The process of data warehousing involves information from a company’s internal system, such as invoices and sales logs, as well as data from outside sources, being filed away in an electronic vault.
How it works
The data warehouse is a repository that holds the company’s sales and operational history, as well as relevant economic and trade information from other sources. The data goes through three stages before it is stored in the warehouse, which makes it usable for analytical purposes. Once stored, the data may be accessed by all areas of a company—from accounts and operations to sales and marketing.The data is often used to assess beliefs and intuitions about the business. For example, the marketing manager of a power tools company might presume that 25–35-year-old men are more likely to purchase their products than women in the same age bracket. The manager would test this belief by analyzing sales data and customer records accessed from the data warehouse.
Warehousing process
The data stored is regularly updated. When the business requires information from the warehouse, it is transformed into an accessible format and analyzed using software tools.
Tapping data sources The information a company collects includes online transaction processing (OLTP) data, historical data, and data from external sources.
OLTP Includes transactions such as sales and refunds recorded via OLTP
HISTORICAL DATA Repository of past sales information
EXTERNAL DATA Includes government statistics on business
EXTRACT, LOAD, TRANSFORM (ELT)
Staging data The ELT process converts raw data into a usable format.
USABLE FORMAT
USABLE FORMAT
Storing data The data is stored in three sections: metadata, summary data, and raw data.
METADATA Information relating to the data itself
SUMMARY DATABusiness activity information
RAW DATA The original form of the information
Accessing data Using software, the data can be analyzed and retrieved in three ways: via online analytical processing (OLAP), reporting tools, and data mining.
OLAP Accesses data to answer specific questions
REPORTING TOOLS Presents data as tables or graphs
DATA MINING Finds detailedpatterns in data for analysis
WHO USES THE DATA WAREHOUSE?
The key departments of a company can access the data warehouse to find out how they are performing. The method in which the data is formatted and stored makes it possible for them to seek answers to questions relevant to them. Typical questions various departments might ask include:
FINANCE “What was profit margin on product sold in a region?”
MARKETING “How did online ad compare to poster ad campaign?”
SALES “What are average sales of product by region?”
HUMAN RESOURCES “How much have we spent on contract staff this year?”
Capturing key data is a priority for any business seeking to understand the marketplace. However, the task requires the use of innovative strategies to circumvent consumer sensitivity about privacy issues.
How it works
There are a number of methods companies use to collect customer data. When there is contact between a customer and the company, marketers can use the opportunity to gather as much information as possible. This might happen at the point of sale in a store or online, where marketers are able to observe customer behavior. Marketers may also choose to solicit information directly by asking their customers to fill in registration forms and conducting telemarketing calls or customer surveys.
Collecting data to create consumer profile
Digital marketing and e-commerce have accelerated the rate at which customer information is gathered. Some methods require the customer’s input, such as questionnaires that appear online. Others, such as website tracking, are possible without the need to contact the customer.
Surveys Gather customer feedback via email, text, or mail, and face-to-face questionnaires.
Social media View customer’s profile information on social media.
Observations Study customer’s behavior while they shop in a store or online.
Website trackers Track website visitor’s movement around a site and see what attracts interest.
Customer research Conduct research on existing customers or on those who fit the customer profile.
Competitions Use competitions to collect information, from opinions to demographic data
Contact center Monitor customer calls and store data on preferences and purchase history.
Transactions Ask questions at checkout—in the store, online, or on the phone.
TECHNOLOGY AT THE CHECKOUT
In this technological age, businesses have the means to learn about their customers without bombarding them with questions. Retailers, for example, typically use three methods in stores to capture information about the customer.
Loyalty program A company may collect information by inviting customers to register for a loyalty program that offers an incentive. A loyalty program also helps track customer preferences.
Point of sale software Computer software programs that track a customer’s purchases are available, allowing marketers to tailor offers to their spending habits.
Mobile technology The use of smartphones enables marketers to compile data, for example the frequency of customer visits and the amount of time they spend in the store.
WARNING
Data collection errors
❯ Barraging Using a customer’s data to bombard them with information on products viewed or sites visited
❯ Overlooking technical flaws Failing to integrate apps properly, leading to inconsistency (and errors) in collecting customer data
❯ Using only automated systems Neglecting the opportunity to strengthen relationships with customers by communicating with them personally
The rise of digital marketing strategies means that marketers are working more closely with IT specialists to develop the best ways of launching and managing online publicity campaigns.
How it works
Marketers need to know how to use technology to increase revenue. At the same time, chief information officers (CIOs) are adapting to changes in external technology. This has led to an increasing overlap between the marketing and IT departments, and to the emergence of a new hybrid professional role—the marketing technologist (see below).
Convergence of marketing and IT
Communicating with customers online has become a vital part of many businesses. As a result, marketing relies so much on IT that in some companies marketing teams spend more money on technology than their IT departments do.
Marketer
Must grasp technology required to execute and track online campaigns.
Areas of overlap
Digital marketing Developing a technology program for publicity campaigns
Real-time transactions Installing a system for recording and tracking online sales as they happen
Big data Locating key statistics from vast amounts of online information to improve marketing
Data analytics Using advanced tools to gather and analyze data for developing future marketing strategy
Mobile technology Understanding and keeping up to date with advances in mobile applications and e-commerce potential
Data storage Building infrastructure and software for storing and retrieving sales, campaign, and customer history
Social media Developing the best methods for increasing online traffic via social media channels
Tracking Following a customer through the online engagement and sales process
IT person
Must find or develop software tools to implement and manage online campaigns.
RISE OF THE MARKETING TECHNOLOGIST
Online marketers rely on software to monitor and analyze campaigns, generate content, and extract data. The job of the marketing technologist, who has knowledge of both marketing and IT, requires a broad knowledge base.
IT OPERATIONS
DATA AND ANALYTICS
SOFTWARE PROGRAMMING
WEBSITE ARCHITECTURE
MARKETING SOFTWARE
SOCIAL AND MOBILE
PLATFORMS
CONTENT MARKETING AND SEO
NEED TO KNOW
❯ MarTech Annual business conference that focuses on overlap of marketing strategy and technology
❯ Actionable metrics Measurement of campaign results which enable businesses to make informed decisions
❯ Vanity metrics Measurements of campaign results that appear positive but are not meaningful
❯ Growth hacking Low-cost online marketing techniques, such as using social media to improve sales
More cutting-edge than business intelligence (BI), business analytics (BA) allows advanced statistical analysis of data, which is used to help make future business decisions.
How it works
BA takes a scientific approach to interpreting information. Businesses use BA’s advanced software tools to analyze information about past or current trends and behavior to predict a future scenario. Unlike business intelligence or predictive analytics that analyze current and past data, BA allows businesses to forecast with a high degree of confidence. BA can be applied on a macro level to get a broad view of future business performance and on a micro level to assess, for example, the likelihood of individuals in niche markets making purchases.
Business analytics process
A skilled analyst interprets the raw data using BA tools. The results influence the business actions that will be taken in the future.
Raw data (in)This includes company records (past and current customer data and transaction histories) and external data (economic, trade, and industry reports).
Predictive modeling Software program that predicts patterns of behavior and the likelihood of specific sets of customers, or even individuals, making a purchase.
Pattern matching Process of trawling through large quantities of data to find patterns between variables, which can be applied to other sets of data.
Data visualization Formulation of graphs depicting the results of data analysis; graphs may rank data, group common attributes, and compare relationships.
Data mining Use of computerized processes and software programs to find relevant patterns in large sets of data.
Analysis(out) Software tools are used to process and study raw data. Analysts interpret results and make forecasts that help future business decisions.
BUSINESS INTELLIGENCE AND BUSINESS ANALYTICS
The example of a 5 percent sales dip shows how BI and BA can be used to examine and understand the situation.
Business intelligence
❯ Type of data investigation Results reveal past and current event in the business.
❯ Questions answered What has happened in the business in the past and what is happening currently?
❯ Tools used Reporting, dashboards, scorecards, online analytical processing (OLAP)
Business analytics
❯ Type of data investigation Examines past event in the business, and applies the patterns discovered to a future scenario.
❯ Questions answered Why did it happen? Will it happen again? What can we do to stop it from happening again?
❯ Tools used Statistical analysis, data mining, pattern matching, predictive modeling
DATA USEFULNESS
Some data is more useful than other data; value is determined by the extent to which marketers can use it to make confident forecasts. Methods of interpreting data are increasingly sophisticated.
