behavior. How does a leader establish corporate culture? Tony Hsieh of Zappos.com, the online shoe giant, is a powerful example of how a leader can establish corporate culture. Hsieh started Zappos at a time when selling a product like shoes online was thought to be impossible. But he was sure top-notch customer service could make selling shoes on the Internet a successful venture. In his book Delivering Happiness: A Path to Profits, Passion and Purpose, he explains how first establishing a corporate culture naturally led to the customer service levels he wanted, the profits he wanted, and the purpose he wanted in his life and the lives of his employees.

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Do You have to be Tall to be a leader?

o taller people have more charisma and self-confidence? And what does height have to do with successful leadership in business? A lot, according to many industry experts and observers. Several studies have found that height is a tool business leaders try to use to appear powerful.16

What do you think? Does height affect success in business? Would the answer be the same for men and women? Or is the idea that height, rather than skills and talents, leads to promotion a myth?

Hsieh and the two other founders hold the company to a set of core values that evoke a combination of a focus on customer service combined with a sense of fun and adventure. The corporate culture of Zappos shines through, even in the hiring process. For example, value 10 is “Be Humble.” Candidates are picked up from the airport with a Zappos shuttle bus. Later, the bus driver is interviewed to see how the candidates treated the driver. The interview starts before the candidates realize it! The first requirement of a successful applicant is that they are considered a “culture fit,” a match to the values of the company. Zappos is looking for employees who are willing to bring some personality to the office, not hide behind what they think is expected of them. One week after they have been hired, employees are offered $2,000 to leave Zappos if they don’t think the company is right for them.17 What does all this focus on building a corporate culture do for the company? Zappos has become a company with a “higher purpose of vision that is more than just about money or profits or being No. 1 in the market,” describes Hsieh.18 Along the way, the staff has become renowned for outstanding customer service, being friendly, and even spending hours on the phone with a single caller if needed. That has translated into more than $1 billion in annual sales for Zappos.

Southwest Airlines

ne company that has benefited from strong leadership and employee motivation is Southwest Airlines, one of the most admired companies in the world. Southwest Airlines has an amazingly low turnover rate for its industry, which the firm credits to allowing its employees to express their individuality. Singing flight attendants and comedic reports from pilots are common on Southwest flights. The company’s charismatic CEO, Gary Kelly, outlines the three key criteria a Southwest employee must have: “a Warrior Spirit, a Servant’s Heart, and a Fun-LUVing Attitude.”19 Managers encourage input from employees at all levels—one’s position does not prevent anyone from contributing a new idea.

On TARgET

Southwest has never furloughed employees, a common industry practice where more people are hired to cover busy travel seasons but are then not given any work when traffic drops. Because they know their jobs are secure, Southwest employees are confident they can grow into new positions. The largely union environment has a similar pay structure to other airlines but also a profit-sharing plan. Employees own 5 percent of the company.20 The company’s stock has soared to such heights over the years that a number of longtime Southwest employees have become millionaires as a result. Not surprisingly, the company has repeatedly made Fortune magazine’s annual “100 Best Companies to Work For” list.

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 Elon Musk has found that to accomplish the visionary goals he had, he needed to become a great leader. He was the founder of the online service PayPal. Musk is the CEO and chief designer of the first company that sent a spacecraft to the International Space Station (SpaceX). He is also CEO of Tesla Motors, whose award-wining line of electric cars has revolutionized the automotive industry. How can one person create disruptive change in three industries? By being a powerful, transformative leader. Musk has consistently been willing to challenge the status quo. For two years, he pumped millions of dollars of his own money into Tesla Motors because no one else was willing to imagine that a business selling all-electric vehicles would be successful.21 He inspires others with his vision and lures talented engineers from other great companies. The engineers know that at SpaceX and Tesla, they will get to push the envelope and create products never seen before. Musk’s clarity of vision and dedication to creating important and beautiful products servesas a model of what is expected and what is possible at his companies.

Objective 8-3

Teamwork Explain the best ways to create, manage, and participate in teams.

 There

is probably no team you want to be more efficient, communicative, and effective than an operating room team performing surgery on you. It’s not uncommon for an operating room team to be comprised of seven or more members who have never met each other before the day of the surgery. As medicine has become more sophisticated, even the most routine tasks have become so complicated that mistakes are all too common. Dr.Atul Gawande saw this happening and wanted to develop a way to make his operating teams function better. But where to begin?

It’s challenging to develop effective teams, but the benefits can be extraordinary. In this section, we’ll discuss teamwork and how it affects organizations.

Source: tyler Olson/Fotolia

THE LIsT

Does Your Team Function Like Google Teams?

1. Can we take risks without feeling embarrassed? 2. Can we count on each other to do quality work on time? 3. Are the goals, roles, and plans clear? 4. Are we working on something important to each of us? 5. Do we believe the work we are doing matters?22

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Motivation, Leadership, and Teamwork

The Advantages of Teams in the Workplace What is the value of using teams in the workplace? Although the different personalities of people have the potential to create conflict within a team, they can also produce unique ideas. Successful teams ultimately agree on the objectives they need to accomplish, and the members depend on one another’s ideas and efforts to develop successful plans and implement them. There is a sense of accountability, and the members are committed to one another’s success. One product that benefited from team development is the Microsoft Kinect. A breakthrough product for the video gaming industry, the Kinect allows video game players to play games without handheld devices. Players use voice commands and gestures instead. The Kinect was not designed by a single team but was made up of seven teams from seven different disciplines. A small team began exploring ways to track player’s body movements. Another small team of computer vision experts from Microsoft Research worked on the key algorithms. Once demos of the team’s work began spreading through the company, engineers began to volunteer to come in and work nights on the project. In its first 60 days on the market, the product sold 8 million units and set a Guinness world record asthe fastest-selling consumer electronics device.23

The Challenges of Teams in the Workplace Do teams always improve the development process? Although teams have been shown to be effective in many situations, some people suggest that teamwork does not always result in more creativity. Research conducted by Barry Staw at the University of California–Berkeley, found that when college students were asked to think of business ideas—either individually or in teams—the individuals came up with more ideas than the teams did. In addition, the individuals’ ideas were voted as more creative than were the teams’ concepts. Staw concluded that collective thinking does not lead to increased creativity and can, in fact, hamper it. One possible reason, Staw proposes, is that team members often want to “fit in,” but creativity demands a person take risks and “standout.”24 If the members of a team are not carefully selected, “wanting to fit in” can lead to narrow-mindedness within the group, a phenomenon referred to as groupthink. People who are from similar backgrounds and sectors of a company tend to have the same ideas and work with the same set of unspoken assumptions, which can lead a group to reject different ideas without fair examination. Groupthink can hamper the creativity of teams, although this challenge can be minimized by carefully designing them, a topic we will discuss shortly. Another challenge is the fact that there is now a wide mix of generations in the workforce (see ◼ TABLE 8.3). By 2020 there will be five generations in the workplace at the same time. Imaging the challenges for a single team in which each member has grown up with such different social and educational experiences. Each generation exhibits distinct styles in the workplace. Combining those in ways that benefit the team efforts will be an important challenge. Are generational differences really that significant in the workplace? In their book Millennials Rising: The Next Great Generation,25 researchers Neil Howe and William Strauss discuss the three dominant generations in the workplace today: • Baby boomers. Those born between 1943 and 1960. Baby boomers are the veterans in the workforce. Many have been with their same companies for decades. • Gen-Xers. Born between 1961 and 1981. Gen-Xers, who are independent thinkers and hanker for change, are the first generation of workers to value family life over work life. • Millennials. Born between 1982 and 2002. Like Gen-Xers, Millennials want their jobs to accommodate their personal lives, but they also have high expectations for achievement in their careers.

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TAblE 8.3

There are challenges in having three generations of employees in the workplace. Source: Adrian Weinbrecht/Alamy Stock Photo

five generations in the 2020 Workplace

Generation

Birth Years

Influences

“Greatest” Generation

Before 1945

WWII Great Depression Korean War

Boomer

1945–1960

Civil Rights movement Vietnam war

Gen X

1961–1980

HIV/AIDS Internet

Gen Y (Millennials)

1981–1995

9/11 Bombing of World Trade Center Expansion of social media

Gen Z

After 1995

“War” on Terrorism Mobile computing Rise of China

Millennials, who are now entering college campuses and the workforce, believe in their own self-worth and value.26 They feel they have the capability to change the companies they work for and the world. According to Howe and Strauss, members of this generation expect to make their mark on society by using technology to empower the community. Teamwork, good behavior, and citizenship are much more important to Millennials than to previous generations, and they see equality between different races and genders. How will this affect business? How will businesses react to the needs of younger workers, who are juggling work demands along with the demands of their new families? How will older employees respond to their sense of confidence and their tendency to work toward team-based solutions?

best Practices for Teams What kinds of practices set the stage for the best team performance? Psychologist Mihaly Csikszentmihalyi has applied his idea of flow, discussed previously, to teams. Group flow occurs when a group knows how to work together so that each individual member can achieve flow. The characteristics of such a setting are as follows: • Creative spatial arrangements. Pinning ideas on the walls and using large charts to combine ideas from the entire group tend to lead to the open consideration of ideas. Tables are used less because working while standing and moving promotes more discussion and interaction. • Playground design. This begins with creating a space where it’s safe to divulge ideas that normally people might just keep to themselves. Often, a large number of charts display information inputs, graphs, and the project summary. Wall space can be used to collect results and lists of open topics. • Constant focus on the target group for the product. At Amazon.com, CEO Jeff Bezos has the nickname “the empty chair” because he often keeps a seat open

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Motivation, Leadership, and Teamwork

On TARgET

Red Teamers in the Military

eamwork is a critical part of business, but one place you might not think of team decision making occurring is in the military. The military is organized around the chain of command: Commanders call the shots, and the rank and file must obey their orders without question. Recently, the U.S. military has become sensitive to how this conditioning could contribute to groupthink. So, a program of study was developed to produce “Red Teamers,” officers trained to analyze problems from a wide range of points of view—including how a decision will impact the military’s allies and how people in occupied countries will respond to the decision. Red Team students study military theory but also Eastern philosophy, for example. The goal

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is to expand their worldview. In Iraq, Red Team officers were used to decide how military dogs would be used. Why? Because Iraqi citizens generally have different cultural attitudes toward dogs and consider them unclean. A Red Teamer is responsible for raising issues that the group might not have considered but then stepping out of the way and not obstructing the decision making. The same idea of injecting a skeptic into a group to promote a variety of points of view is used in other government agencies. For example, the Federal Aviation Administration uses Red Teams to conduct airport testing to find and resolve security weaknesses. Is there a Red Teamer in your group—or do you need one?

at team meetings. The empty seat is the most important one in the room because it represents the customer.27 • Visualization. Visualization and prototyping are used to construct initial models for product and service models, which are later refined. How do managers create the best teams? Some important aspects a manager should consider in forming a team include the following: • Size. A team that is too large may struggle with cohesiveness. At the same time, a large group can offer the benefit of diverse perspectives. • Psychological safety. Members of the team perform best when they feel safe to take a risk. If they are confident they will be supported by the team even if the approach fails, the team benefits. • Time frame. Some teams are put together to work on a specific problem or project within a short time frame, whereas others may work together for longer time periods on everyday tasks. • Status. A team formally created by a company may be required to provide progress reports and updates, and it often has access to company resources. Less formal teams may need to take the initiative when it comes to communicating their progress to other people and groups. According to business writer and theorist R. M. Belbin, effective teams are comprised of people with diverse skills, talents, and points of view. Team members’ respective skills and talents should complement one another so the team can perform at an optimum level. For example, what if all of the members of a team are extremely creative yet inexperienced in effective time management? What if five of six team members are all aggressive leaders? Clearly, a balance of people who embody different team roles is the key to the success of a team. Belbin’s model of nine team roles is outlined in ◼ TABLE 8.4. Considering both the personality traits of potential members and the roles they can play can be helpful when designing teams. What are cross-functional teams? In the past, the members were often from the same department and reported to the same supervisor. But today, cross-functional teams have become more common. In a cross-functional team, members are selected across a range of critical functional divisions of a business. For example,

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TAblE 8.4

belbin’s nine Team Roles

Role

Personality Traits

Plant

Creative and imaginative

Resource investigator

Extroverted and communicative

Coordinator

Mature and confident

Shaper

Challenging and dynamic

Monitor evaluator

Serious and strategic

Teamworker

Cooperative and diplomatic

Implementer

Disciplined and reliable

Completer/finisher

Painstaking and conscientious

Specialist

Dedicated and self-starting

Source: Adapted from R. M. belbin, “team Role Descriptions,” belbin Associates, www.belbin.com/content/page/731 /belbin_team_Role_Descriptions.pdf., www.belbin.com. © Kendall Martin

in 2004, the LEGO Group was near bankruptcy. The company’s investment in LEGO theme parks weren’t yielding a good return, and some products like Clikits had struggled in the marketplace. To turn things around, LEGO created a cross-functional team of employees to help the company push through new product innovations, pricing models, business processes, marketing plans, and community building efforts. The group ushered through modifications to existing product lines as well as new products, such as the series of LEGO board games. Now, for several years in a row, LEGO has been growing its revenues by more than 20 percent per year. What effect does technology have on team design? In a virtual team, members are located in different physical locations but work together via telecommunications technology to achieve a goal. The need for virtual teams has grown out of the increased globalization of business. Familiar tools like conference calls and e-mail have evolved to include videoconferencing and live broadcasting of key meetings and events over the Web. Webcasts can now support interactive participation of the viewing audience. In real time, audience members can ask questions, exchange electronic files with the group, and record the presentation for repeated viewing. Web conferencing software like Cisco WebEx and Microsoft Lync allow participants in any geographic location to brainstorm together in real time on a common “virtual whiteboard,” watch demos and presentations live, and record and annotate these discussions for later playback. How can social media tools like wikis help modern teams? Modern tools for collaboration are now often replacing endless streams of e-mails with file attachments. Wikis are one example. Wikis are websites that support editing by multiple authors. Team members can work on one common document all at the same time, watching each other make editing changes and having a live chat window open at the same time. Changes are archived and can be recalled; if a member of the team later reads the document and wants to revert back to a previous version, he or she can do so with just one click. The problem of having multiple versions of a document is eliminated, so there are no concerns about synchronizing the different versions between all team members; the most current version is always available on the wiki. One of the best-known public wikis is the encyclopedia project Wikipedia. Wikipedia is not the only use of wikis, however. Wikis can be run and

ChAPTER 8

Motivation, Leadership, and Teamwork

maintained by individuals or within a specific corporation. Sites like www.wikimatrix.org can help identify the type of wiki software best suited to a specific virtual team. Products like Blackboard and Microsoft Windows SharePoint contain wiki tools. Is designing a strong virtual team the same as creating a strong face-toface team? Most successful virtual teams include some periodic face-to-face meetings. Few virtual teams are 100 percent virtual. Although technology allows teams to communicate without ever meeting face-to-face, it is still important to have the group occasionally meet with each other in the same space to build social connections. Keeping the team connected is a key priority for a virtual team, and it can be difficult to keep contacts strong from a distance. There can be communication delays from working across time zones or using e-mail as a primary mode of communication. Establishing team rules, such as agreeing to respond to e-mail messages within a certain window of time or initiating global office hours, can minimize these problems. (For more on communicating with teams, see Mini Chapter 3.)

Your Role on a Team How can I be a valued team player? It is important to begin now to build the skills that will make you successful in a team. Preparing yourself to contribute in a team setting may be the most important thing you can do to increase your value to an organization, no matter what position you hold. What habits will give me the best chance to contribute to a team? There are many skills that you can build to enhance your success as a member of a team. One model that organizes these skills is the Seven Habits model developed by famed management author Stephen Covey.28 Covey has found that there are seven habits of behavior exhibited by successful people: • Be proactive. This is the ability to control your environment rather than have it control you. Proactive team members are constantly looking “down the road” in terms of their time management, work, and obstacles that could impede the success of a project. • Begin with the end in mind. This means you are able to see the desired outcome and the activities that need to be done to achieve it. Staying focused on the ultimate goal allows you to avoid taking a team in the wrong direction or a direction that will cause divisiveness and waste resources and energy. • Put first things first. Manage your time and energy so that the required tasks are prioritized. This skill works together with the second habit to push you toward success in your team role. • Think win–win. This is the most important aspect of interpersonal leadership because most achievements are based on cooperative effort; therefore, the aim needs to be win–win solutions for all. • Seek first to understand and then to be understood. Good communication is critical to developing and maintaining positive relationships. Listening to your teammates and giving them the chance to be heard will be the key to your own success when it comes to being understood and contributing. • Synergize. This is the habit of creative cooperation—the principle that collaboration often achieves more than could be achieved by individuals working independently toward attaining a purpose. • Sharpen the saw. This catchphrase comes from the metaphor for chopping down a tree. If you are constantly sawing and never take time to stop and sharpen the saw, you’ll feel as if you’re investing tremendous energy, but the results will not be what they could be if you just stopped to sharpen the

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saw first. Strong team contributors take time to develop their skills, step back from “the grind,” and reanalyze the task at hand so that they can work more efficiently. If you work to develop and use these habits, you will find that both you and the teams you are a member of will become more successful—and that you will be in demand for increasingly more important team assignments.

 The

key to promoting better team function for Dr. Gawande was to develop a checklist. His book, The Checklist Manifesto, describes how he worked with his staff to create a checklist used during surgeries. Issues were identified, like the need for a mandatory introduction of each person on the team before the procedure was performed, and giving a clear authorization to nurses to stop the surgery if an item on the checklist was missed. By having every member of the team involved in developing the checklist, critical items were included that could easily be overlooked. The result? At a multihospital study, the number of surgical deaths dropped by 47 percent.

Chapter 8

summary 8-1

Understand the main theories of motivation and how these have changed the work environment.

• Managers can increase motivation and foster flow. Flow is a state of feeling completely involved and focused on a task. Keeping employees intellectually engaged, removing distractions, encouraging creativity and flexibility, and supporting employees in all aspects of their lives builds motivation. • Maslow’s hierarchy of needs describes motivation as a response to a progressive set of needs for physiology, safety, belonging, esteem, and self-actualization. • McClelland’s three needs theory states the main motivators are the need for achievement, affiliation, and power. • Herzberg broke the idea of motivation into two categories: hygiene factors and motivators. • Extrinsic motivators are factors external to the employee, such as pay or promotions, which improve their engagement at work. • Intrinsic motivators are internal factors inside of a person that come from his or her actual interest in the work or from a sense of purpose and value in the work being done.

• Studies that have shown that today’s workers value autonomy, mastery, and purpose at least as much or as more as they do economic rewards. Studies of people engaged in creative work show they are often demotivated by traditional financial incentives and highly motivated by offers of autonomy, mastery, and purpose.

8-2

Identify the various leadership styles and traits, and explain how they affect business.

• Leaders may exhibit a democratic, autocratic, affiliative (laissez-faire), or visionary style. Many top executives demonstrate one or more of these styles. • Certain traits are common among effective leaders. They challenge conventional beliefs, inspire a shared vision, model by example, use emotional intelligence, and enable others to perform to their fullest potential.

8-3

Explain the best ways to create, manage, and participate in teams.

• Theory X states that humans inherently dislike work and will try to avoid it if they can. As a result, managers should adopt a hard-line, authoritarian style.

• Teams can benefit the workplace by encouraging collaboration, which can lead to greater innovation and the speed with which organizations are able to respond to changes in the marketplace.

• Theory Y proposes that people view work as natural and will be motivated to work as long as they are satisfied with their jobs. Thus, managers should implement a softer style that involves ample employee participation.

• Effective teams must be designed and managed thoughtfully. Today’s workplace includes employees from three or more generations, and it takes care and insight to make them mesh well on a single team.

• Theory Z suggests that workers want to cooperate and be loyal to an organization and emphasizes collaborative decision making.

• Group flow is achieved when a group knows how to work together so that each individual member can achieve flow. Best practices for creating strong teams include considering the size, the life span, and the status of the team.

• The Vroom model (expectancy theory) states that an individual’s motivation can be described by the relationship between three factors: expectancy, instrumentality, and valence. • Industrial psychology is a field of academic study developed to scientifically understand how to optimally manage people and work. • A 1932 study by Elton May concluded that when workers feel important, productivity increases. This is called the Hawthorne effect. After World War II, research began to focus on the management of entire organizations rather than individual workers.

• R. M. Belbin outlined a model of nine team roles. An effective team requires a variety of roles, and the members must be matched carefully to the team needs. • E-mail, videoconferencing, webcasts, wikis, and other technology allow for virtual teams in which members are in different locations around the country or the world. However, most virtual teams meet face-to-face periodically. • Stephen Covey’s Seven Habits model can help employees enhance their success as members of a team.

Key Terms affiliative leader (laissez-faire leader) autocratic leader

belonging needs corporate culture

cross-functional team democratic leader 247

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emotional intelligence equity theory esteem needs expectancy expectancy theory extrinsic motivators flow group flow groupthink Hawthorne effect hierarchy of needs

hygiene factors industrial psychology instrumentality intrinsic motivators leading motivator factors motivator-hygiene theory (two-factor theory) organizational psychology physiological needs safety needs

self-actualization needs Seven Habits model strength-based management Theory X Theory Y Theory Z three needs theory time-motion studies valence virtual team visionary leader

MyBizLab To complete the problems with the

, go to EOC Discussion Questions in the MyBizLab.

self Test Multiple Choice You can find the answers on the last page of this text. 8-1 Which of the following are types of leadership styles? a. b. c. d.

visionary, affiliative laissez-faire, democratic autocratic all the above

8-2 The corporate culture is

a. is a set of rules written down and distributed. b. the values and behaviors shared by managers and workers. c. defined by the country where the corporate headquarters are located. d. not going to impact you in the workplace.

8-3 Maslow’s hierarchy of needs

a. is a theory of why people are motivated. b. uses three factors to compute the motivation of a person in a situation. c. was developed to address the Hawthorne effect. d. was displaced when Theory Z was introduced.

8-4 With creative and abstract work, studies find that the principal motivators are a. financial incentives. b. autonomy, mastery, and purpose. c. competitive push for advancement. d. reduction in hours involved at work.

8-5 Teams improve creativity

a. when the phenomenon of groupthink sets in. b. no matter what the makeup of the team. c. when best practices for selecting the team members and roles are followed. d. when individuals work with others who are just like themselves.

8-6 An example of Herzberg’s hygiene factors is a. b. c. d.

feeling of belonging. creativity. safe working environment. respect.

8-7 Theory Z is different than Theory X or Theory Y

because a. it relies heavily on collaborative decision making. b. it is authoritarian and hard line. c. it is often seen in mass-manufacturing settings. d. managers believe people will seek out responsibility.

8-8 Virtual teams are teams that a. b. c. d.

are incomplete and need to be dissolved. communicate only through face-to-face meetings. primarily focus on technology-based projects. work in different physical locations.

8-9 A laissez-faire leader would a. b. c. d.

challenge every decision. take a hands-off approach to management. believe in strong involvement in employee teams. be very important to a company experiencing a crisis.

8-10 Extrinsic motivators include such things as

a. doing work that you enjoy. b. believing your opinion matters. c. knowing there is a large financial bonus for good work. d. working for a company whose mission is meaningful to you.

ChAPTER 8

True/False

You can find the answers on the last page of this

way to develop talent is to help employees add skills and knowledge that build on their existing strengths.

8-11 Corporate culture is the set of sports and extra-

True or

curricular activities promoted at work.

False

8-15 Groupthink is the convergence of the group on the best idea.

8-12 Great leaders exhibit a high degree of emotional

True or

intelligence.

True or

249

8-14 Strength-based management believes the best

text.

True or

Motivation, Leadership, and Teamwork

False

8-13 Intrinsic motivators come from a sense of purpose and value in the work employees are doing.

True or

False

Critical Thinking Questions 8-16 When in your life have you been motivated by external factors like rewards, money, or promotion? In what kind of setting would the combination of autonomy, mastery, and purpose be more successful in focusing you to go above and beyond? 8-17 Consider the traits of effective leaders presented on (p. 237) in the chapter. Then consider your own personality traits. How could you strengthen the leadership traits you do not currently see

in yourself? How could you find more opportunities to use the leadership strengths you do have? 8-18

You have just been assigned a position on a virtual team. What specific strategies would you focus on to be a strong, contributing member of the team? Are there specific skills you would need to learn? How would your role be different than if the team were physically meeting on a regular basis instead of virtually meeting?

Team Time FoRMING A sUCCEssFUL TEAM A shoe manufacturer wants to diversify its successful product line of hiking boots. The company wants to appeal to young people, a rapidly growing consumer base with increasing amounts of disposable income. The company has decided to give one team almost unlimited resources and freedom to develop a flip-flop sandal for modern, gadget-loving youth. You need to apply the best-practices principles in team formation to determine the personalities and strengths of each member and assign roles in which the members will be motivated to contribute.

Process Step 1. Break up into teams of three or four individuals. Step 2. Begin by deciding what tool you will use to evaluate each member for

personality traits, strengths, and weaknesses.

Step 3. Develop a strategy for assessing what work needs to be done and then

how your team will assign appropriate responsibilities to each member.

Step 4. How will you evaluate the level of motivation and creativity for the team?

What changes can be made if the team’s performance is not adequate?

Step 5. Present your findings to the class for discussion.

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ethics and corporate social Responsibility ETHICs IN TEAMwoRk Being a member of a team means you are accountable for your actions and the actions of your fellow teammates. Review the following scenario.

scenario Imagine you work at an advertising firm. You’re on a team that is developing an advertising campaign proposal for a chain of fitness centers. The firm has been struggling and needs your team to land this account. At a meeting, one of your teammates reveals that he has hacked into a competing firm’s network and has a draft of its proposal for the same account. Your teammate wants to steal the idea and use it in your team’s proposal. Most of your teammates agree with this idea, but you think it is unethical.

Questions for Discussion 8-19

How would you handle this situation? Would you voice your objection or go along with the team?

8-20

If you decide to voice your objection, do you address the entire team or speak to members individually? Why?

8-21

How would you reconcile your role as a loyal employee and team player with your need to uphold ethical standards?

Web exercises 8-22

8-23

8-24

Testing 1, 2, 3 . . . Find three online leadership, team roles, or personality assessment tools. Go to testyourself.psychtests.com for examples. How consistent are the results in describing your personality or tendencies? How accurate would you rate the results? Great American Leaders Do an online search for the “20th Century American Leaders Database,” which is a database maintained by the Harvard University Business School (www.hbs .edu). Select one leader from your state, one of your gender, one leader of the same ethnicity as you, and two additional people profiled from different industries. What similarities and differences do you see in this group of five great leaders? Drive and Inspiration Go to YouTube and view Daniel Pink’s animated video on intrinsic motivation titled “Drive.” Describe the presentation in terms of what motivates you in school and in your free time. Then watch Simon Sinek’s talk on “The Golden Circle” of why, how, and what and explain

how that talk relates to inspiration. How could you use these ideas to inspire the next group project in which you participate? 8-25

Too Much Collaboration? Review the materials published by Susan Cain on the value of being introverted. Cain argues that some people are more creative and productive when given the space to work alone. Has our culture overvalued collaboration? Examine the story of the founding of Apple computer and the research of the Coding War Games to delve into this idea further.