Predictive analytics Program that conducts advanced analysis of data to forecast future outcome
Monitoring Process that uses software to show what is currently happening in a business, providing real-time results to help key operations make decisions
Statistical analysis Software that organizes and investigates every piece of relevant data and interprets it to show trends and patterns
Reporting Method that draws on historical data to provide a general overview, revealing, for example, how the business performed in a given year
93% of IT executives in Brazil say that their business could be improved by using big data analytics or intelligence
Business intelligence (BI) is an umbrella term referring to the variety of software applications companies use to access and analyze the massive amounts of raw data they have at their fingertips.
How it works
BI relies on software programs and computerized systems for collecting and integrating data in order that a business can report on its activities, both past and present. The tools allow staff to pull relevant data from the company database. The marketer then views the information on a computer screen using a data visualization tool known as a dashboard, which can also be used for real-time monitoring of business operations.
Business intelligence process
BI tools allow retrieval of specific relevant data by specifying the terms of the intelligence they need (such as real-time sales compared to previous year’s sales).
Collect source data Company gathers raw data via several operation systems.
SUPPLY CHAIN MANAGEMENT (SCM) Data from SCM sources
ENTERPRISE RESOURCE PLANNING (ERP) Manages company data
WEB LOGS Data relating to activity on corporate or e-commerce sites
TRANSACTIONAL DATABASE Data of current commercial transactions
CUSTOMER RELATIONSHIP MANAGEMENT (CRM) Data from CRM sources
EXTERNAL DATABASE Information gathered from sources outside the company
Extract, transform, load: ETL process
ETL system pulls raw data from the source, formats it, and loads it for use.
ETL SYSTEM Migrates raw data to data warehouse
Translates data codes
Transposes data columns and rows
Splits and separates information
Creates data archives
Store data Business uses data warehousing to integrate and bank data in a readily accessible form.
DATA WAREHOUSE Flexible access to data
Data from across organization
Data from outside organization
Current data
Historical data
Retrieve and analyze Staff can fetch data to answer specific questions about what is happening in the company.
SPREADSHEETS Form primary BI tool to display data (basic or advanced)
OLAP CUBES Online analytical processing cubes enable 3-D analysis of three variables on spreadsheet
DATA MINING Allows the sifting of data to find patterns and relationships
REPORTING TOOLS Help users develop and produce reports
TRACKING SALES
This dashboard shows the sales a company actually makes as a percentage of expected sales.
Digital dashboard
Displays regularly updated business results using customized graphics.
NEED TO KNOW
❯ Star schema Simplest format of online analytical processing (OLAP) in data warehouse
❯ Data quality (DQ) Condition of company’s master data, which should be complete and accurate
❯ Slice and dice Process in which large amounts of data are broken down to help analysis
14% the increase in sales per employee if data usability is improved by 10%
The knowledge within a company that is used to improve business performance is known as its intellectual capital.
How it works
Every business has capital, which refers to the physical, tangible assets that appear on the balance sheet of its financial statements. A business also has intellectual capital—the knowledge and skills inside the company. This collective knowhow is hard to quantify and measure, but it is essential to a company’s ability to generate revenue. For instance, management must provide training and a handover period for new staff so that human capital does not go down when people leave the company, taking their expertise with them. Management academics have identified three main kinds of intellectual capital: human, structural, and customer.
Human capital
The combined talents of the staff and T I executives employed by the business. It includes skills and abilities, drive, creativity, and innovativeness, all of which can be quite hard to measure.
Top talent
Human intellect
Volume of practical experience
Customer capital
Goodwill developed between a company and its customers, reflected in customer loyalty to the business and its products. This relational capital can be extended to suppliers, but is very hard to quantify.
External links
Market relationship
How long relationship last
Structural capital
The support structures developed and held by the company, including its own software, databases and other information systems, patents, copyrights, and trademarks. Structural capital is non-physical, so it can be hard to assess.
Organizational routine
Innovation
Internal link
MEASURING INTELLECTUAL CAPITAL
Various different methods have been developed to quantify and measure a company’s intellectual capital.
Watson Wyatt index A survey conducted every two years in public companies to assess the value of human capital and HR practices.
Intellectual capital monitor Matrix that measures the past effects, present power, and future potential of the intellectual capital in a company.
FIVA Framework of intangible value areas (FIVA): an eight-step system used to calculate the worth of a company’s intellectual capital.
Knowledge capital scorecard Method developed by New York University professor Baruch Lev to rate a company’s intellectual capital and assess its contribution to a company’s success.
NEED TO KNOW
❯ Strategic capital A company’s knowledge of its market and the business model needed for success
❯ Intellectual property Creations or inventions that are legally recognized as belonging to a particular entity or individual on a balance sheet
❯ Intangible capital All knowledge assets belonging to a business or organization; can be audited under various systems
“The only irreplaceable capital an organization possesses is the knowledge and ability of its people.”
Many organizations gauge the effectiveness of the amount they spend on marketing campaigns by measuring the return they make on marketing investment, which is commonly known as ROMI.
How it works
A subset of ROI (return on investment), ROMI is one of the key calculations businesses use to work out the effectiveness of the money they spend on marketing. ROMI is measured by comparing the revenue gained against the investment made in marketing, and is used to assess online campaigns, in particular. This calculation, however, only reflects the direct impact of marketing investment on a business’s revenue and fails to take into account other gains, such as the word-of-mouth effect on social media, which is more difficult to quantify than the more clear-cut response received from advertising or direct mail. As a result, many digital marketers now factor lag time or brand awareness into their ROMI calculations in order to quantify less tangible benefits and target future campaigns more effectively.
ROMI in practice
The diagram shows how a commercial air-conditioning company might use ROMI to measure the performance of a marketing campaign. The company spends $2,100 on a direct-mail promotion, which it aims at offices in three major cities to generate sales leads and secure new contracts. The direct-mail brochure contains a contact form offering a 10 percent discount to new clients who respond to the promotion within a specified period of time.
Results
LONG-TERM BENEFITS OF MARKETING INVESTMENT
Some aspects of marketing investment are difficult to measure immediately. The benefits of providing excellent customer service, for example, or investing in research to help marketers retain customers, may not be evident right away but will reap long-term profits.
NEED TO KNOW
❯ 4P3C1E framework Method that uses several variables to calculate effectiveness of marketing campaign
❯ Success metrics Use of standard measure (metric) to help manage marketing process and to assess its performance
Existing customers help businesses generate the majority of profit and growth through making additional sales and referrals, and so retaining these customers is a high priority for marketers.
Measure customer retention level Track how many customers repeat purchase or buy more products.
How it works
There are two stages to the process of customer retention: measuring the current rate of retention, and applying strategies to manage and improve it. Practices include identifying the most valuable customers and nurturing relationships with them. The least valuable or most costly customers may be dropped if they show little development potential.
Identify satisfied customers
Customer referral Measure the number of referrals an individual customer generates.
Loyalty Pinpoint customers who are active in the brand’s loyalty program.
Identify the dissatisfied
Defection Find out why certain customers have left and which competitor they have gone to.
Complaint analysis Examine written customer complaints and call-center records.
Introduce retention improvement strategy
Early warning systems Anticipate any problems and alert customers in advance.
Recovery programs Apologize for any mistakes and make amends to woo dissatisfied customers back.
Customer feedback surveys Listen to customers and identify people at risk of defecting.
Loyalty programs Reward customers with improved incentives for staying loyal.
Boost customer service service Offer employees incentives to build customer relations.
Monitor and measure by analyzing
Customer satisfaction Assess rate of customer complaints and recommendations.
Attrition rate Calculate the number of customers retained (existing), lost (exiting), or gained in a given period.
Revenue targets Measure revenue targets against cost of customer retention efforts.
Upsell and cross-sell leads Identify customers who may buy larger products, or related items.
Net promoter score ® Use management tool to gauge how likely a customer is to recommend company to others.
Customer retention savings Calculate savings made in marketing spend by retaining existing customers.
TOP FIVE REASONS FOR LOSING A CUSTOMER
Senses indifference from provider
Dissatisfied with product or service
Unhappy with price
Lured by competition
Natural attrition (death, relocation)
NEED TO KNOW
❯ Customer lifetime value (CLV) Measure of the amount customer will contribute to company revenue in the long term
❯ Customer retention rate (CRR) The number of customers retained over a given period, expressed as a percentage
❯ Customer acquisition cost (CAC) The amount company spends to gain a customer; also called cost of customer acquisition (COCA)
The process of turning a customer’s interest into a sale is called lead conversion. The task requires not only a sales pitch to promote the product or service, but also an approach tailored to the customer.