8-26

Measuring Your Team’s Health Consider a team that you are part of and complete the Team Effectiveness Assessment form at www.mindtools.com. Submit the form and examine the summary for your score. Do you agree with the analysis of your team’s dynamics? Use the material following the score interpretation to spark useful discussion in your team. What action steps can you take personally and as a group to become more effective?

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Motivation, Leadership, and Teamwork

251

MyBizLab Go to the Assignments section of your MyBizLab to complete these writing exercises. 8-27 Several theories of motivation have been presented. Describe how they fit what you have seen in the academic part of your life. Is creating motivation different in other parts of your life—for example, work, sports? 8-28 What factors are the most important for creating a team that works efficiently together? What problems have you seen in your own academic career when working in group settings, and how could they be prevented?

References 1. Mihaly Csikszentmihalyi, Flow (New York: HarperCollins, 1990). 2. Adkins, A. (2016, January 13). Employee Engagement in U.S. Stagnant in 2015. Retrieved April 16, 2016, from http:// www.gallup.com/poll/188144/employee-engagementstagnant-2015.aspx. 3. Ian Tan, “Why Work for SAS,” www.sas.com/offices /asiapacific/singapore/press/why-sas.html. 4. SAS celebrates 40th year of record revenue – US$3.16 billion in 2015. (2016, February 2). Retrieved April 16, 2016, from http://www.sas.com/en_us/news/press -releases/2016/february/2015-financials.html. 5. SAS Institute. (2016, March 03). Retrieved April 16, 2016, from http://fortune.com/best-companies/sas-institute-8/ 6. State of the American Workplace. (n.d.). Retrieved August 17, 2016, from http://www.gallup.com /services/178514/state-american-workplace.aspx. 7. Casey Slide, “9 Leadership Lessons & Quotes from Truett Cathy, Founder of Chick-fil-A,” www.moneycrashers.com /leadership-lessons-from-truett-cathy-founder- of-chick-fil-a. 8. Restaurant News. (2016). Retrieved April 16, 2016, from http://nrn.com/top-100/chick-fil. 9. E. Polman and K. J. Emich, “Decisions for Others Are More Creative Than Decisions for the Self,” Personality and Social Psychology Bulletin, 2011 (PMID: 21317316). 10. Daniel Pink, Drive: The Surprising Truth about What Motivates Us (New York: Riverhead Books, 2009). 11. Ibid. 12. Peter Drucker, “Quotation Details,” http://quotationspage .com/quote/26536.html. 13. Black Friday, a seven-minute video on the Toy Story BluRay DVD, www.youtube.com/watch?v=bk8a_C0ao9Y. 14. James M. Kouzes and Barry Z. Posner, The Leadership Challenge, 4th ed. (San Francisco: Jossey-Bass, 2008). 15. Aaron Sheldrick, “Former Tepco Chief to Be Grilled over Fukushima Disaster,” Chicago Tribune, June 7, 2012, http://articles.chicagotribune.com/2012-06-07/news /sns-rt-us-japan-nuclear-shimizubre85703w-20120607_1 _fukushima-plant-masataka-shimizu-tepco-executives. 16. M. Hamstra, “‘Big,’ Men: Male Leaders’ Height Positively Relates to Followers’ Perception of Charisma,”

17. 18.

19. 20. 21.

22.

23.

24. 25. 26.

27. 28.

Personality and Individual Differences 56 (2014): 190–92, www.melvynhamstra.com/wp-content/uploads/2013 /10/ Hamstra-PAID-2014.pdf. Based on “Our Unique Culture” and various blogs, www .zappos.com. Tony Hsieh, quoted in Venuri Siriwardane, “Zappos CEO Adds Happiness to Corporate Culture,” July 7, 2010, www.nj.com/business/index.ssf/2010/06/zappos_ceo _adds_happiness_to_c.html. “Culture,” 2016, www.southwest.com/html/about -southwest/careers/culture.html. Southwest Corporate Fact Sheet,” 2016, www.swamedia.com /channels/Corporate-Fact- Sheet/pages/corporate-fact -sheet. Moryt Milo, “Executive of the Year,” San Jose Business Journal, 24 December 24, 2010, www.teslamotors.com /sites/default/files/blog_attachments/elon_musk_ceo _of_the_year.pdf. Mendoza, M., & Liedtke, M. (2015, November 17). Google searches itself to build more productive teams. Retrieved April 17, 2016, from http://bigstory .ap.org/article/8c60341cc1da47e084b8e17e62e83c98 /google-searches-itself-build-more-productive-teams. Matt Rosoff, “The Story behind Kinect, Microsoft’s Newest Billion Dollar Business,” Business Insider, January 19, 2011, www.businessinsider.com/the-story -behind-microsofts-hot-selling-kinect-2011-1?op=1. National Association of College Stores, “Teamwork Concept Questioned,” August 11, 2006, www.nacs.org /news/081106-teamwork.asp?id=cm. Neil Howe and William Strauss, Millennials Rising: The Next Great Generation (New York: Vintage, 2000). Stephanie Armour, “Generation Y: They’ve Arrived at Work with a New Attitude,” USA Today, November 6, 2005, www.usatoday.com/money/workplace/2005-11-06 -gen-y_x.htm. George Anders, “Jeff Bezos Gets It,” Forbes, April 25, 2012, www.forbes.com/global/2012/0507/global-2000-12 -amazon-jeff-bezos-gets-it.html. Based on Stephen R. Covey, The 7 Habits of Highly Effective People (New York: Free Press, 1989).

Chapter 9

Human Resource Management Objectives 9-1 Human Resource Management

Describe the processes involved in human resource management (HRM). H and R—two simple letters that together represent a vital component of any successful business. Indeed, a well-managed human resource (HR) department is essential to the smooth operation of all organizations. HR managers like Leslie Booth are responsible for many tasks, from hiring to firing and everything in between. Why is human resource management so important?

9-2 Training and Evaluating Employees

Explain how employees are trained and evaluated. Training allows a business to leverage the talents of its employees across a whole company. George Hensel knows how to run the perfect meeting. Howcan his company use him most efficiently to train others?

9-3 Compensating, Scheduling, Promoting, and Terminating Employees

Understand how employees are compensated and scheduled and detail how an employee’s status can change as a result of promotions, termination, and retirement.

To attract high-caliber applicants, companies need compensation packages that are comparable to their competitors or better. Kathy Sanchez is a fulltime graphic designer but is struggling to afford health insurance. What other types of benefits are important in a good compensation package?

9-4 Managing Workplace Diversity

Describe how incorporating diversity affects the workforce. Diversity is encouraged because it benefits a company, but it has been a challenge for Chandraki Patel to manage the widely diverse group she is responsible for. What issues do companies and managers face when establishing more diversity in the workplace?

9-5 Labor and Union Issues

List the objectives, structures, and future of labor unions in the global business environment. College athletes at Division I schools are key contributors to athletic programs that generate millions of dollars for the school. Does this make them employees, or does their academic status mean they cannot unionize to negotiate for better working conditions?

CHAPTER 9 1

Objective 9-1

Human Resource Management Describe the processes involved in human resource management (HRM).

 When

HR manager Leslie Booth needed to hire a new senior account executive for her firm, she weighed her options carefully. Filling a senior position required patience. She hired a recruiter to find outside candidates to interview for the position, and to keep her options open, she also ran job advertisements in local newspapers and top accounting journals. After no one with the right qualifications applied, she began to feel pressured by her boss to get the position filled. What should she do?

When you think about the resources required to run a business, you probably think about things like money, space, equipment, and supplies. Although those resources are key components, the “human” resource—people—is often taken for granted but is arguably the most important. People provide the ideas, creativity, knowledge, and ingenuity that make a business run. Human resources—the people in an organization— need to be managed just as carefully as the material and financial resources of a business. Human resource management (HRM) is the organizational function that deals with a firm’s employees. As ◼ FIGURE 9.1 shows, HRM encompasses every aspect of the“human”in a business, including the hiring, training, motivating, evaluating, and compensating of personnel, as shown. In this section, you’ll learn the processes involved in human resource management.

Source: Frances Roberts/Alamy Stock Photo

Managing Staffing Needs How does planning for staffing needs change as a company evolves? A small business may initially have one person working for it—the person who launched the business. Once the business begins to grow, new people are brought into the organization. Although keeping track of HR needs at small businesses can be fairly simple, companies that add employees and continue to grow require more specific HR planning. Poor staff planning can be costly. Being overstaffed burdens a company with the unnecessary expense of maintaining salaries, benefits, and training for surplus employees. An understaffed organization can lead to a loss of sales and competitiveness if customer needs are not met. A key part of human resources planning includes the following: • Determining the optimal number of employees a business needs • Clearly identifying the exact job positions and the requirements of those positions How does a company determine whether it has the correct number of employees? The process begins with gathering information on a firm’s current workforce and on the future demand for workers within the company. The

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◼ FIGURE 9.1 The Functions of HRM

Planning for Staffing Needs

Terminating and Repositioning

Recruiting and Hiring

Human Resource Management

Training and Motivating

Compensating

Evaluating

current supply of employees is determined by developing a workforce profile. A workforce profile is a personnel inventory that includes information about each employee, such as his or her age, education, training, experience, specialized skills, and current and previous positions held within the company. The future demand for employees is determined by a process called forecasting. Forecasting is based on several factors, such as the predicted sales of a company’s goods or services, the current skill level of employees, whether a firm plans to contract or expand, how technology is changing or will change a firm’s staffing needs, and available employment alternatives, such as outsourcing, offshoring, or using part-time or temporary employees. In addition, staffing changes that are expected to occur through normal turnover, retirement, and any planned reassignments are also taken into consideration. If the forecast indicates an imbalance between the supply of and the demand for employees, adjustments can be made, for example, by recruiting, training, or retraining employees, making labor force reductions, or changing the extent to which the workforce is used by increasing or decreasing the hours employees work. How do companies identify the exact jobs they need to staff? The HR department also completes a study of the tasks to be performed within the organization. A job analysis defines in detail the duties and requirements of the tasks an employee is required to perform. A job analysis includes the following: • A job description—a formal statement that summarizes what the employee will do in that role. It includes the responsibilities of that position, the conditions under which the job will be performed, and its relationship to other functions in the organization. Job descriptions are important because they define job objectives that are used later in performance appraisals.

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They also can become a part of the legal contract between the employee and the employer. • Job specifications—the knowledge, skills, education, experience, personal attributes, and physical requirements a person needs to successfully do the job. ◼ FIGURE 9.2

specifications.

shows a job analysis with a sample job description and the job

Once a job is well defined, how does HR find the best candidates to interview? Matching the right person for each job depends on a well-devised recruiting plan. Recruitment is the process of finding, screening, and selecting people for a specific job using a variety of methods and resources. Internal recruiting, or filling job vacancies with existing employees from within a business, is the first choice of many companies. Often, companies post job openings on the company intranet, in in-house newsletters, or bulletin boards in break rooms or announce them at staff meetings. Internal recruitment has several advantages. It tends to be a morale booster for employees because they know that the company has an interest in promoting its own employees. In addition, because employer and employee have established a working relationship, the risk of filling a position with an unsuitable candidate is lessened. Filling jobs internally is also generally quicker and less costly because it reduces

Job Analysis Company: Nelson Wireless Position title: Marketing manager (a) Job description

(b) Job specifications

Join a team of marketing professionals focused on mobile technologies in the consumer market segment.

• College degree required with emphasis in marketing, business administration, or communications preferred

The marketing manager is responsible for coordinating and/or implementing marketing projects designed for the consumer market segment. Working in cooperation with the sales team, product offers, and other headquarters marketing teams, the marketing manager will coordinate public relations projects and other promotional activities to drive Nelson Wireless brand awareness and product demand and generate consumer purchases.

• 3+ years marketing/communications experience required

The marketing manager will provide strategic oversight for regional-level industry events, and be responsible for planning and executing customer events. The marketing manager will be responsible for coordinating budgets and timelines, maintaining accurate records of expenditures, and compiling reports of activity results. Additionally, he/she will be responsible for managing a team of 8–10 marketing associates. The marketing manager role will also include administrative elements such as invoice processing, event scheduling, and maintenance of a promotional calendar.

• Excellent demonstrated verbal and written communication skills • Demonstrated experience in event execution • Demonstrated ability to coordinate cooperative working relationships across multiple parties • Ability to work well under pressure • Extremely well organized, strong project management and time management skills and strong ability to multi-task • Proven ability to operate in a fast-paced, high-growth professional environment

◼ FIGURE 9.2 A Sample Job Analysis

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the costs associated with outside recruiting and often shortens the length of the training time new hires need. Internal recruiting has its disadvantages, however. This includes the possibility of not getting the best candidate because of the limited search process. In addition, when a firm hires from within, another internal vacancy is created that must be filled. Moreover, relying on internal employees can result in “inbreeding” and leave a firm with fewer new perspectives and ideas that people coming in from outside a firm often have to offer. As a result, businesses also rely on external recruiting to meet staffing. External recruiting is the process of searching outside of a firm to fill job vacancies. Posting ads in newspapers, in trade magazines, on Internet job sites, or on social media sites such as LinkedIn, Facebook, and Twitter are methods used to reach a wide audience. ◼ FIGURE 9.3 lists various resources HR staff use when recruiting externally. Depending on the type of position, employment agencies may be used. Employment agencies often specialize in specific sectors, such as accounting, sales, or clerical services. They provide a pool of screened candidates, which reduces the hiring company’s administrative burden of recruitment. Recruitment consultants, often referred to as “headhunters,” conduct more specialized searches, usually for senior managers or key employees. Using external firms to help with the search is often expensive, but the costs of finding the wrong candidate can be even higher. How do social networking sites impact recruiting? Social media sites specifically for the professional community include LinkedIn, Data.com, and Spoke. LinkedIn has become a primary source recruiters turn to find candidates. Most people would like to hire or work with someone they know, and LinkedIn can provide helpful colleague and customer recommendations. Using applications

◼ FIGURE 9.3 External Recruitment Resources

Word-of-mouth referrals

Trade shows

College career fairs/ offices

Internet job/ networking sites

Employment agencies

External Recruitment

Virtual job markets

Headhunters

Newspapers

Hiring from competition

Industryspecific magazines

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257

such as SlideShare and Google Docs, LinkedIn members can post presentations they have given as well as showcase their portfolios of work. This helps recruiters quickly evaluate and sort prospective candidates. With versions available on mobile devices, LinkedIn is always there when an HR recruiter wants to follow a lead. Additionally, LinkedIn, along with Glassdoor.com, can help job seekers by providing them with “insider” information on companies and employees. For example, before an interview, LinkedIn might be able to provide background information on the person with whom you are meeting. Knowing more about the interviewer and the company can provide good conversation during the interview. Does technology help or complicate recruiting? There are both opportunities and challenges that come with the use of technology. Compared to older methods of recruiting, candidates can be recruited much more quickly, and different types of candidates—often those who are technologically savvy—are more likely to be recruited. For example, by ensuring all of its jobs were viewable on mobile platforms, UPS has been able to recruit younger employees in inner cities who might not have regular access to computers at home and must go to their schools or libraries to look for jobs. By searching sites like LinkedIn, recruiters can also find talented employees who might not be actively searching for work but who would consider leaving their jobs for the right opportunities. The drawback of online job postings is that they yield many responses and thus a large pool of candidates, so sifting through these responses to find the right person for the job can be a time-consuming process for HR professionals. The challenge of finding qualified candidates for critical positions is significant. Therefore, HR managers must know how to skillfully use technology. At a basic recruiting level, this means learning how to make a posted job description appeal to the most qualified candidates as well as stand out from competitors in the online environment so the right person can find the open position more readily. In addition, HR departments are using software systems to scan résumés and help screen applicants to weed out those who are unqualified. The software program Unicru is used by many retail stores to screen candidates for dependability, honesty, and other qualities. Some firms have successfully reduced their employee turnover rates using electronic screening methods. Other people argue that electronic screening eliminates strong candidates with interesting backgrounds because they don’t fit job profiles

Social Media and Privacy

hat are the risks of posting information on social media sites if you are trying to find a job? As a job applicant, don’t be surprised if the people considering hiring you review public information you post— such as reading your Facebook Wall and checking out the Facebook pages of your friend. What if during an interview an employer asks that you “friend” them into other areas of your Facebook site? The proper workplace use of public information is not yet clearly defined, so some employers watch public postings to see what kind of comments employees are making about the company. What if confidential information that is sensitive to the company appears on your Twitter feed—can the company take action against you? If you are using geolocation apps like FourSquare, your location becomes public information that might give away important clues to a technologically savvy recruiter or hiring manager who wants to know where you “hang out.”

Even if the recruiter or hiring manager doesn’t personally conduct a search, he or she can hire an outside firm, such as Social Intelligence, to do so. For a fee, firms like Social Intelligence scour social media sites and other sites and, based on the information they find, create reports on candidates. For legal and other reasons, companies are finding it important to establish policies for employees on how to use social networking. The site Social Media Governance provides the current policies of many major corporations. For example, Intel has set of Social Media guidelines that require employees to disclose employment relationships when commenting on Intel’s products/services on social media.1 On a positive side, social media can be used as your own personal marketing agency, creating a “brand” for you as a prospective employee. Does your Facebook page attract a second look from a professional recruiter? Consider including presentations and videos that show your abilities and potential.

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Candidates Determine initial pool of candidates from applicant files

◼ FIGURE 9.4 The Hiring Process

Managing a Business and Employees Interview Conduct initial and follow-up interviews

Skills Check

References

Test for specific job skills

Conduct background and reference checks

Select Make final selection

Hire Hire and monitor through probationary or trial period

programmed into the software. Strong candidates who simply don’t use words in their résumés that the software is searching for can also get eliminated.

hiring What happens in the hiring process? As ◼ FIGURE 9.4 shows, hiring is a multistep process. The first step is to select a pool of qualified candidates from the original group of applicants. To do this, HR managers compare the applicants’ qualifications to the job specifications. Some firms use applicant-tracking system software to screen résumés and narrow down the pool. The software also tracks applicants’ progress through the hiring process and can notify them and hiring managers about where each person stands in the process.2 After identifying a small pool of appropriate candidates, department and HR managers generally interview them to gauge their strengths and weaknesses, clarify information in the candidate’s résumé, and determine whether he or she is a good match for the position. Candidates might also need to complete some skills-related tests and be asked how they have handled specific job-related situations in the past. Qualified candidates are then asked to interview with the job’s manager and his or her employees. Once a candidate is selected, a conditional offer will be made. If the candidate accepts, the company completes thorough background and reference checks and drug and medical tests if the firm requires them. It’s not uncommon to hear stories about companies that failed to conduct background checks and were later sued by their employees and other people because the person became violent on the job and injured them. It’s also not uncommon for someone to falsify his or her educational or professional experiences or to have been in trouble with the law. For example, Dennis O’Riordan, a high-powered lawyer and partner in the London firm Paul Hastings, was disbarred when it was revealed he has falsely claimed he had degrees from Oxford and Harvard.3 After accepting a position, it is typical for the employee to have probationary status for a certain period of time to make sure the hiring is a good fit. What legalities must be considered when hiring? Several federal laws must be observed during the hiring process: • Federal equal employment opportunity. Established in 1965, the Federal Equal Employment Opportunity Commission (EEOC) enforces federal legislation prohibiting employment discrimination. This legislation consists of a number of different acts and laws known as equal employment opportunity (EEO) laws. The EEOC investigates discrimination claims made by job applicants and employees and files lawsuits against companies when necessary. • Civil Rights Act of 1964. The Civil Rights Act of 1964 prohibits discriminating based on a person’s race, color, gender, religion, and national origin. Title VII of the act also established the EEOC to enforce anti-discrimination laws. • Americans with Disabilities Act. The Americans with Disabilities Act of 1990 (ADA) prohibits discrimination based on disabilities (or perceived disabilities). It also requires employers to make reasonable accommodations to the known disability of a qualified applicant or employee as long as it does

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not impose an “undue hardship” on the operation of an employer’s business. Reasonable accommodations might include providing wheelchair accessibility, modified equipment, or interpreters. • Age Discrimination in Employment Act. The Age Discrimination in Employment Act (ADEA) of 1967 makes it unlawful to discriminate against a person because of his or her age with respect to employment. It also prohibits the inclusion of age preferences in job notices or advertisements, except in specific circumstances where age is considered necessary to the job’s function. • Fair Labor Standards Act. In addition to establishing the minimum wage and how overtime pay must be calculated, the Fair Labor Standards Act (FLSA) governs the use of child labor—what jobs minors are allowed to do and what hours they can work.

 HR departments take care of a company’s biggest resource—its employees. HR managers like Leslie Booth must possess a variety of skills to capably oversee a wide array of complex tasks. Although these tasks—planning, recruiting, and hiring—may not seem directly related to the overall success of a company, they are, in fact, closely entwined. After not finding a strong candidate for four weeks, Leslie decided to rewrite the job description to more carefully match the job specifications. She expanded the search into virtual job markets and LinkedIn and offered a bonus to employees for word-of-mouth referrals. Applications began to arrive that were from higher-caliber candidates, and sheis confident her firm will hire someone for the position soon. Objective 9-2

training and evaluating employees Explain how employees are trained and evaluated.

 George Hensel is an expert at running meetings— and everybody knows it. A meeting with George in charge will be just the right length, everybody will have their voice heard, and creative results often emerge. Employees throughout the national company would love to run a meeting like George does, but there is no time or budget to send him around the country to train them on how to do so. How can George’s skills be leveraged to help the entire company? Companies that emphasize training and development experience greater employee productivity, loyalty, and retention—all of which are good for the bottom line. In this section, you’ll learn about how training and evaluating employees can enhance the success of a business and ensure that employees stay in top form.

Training Methods and Requirements What kind of training do new employees receive? Initially, when an employee is hired, an organization uses an orientation program to integrate a new employee into the company. Orientation can be as simple as an overview

Source: eric Audras/PhotoAlto/Alamy Stock Photo

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New employee Orientation

Introduction

To Fellow Workers and Supervisors

Tour of Work Area

Employee’s job

Role of supervisor

Position description

Hours of work

Schedule (flextime/ compressed)

Breaks and lunch periods

Performance

Probationary period

Job elements and standards

Appraisals and evaluations

Leave

Employee responsibilities in application

Reporting illness or emergency

Signing in/out

Training and advancement

On-the-job; classroom

Schedules

Individual development plan

Ethics

Training

Security

Use of property

Safeguarding passwords/IDs

Security awareness training

Health professionals can practice emergency skills on simulators. Source: burger/Phanie/ canopy/Getty images

To Organizational Mission Employee responsibilities

To Health Unit Sources of assistance

of an organization and the distribution of basic information, such as company procedures and expectations. Today, however, many companies are going beyond the traditional orientation program of explaining rules and regulations, as reflected in the orientation checklist in ◼ TABLE 9.1. Orientation is more effective when it familiarizes the employee with a company’s mission and discuss how a new employee’s contribution can add to a company’s success. What other training is required of new and current employees? Training begins where orientation ends. Training should teach employees new skills or ways to improve their existing skills. For example, a salesperson might know how to sell a product but may not know all the intricacies of selling a new product. Often, other employees in the department or the recent hire’s mentor can conduct on-the-job training. With onthe-job training, employees learn skills by performing them. For example, there are many training and certification programs to become a pharmacy technician. But the specialty of nuclear pharmacy technician, a position that requires dispensing radiopharmaceuticals for use as therapies or for diagnostic testing in hospital settings, requires 500 additional hours of onthe-job training.4 Some jobs require an apprentice training program. In an apprentice training program, people go through classroom or formal instruction and get on-the-job training. For example, there is a growing need for underwater welders to repair the infrastructure of bridges and other underwater structures. To be an underwater welder, you need to complete a surface welder program and a commercial diving program. Next you would apply to a commercial diving company that offers underwater welding as a service. You would begin your career as a diver tender (apprentice diver) to gain experience. Once you gain enough experience, you can advance to welder-diver status, at which point your wage rate would increase. A programmed learning approach is one in which an employee is asked to perform step-by-step instructions or respond to questions, often in the form of computerized multiple-choice

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tests that provide immediate feedback. The benefit of programmed learning is that an employee can progress at his or her own pace, picking up information piece by piece. For some settings, though, this kind of training may not match the type of complex decision making needed to teach employees. A firm must also provide computer access to employees and acquire and maintain the software needed for this type of a training program. What kind of impact does technology have on training? Improvements in technology provide companies with other training options, such as simulated training and interactive multimedia training. Gamification, the application of game design concepts to nongame settings, has led to some training tools that are engaging. Cold Stone Creamery, the U.S. Army, and Hilton are all turning once-dull training into an interactive video experience by using games to train their employees. One study by the Entertainment Software Association showed that 70 percent of major U.S. employers have used interactive software and games for training.5 Other companies offer simulation training. Simulations provide employees with realistic experiences they would face on the job without having to worry about the catastrophic consequences that would result by making a wrong move. Simulation training is suitable for airline pilots, astronauts, and medical professionals for whom making mistakes during training is not an option or is too costly. Online training allows employees to get training on the Internet either delivered live or at their own convenience. Instructors in one location can train groups of employees at remote locations via webcasts, webinars, and videoconferencing technology. These technologies allow users to share documents, share application software, swap control of meetings, and depending on the type technology, allow trainers to take over an attendee’s desktop for demonstration purposes. Attendees can ask questions in real time, comment to the group as videos are being shown, and archive the session for later viewing. Electronic Performance Support Systems (EPSSs) contain online modules employees can access when they need training instead of attending long, formal training sessions disconnected from their daily work. Organizations are finding that EPSSs can be cost effective. One case study reported that after a client implemented an EPSS, a year later, the firm’s employees had made more than 300,000 requests for training. By being able to be train its employees on the spot and electronically, the company saved $2.6 million.6 Do managers need training? Yes, but because of their roles in the organization, managers require different types training. Managerial training often focuses on leadership, communication, teamwork, and relationship-building skills. In addition, managers need to keep abreast of changes in employment laws, such as laws related to discrimination and harassment, as well as updates in using new tools for electronic communication. Management development programs prepare managerial trainees to become managers. These programs may have trainees participate in an on-thejob training program, which might include job rotation, whereby an employee rotates through different departments to learn firsthand the various aspects of the business, or a coaching/understudy program, in which an employee works directly with the company’s senior managers to learn how to plan, lead, and make decisions at the corporate level. With action learning, another management development training approach, trainees work alone or together on teams to analyze real-time corporate problems that extend beyond their areas

Video conferencing and teletraining allow employees at various remote locations to train and work together easily. Source: Monashee Frantz/OjO images Ltd/Alamy Stock Photo

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of expertise. Companies such as Microsoft, DuPont, and Boeing have successfully implemented action-learning teams as part of their management developmentprograms. Some companies use off-the-job training and development techniques that require employees to participate in outside seminars, university-conducted programs, and corporate universities. Hamburger University, McDonald’s system of 22 corporate training facilities, trains employees for management roles. Nineteen full-time professors offer training for restaurant managers, department heads, and executive development. Through interpreters, McDonald’s trainers can deliver courses in more than 28 languages.7

◼ FIGURE 9.5 A Sample Performance Appraisal

How are experienced managers developed? Senior managers often use executive coaches to further develop their effectiveness. Executive coaches identify a manager’s strengths and weaknesses by interviewing those who work closely with the manager. They then meet with the manager to minimize their weaknesses and further develop their strengths. Mentoring is another option companies use. A mentor is an employee with more experience who takes a less experienced coworker under his or her wing. The mentor shows the person how to perform specific tasks, creates opportunities for him or her to learn new skills, and counsels him or her about the consequences of particular actions and decisions. A new practice named reverse mentoring is beginning to show up in the workplace as well. In reverse mentoring, older employees, often executives, are trained by younger ones on how to use technology and on new trends in the marketplace. It benefits both because the younger employees garner experience and time with higher-level management. Like other forms of training and management development, mentoring increases employee performance, satisfaction, and loyalty.