How it works
Sales and marketing departments are responsible for generating sales income for a company. The first step is to locate or identify potential customers—lead generation. The second step is to make contact with those potential customers and entice or persuade them to buy—lead conversion. A sales pitch is used to convert leads into customers. However, nowadays the stereotypical spiel delivered by an overzealous salesperson has been largely replaced by more sophisticated tactics, such as live chat on shopping websites, which inform customers and invite them to participate in a dialogue, rather than simply pestering them.
Raw lead Potential customer— perhaps a website visitor, or a suitable person who can be approached by cold-callingq
Suspect Raw leads show their interest by remaining on website or by not ending phone conversation with cold-caller.
Prospect One step away from becoming a customer, prospects need a final enticement to convince them to buy the product.
Inactive Prospect isn’t ready to buy immediately, but shows enough interest to suggest they might buy in the future.
Customer Raw lead has committed to buy; focus is now on retaining the customer and enticing them to make repeat purchases.
Dead lead Lead will not convert, but may be worth trying to revive in future.
Online lead conversion
A strategy is required for steering website visitors through every step of the lead-converting process. It is often presented as a funnel. Once visitors have arrived at a website, they are enticed to click on a “call to action” (CTA) button, which takes them farther into the funnel.
THREE CLASSIC SALES PITCHES
High concept Catchy introduction that captures the vision or key idea of a product or business; intended to grab attention and interest
Elevator Short summary (under a minute long) that explains the why, what, and how of a business or product
20-minute deck Presentation that explains the product or business in detail; how it can serve the need a prospective customer may have
NEED TO KNOW
❯ Lead scoring System used to measure the readiness of leads for conversion
❯ Sales pipeline Visual tracking of the number of leads, suspects, and prospects at each stage in order to monitor sales process
❯ Lead nurturing Informal contact with a lead designed to gradually win them over as a customer
❯ Cost per touch Measurement of the cost of sales labor each time a lead is “touched” (contacted)
For a business to grow, one of its basic goals is to acquire new customers. Lead generation is the strategy it uses to locate, target, and nurture leads (potential customers).
How it works
The purpose of generating leads is to find consumers who may need or want to buy the product a business is selling. Sales teams do not want to waste resources on people who have no interest in the product in the first place, so the process of lead generation helps to define and capture the potential customers who seem most inclined to become actual customers—known as high-quality leads. To generate leads, marketing and sales departments typically collaborate on a campaign, offline or online, designed to identify and recruit promising customer prospects. Acquiring contact information is the first part of the process. Converting leads into sales is the next step.
Lead-generation process
Generating leads is a multi-step process that involves sales, marketing, and customer service teams working together to plan, design, produce, test, and refine a campaign.
Plan the approach Set goals and parameters, including expected return on investment (ROI) and number and quality of leads.
REVIEW OBJECTIVESCheck that they are realistic; compare with previous efforts.
PLANNING Ensure that sales, marketing, and customer service are working together.
AUDIT Assess current lead generation.
SYSTEMATIZE Integrate customer relationship management (CRM) software to manage the leads.
Identify target customer Define the characteristics of the customer the business is aiming to capture in as much detail as possible.
Design campaign Craft a multi-channel message to entice the lead to opt in and give contact information.
BIG IDEA Devise a compelling message to engage and entice leads.
RESEARCH A certain which media and touch point are most effective.
Produce campaign Create and deliver materials for each medium involved in the campaign.
SEO/PPC Integrate search engine optimization (SEO) efforts and pay-per-click spend
EMAIL BLASTS Include a benefit for the recipient and a call to action
TELEMARKETING Review key message and call script with customer service team.
Trade show invite potential lead to visit the company and meet face to face.
ADVERTISING Generate broad interest with ads on selected media.
Test campaign Monitor the initial hours and days of the campaign and make any corrections that are needed.
Measure Track and measure the response from the various campaign activities to gauge effectiveness.
RESPONSE RATES Tally how many leads have been generated so far.
QUALIFIED LEADS Determine percentage of initial contacts with purchase capability.
CONVERSION RATES Calculate percentage of web visitors converted to leads.
ANALYZE PERFORMANCE Identify adjustments needed to keep campaign on track.
Refine Fine-tune the filtering process to ensure that leads being generated are high quality and likely to buy.
B2B LEAD GENERATION
Most businesses selling to other businesses (B2B) identify lead generation as one of their most important digital marketing priorities. But which tactics do they find most effective?
TOP FIVE STRATEGIES FOR LEAD GENERATION
❯ Create content such as a viral video or a newsworthy business report that takes leads to a sign-up page.
❯ Use both online and offline channels, as most customers will respond to just one channel.
❯ the customer touchpoint— the point at which a customer comes into contact with the product—before, during, and after purchase. Touchpoints may range from online reviews to billing.
❯ Tailor the call to action to the channel, such as inviting trade show visitors to enter a competition.
❯ Design effective opt-in web forms to capture data, such as asking customers to sign up for updates.
NEED TO KNOW
❯ Owned media Channel owned by a business, such as a website, blog, or social media profile
❯ Attention, interest, desire, action (AIDA) Model for effective marketing messages
❯ Cost per lead (CPL) Amount it costs the company to acquire one potential customer
A brand is defined by the characteristics that mark a particular product. Branding is used to communicate a product’s qualities to a consumer, and create a lasting bond between supplier and customer.
How it works
When a supplier develops a brand, it creates a defined set of values, expressed in product imagery, colors, logo, slogan, jingles, promotional imagery, and association with high-profile individuals or characters. The brand works for both the supplier and the customer, aiming to eliminate uncertainty and risk and to convey key attributes. Social media helps to promote brands—for example, 29 percent of Facebook users follow a brand and 58 percent have “liked” a brand.
The branding cycle
There are typical stages to branding a product. In order to rebrand (redevelop) a product, the supplier starts over at the beginning.
Develop the concept Marketer focuses on positioning (where brand sits among competition in terms of function and look) and building a consistent and clear personality.
The overall goal of sales and marketing teams is to generate customer contact and convert it into revenue. This is the core of business development, and it involves a continual process of drawing in potential customers, enticing them to purchase, and keeping them engaged. During this process, marketers and sales people use a range of strategies and channels to attract customers and to earn their long-term commitment to a brand and product.
Collaborative process
Marketing departments generate brand identity while sales teams do the selling. Working together, they aim to take potential customers on a journey from brand awareness to repeat sales, communicating the message through various channels.
Build brand awareness Target customer groups with content and/or ad campaigns to inform them about the brand and its values. This will lay the foundation for a long-term relationship.
Generate leads Use a combination of inbound and outbound marketing strategies to entice potential customers to seek out the brand
Convert leads into sales Once potential customers are interested, entice them to buy with targeted messages, offers, and well-designed e-commerce sites.
Retain customers Follow up sales with efficient delivery, excellent customer service, and personal contact to reinforce positive customer relationships.
Review effectiveness Track marketing spend on each channel and analyze results to gauge return on marketing investment (ROMI).
Develop intellectual capital Nurture talent and foster creativity in order to optimize ongoing marketing efforts.
BUSINESS DEVELOPMENT STRATEGIES
Business development is reliant on growth. Sales and marketing teams can increase long-term profitability by building up a customer base and then trying to retain it. There are several ways to ensure that the customer base remains buoyant.
❯ Chart customer journey from before to after sale
❯ Think of ways to reduce cost of sale and increase customer satisfaction
❯ Integrate sales processes with marketing to gain and retain customers; think about ideal customer
❯ Monitor and evaluate these processes regularly
15% of companies have specialized business development staff who are not involved in sales
SEO is a process marketers use to acquire traffic from search results on search engine sites. SEO software tools are available to help the user create web pages that will appear at the top of search engine listings.
How it works
Companies that have a web presence must ensure that their website has a high ranking on search engine listings. To achieve this, they frequently use SEO tools to monitor where their website appears when keywords are searched for, and take steps to keep it moving up the search results page. Some of the important measures marketers take include coming up with the right keywords, linking to other websites, and generating content that includes frequently searched keywords or phrases, so that their website remains relevant to a wide variety of search queries. Search engines offer pay-per-click, a service that places a company’s listing at the top of a search results page. Every click generates a fee payable to the search engine.
SEO process
Keyword research Use SEO tools to research the most popular keywords.
❯ Brainstorm keywords
❯ Find words in top engines
❯ Test traffic using words
Keyword selection Use a combination of intuition and analysis to choose words.
❯ Think of key phrases
❯ Avoid overused words
❯ Try variations of a word
Competition analysis Check competitors’ rankings to ascertain how to rise above them.
❯ See ranking with SEO tool
❯ View rival web links
❯ Find top-ranked domain
Link-building Add links from related websites to point back to own site.