Performance Appraisals and Alternatives Why are performance appraisals necessary? A performance appraisal is a formal evaluation, usually done annually or biannually, that provides an employee with feedback about how well he or she is doing on the job. A sample appraisal form is shown in ◼ FIGURE 9.5. Managers use the results of performance appraisals to make decisions about promotion, raises, additional training, or reassignments. The performance appraisal process is important for both employees and the organization as a whole and includes three aspects: • Evaluating the performance of an employee relative to the job’s performance standards • Providing feedback to reduce and eliminate poor performance and improve or enhance positive performance • Setting goals toward which employees should aim in their work When employees are hired, they should have a good understanding of what is expected of them. These expectations become the performance standards on which they’ll be

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measured. Appraisals act as a confirmation of these standards and help employees establish quantifiable and measurable goals for improvement in the upcoming year. Are there problems with performance appraisals? Performance appraisals, when conducted properly, are helpful to an employee and ultimately an organization. However, they are often not effective. Many managers shy away from them because they are uncomfortable delivering negative comments. Managers also sometimes have a difficult time objectively appraising the performance of employees because they often do not see all of the aspects of the employees’ performance. The use of a 360-degree appraisal can help in this instance. Input for the appraisal is solicited, usually anonymously, not from just a person’s managers but also from coworkers, customers, and subordinates. Although performance appraisals are way to provide feedback to an employee about how to improve a weak performance or enhance a solid one, the process does not always result in follow-up to ensure the feedback has been acted on. Typically, it is not until the next performance appraisal that a manager and employee reluctantly admit that the needed training and development did not occur. And when the next appraisal can be a year away, more immediate crises can take time away from the focus on an appraisal’s recommendations. What alternatives exist for performance appraisals? An alternative to a performance appraisal is performance management. Performance management is an approach that combines goal setting, performance appraisals, and training and development into a unified and ongoing process. As such, it is more of a cyclical and fluid process than the single occurrence of a performance appraisal. Employees are constantly receiving feedback and given opportunities for training and development to ensure that they have the right tools with which to perform their jobs. ◼ TABLE 9.2 summarizes several aspects of the performance management process. The concept, although often applied to employees, is also applicable to other components of an organization, including an entire department, a product or a service, or an organization as a whole.

TAble 9.2

Aspects of Performance Management

Direction sharing

Communicating an organization’s higher-level goals, such as vision, mission, values, and strategy

Role clarifying

Defining roles in terms of daily work tasks

Goal setting and planning

Translating organizational or departmental goals into specific employee goals, which includes an employee’s development of the steps necessary to achieve goals

Ongoing performance monitoring and feedback

Periodic performance reports about an employee’s progress toward meeting his or her goals as well as feedback about how better to achieve them

Coaching and support

Ongoing feedback and support for the employee

Performance assessment (appraisal)

An element in the performance management process that offers specific information about how an employee’s performance is improving the company’s results

Rewards, recognition, and compensation

Given as appropriate to motivate an employee toward achieving current and future goals

Work flow, process control, andreturn on investment

Making sure an employee’s measurable performance is linked to measurable goals of company

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 Performance management, appraisals, and training can play a significant role in keeping a business productive and efficient. George Hensel’s company decided that knowing how to run and participate in a productive meeting are skills all employees should have. They therefore created online learning modules that featured videos in which George explained how people often allow meetings to go off track. The company then created a game that allowed players to conduct a virtual meeting and be scored based on how well they did. Employees who watched the online training and attempted the simulation a certain number of times received credit for doing so in their performance appraisals. The commitment to training created more productive meetings throughout the company.

Objective 9-3

compensating, scheduling, Promoting, and terminating employees Understand how employees are compensated and scheduled and detail how an employee’s status can change as a result of promotions, termination, and retirement.

Source: Glowimages RM/Alamy Stock Photo

 Kathy Sanchez loves what she does. Since graduating from college two years ago, she has worked for a small start-up company as a graphic designer, creating brochures and other materials for a wide variety of clients. Because the company is so small, she gets to work on projects she would never have a chance to work on in a bigger company. She also loves the relaxed atmosphere of the office and feels like her coworkers are actually her friends. So what’s the problem? Because the company is still finding its footing in the marketplace, it isn’t able to offer her much in the way of pay or benefits. Although she loves her work, she is tired of reaching the end of each pay period with no money left. And don’t even ask her about her retirement plan or dental insurance! What should she do? Having the right pay system in place is very important for a company to become and remain competitive. A good compensation package attracts high-quality employees and keeps them from leaving. But compensation is not just about monetary rewards. In today’s workplace, employees frequently receive compensation in a variety of forms, including work/life benefits, health insurance, and retirement plans. Because there are many ways to compensate employees, deciding how to structure a competitive compensation package is not an easy one. It’s often a delicate balance between paying employees enough to attract, motivate, and retain them while keeping a company financially sound and providing its owners with a return on their investment. In this section you’ll see how HR professionals manage compensating, scheduling, promoting and terminating employees.

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Compensation Strategies Are all employees paid in the same way? There are many ways to pay workers for their time and effort. Compensation, payment for work performed, is generally offered in the form of fixed salaries (annual pay for a specific job) or wages (payments for hourly work). Usually, on an annual basis, an employee’s compensation level has the potential to increase based on the results of the person’s performance evaluation. Incentive-based payment structures are better compensation strategies for some positions, such as those in sales. A salesperson typically has a lower base salary, which can be enhanced with commissions based directly on the employee’s sales levels or performance. Incentive-based compensation rewards employees who achieve strong measurable results. Bonuses, compensation based on total corporate profits, help tie employees’ efforts to the company’s bottom line. Higher corporate profits mean higher bonuses. What types of retirement plans do companies offer employees? The most popular retirement plan offered today is the 401(k) plan. A 401(k) plan is a retirement plan in which an employee invests pretax dollars in a bundle of investments generally managed by an outside investment company, such as the Vanguard Group or Fidelity Investments. The amount of the annual contribution is determined by the employee as a percentage of salary up to a specified legal limit. In some cases, a company will match a portion of the employee’s contribution to the account. A 401(k) is referred to as a defined contribution plan because the amount an employee receives at retirement depends on the amount of the contributions and the fund’s investment earnings. The burden of risk falls on employees because they decide how much to contribute to their plans and how the money will be invested. An employer that has a pension plan regularly contributes a certain amount of money to a retirement fund for its employees. Employees know ahead of time exactly how much pension money they will receive when they retire based on their years of service to the company. A pension plan is a defined benefit plan. Defined benefit plans are not popular with employers because they entirely fund them and take on financial risks if the fund’s investments do not perform as expected. A profit-sharing plan is a term used for a range of different types of compensation options. If the company hits certain profit targets, then there is a bonus structure for employees. Sometimes the term profit sharing is used for company contributions to an employee retirement plan. Profit-sharing plans are often offered as a part of executive compensation in larger companies, but in many small companies, they are a way to motivate employees, especially during the start-up phase when cash is tight and salaries may be low. What other financial incentives do companies offer as compensation? Stock option agreements allow an employee to purchase a specific number of shares of stock at a specific price but only at a specific point in time. If the stock’s value increases beyond that point, the employee can reap a huge financial reward. If not, however, the employee gains little. Facebook used stock options as part of a compensation package designed to lure top engineers. When the company began selling shares to the public, the engineers were able to exercise their stock options, and thousands of employees at Facebook became millionaires as a result.8 Employee stock purchase plans allow employees to buy company stock at a discount (usually at 85 percent of their market value). Companies typically limit the amount of stock an employee can purchase this way to 10 percent of their total salary. Employee stock ownership plans (ESOPs) are plans whereby employees are given stock in a company based on the amount of time they have worked for it. The stock is held in the ESOP’s trust fund until the employees either retire or leave the company. The largest employee-owned company is Publix, a supermarket chain that tops $25 billion in sales each year. Every employee, from managers to checkout clerks, owns a piece of the company. Publix commonly places in the

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Forbes list of “100 Best Companies to Work For” and almost always relies on internal recruiting to promote employees. In fact, Publix president and CEO Todd Jones started there as a bagger over 30 years ago. An advantage of providing employees with ownership in a company via stock transactions is that employees feel more connected to the business and are motivated to ensure that the business succeeds.

benefits What are noncash forms of compensation? Employee benefits are indirect financial and nonfinancial rewards employers provide their employees to supplement their wages and salaries. Some benefits are mandated by law. For example, the Affordable Care Act, passed in 2010, requires firms with more than 50 full-time employees to provide them with healthcare coverage or else pay a penalty. Other benefits are voluntarily provided by employers. Vacation time, holidays, and pensions are examples. Some companies offer flexible benefit plans (or cafeteria plans) that allow employees to pick from a menu of several choices of taxable and nontaxable forms of compensation. Flexible benefit plans allow employees to choose the benefits that are most important to them while reducing the cost of offering all benefits to all employees. What are work/life benefits? Work/life benefits are benefits that help an employee achieve a balance between the demands of life both inside and outside the workplace. Work/life benefits include flexible schedules, relaxed atmospheres, and child care and fitness/gym programs. For example, the SAS Institute, the largest privately held software developer in the United States, offers employees unlimited sick leave, an on-site fitness club with indoor pool, on-site car detailing, massages, and a hair salon. There are four subsidized child care centers on site and pantries stocked with free food. Although seemingly expensive, this strategy of keeping its employees happy saves the company approximately $70 million per year because it experiences low turnover. In fact, compared with an industry average of 20 percent turnover, SAS has kept its turnover rate below 5 percent.9

The Googleplex, Google’s Mountain View, California, campus, has amenities including swimming pools, 11 free gourmet cafeterias, volleyball courts, and massage services. Source: Yana Paskova/Getty images

What are some other trends in employee benefits? In the early 1980s, the Village Voice, a free alternative weekly newspaper in New York City, began offering domestic partner benefits. These benefits provide for an employee’s unmarried partner of the same or opposite sex. Since then, domestic partner benefits have become increasingly common components of compensation packages. In fact, almost 62 percent of Fortune 500 companies offer domestic benefits to their employees.10 Benefits such as health care and family leave policies are extended to domestic partners.11 The Family and Medical Leave Act states that companies with more than 50employees must allow all eligible employees to take up to 12 weeks of unpaid time off to be with family because of medical issues, births, or adoptions. Upon the employee’s return, the act guarantees that the employee can return to his or her job or a comparable job. This benefit compares weakly to those of other countries. At least 178 countries have laws that guarantee paid leave for new mothers; more than 50 countries offer paid leave for new fathers as well. Rising healthcare costs are impacting businesses and bringing changes to the medical benefits employees can expect. A rising trend is for employers to provide employees with a fixed amount of money to purchase health care on their own in the marketplace instead of providing a choice of specific plans. Some companies are dropping working spouses from eligibility, requiring them to negotiate health care with their own employer.

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Alternative Scheduling and Work Arrangements What work schedules are possible outside of the traditional workday? An increasing number of employees are finding that keeping up with the demands of their work and personal lives has left them doing neither well. The added stress employees today face from child care, elder care, commuting, and other work/ life conflicts have led to a decrease in productivity and an increase in employee absenteeism and tardiness. As a result of these demands, more and more employers are offering alternatives to the traditional 9-to-5, Monday-to-Friday workweek. In addition to benefiting employees, flexible work schedules can also benefit employers. A study conducted by the Gallup research group looked at employees with flexible schedules who were allowed to work from home and found that they actually worked an additional 4 hours per week.12 The most popular flexible work arrangements include the following: • Telecommuting. Telecommuting allows employees to work in the office part-time and work from home part-time or to work completely from home and make only occasional visits to the office. Cisco employees work remotely an average of two days per week, a practice that the company estimates has saved it $277 million.13 The disadvantages of telecommuting include monitoring employees’ performance at a distance, servicing equipment for off-site employees, and communication issues. Additionally, employees who telecommute can become isolated from other employees. Yahoo! used to allow telecommuting but ended the practice because its CEO believed it was leading to less collaboration and idea generation among employees. • Alternative scheduling plans (flextime). When a company implements flextime, it specifies a core set of hours that define the workday and is flexible with the starting and ending times employees can work. • Compressed workweek. A compressed workweek allows employees to work four 10-hour days instead of five eight-hour days each week or nine days instead of 10 in a two-week schedule for a total 80 hours. However, firms need to check their state labor laws. Many states, for example, prohibit minors from working in excess of eight hours per day. • Job sharing. Job sharing is an arrangement in which two employees work part-time to share one full-time job. Those who share a job are often motivated to make the arrangement work, and productivity and employee satisfaction can increase. However, job sharers must carefully coordinate and communicate with one another and their employers to ensure that all of the responsibilities of the job are met. • Permanent part-time. Permanent part-time employees are hired on a permanent basis to work a part-time week. Unlike temporary part-time workers who are employed to meet a firm’s shortterm needs, permanent part-time employees in some firms enjoy the same benefits full-time employees do. What benefits do employers see from supporting alternative work schedules? Despite the costs associated with designing and implementing flexible working arrangements, employers can expect positive bottom-line results as a result of increases in employee satisfaction, decreases in absenteeism, and increases in worker productivity. Similarly, reductions in employee turnover lead to a decrease in time and costs associated with employee recruiting and replacement training.

UPS offers a permanent part-time package handler position in which employees work about four hours per day, Monday through Friday. UPS offers permanent part-time employees health insurance, vacation time, a stock purchase plan, and, in certain locations, tuition assistance. Source: Gg/AGe Fotostock

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Contingent Workers Why does a company hire contingent workers? Contingent workers are people who are hired on an as-needed basis and lack status as regular, fulltime employees. These workers often fulfill important and specific functions. Contingent workers are most likely hired by companies in business and professional services, education and healthcare services, and construction industries. Companies hire such temporary workers to fill in for absent employees or augment the staff during busy periods. Long-term temporary employees are often hired for indefinite periods of time to work on specific projects. In many cases, temporary staffing is part of a company’s HR “temp to perm” strategy in which temporary employees are evaluated and then moved to permanent positions if they are found to be reliable and skilled. Independent contractors and consultants are examples of contingent workers who are generally self-employed. Companies hire them on a temporary basis to perform specific tasks. Often, contractors are hired for jobs that involve state-of-the-art skills in construction, financial activities, and professional and business services. For example, it might be most cost efficient to hire a web page developer as an independent contractor rather than keeping one on staff permanently. Consultants are hired to assist with long-term projects, often at a strategic level, but also with a specific end in sight. For example, a company that is reviewing its executive management compensation arrangements might hire a compensation consultant. Is temporary work a common situation for people? The U.S. Bureau of Labor Statistics estimates that the temporary workforce accounts for more than 2 percent of the U.S. workforce.14 Temporary staffing is a $70 billion industry. Kelly Services and Manpower are two prominent temporary agencies. Temporary workers often get the opportunity to work in many different companies, do different jobs, and meet numerous people. Recent college graduates and college students may find that temporary work is a good way gain real-world experience in an industry they are interested in pursuing on a full-time basis and see if the companies they are temping at are employers for whom they would like to work full-time. But temporary workers are often paid less than full-time workers and are less likely to receive benefits. The temporary agencies they work for may provide them with some benefits, however.

Promotions How can employees increase their levels of responsibility in a company? After performing successfully in a position, many employees look to increase their responsibility levels and pay in a company or a department by seeking a promotion. Employers like to promote from within because it allows them to reward exceptional behavior and fill positions with tested employees. However, a promotion may not always result in a positive situation if it was made in secrecy or arbitrarily. Sometimes employees are promoted to new positions without other employees being given a chance to apply for them, which can lead to hard feelings. Therefore, management must ensure that promotions are based on a distinct set of criteria, such as seniority or competency, and that HR protocols are followed.

THE LIST

Top 10 Ways to Get Promoted

1. Get a mentor.

6. Be consistent.

2. Learn outside of work.

7. Help your colleagues.

3. Self-promote your successes.

8. Tell your boss you want to be promoted.

4. Volunteer. 5. Ask questions.

9. Be a team player. 10. Create your own opportunities.

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Do promotions always move you into management positions? Consider an engineer who succeeds on the job but has no desire to manage. Some companies provide two career paths: one toward management and the other for “individual contributors” with no management aspirations. Engineers with a desire to manage can pursue one track, and other engineers without managerial aspirations or capabilities can be promoted to “senior engineer” positions. Alternatively, it’s always possible to keep employees in their same job but give them more responsibility, thus enriching their experience while continuing to prepare them for further advancement.

Terminating employees Why do companies lay off workers? At times, it becomes necessary to reevaluate an employee’s contribution or tenure at a company or the composition and size of the workforce altogether. Downsizing and restructuring, the availability of outsourcing and offshoring, the pressures of global competition, and the increased uses of technology are also reasons companies look to reduce the number of employees. Termination refers to the act of permanently laying off workers resulting from poor performance or a discontinued need for their services. Companies often offer a set of benefits for terminated employees, including the continuation of healthcare coverage for a period of time, severance pay, and outplacement services, such as résumé writing and career counseling. Terminating employees as a result of poor performance or illegal activities is a complex process. Most states support employment at will, a legal doctrine that states that an employer can fire an employee for any reason at any time. Likewise, an employee is equally free to resign at any time for any reason. Regardless of the employment-at-will doctrine, employers cannot discriminate or fire someone because of the person’s race, religion, age, gender, national origin, disability, or childbearing plans. In addition, companies cannot terminate employees for whistle-blowing (revealing company wrongdoing to authorities), engaging in legal union activities, filing a worker’s compensation claim, performing jury duty, or testifying against a company in a legal proceeding. How does a manager prepare to terminate an employee? Before firing an employee for wrongful acts or incompetence, managers must take steps to avoid a wrongful discharge lawsuit. These steps include maintaining solid records so that they can build a documented case for dismissal that’s legally defendable. Courts have sided with the terminated employee, especially when not enough evidence of poor behavior is brought forth. Hearsay and rumors of wrongdoing often do not stand up in legal proceedings. Consider Monique Drake, a medical secretary in the same physician’s practice for 12 years. The doctor married, and his new wife began running the office. This new office manager told Drake that because of poor performance, her salary was being cut from $54,000 to $40,000, her sick days would be eliminated, and her vacation time would be cut. A month later Drake was terminated. She sued and won her case for wrongful dismissal. Part of the reason why she won was because there was a lack of documentation showing that her performance was weak and because her employers clearly had no ongoing discussion with her about improving her performance.15

Retirement Is there a set age when employees retire? It Retirement is the point in one’s life where one stops participating full-time in a career. It used to be that employees retired when they were 65 years old. However, the legal age at which workers can collect Social Security is gradually rising. Workers born after 1959 must now work until age 67 before then collect it.

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Many older employees are continuing to work to stay active and engaged and remain on their firm’s healthcare insurance plans. Other employees are remaining on the job because they haven’t saved enough money to retire or their savings haven’t grown as much as they hoped for as a result of the last recession. One impact of this shift in workforce demographics is that younger employees are experiencing greater competition for jobs and promotions than they have in the past. For employers, an aging workforce may present other challenges, such as age-discrimination lawsuits if they aggressively lay off older workers. To encourage older workers to retire, some companies offer them worker buyouts (or golden parachutes), which are one-time payments to leave a company. For example, in recent years, the U.S. Postal Service has offered its employees several buyouts to reduce its operations and costs. Phased employment is another option. Longtime employees are moved to part-time basis for a period of time and then shifted into retirement. That practice offers the company the chance to avoid a sudden draining of experience from the company.

 Remember Kathy Sanchez? She loved her job but wasn’t sure what to do because of her low pay and benefits. After some serious soul-searching, Kathy decided to stay on at the small company, but she has set a limit of two more years before she starts looking for a job elsewhere. She is hoping that within that time frame, the start-up company will find solid footing and be able to offer its employees a more attractive and competitive compensation package that could include stock options.

Objective 9-4

Managing Workplace Diversity Describe how incorporating diversity affects the workforce.

 Chandraki Patel always thought of herself as

Source: jose Luis Pelaez iNc/image Source/Alamy Stock Photo

someone who was familiar with a range of types of people and cultures. Although she was born in Detroit, her parents came from India, and she has often traveled abroad for vacations. But now that she is a manager at an international marketing firm, she is faced with issues she never anticipated. She has a staff that includes men and women from six different nationalities with five different religions (each with different holiday calendars). In addition, she is responsible for remotely managing sites in Dublin, Ireland, and one in Beijing, China. The language and cultural differences there have caused misunderstandings more than once. How could anyone manage so many different types of people and locations? The workforce is becoming more diverse. In this section, you’ll learn why and how diversity creates both challenges and benefits for organizations.

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benefits and Challenges of Diversity Why has the modern workplace become so diverse? The changing demographics of the United States is a major reason why the workplace is becoming more diverse. Workers of Hispanic origin, for example, make up about 15 percent of the workforce today. But because of the rapid growth of this segment of the population, by 2050 it is estimated they will make up 30 percent. The percentage of people of Asian descent in the workforce is also expected to double by 2050.16 Advancements in technology have made it possible for businesses to operate with relative ease on a global basis. It’s not unusual for companies to outsource or offshore work to other countries to decrease labor costs or establish operations in other countries to broaden their market reach. Hiring patterns are adding to the diversity of the workforce as U.S.-based companies hire workers who have emigrated from other countries. European and Middle Eastern companies are experiencing similar increases in immigration. More women are now in the workforce than in decades past. And, as we indicated, many more employees than ever are indicating that they plan to work beyond the traditional retirement age, meaning increased age diversity in the workforce. For all these reasons, the modern workplace is now diverse in age, gender, and ethnicity. How is a diverse workforce beneficial? Diversity is an important component of the modern workplace. For many companies, hiring to diversify the workforce initially meant fulfilling an affirmative action requirement by filling positions with a certain number of women, Hispanics, or African Americans. Some criticized this strategy as unfair and bad for a company if the best candidate was not hired in favor of meeting such a requirement. Over time, however, many companies have come to embrace the idea of diversity beyond just satisfying a requirement. It’s now becoming clear that companies should embrace diversity to improve their competitiveness. A diverse workforce helps companies offer a broad range of viewpoints that are necessary to compete in a world that is more globalized. In addition, products and services need to be tailored to customers and clients with diverse backgrounds, so it’s vital to have a workforce that understands the cultural needs of different customers. When PepsiCo’s Frito-Lay division launched a Doritos guacamole-flavored tortilla chip to appeal especially to Latino consumers, its Latino employees provided valuable feedback on the product’s taste and packaging. The new chip variety generated more than $100 million in sales in its first year, making it the most successful product launch in the company’s history. What issues do companies face while managing diversity? Despite its many benefits, a diverse workforce can pose challenges. For example, a more culturally diverse population naturally brings about a wider variety of religious beliefs and practices, with more employees trying to integrate their religious practices into the workday. As employers struggle to accommodate workers’ religious needs, they must also try to avoid the potential friction that open demonstrations of religious practices might provoke. Many employers strike a balance by allowing employees to take prayer breaks and time off to observe religious holidays, catering to dietary requirements, and permitting differences in dress. Floating religious holidays and on-site religious accommodations, such as prayer rooms, are used by companies to meet the needs of a diverse religious workforce. Although the number of women in the workforce is growing, women are still battling some of the

Harley-Davidson realized that to remain competitive, it needed to understand the needs and wants of customers beyond the traditional stereotype of the white male. The motorcycle manufacturer has made a significant effort to hire and retain women and minority managers. Source: Gary Gardiner/Getty Images

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One Diversity Training Does Not Fit All

iversity training workshops and seminars that teach managers and their employees about the benefits of having a diverse workforce can be quite costly. And yet, according to a recent study, most of these programs don’t work.17 After analyzing years of national employment statistics, a major study concluded that standard diversity training rarely had an effect on the number of women or minority managers employed by companies where it was used. Why not? Some people theorize that mandatory training inevitably leads to backlash; others say that altering people’s inner biases is a nearly impossible task.

OFF The MARk

Hope for promoting diversity in the workplace is not lost, however; the study also found that two techniques had significant, beneficial effects on workplace diversity: (1) The appointment of a specific person or committee accountable for addressing diversity issues within the company led to 10 percent increases in the number of women and minorities in management positions, and (2) mentoring increased the number of African American women in leadership positions by 23.5 percent.

same issues that their mothers and grandmothers faced: sexism, salary inequities, and sexual harassment. Historically, women in similar positions as their male counterparts were paid less and experienced fewer promotions despite documented higher performance ratings. Gender-discrimination and sexual harassment lawsuits continue to receive national press and indicate that gender-related challenges have not gone away. Moreover, men still dominate top managerial positions. Fewer than a dozen Fortune 500 companies are headed by women. The aging workforce also creates several challenges. Compared with younger workers in the same position, older workers often expect higher salaries and better benefits. Healthcare costs, for example, are higher with an older workforce. However, many employers find that there is less turnover and absenteeism among older workers and that they are willing to learn new skills as well as help and train their younger coworkers. These benefits can offer enough savings to a company to negate the higher costs of retaining more senior workers. How can employees improve their understanding of each other’s differences? Differences can create misunderstandings and conflict despite the most well-intentioned actions. Therefore, it is important that employers provide effective diversity training for their employees. It is also important for coworkers to learn to look at situations from perspectives that are different than their own. Ultimately, managing diversity means developing a workforce that has the capacity to accept, incorporate, and empower the different talents, backgrounds, and perspectives people have.