❯ Link to high-profile sites
❯ Contribute to forums
❯ Ask partners to link
Reporting and tracking Use tools to track traffic and report on website ranking.
❯ Focus on quality of visits
❯ Check server reports
❯ Tally sales from searches
Keyword revision Monitor search results from current keyword selection and make adjustments.
❯ Make sure terms aren’t broad
❯ Avoid specialized words
❯ Alter word order
SEO spider Software that crawls the internet, adding content to search engine databases
SEO TIPS
Avoid single words because multiple-word phrases rank higher.
Add blog to offer content that search engines will pick up.
Use reputable sites with relevant content to link back to your site.
Monitor search statistics using Google Keyword Tool, for example.
Prioritize good content and update it regularly with keywords.
Give headings keywords that relate to content on page.
NEED TO KNOW
❯ Robot.txt Text file that stops web crawler software, such as Googlebot, from crawling certain web pages
❯ Search algorithm Step-by-step calculation that looks for clues to decide on search rankings
❯ Metadata Information that describes stored data – data about data
❯ Cloaking Technique for improving SEO by making some web content invisible
❯ Panda and Penguin Two updates to how Google calculates its website rankings, preventing unfair rankings from SEO tools
Businesses post information articles on web logs, or blogs, as a way to attract consumers to their websites. They may blog on their own website or rely on independent bloggers to achieve this goal.
How it works
Unlike a conventional website, a blog is a site that consists purely of informational posts or entries that appear in chronological order, starting with the most recent. Blogs first started appearing in the mid-1990s, when new web tools made it possible for non-experts to publish material online. This type of web content has since become one of the most common sources of information and opinion on the internet. Although it was once only individuals who published blogs, many are now commissioned or professionally edited and produced by the company’s marketing department.
Blogging process
Marketers may use SEO tools to gain insight into what’s being talked about online, which helps them to determine the most suitable topics for blogs. Many companies have the in-house talent to create blog content.
Select key word or question Determine key word, phrase, or question that appeals to the target audience.
Create content Base content on key word/ question, and ensure that it gives readers valuable insight into the chosen topic.
Add links Cite industry experts and research reports; add photos or videos, and provide links to the original sources.
Post Publish blog entry on internet using web software or specialized corporate blogging platforms.
Syndicate/share Submit blog to syndication sites and share with social media networks, such as Facebook, Twitter, Instagram
Track and measure Monitor key blog statistics, such as the number of unique visitors and the number that sign up for RSS feed and email.
Blogging vital statistics
Top five statistics to track
❯ Number of visitors Potential customers visiting blog and their route in—via links or direct entry
❯ Bounce rate Share of visitors who leave site within 10 seconds
❯ Pages per visit Number of pages viewed by visitor
❯ Conversions Proportion of visitors who subscribe to blog
❯ Keywords Common words visitors use to find blog site
Three blogging mistakes
❯ Obsession with SEO Although SEO is important, focus should be on publishing quality content
❯ Omitting facts Posts should offer factual information, not just opinion or repackaged content
❯ Lack of legibility Poorly designed blogs with unclear typography will discourage customers from reading content
NEED TO KNOW
❯ Disclosure Statement of whether blog is sponsored, or if reviewed products are given to blogger or were independently bought
❯ Splog Spam blog containing fake articles designed to increase the search engine rankings of specific websites
Podcasting/vidcasting
Businesses may post audio or video files on the internet to attract and engage website users; the goal is to convert first-time users into subscribers. Once consumers engage with podcasts or vidcasts, companies try to sell products either through advertising on the podcast or the podcast download page, or by sponsoring the podcast or vidcast to create brand reinforcement.
Podcasting/vidcasting process
In order to get commercial results from a podcast or vidcast, a company needs to create and publish interesting and informative content.
Capture content Decide on topic, and create an outline, then film video for vidcasts or record audio material for podcasts.
Process content Edit video footage or audio track for background noise, mistakes, repetitions; test and edit further, if necessary.
Select correct format Save podcasts in MP3 format; save video in small-screen format; compress file size for optimal download speed.
Publish contentn Embed and publish content on new post. Use app to generate feed address; submit to iTunes or other platform.
Tracking Count number of subscribers; use web feed services to access user location, level of interaction, and other statistics.
BUSINESS BLOGGING AND PODCASTING ETHICS
Independent online reviewers often collaborate with businesses, which is beneficial to both. However, business promotion on blogs/podcasts is not regulated like advertising, and ethical boundaries can become blurred.
NEED TO KNOW
❯ Vodcast Alternative term for vidcast (both short for videoon-demand broadcasts)
❯ Rich site summary (RSS) Format used for frequently updating text, audio, and video content online
❯ Mobcast Podcast that is created and published on a cell phone
Outbound marketing interrupts consumers to promote a product or brand, but inbound marketing needs consumers’ permission—they have to seek out information that leads to the marketing message.
How it works
Before the rise of the internet and the phenomenon of social media, most marketing strategies were outbound. In other words, marketers pushed messages at consumers by interrupting them with advertisements or direct mail. The same principle applies to outbound marketing that appears on the internet, with pop-up ads interrupting the content the consumer wishes to access. However, because consumers from all over the world now use the internet to search for information and entertainment, marketers have adopted inbound strategies instead, providing content that draws the consumer to the brand or product, rather than pushing marketing messages at them.
Pros and cons
Marketers interrupt consumers with hundreds of outbound marketing messages every day, but they also use subtle inbound marketing tactics to attract consumers. Each strategy has its advantages and drawbacks.
Company
Inbound
Pros
❯ Campaign results can be forecast and measured
❯ Marketing material is easier to create
❯ Campaigns can be tightly controlled
Cons
❯ Customer conversion rates are low❯ Marketing campaigns are expensive to create
❯ Effects of campaign are often short-lived
bound
Pros
❯ More likely to draw customers with long-term interest in the brand❯ Non-intrusive approach preferred by customers
❯ Cost-effective compared with outbound campaigns
Cons
❯ Response from market may take longer ❯ New content must be generated regularly to keep customer interested ❯ Campaign results can be difficult to measure
NEED TO KNOW
❯ Push or interruption-based Alternative marketing terms used to describe outbound marketing
❯ Pull or permission-based Alternative marketing terms used to describe inbound marketing
60% of marketers have added inbound marketing to their existing outbound strategies
Inbound marketing lures customers by offering them appealing content, and engaging with them. The approach pulls customers into a relationship with a brand rather than “pushing” them into making a purchase, which is how advertising works. Inbound marketing is also known as permission marketing as potential customers are giving a business permission to communicate with them. In other words, they are actively interacting with the company or brand.
Inbound marketing process
Content forms the core of inbound marketing. It includes text, images, and video that consumers seek out online, especially on social media sites, or in person at events, such as trade fairs, and share with their network of friends, family, and colleagues. Potential customers respond to inbound marketing because the business or brand is offering interesting and relevant information, entertainment, or content with emotional value. Businesses expect this interaction to culminate in a sale, or create brand recognition that leads to a sale.
Exploration Publish and actively promote content; use search engine optimization (SEO) to attract consumers online
Search engines, social media networks, web publishers, and third-party blogs
Decision-making Ensure that content captivates potential customers or solves problems for them; encourage two-way communication
Company website, blog, podcast, community, and interactive tools
Purchase Entice interested site visitors to become customers; make shopping online an easy and positive experience
E-commerce process, product, price, discount, and promotion
Advocacy Provide excellent customer service; spur customers to make recommendations and share on social media
Customer championing of product or service
Top types of content marketing
1. Blogs
2. How-to guides
3. Images
4. Infographics
5. Videos
6. Testimonials/reviews
7. Case studies
8. Internet memes
9. Email newsletters
10. E-books
11. Podcasts
12. Twitter chat
13. Newsjacking (giving content to news media)
INBOUND MARKETING STRATEGIES
Offline
❯ Optimize retail space Provide a well-designed physical environment that will both draw customers in and encourage them to come back.
❯ Engage media Generate press releases to gain media coverage. Focus on topics of real interest, especially ones that can be backed up by statistics and research.
❯ Interact face to face Conduct events in stores that provide a new experience/benefit to customers; rent a stand at a trade event and offer key information.
Online
❯ Post blogs Update company blog with appealing content to attract visitors.
❯ Create podcasts Produce content relevant to customers searching for information; engage experts to add value.
❯ Produce other content Post articles, photos, and videos on social media sites; target influential users to encourage viral sharing.
❯ Apply search engine optimization (SEO) Fill search engine listings with key phrases that answer specific questions; add inbound links from popular sites.
NEED TO KNOW
❯ Top of funnel marketing (TOFU) Offers content to grab the initial attention of potential customer
❯ Middle of funnel marketing MOFU Offers more detail and encourages participation
❯ Bottom of funnel marketing (BOFU) Attempts to win a sale with low pricing, offers, or via customer recommendations
Sensory marketing targets multiple senses to sway purchasing decisions. Based on research showing how the brain responds to sensory input, this type of marketing acts covertly on the customer.
How it works
Sensory marketing is most obviously used by the food and drinks industries, but its use extends to diverse products and services: computers designed with tactile materials, hotels scented to relax customers, and even fireworks displays featuring edible confetti. Typical channels for sensory marketing include field marketing (in-store events, samples, and person-to-person sales), direct mail, and product delivery. For online businesses, however, finding a way to use it remains a challenge.
Sight Technology is making advances with this, the most stimulated sense in marketing, by using optical illusions, digital effects, 3-D, and 360-degree photography
Smell Customers are willing to pay more for a product sold in an environment that is scented appealingly
Taste Taste sensations can be enhanced or subtly altered by combining them with touch, sight, and especially the closely linked sense of smell.
Touch Marketers use 2-D and 3-D textural print techniques for promotional materials and packaging, as well as to sell products with tactile appeal.
Hearing Sound is more effective than sight in triggering the brain areas that process emotions
Attitude, memory, behavior, and mood
The sensory input results in a short- or longterm effect on attitude, memory, behavior, and mood. This can be influenced by the intensity of sensory data and by using it to stimulate more than one sense at the same time.
Perception The brain receives stimuli from one or more senses.
Emotion Sensory stimuli tap into the store of emotional memories, as Cognition both are processed by the same area of brain.
Cognition After processing sensory stimuli, the brain embeds memory, regulates emotion, and makes decisions.
NEED TO KNOW
Sensory testing Assessment of products by panel members with exceptional sensory perception
Haptic technology Invention that simulates touch through vibrations on computers
3-D marketing An immersive form of consumer marketing
81% of consumers born from 1980 to 2000 value experience over material items
Before the digital age, marketers relied exclusively on non-digital channels, such as TV, radio, and print media, as well as direct mail, events, and cold-calling, to convey their message to the consumer.
Traditional marketing process
Small and large businesses use a range of conventional marketing channels, and often integrate them with digital marketing strategies.
Events Staging sports activities, themed displays, parades, or exhibits to promote a product, cause, or brand.
TV Promoting sales through TV ads, program sponsorship, or product placement.
Face-to-face Approaching customers directly to create brand awareness or persuade them to buy a product.
Telemarketing Calling potential customers who have an identifiable need for a product with a sales pitch.
Direct mail Mailing catalogs or circulars to a targeted list of consumers, often promoting special offers on products.
Brochures and flyers Promoting through mailing or locally hand-distributing printed materials to promote businesses.
Radio Using commercial slots on radio to promote products either locally or nationally, depending on the station’s reach.
Product samples Offering free samples of a product to customers, giving them the opportunity to try it before making a purchase—an effective way to launch new products and build a customer base.
Billboards Renting large outdoor advertising spaces to market products. Cost depends on the size of space, its visibility, and the amount of traffic that passes the location.
Newspapers and magazines Buying space in print media to run advertisements, or creating advertorials to market products or services.
Networking Interacting with other people at special events to develop professional contacts.
Two fundamental choices traditionally face marketers: whether to try to sell a product with broad appeal to as many people as possible, or to focus on selling a tailored product to a defined group.
How it works
Both niche and mass marketing strategies offer businesses the potential to make a high return on investment. A niche approach generally works on the basis of lowvolume sales at a premium price to a specific group of consumers, while a mass approach tends to use heavy promotion to a wider audience and aims to achieve high-volume sales. In reality, businesses tend to mix up both approaches, launching a niche product and then expanding it to a mass market. Marketers also use internet channels to promote the same product to different groups of customers within a mass audience.
Niche market
❯ Business targets a select group of consumers with specific need and wants.
❯ Customers often prepared to pay a premium price for an uncommon product.
❯ Sales volume of niche product low, so does not benefit from production economies of scale (manufacturing large quantities to decrease the unit cost of production).
Mass market
Who and how
❯ Business targeting a large group of consumers with generalized wants and needs.
❯ Requires high marketing spend to promote products, which must be widely distributed.
❯ Marketplace often crowded with other competitors selling a similar product.
HYBRID APPROACHES
Using social media to identify and reach more than one target market, marketers have developed hybrid approaches that are more flexible than conventional niche or massmarket positioning of products.
Mass market An unfocused strategy that aims at the broadest customer base.
Large segment Channels marketing resources to one large segment of the mass market.
Adjacent segment Once large segment is fully penetrated, product expands into related segment.
Multi segment Markets to several segments at once, with a customized strategy for each.
Small segment Markets to a small segment with few competitors, if resources are limited.
Niche segment Focuses marketing resources on a specific group of customers.
Mass customization Customizes a strategy for each sub-segment within the mass market.
NEED TO KNOW
Coined by Wired magazine editor Chris Anderson, the term “long-tail marketing” takes its name from a demand curve (see below) depicting products with low demand or sales volume—niche products—that continue to sell and make profit over time.
Every product launch requires strategic planning to make sure messages about a new product reach the right types of consumers, are communicated through the most effective combination of channels, and have the most relevant content and style. Once marketers have researched the market and defined their target audience, they face several key decisions on how to make their approach.
Types of approaches
Whom to target and how to go about it are crucial to success. Marketers may use several complementary approaches to different groups of potential consumers.Rather than sending the same message via different media, they usually adjust the tone and style of the marketing pitch to suit the channel as well as the target consumer.
The big choice
The first decision is whether to go for a narrow, specialized market or to appeal to as large an audience as possible.
How to tell the customer
Marketers often get the best of both worlds by using traditional and online channels in varying styles.
Traditional channel allied with a dominating style. “Let me tell you,” it blares.
Digital channel allied with a soft approach. “Let me woo you,” it whispers.
Sensory marketing “Wake up and smell the roses.” It seduces the customer with sights, sounds, and smells.
Engagement marketing “Come dance with me.” It entices the customer to collude in product sales.
Relationship marketing “Let’s be friends.” It builds a rapport with its audience of consumers
Making a move Turning the buying transaction into an experience the consumer enjoys can help sell a product.
85% of all purchasing decisons in the US are made or influenced by women
In order to make decisions about who to sell their product to, marketers try to identify distinct groups of consumers with similar wants and habits who together form a “segment” of the market.
How it works
Marketing departments use a strategy of market segmentation to find the potential customers who are most likely to buy a particular product, thereby increasing the chances of a successful product launch. They divide a broad group of consumers into subgroups based on many factors, including age, lifestyle preferences, location, family structure, household income, and occupation. This process narrows down a potentially huge market into segments, allowing marketers to identify the ones more inclined to buy a given product. For example, after applying this strategy, a company trying to launch premium-price organic baby food realizes that instead of marketing to all women who have young children, it should aim its product at working mothers with children under six months, above-average incomes, and an interest in healthy eating.
Defining market groups
To establish different consumer groups, marketers create five segments and focus on each individually. Besides identifying groups by geography and demographics, marketers also explore psychology to ascertain how consumers behave, so that they gain a better idea of which products might appeal to which consumer groups.
Behavioral
Focuses on behavioral patterns when it comes to shopping. Understanding this helps marketers adapt campaigns to target specific groups. Potential focus areas include:
❯ Brand loyalty
❯ Regularity of purchases
❯ Credit card usage
❯ Typical expenditure
❯ On- or offline shopping
❯ Heavy product user
Sociographic
Identifies individuals’ connections on social media, or membership of political and other groups, helping marketers learn about consumers’ passions and interests. Potential focus areas include:
❯ Group memberships
❯ Number of friends on social media
Psychographic
Focuses on consumer’s interests, values, and opinions to help marketers develop relevant messages and find the right media channels to target a segment. Potential focus areas include:
❯ Risk taker
❯ Charitable
❯ High achiever
❯ A tendency towards expensive tastes
❯ A preference for email contact
Geographic
Concentrates on a customer’s place of residence, so that any product launched is made relevant to their environment. Potential focus areas include:
❯ Post code
❯ Continent
❯ City
❯ Neighbourhood
❯ Population density
❯ Climate
Demographic
Uses basic consumer data, such as gender or age, to accurately categorize needs and target products appropriately. Potential focus areas include:
❯ Income
❯ Nationality
❯ Family size and age
❯ Ethnic background
❯ Occupation
❯ Religion
NEED TO KNOW
❯ Baby Boomers Section of population born between 1946 and 1964
❯ Generation X People born between 1966 and 1980
❯ Millennials Section of population born between 1980 and the early 2000s
“Market segmentation is a natural result of the vast differences among people.”