 Recall that Chandraki Patel was responsible for managing people with different cultural backgrounds, languages, and beliefs and was unsure how best to do it. To see if she could improve her performance in this area, she began researching all the ways that the diversity of the group she managed had led to innovative solutions to problems for her company. As she counted the many benefits of working with such a varied range of people in the group, she felt more motivated to manage some of the challenges. She began a training program to help employees become more adept at examining issues from a variety of perspectives. Not only did that help the group she headed up, but it also resulted in the group working better with the company’s Chinese and Irish divisions.

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Objective 9-5

Labor and Union issues List the objectives, structures, and future of labor unions in the global business environment.

 Are college football players employees of the schools they play for? College football player across the country have begun wearing wristbands with the letters APU printed on them. APU stands for “All Players United” and is a slogan of protest against the National Collegiate Athletic Association (NCAA). Some players feel they should be compensated with some fraction of the money from the television rights, merchandising, and ticket sales their play generates. They also believe the NCAA is not doing enough to protect players from head injuries or to provide them with medical insurance and care for injured players. When athletes’ images are used in ads or in video games, they earn none of the profits. Should the athletes be allowed to form a union to have a single voice in these issues? Have you ever passed a picket line and wondered why the workers were on strike? A strike occurs when workers agree to stop work until certain demands are met. In this section, you’ll learn about organized labor and its effect on the workplace.

Organized labor What is a labor union? A labor union is a legally recognized group dedicated to protecting the interests of workers. Unions represent many types of workers, such as teachers, nurses, and firefighters in the public sector; employees in the manufacturing industries; and engineers, plumbers, and roofers in the construction industry. Entertainers such as actors and writers also have unions. Labor unions negotiate various employment issues on behalf of the workers they represent, such as their salaries, benefits, and working hours. What are the objectives of organized labor? Labor unions were formed to protect workers from the terrible injustices employers inflicted on their workers in the nineteenth century during the U.S. industrial revolution. During that time, employers subjected workers to long hours, low pay, and health risks. Women and children were often treated even worse and paid less. Labor unions formed to fight for better working conditions and employee rights. A number of these unions later united to gain more power to negotiate better working conditions. Two of the more influential unions are the American Federation of Labor (AFL), founded in 1886 to protect skilled workers, and the Industrial Workers of the World, founded in 1905 to represent mainly unskilled workers. The Congress of Industrial Organizations (CIO) was formed in 1935 to represent entire industries rather than specific workers’ groups. The CIO was initially a separate organization within the AFL but soon split to form its own organization. In 1955, the two were reunited to form the AFL-CIO, which is still in effect today as a federation comprised of 56 member unions. The Change to Win Federation, formed

Source: Superstock/Glow images

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in 2005 as an alternative to the AFL-CIO, is the newest organized labor union. Other prominent unions include the United Auto Workers (UAW), the International Brotherhood of Teamsters, and the Service Employees International Union. How are labor unions structured? To form a union, a group of workers must either have their employer voluntarily recognize them as a group or have a majority of workers form a bargaining unit for union representation. A bargaining unit is a group of employees that negotiates with an employer for better working conditions or pay. When a union forms, workers join and pay membership dues. Most unions have paid, full-time staff members as well as substantial numbers of volunteer workers. In addition to the dues they collect from their members, some unions create strike funds that help support workers should they strike. Union members elect officers and shop stewards who make decisions for the entire body and represent the members in dealings with management. So that unions can better represent specific interests, union locals are created by workers of the same industry, company, region, or business sector.

Collective bargaining What is the collective bargaining process? Collective bargaining is the process that occurs when a union negotiates with an employer. The union’s goal is improving the wages, insurance and benefits, working hours, pensions, and grievance procedures for its members as a group (collectively) rather than each of them having to negotiate individually with their firms. A collective bargaining agreement is the result of such negotiations, and it forces an employer to abide by the conditions specified in the agreement. Change can be made only through subsequent negotiations. What happens if an agreement cannot be reached through collective bargaining? If negotiating does not produce a collective bargaining agreement and both parties seem to be at an impasse, then other methods are used to settle their differences before workers go on strike. One method is mediation, a process in which a neutral third party helps the two parties reach an agreement. The mediator works with both sides to understand their genuine interests and helps each side generate proposals that address those interests. Another method is arbitration, whereby a dispute is sent to an arbitrator to resolve. An arbitrator hears both sides of a dispute, and the parties involved agree in advance that the arbitrator’s decision is final. Sometimes, arbitration is nonbinding, meaning that neither party is required to accept the arbitrator’s decision. What happens when negotiations break down? When negotiations reach an impasse, union workers have several ways to persuade a firm to accept their demands. For example, the workers and people who are sympathetic to their cause can boycott the firm. A boycott occurs when people refuse to buy or distribute a company’s products or services. Companies have their tactics as well. One is a lockout. In a lockout, union members are not allowed to enter the firm’s premises. Lockouts are legal only if negotiations have come to an impasse and the company is defending a legitimate position. As a last resort, union workers may vote to go on strike and agree to stop working. Strikes jeopardize the productivity of an organization, so they are used to force management into making concessions that they might not have made otherwise. Strikes also gain considerable media publicity, especially when workers picket a workplace by walking outside a company’s entrances with signs that reflect the employees’ grievances. It is not easy to persuade a union’s members to go on strike because they risk losing income throughout the strike period. For example, a six-week strike would cost a worker earning $700 per week a total of $4,200 in lost wages. If the new contract negotiated a weekly wage increase of $1, it would take about two years

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to recover the lost wages. Additionally, strikers might be replaced by a firm temporarily or permanently with workers, known as strikebreakers, or scabs. Some states prohibit public safety workers, such as police officers and hospital workers, from going on strike. In these cases, workers often have “sick-outs,” during which union members are not officially on strike but instead call in sick and refuse to come to work.

The State of labor Unions Are labor unions still effective today? In the United States, the role of labor unions is declining. Today, only a little more than 10 percent of the nation’s workers are unionized.18 Many private-sector unions, such as the automobile workers and construction trade unions, have experienced dramatic reductions in their membership. This decline is the result of several factors, including a reaction to their own success by fighting for better working conditions, higher wages, and more benefits. Additionally, the introduction of technology has resulted in a shift from blue-collar–based industries to professional white-collar, service-based industries, for which unions are less common. Employers are also in a better position to outsource and offshore jobs done by union members. Despite their declining numbers, labor unions continue to be influential in many industries as well as in other countries. Efforts are under way to organize retail workers and service-sector workers, such as those in the fast-food industry. What is the future of unions and labor–management relations? U.S. unions have begun to build alliances with unions in other countries. They recognize that when multinational corporations decide to move production abroad, for example, there might be a negative impact on local and international workers. Consequently, in an effort to protect their interests, unions must broaden their reach to try to achieve international labor solidarity. Immigration is another issue affecting unions. Immigrant workers are crossing borders and threaten to take jobs traditionally done by the members of labor unions. Unions, especially in California and Florida, continue to grapple with integrating and embracing these potential new members into their organizations. Finally, and perhaps most important, unions will need to transform themselves to survive the effects of globalization.

 So what about student athletes who spend 50 hours a week training and practicing? Are they employees of their college? Can they form a union? Agroup of football players from Northwestern University brought a case to the National Labor Relations Board, requesting the right to unionize. The board ultimately decided not to decide, saying they did not have jurisdiction. So the door to a future challenge and the beginning of unionized college sports is still open.

After the negotiations the snack-food maker Hostess had with its unionized employees broke down, the company filed for bankruptcy. A reorganized, nonunion Hostess emerged, with new workers making far less. Source: Kevork Djansezian/Getty Images

Chapter 9

summary 9-1

Describe the processes involved in human resource management (HRM).

• Human resource management (HRM) is the organizational function that encompasses every aspect of the “human” in a business, including hiring, training, motivating, evaluating, and compensating personnel. • Staff planning involves determining how many employees a company needs. A workforce profile is compiled as a form of “personnel inventory” and includes information about each employee. The future demand for employees is determined by a process called forecasting. • Recruitment is the process of finding, screening, and selecting people for a job. • Hiring begins by narrowing down the number of applicants who are qualified for a job. They are then interviewed by human resources personnel and the job’s manager and sometimes the other people he or she supervises. Often a firm will make a conditional offer to the candidate selected, who then must first pass background and reference checks and sometimes medical and physical tests before officially being hired.

9-2

Explain how evaluated.

employees

are

trained

and

• Orientation integrates new employees into an organization so they become productive faster, feel part of the organization, and do not quit shortly after being hired. Other forms of training include on-the-job training, apprentice training programs, and simulation training. • Management development programs prepare management trainees to become managers within an organization by having them participate in on-the-job training programs, such as job rotation, coaching/understudy programs, action learning, and mentoring. • Off-the-job training and development require the employee to participate in outside seminars, universityconducted programs, and corporate universities. • A performance appraisal is a formal evaluation of an employee’s performance. Providing feedback and suggestions to employees for improvement, coaching and encouraging them, and helping them set goals are parts of appraisals. They are useful when done properly, but many managers avoid performance appraisals because they do not feel comfortable critiquing employees and do not see all aspects of their performance. A 360 performance appraisal in which input is solicited from an employee’s coworkers, customers, and subordinates and incorporated into the appraisal, can help in this regard.

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• Performance management is an alternative to performance appraisals. It approaches employee evaluations as ongoing and systematic.

9-3

Understand how employees are compensated and scheduled and detail how an employee’s status can change as a result of promotions, termination, and retirement.

• Compensation, or payment for work performed, consists of financial and nonfinancial payments. • Salaries and hourly wages, bonuses, commissions, and retirement pension plans constitute financial compensation. • Defined benefit plans specify the amount of retirement benefits employees will receive, and defined contribution plans identify the maximum contribution employees can make to their retirement plans. 401(k) plans allow employees to contribute pretax dollars to their retirement plans. • Noncash employee benefits come in many forms, including health and disability insurance, vacation and sick pay, and retirement plans. Some benefits are mandated by law. Others are provided voluntarily by employers. • Work/life benefits, such as gym memberships, are important for those employees who are trying to balance busy lives both in and out of work. • Alternative scheduling arrangements enable employees to have more flexibility in their lives. Flextime, job sharing, permanent part-time jobs, telecommuting, and compressed workweeks are alternative scheduling methods. • Employees increase their level of responsibility through promotions—taking on a job that has more responsibility and greater status and pay in a company or a department. • Termination is when companies permanently lay off workers as a result of poor performance or a discontinued use for their services. Downsizing and restructuring, outsourcing and offshoring, pressures of global competition, and increased uses of technology are reasons companies look to reduce the number of employees through termination. • Retirement occurs when employees decide to stop working on a full-time basis or stop working altogether. Financial security, staying active and engaged, and learning something new are reasons seniors cite for deferring retirement.

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9-4

Describe how incorporating diversity affects the workforce.

• The workforce today consists of employees from many different cultures and religions, which can lead to challenges in helping employees understand one another. • More women are now in the workforce than in decades past, but few are reaching executive management levels. Sexism, salary inequity, and sexual harassment remain prominent issues. • The workforce is getting older as more baby boomers work beyond typical retirement age. An aging workforce increases a firm’s health care costs but also can increase a firm’s productivity and decrease its training costs. • A diverse workforce has proven to be more creative and innovative than a nondiverse workforce. Diversity keeps companies competitive by helping them develop products and services tailored to diverse customers.

9-5

List the objectives, structures, and future of labor unions in the global business environment.

• A labor union is a legally recognized group organized to protect the interests of workers. Labor unions

Human Resource Management

typically negotiate various employment terms, such as the salaries, health benefits, and work hours of their members. • Representatives of the labor union form a bargaining unit that negotiates with an employer. The negotiations are referred to as collective bargaining. • If satisfactory terms cannot be agreed on by both sides, mediation is used. A neutral third party assists both sides and generates a proposal that addresses each party’s interests. • In the arbitration process, a third party settles the dispute after hearing all of the issues. • If negotiations break down, unions and their supporters may choose to boycott a company (not do business with it). • As a last resort, union members may vote to go on strike and agree to stop working altogether. • As the business community continues to expand globally, unions will need to increase their numbers by allying themselves with international workers and workers and immigrant workers.

Key terms 360-degree appraisal 401(k) plan affirmative action American Federation of Labor apprentice training program arbitration bargaining unit bonus boycott collective bargaining commissions compensation compressed workweek Congress of Industrial Organizations consultants contingent workers diversity training employee benefits employee stock ownership plan employee stock purchase plan employment at will

external recruiting flexible benefit plan (cafeteria plan) flextime forecasting human resource management incentive-based payment independent contractors internal recruiting job analysis job description job sharing job specifications labor union locals lockout management development programs mediation mentor off-the-job training and development online training on-the-job training

orientation program pension plan performance appraisal performance management permanent part-time employee picket profit-sharing plan programmed learning approach recruitment retirement reverse mentoring salary simulation training stock options strike strikebreakers telecommuting termination wages worker buyout workforce profile work/life benefits

MyBizLab To complete the problems with the

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, go to EOC Discussion Questions in the MyBizLab.

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self test Multiple Choice You can find the answers on the last page of this text. 9-1 Human resource management requires expertisein

a. managing staffing needs as a company evolves. b. training and evaluating employees. c. compensation, disciplinary actions, and promotion of employees. d. All of the above.

9-2 A company that gives employees an amount of

stock based on the time the person has worked there is running a(n) a. ESOP b. AESOP c. 401k d. IRA

9-3 Types of training required in some careers include

a. an on-the-job mentor. b. time spent as an apprentice. c. programmed learning. d. All of the above.

9-4 The performance review process often includes all of the following except

a. an evaluation of the employee’s social standing in the work environment. b. an assessment of the employee’s relative to the job’s performance standards. c. specific feedback on how to enhance a positive performance. d. the employee’s job expectations.