Promotion is necessary for generating interest in and sales of a product or service. A complex and expensive part of the marketing mix, it involves communicating to customers and influencers such as peer groups.
How it works
The primary purpose of promotion is to boost sales by attracting new customers, while enticing existing ones to try out something new. Most companies use a number of communication activities to inform and remind their target audience of a product’s benefits . One of the long-term benefits of communicating with customers is that it helps to build brand loyalty.
Customer service Provides customers with information about the product; offers updates and special deals.
Personal selling Interact with customers face to face and tailor sales messages to their needs.
Advertising Run ad campaigns through media channels most likely to reach target market, and stick to budget appropriate for the product.
Direct marketing Send product offers and information directly to the potential consumer, via mail or email.
Sales promotion Entice customer with offers, free samples, gifts, competitions, packaging, and point-of-sale displays.
Public relations Generate positive interest in the company by sponsoring events and charities, or pitching news content to media.
Interactive marketing Build long-term relationships with customers using twoway communication, especially online.
NEED TO KNOW
❯ Integrated Marketing Communication (IMC) Promotion of the same brand message across all media channels
❯ MarCom (Marketing Communication) Full range of promotional activities used to reach out to the market
Knowing where customers shop, where a product is sold, and how efficiently goods can be delivered to the consumer—called “place” in marketing terms—is essential to sales success.
How it works
Whether a company sells goods or services, customers must be able to find and buy those products as easily as possible. Businesses have to decide on the best sales outlet and sales channel to get their products to customers in a way that benefits both parties. A sales outlet is the place where a product is sold, suchas stores, catalogs, or e-commerce sites. Sales channels are the merchants, agents, and distributors who take a product from the seller and bring it to the consumer.
PROS AND CONS OF USING INTERMEDIARIES
Main distribution channels
A product reaches the marketplace through one of four main types of distribution channels. The most suitable distribution channel is usually dictated by where customers prefer to buy the product.
Producer A producer chooses the distribution channel, or a combination of channels, that will maximize the number of customers it can reach while keeping costs as low as possible.
Selling direct to consumers Product is sold directly by the producer, online, or through a mail-order catalog, and delivered to customer without intermediary.
Example E-commerce site selling vitamins; they are sent to customer by mail or delivery service.
Selling through retailers Goods are delivered by producer directly to retail outlets; retailer adds a markup onto the price they pay to producer.
Example Electronics company distributes its television sets to a chain of retail stores.
Selling through wholesalers and retailers Products are distributed in two stages: by producer to wholesaler and then wholesaler to retailer.
Example Farmer sells apples to wholesaler, who sells them on to supermarkets.
Selling through an agent Products are distributed in three stages: from producer to agent, from agent to wholesaler, and then on to retailer.
Example Chocolatier in France uses import agent in Japan to sell its products to wholesalers and on to retailers.
NEED TO KNOW
❯ Channel margin The cost intermediary adds to producer’s selling price, which is added to price paid by customer
❯ Push strategy Method in which producer promotes products to wholesalers, wholesalers to retailers, and retailers to customer
❯ Pull strategy Use of advertising and promotion to sell to customer
Price is a crucial variable of the marketing mix: it generates revenue, while product, promotion, and place yield costs. Pricing may also be the marketer’s most potent tool because even minor tweaks affect returns.
How it works
To set the price of a product, marketers adopt a pricing strategy based not only on the actual cost of production but also on the perceived attractiveness of the product to consumers. If consumers think a product has a high value, they will be prepared to pay more for it, but if they believe the value of the product is low they will look for the cheapest price among competing products. A business must also take into account the price charged by rival organizations, particularly in competitive markets. Setting a price above that charged by competitors can only work if the product is superior to others.
Pricing strategies
A number of different strategies can be used to determine the price of a product. Cost-plus pricing is a retail markup used by many companies to ensure a profit is made. For example, adding a markup of 50 percent to a product that costs $2 to make means that every unit will sell for $3, generating a $1 profit.
Pricing matrix: price vs. quality
A product’s quality affects its price tag— the higher the quality, the more money consumers will pay for it—but marketers use strategies that play on the interaction between price and perceived quality.
Low quality
Economy
❯ High prevalence Manufacture a product that is very similar to others in the same category.
❯ Low price Undercut competitors’ pricing and gain a larger share of the market.
❯ Minimal marketing Keep the marketing and branding spend as low as possible.
Skimming
❯ High launch price Charge more than usual in the short term while a product is seen as unique.
❯ Correct timing Set a higher price when the business has a temporary advantage in the marketplace, before competing products appear.
❯ Price adjustment Reduce the price once competitors enter the market, or to draw more customers.
High quality
Market penetration
❯ Low price Charge the lowest price possible in order to lure customers away from competitors.
❯ Price adjustment Increase the price to a normal level once the product has a loyal following.
❯ High price Charge as much as the market will pay for an item.
❯ Unique value Apply premium prices to products that have no comparable substitute, such as famous brand-name goods.
❯ High production cost Charge a premium price because a product is customized and offers no savings through volume manufacturing.
Other pricing strategies
Psychological pricing Manipulate a customer’s emotions, appealing to their thrifty side or desire for prestige.
Bundle pricing Offer several products for an overall price, providing better value than buying separately.
Geographic pricing Charge different prices for the same product in different locations.
Non-pricing strategies Avoid adjusting the price to attract sales, promoting superiority of product instead.
PRICING MARKUP COMPARISON
Different industries adopt different approaches to markups. A markup of two to five times the cost is typically applied to drinks served in bars and restaurants. The highest markup is usually applied to the second-cheapest bottle of wine on the wine list, as people tend to avoid the cheapest item.
NEED TO KNOW
❯ Price, value, and cost Price refers to the amount a product sells for; value refers to the product’s actual worth; cost is the amount that has been spent to manufacture the product.
5% increase in price is worth more than a 5% increase in market share
Every successful product launched on the market experiences growth followed by decline. To maximize profitability, business managers must recognize and manage each stage of the product’s life span.
How it works
There are typically six identifiable stages in a product life cycle, with the product’s rate of growth measured by time and revenue. Most businesses have more than one product on the market at any time, and strategic manipulation of the portfolio of products at their different stages in the cycle is crucial to maintaining business growth. The life of older products may be prolonged by extension strategies, but if they are no longer grabbing new market share, the business must consider launching new products in order to continue generating revenue.
Introduction Sales are typically low and cost per customer is high as the market takes time to accept the new product.
Launch Business outlay is high due to product development costs and marketing budget. There is no return on investment.
Growth Sales increase and the cost per customer falls as profits rise. There are more customers—and more competitors.
Saturation Sales peak and the cost per customer is at its lowest. Profits are now high and competition is intense.
Withdrawal The product is phased out as sales stall or continue to fall. The business introduces a replacement product before the old one is withdrawn.
Diffusion of innovation (consumer uptake) %
Marketers identify five distinct customer types according to how quickly they pick up on a new product.
PORTFOLIO ANALYSIS
Rising stars Products with a high market share in a high-growth market; they require a big marketing spend to keep them growing.
Cash cows Products with a high market share in a low-growth market; they generate money to support rising stars.
Problem children Products with a low market share in a high-growth market; they need a big marketing spend.
Dogs Products with low market share and low growth; they may stay in portfolio to keep customers happy.
NEED TO KNOW
❯ Extension strategy Revival of a product by rebranding, or repackaging, repricing it, or finding new markets
❯ Portfolio analysis Each of a company’s products measured by growth rate and market share to determine marketing spend
❯ Product life cycle management (PLM) Tracking of product data from inception to withdrawal
6 months the length of time a product can be labelled as “new
A vital step in the process of deciding how to market a product is defining how it is distinct from the competition—what is unique about it and what are the qualities that make it better than rival products.
How it works
Before a company launches a product, the marketing department has to decide how to position it in the marketplace compared to competitors’ products. To determine the positioning of a product, marketers must define the most important features and values of the product or brand, and clarify how it is different from similar types of products offered by competitors. They also need to identify the criteria that customers are most likely to use when choosing a particular product or brand. With this information the marketers can then create a product positioning matrix or map.
Product positioning maps
Marketers commonly create a perceptual “map,” using a product’s two most important attributes, presented as variables on an x and y axis, to work out where to position it. Attributes may include price, quality, status, features, safety, and reliability. Once the map is labeled, existing products are placed on it to reveal the best position or gap for the proposed launch.
Product positioning template
The map shows how marketers position competing products in the marketplace according to the price/quality variables (the most commonly used) to identify a gap for the new product.
Breakfast positioning map
The positioning of the various breakfast foods has been determined by the speed at which the food is prepared, measured from slowest to fastest, and the price of each food type, from the least expensive to the most expensive.
FOUR POSITIONING STRATEGIES
❯ Value positioning A product plotted on the map so that it has an attractive price while delivering good functional qualities
❯ Quality positioning A product that is located on the map on the basis of its perceived quality or superiority.
❯ Demographic positioning A product mapped according to its appeal to a specific population segment, such as consumers with a particular occupation.
❯ Competitive positioning A product that is very similar to those of competitors, relying on correct pricing to find a viable position in the marketplace
“Positioning is not what you do to a product. (It) is what you do to the mind of the prospect.”
The goods and services a company sells are its product. A product can be defined in terms of features, design, size, packaging, service type, return policies, and warranties, together intended to meet the customer’s needs.
How it works
Consumers can be said to buy benefits rather than products. For the marketer, the product itself is that benefit to the consumer, as packaged and presented.Marketers identify the goods and services they sell in three or five product levels, with the benefit at the core. The marketer’s job is to translate and communicate each product level as an offer to the consumer.
Total product concept: three product levels
From a marketer’s perspective, a product is more than the end commodity bought by a customer. It is a total product concept with several layers of benefit, and these must be conveyed to the consumer.
Actual product Packaging, brand name, quality level, design, and additional features that set it apart from rival products
Augmented product Additional benefits, such as delivery and credit, warranty, after-sales service
Core product Product’s basic function and its core benefit to consumer
Variation: five product levels
This variation on the total product concept is more detailed. It introduces two more levels by breaking down the actual product level into a generic and an expected product, and also includes an extra level of benefit—the potential product.
Core product Product’s core benefit to consumer
Generic product Basic functional benefits
Expected product Additional desirable benefits
Augmented product Extra features and benefits
Potential product Future, improved version
NEED TO KNOW
❯ Personal branding Promoting oneself as a product with a distinct brand personality
❯ Fast-moving consumer goods (FMCGs) Sold quickly and at relatively low unit cost, such as food and household products
42% of new product launches can be expected to fail
The successful marketing of a product depends on the consideration of four key elements—the product itself, its price, how it is promoted, and where it is sold. This combination is called the marketing mix, and it is used as a tool for planning product launches and campaigns. Before focusing on the marketing mix, marketers need to define the target market for their product by determining which groups of customers are most likely to purchase it.
The 4Ps and 4Cs of the marketing mix
First proposed in 1960, the classic marketing mix tool contains the 4Ps: product, price, promotion, and place. In the 1990s, these were recast as the 4Cs, which emphasized the customeroriented dimension of the tool.
Commodity
❯ Has the product been specifically engineered and designed to meet and exceed customer expectations?
Product
❯ Is the product the right design, size, and color to appeal to customers?
❯ What are its unique features? How does it compare with competitors?
Price
❯ What is the value of the product to prospective customers?
❯ What is the usual price point for this type of product?
Cost
❯ How much will the product cost the customer, and will it be seen to represent a good buy?
Communication
❯ What is the most meaningful way to get marketing messages to customers and provide them with useful information?
Promotion
❯ What combination of marketing and media channels will be most effective?
❯ When is the best time to run promotions?
Place
❯ Where should the product be sold—stores, online, or catalogs?
❯ Where do competitors sell, and is there a way to stand out in the same place?
Convenience
❯ How easy is it for busy customers to find and buy the product?
The 7Ps of the marketing mix
Some marketers use a more detailed model of the marketing mix, which has three additional elements.
❯ Product
❯ Price
❯ Place
❯ Promotion
❯ People Does the business employ the right people to deliver optimum service to customers?
❯ Physical environment Does the design and layout of the business premises appeal to customers?
The 7Cs of the marketing mix
This model offers a customerfocused variation of the 7Ps, adding three more elements to the 4Cs.
❯ Commodity
❯ Cost
❯ Convenience (or Channel)
❯ Communication
❯ Corporation How do company structure, stakeholders, and other competitors affect marketing?
❯ Consumer What are the customer’s needs and wants? Is the product safe? What product information is available?
❯ Circumstances Can the business deal with external factors, such as laws, weather, economy, culture?
DEFINING THE MARKET
In order to establish a marketing strategy for the product they are introducing to the marketplace, businesses have to define the customers they aim to sell to by researching and segmenting the market.
Market research
❯ Identifies gaps in the market for the launch of new products
❯ Measures customer reactions to new offers and campaign messages
Market segmentation
❯ Breaks down the market into smaller customer groups with similar needs
❯ Allows more focused campaigns with a greater chance of success
“ Product, promotion, and place create value. But price harvests value.”
Capital gearing is the balance between the capital a company owns and its funding by short- or long-term loans. Investors and lenders use it to assess risk.
How it works
Most businesses operate on some form of gearing (also called financial leverage). They partly fund their operations by borrowing money, via loans and bonds, on the condition that they make regular repayments of a fixed amount to the lender. If the level of gearing is high (in other words, the business has taken on large debt), some investors will be concerned about its ability to repay and see this as an insolvency risk. However, if the amount of operating profit is more than enough to repay interest, high gearing can provide better returns to shareholders. The optimum level of gearing for a company also depends on how risky its business sector is, how heavily geared its competitors are, and what stage of its life cycle it is at.
Low gearing
Company has less debt
Company has more equity Low proportion of debt to equity, also described as a low degree of financial leverage. Equity comes from:
❯ Reserves (retained profits)
❯ Share capital
Equity finance (shares)
Pros
❯ Does not have to be repaid
❯ Shareholders absorb loss
❯ Good for start-ups, which may take a while to become profitable
❯ Angel investors share expertise
❯ Low gearing seen as a measure of financial strength
❯ Low risk attracts more investors and boosts credit rating
Cons
❯ Shared ownership, so company has limited control of decisions
❯ Shared profit in return for investors risking their funds ❯ Legal obligation to act in the interests of shareholders
❯ Heavy administrative load
❯Complex to set up
High gearing
Company has more debt
High proportion of debt to equity, also described as a high degree of financial leverage. Typical examples of debt are:
❯ Loans
❯ Bonds
Company has less equity
Debt finance (loans)
Pros
❯ If the company makes a profit, it can reap a larger proportion
❯ Paying interest is tax deductible
❯ Does not dilute ownership
❯ Company retains control of decisions
❯ Repayment is a known amount that can be planned for
❯ Quicker and simpler to set up
❯ Small business loans at favorable rates may be available to start-ups
Cons
❯ Loan must be repaid
❯ Interest must be paid, even if operating profit shrinks
❯ Debt may be secured on fixed assets of company
❯ Unpaid lender can seize assets and force bankruptcy
❯ Lenders first to be paid in the event of insolvency
❯ High gearing considered a measure of financial weakness
❯ High risk may put off investors and adversely affect credit rating
Gearing ratio calculation Analysts and potential investors assess the financial risk of a company with this calculation, presented as a percentage.
Low gearing A software company is going public. Its ratio of 21.2 percent tells investors that it has relatively low gearing and is well positioned to weather economic downturns.
High gearing A water utility is the only water provider in the area, with several million customers. The ratio of 64 percent is acceptable for a utility company with a regional monopoly and a good reputation.
NEED TO KNOW
❯ Interest cover ratio An alternative method of calculating gearing—operating profit divided by interest payable
❯ Overleveraged A situation in which a business has too much debt to meet interest payments on loans
❯ Deleverage Immediate payment of any existing debt in order to reduce gearing
The capital market is a global financial marketplace for trading long-term securities—bonds with a maturity of at least a year, and shares. It is where governments and businesses can raise funds and investors make money.
The structure
The capital market encompasses the debt capital market, where bonds are sold, and the stock exchange, where shares are sold. Both have a primary and a secondary market.
Capital market
Primary market
The market issues new bonds and shares, with investment banks overseeing the trading. It is also known as the new issue market (NIM).
GOVERNMENTS SELL BONDS
COMPANIES SELL BONDS AND SHARES
BONDS SHARES Sold on debt capital market (bond market)
SHARES Sold on debt capital market (bond market) Sold on stock exchange (equity capital marke
INVESTORS
Secondary market
Investors buy bonds and shares from other investors, not from issuing companies. The cash proceeds go to an investor, not to the underlying company or entity
BONDS
SHARES
Individual investors buy and sell shares and bonds previously issued on the primary market
WHAT IS A BOND?