9-5 Amit Patel, as part of his compensation package,

was offered an opportunity to purchase his company’s stock at a later date at its current, lower price. Which of the following was Amit given? a. A stock option b. A stock ownership plan c. A stock purchase plan d. None of the above

9-6 James Rodriguez wants to spend more time at

home with his two-year-old granddaughter and is considering leaving his company. He could receive three months’ pay and the same retirement package he will be eligible for in three years’ time if he leaves now. This type of offer is called a(n) a. independent consultant status. b. worker buyout.

c. retirement. d. compressed workweek.

9-7 Which one of the following is not a good reason to hire a contingent worker?

a. To fill in for absent employees b. Keeping employees for shorter periods of time keeps salary costs low c. To supplement staff during particularly busy times d. To evaluate how a person performs on the job before hiring permanently them

9-8 Which of the following are benefits that companies experience by employing a diverse workforce?

a. Cultural differences result in alternative perspectives and lead to better problem solving. b. They fulfill expected affirmative action standards. c. Companies become more competitive in the global marketplace. d. All of the above.

9-9 The AFL-CIO, the UAW, and the Teamsters are examples of

a. illegal organizations. b. labor unions. c. labor relations theories. d. contingent workers.

9-10 A bargaining unit a. works to determine proper sale pricing of products. b. helps in the negotiation of the sale of the company. c. is the price of a share of stock. d. negotiates with employers for better working conditions.

True/False You can find the answers on the last page of this text. 9-11 Internal recruiting means an open position will be filled by friends or family first.

True or

False

9-12 Profit sharing could mean that in a good year, em-

ployees get bonuses, or it could refer to the company’s contributions to an employee retirement plan.

True or

False

9-13 Some companies use 360-degree appraisal of em-

ployees, gathering input from both their managers and their subordinates.

True or

False

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9-14 Employment at will means workers have increased job security.

True or

False

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9-15 A diversified workforce adds creativity and a va-

riety of viewpoints to the workforce, which often helps improve a company’s competitiveness and its bottom line.

True or

False

Critical Thinking Questions 9-16 Performance management is one alternative to a traditional performance appraisal. Which style of evaluation would you prefer as an employee? Which would be more useful to you as a manager? 9-17 An inefficient hiring process can cripple a company because the costs of turnover and

retraining employees are so high. Does electronically collecting and evaluating résumés help companies? Job seekers? 9-18 Describe the “perfect” benefits package. How would your salary and pay level affect your decision? Would you accept a lower pay level for better benefits?

team time SEEInG BoTH SIDES Walmart has been both praised and criticized for many of its HR policies. Form teams of four students. Divide each team into two subgroups. a. Subgroup 1—Good HR Practices: Research articles about the positive HR policies and practices Walmart has implemented. Prepare a summary paper outlining your findings. b. Subgroup 2—Bad HR Practices: Research articles about the negative HR policies and practices Walmart has implemented. Prepare a summary paper outlining your findings.

Process Step 1. As a group, compile your findings, comparing the positive and negative

policies. Were there instances in which a policy started out as a positive and ended up being negative or vice versa? How did the policies work with Walmart’s strategic goals? How have the policies affected Walmart’s stock price and bottom line?

Step 2. If you were employed as an HR consultant for Walmart, what kind of

advice would you give the company based on your findings?

ethics and corporate social Responsibility THE ETHICS oF InTERvIEWInG The interview and hiring process is fraught with ethical concerns. Form a small group and discuss the ethical implications of the following scenario.

Scenario Where does a candidate’s right to privacy end and a company’s right to know begin? As you learned in this chapter, federal laws protect potential employees from discrimination. Hiring managers must observe these laws by refraining

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from asking certain questions during the interview process, such as direct questions about candidates’ ages and physical disabilities. However, to uncover this information legally, managers have devised alternative questions.19 For example: Instead of asking . . .

They ask this legal alternative . . .

Which religious holidays do you observe?

Can you work our required schedule?

Do you have children?

What is your experience with “X” age group?

Do you have any disabilities?

Are you able to perform this position’s specific duties?

Process With your group, discuss your opinions on the use of these “legal alternatives” as an HR strategy. They are legal, but are they ethical? Do managers undermine the laws by finding ways around them? Or does a company have a right to know this information to make the best hiring decision?

Web exercises 9-19

Analyzing Annual Reports Using the Internet, access the annual reports of three companies in different industries. How are human resources issues handled in the annual report? What kind of HR issues do the reports discuss? Are the issues similar or different among the companies?

9-20

Social Media and HR It is happening more and more that a candidate’s social media profile has caused him or her not to be hired. Review all of the online materials available about you— Facebook, LinkedIn, blog postings you have made, photographs uploaded—from the perspective of a potential employer. Do you have any materials that might keep you from being hired? What do you think of the privacy issues surrounding this practice?

9-21

Battle of the Superstores Costco directly competes with Sam’s Club, the bulksales retailer owned by Walmart. Costco and Sam’s Club approach labor in different ways. This can be seen in the salaries they pay, in the benefits they provide, and in their relationship with unions. How do labor rates at

Costco compare to those at Sam’s Club? What about the profit per employee, turnover cost per employee, and turnover rates? Try to compare the overall labor costs for each of the businesses in contrast to just the labor rates they pay workers. 9-22

Benefits Packages Many companies have determined that their biggest asset is their employees, so taking care of employees is a mission-critical objective. Research companies that use benefits packages as a way to make their employees feel cared for and that retain a high percentage of employees. Consider both small and large businesses.

9-23

A Student and an Employee Research several colleges’ policies on student employees. How many hours can students work, and what types of employee behaviors and disciplinary actions do the policies specify? How do the rules at specific schools overlap with federal and state laws? Do you see specific rules that need to be revised to better accommodate student workers?

MyBizLab Go to the Assignments section of your MyBizLab to complete these writing exercises. 9-24 Compensation is more than just salary. Discuss the various compensation strategies and how important each would be to you. Would that change for workers at different stages of their careers? How can employers best meet the needs of compensating fairly their entire workforce? 9-25 Labor unions were born at a time when working conditions were quite exploitive and even dangerous in many parts of the United States. Do labor unions serve a purpose in today’s workplace environment? Discuss what functions unions provide that benefit a company as a whole.

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References 1. Intel Social Media Guidelines, May 1, 2016, www.intel.com /content/www/us/en/legal/intel-social-media-guidelines .html. 2. Peter Cappelli, “How to Get a Job? Beat the Machines,” June 11, 2012, http://moneyland.time.com/2012/06/11 /how-to-get-a-job-beat-the-machines. 3. D. Weiss, “Resume Lies Lead to Disbarment for Former Paul Hastings Partner,” January 23, 2014, http://www .abajournal.com/news/article/resume_lies_lead_to _disbarment_for_former_paul_hasting_partner. 4. “Nuclear Pharmacy Opportunities with Cardinal Health,” RXInsider, www.allpharmacyjobs.com/nuclear_pharmacy _cardinal_health_nuclear.htm. 5. Scott Steinberg, “Video Games Are Tomorrow’s Answer to Executive Training,” March 14, 2012, www.fastcompany .com/1824740/video-games-are-tomorrows-answer -to-executive-training. 6. L. Lanese and F. Nguyen, “The Journey from Formal Learning to Performance Support,” Performance Improvement, May 11, 2012, http://frankn.net/Publications/PI2012 -JourneyFormal2Ps.pdf. 7. McDonald’s, “Our Curriculum,” www.aboutmcdonalds .com/mcd/corporate_careers/training_and_development /hamburger_university/our_curriculum.html. 8. Alexei Oreskovic and Sarah McBride, “Facebook IPO Sparks Dreams of Riches, Adventure,” December 9, 2011, www.reuters.com/article/2011/12/09/us-facebook -millionaires-idUSTRE7B72NK20111209. 9. “Why Work for SAS,” www.sas.com/offices/asiapacific /singapore/press/why-sas.html. 10. Human Rights Campaign, “The Domestic Partnership Benefits and Obligations Act,” May 1, 2016, www.hrc.org

11.

12. 13.

14. 15.

16. 17. 18. 19.

/laws-and-legislation/federal-legislation/the-domestic -partnership-benefits-and-obligations-act. “Domestic Partner Benefits: Grossing Up to Offset Imputed Income Tax,” April 8, 2014, www.hrc.org/resources /entry/domestic-partner-benefits-grossing-up-to-offset -imputed-income-tax. S. Sorenson, “Don’t Pamper Employees—Engage Them,” July 2, 2013, http://businessjournal.gallup.com/content /163316/don-pamper-employees-engage.aspx. Cisco, “Transforming Employee Engagement,” www .cisco.com/en/US/solutions/collateral/ns340/ns1176 /business-of-it/Cisco_IT_Trends_in_IT_Article_Employee _Engagement_V2.html. U.S. Bureau of Labor Statistics, Current Employment Statistics Highlights, April 4, 2014, www.bls.gov/web /empsit/ceshighlights.pdf. “Medical Practice Messes Up Secretary’s Termination,” Canadian Employment Law Today, May 23, 2012, www.employmentlawtoday.com/articleprint .aspx?articleid=2731. U.S. Census Bureau, “Table 4. Projections of the Population by Sex, Race, and Hispanic Origin for the United States: 2010 to 2050,” April 1, 2016, http://www.census.gov. Lisa Takeuchi Cullen, “Employee Diversity Training Doesn’t Work,” Time, April 26, 2007, www.time.com /time/magazine/article/0,9171,1615183,00.html. U.S. Bureau of Labor Statistics, “Union Members Summary,” January 28, 2016, www.bls.gov/news.release /union2.nr0.htm. Melissa Cooper, “How to Get the Answers to Questions That You Can’t Ask in an Interview,” HirePerfect, March 31, 2016.

Chapter 10

Online business and technology Objectives 10-1 Online Business

Explain how the online environment helps market a business, and describe the types of business transactions that are supported by online commerce. Sonja Pettingill is launching a start-up venture to sell a specialty vest to new moms. Sonja can sell her product through local boutique stores, but she knows she needs a strong online business component to succeed. How does being online change her marketing strategy? How does she take advantage of the latest online technologies?

10-2 Technology in Business

List the functions of a company’s chief information officer (CIO) and information technology (IT) department, and describe how businesses transform data into useful business intelligence.

technology benefit the store? Who is responsible for keeping the store’s technology current?

10-3 Security

Understand the security challenges that arise with the increase of technology. Although Kevin Fossbenner’s business, Flatland Frames, is doing well, he’s worried that a suspicious e-mail sent to his employees on any given day could result in the firm being hacked. How do businesspeople protect themselves against problems like this?

10-4 Impact of Social Media and Mobile Technology

When Ian McGregor started working for a hardware store, he was amazed that the technology it used was so outdated. There was no website or customer database, and the cash registers weren’t even connected to an information system. How could advancements in

Explain how new advances in social networking and mobile technologies have impacted business. You make the effort to stay up on current technologies. You add a social media component to your business. It begins to take off, but then one upset customer seems to begin to drive customers away. There are positive and negative ways to incorporate new technologies into your business, and they can make or break you.

Objective 10-1

Online business Explain how the online environment helps market a business, and describe the types of business transactions that are supported by online commerce.

 When Sonja Pettingill decided to start a business, she knew she had a great idea. Her Mom Utility Vests (MUVs) would give mothers a place to store all the things they need for a day out with their babies but leave their hands free while toting all of that gear. Sonja knows the idea is a solid one.

CHAPTER 10

But how should she to kick off the business for such a product? She could travel from one small boutique to another in the area, but she’d never recoup the cost of developing and producing the products. She realizes she needs to take her marketing message to a national audience and take her storefront online—but how? Online marketing and selling, social networking, and mobile technologies are increasingly being used by firms to grow their businesses, even if they have brick-and-mortar stores. But doing business electronically requires firms and their employees to have a wider set of skills; they need to understand the marketing techniques that work in the cyber environment, possess technical skills to maintain and support the online business, and have security knowledge to recognize and respond to online threats. In this chapter you’ll explore the challenges and opportunities technology brings to businesses.

Marketing Online How can the online environment support a firm’s marketing efforts? Marketing is an aspect of business that has responded to changes in business technology by redefining itself. In today’s world, a marketing department must consider the Internet as a tool for both collecting information about its customers and distributing information about its products and services. Companies such as Constant Contact can organize and control mass e-mail campaigns by providing templates for e-mail newsletters or advice on how to create e-mail surveys. They also provide services that generate reports to track the number of people who read the e-mail message, how many followed the links inside, and how many forwarded the e-mail to another contact. How does having an online presence change a firm’s marketing strategies? For marketing experts, taking advantage of new advertising outlets offers many new opportunities. Online advertising refers to any form of advertising that uses the Internet to market its message to customers. This includes everything from banner ads to Facebook campaigns to spam e-mails and messages sent on Twitter. The insurance company Esurance exploited this shift toward online-based advertising during the 2014 Super Bowl. A single television ad run during the Super Bowl costs a whopping $5 million. Esurance instead ran a short ad after the game letting viewers know they could enter a $1.5 million drawing by sending a tweet to #EsuranceSave30. The hashtag was used more than 3.8 million times and increased the company’s profile significantly. As the number of households with highspeed broadband Internet access and mobile devices has increased, online advertising has become much more sophisticated. QR codes that can be scanned with mobile devices take consumers from magazine ads and counter displays directly to a company’s web content. HTML5 and Java technologies allow advertisers to embed animated ads and

Source: Sonja Pettingill

Google AdWords allows you to reach pot

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