A bond is a debt security that a company issues to investors. By buying bonds, an investor is effectively loaning money to the issuers, who in return agree to pay interest to the investor. A bond has a set term of maturity (a limited number of years of validity) and until that time the interest is paid to the investor annually. When the bond matures, the issuer repays the original sum of the loan to the investor. Companies or governments issue bonds to raise money that can then be put back into the business or used to fund government.
Bonds or shares: pros and cons
Bonds (debt investments)
✓Sellers are contractually obliged to pay interest✓Bonds are less risky: debt capital markets are less volatile than stock exchanges; if the issuing company has trouble, bondholders are paid before other expenses and before compensation to shareholders ✗ Buyers of bonds have no stake in the company
✗ Buyers cannot access principal sum until bonds mature
Shares (equity)
✓Buyers of shares gain a stake in the company
✓Sellers of shares have to pay dividends, although these can be reduced or suspended if the company feels it is necessary
✗ Shares are more risky: changes in company profits and in the economy as a whole can cause share prices to rise and fall; if the company fails, the shares become worthless
How do bonds work?
Bondholders effectively buy a slice of a larger loan with each bond, for which they receive interest, along with the original sum on maturity. Issuing, buying, and selling bonds takes place in the debt capital market. The marketplace has several functions: it offers bonds and other types of loans to investors; it operates as a fixedincome market, because the issuer is required to pay regular interest; and it enables companies and governments to raise long-term funds. Overall, the debt capital market is much larger than the stock exchange (equity capital market), where shares are bought and sold. It attracts investors because bonds provide more protection from risk than shares. There are various types of bonds, some safer than others—the risk lies in whether the issuer will be able to pay the interest and repay the principal sum on maturity. A secured bond is backed by an asset, such as property; an unsecured bond is not and so carries more risk. Both bonds and shares may be referred to as securities. The term describes the share or bond itself, and the certificate of ownership or creditorship that gives the holder the right to receive a dividend, in the case of shares, or interest payments, in the case of bonds.
TYPES OF BONDS
Government bonds are the safest type of bond since governments in developed capitalist economies are unlikely to default on interest payments on the loan or on the principal sum.
Corporate bonds
Secured bonds are secured by the assets of a company, making them a less risky investment than shares. Examples include equipment, trust certificates, and mortgage bonds
Unsecured bonds are not backed by pledged collateral and are a riskier investment—if the company fails, investors are paid only after secured bonds have been paid out. Because they are more risky, investors expect a higher return (interest) on their investment.
Investing in the debt capital market
A company wants to raise $100 million to finance growth but does not wish to issue further shares. Instead, it raises the money by issuing bonds on the debt capital market.
Company issues bonds The company issues 1 million bonds at $100 each. Each bond effectively acts as a loan between the investor and the company.
Investors buy bonds Each bond has a set maturity date of 10 years and a 7 percent interest rate, with a face value of $100. During the 10 years, the company can use the money as capital.
Investors receive annual interest Each year, the company pays an investor $7 (7 percent of $100) for each bond bought, in return for using the principal sum as capital to fund its business. After 10 years, the investor has received a total of $70 interest per bond.
Mature bond is repaid Once the bond reaches its date of maturity, in this case 10 years, the original sum of money, $100, is repaid to the investor. So the investor receives a total of $170, including interest, over the full term, in return for the original $100 investment.
NEED TO KNOW
❯ Debt instrument Official term for bond or other long-term debt
❯ Convertible bond Bond that can be converted into shares of the issuing company, or cash
❯ Warrant Security that allows the holder to buy stock in a company at a fixed price for a certain period of time
❯ Callable bond Bond that gives the issuer the right to redeem it before maturity
❯ Non-callable bond Bond that cannot be redeemed or sold back to the issuer before maturity but continues to provide interest
$100 trillion the estimated value of global debt markets
When a company goes public, it sells shares to investors, who become part-owners in return for capital investment. The number and type of shares bought by each investor determines the size of their ownership.
How it works
Before floating on a stock exchange, a company undergoes a valuation process to set the initial price of its shares. This process involves the directors, prospective investors, and an investment bank, which is appointed to assess the company’s value. Together, they reach a decision on the most financially viable price for the shares that will be offered on the exchange. Upon going public, a company issues ordinary shares to investors as the basic unit of ownership, commonly referred to as a stake in the business. A company may also issue shares privately, rather than publicly to investors via the stock exchange, to retain greater management control.
A share of the pie
Ordinary shares, issued by all companies when they go public, are the most common type of shares. There are also other share types, which give the company more flexibility to control rights available to different shareholder groups. Most shares are sold on the stock exchange, but non-voting and management shares are issued directly to holders. Different types of shares entitle the holder to different rights.
Company shares
Issued directly
Management shares Issued (usually given not sold) to owners and members of company management, who have:
✓Extra voting rights, so control of company stays in the same hands
Non-voting shares Issued to employees, who:
✓Receive a part of remuneration in the form of dividends
✗ Have no voting rights
✗ Receive no invitation to attend annual meeting
Solid bia stock exchange
Common stock Shareholders:
✓Share in the company dividends ✓Share in the company’s assets ✓Have right to attend AGM✓Have right to vote on important company matters such as appointment of directors
✓Receive the company’s annual report and financial statements
Preferred stock Shareholders:
✓Receive fixed dividend, paid ahead of any dividends paid out to ordinary shareholders✓Take priority in receiving a share of any assets left after debts are paid if company is insolvent
✗ Have fewer, if any, voting rights
RAISING MORE SHARE CAPITAL
After the initial sale of shares, when a company goes from private to public, the business can raise additional funds by issuing more shares. There are three main ways to do this:
❯ Rights issue entitles existing shareholders to buy additional shares from the company within a set time frame, before they are offered to other buyers.
❯ Public issue is a process by which the company issues a new allotment of shares to sell to the public on the stock market.
❯ Private placement is a practice by which the company sells its shares (or other securities) directly to private investors, usually large institutions, bypassing the stock exchange all together.
NEED TO KNOW
❯ Flipping Buying and quickly reselling IPOs for a large profit
❯ Redeemable shares Shares that may be later bought back by the issuing company for a cash sum
698% the increase in share price of IPO VA Linux Systems in one day on the New York Stock Exchange, in 1999
Establishing share value
The forces of supply and demand set the price of shares. Companies issue only a limited number of shares to the public, which can then be bought and sold on the stock exchange. Demand for those shares is determined by whether investors think the company has good future economic prospects. If investors believe that the company is primed for substantial growth, they will want to buy shares in it, which consequently drives up the share price.
Rising value of shares
Financial market observers believe that the emphasis on optimizing the value of shares for shareholders began in 1976, when the idea of maximizing profit for shareholders became a priority. Since then, the market has experienced a general upward trend with occasional deep dips. The graph tracks the average value of all shares on London’s FTSE from 1964 to 2013.
SPLITTING SHARES
A company occasionally carries out a “share split” to its existing shares. This increases the total number of shares, although the combined value of shares stays the same. A share split allows a company to lower the price of its shares to bring them in line with the price of competitor shares. The share split is usually a two-for-one or three-for-one increase, whereby the shareholder sees the number of their shares double or triple.
SHARE PRICE TOO HIGH A company listed on the stock exchange has seen its share price increase so that its shares now cost more than its competitors’. The high price puts off investors.
SHARES SPLIT The company decides on a share split. It halves the price of each existing $3 share, so each share is now worth $1.50.
SHARE CERTIFICATES ISSUED It issues new share certificates to holders, doubling shares held: a shareholder with 1,000 shares at $3 each now has 2,000 at $1.50 each. Total worth is still $3,000.
SHARE VALUE ALIGNED The value of shares is now similar to that of competitors. The price encourages new investors to make a purchase.
NEED TO KNOW
❯ Bear market Market that has seen decline of 20 percent over a period of 2 months or more
❯ Bull market Market where share prices are rising and investor confidence is high
❯ Market correction Short-term decline in share prices to adjust for an overvaluation
25% the drop in share value over four days during the Wall Street Crash of 1929
What is a dividend?
Shareholders in a company are usually entitled to a payment of cash from its profits. The company pays a dividend sum on every share it has issued, but it is up to the company’s board to decide how much profit to reinvest and pay out. Investors may look at a company’s rate of dividend payout, along with its capital growth, to gauge its financial health and decide whether to invest in it. Investors who rely on shares for income are likely to invest in companies that reliably pay out dividends. In a good economic climate, they win twice—the dividend provides income and the capital value of the shareholding increases. However, there is always a risk that the value of shares will go down, and companies only pay dividends if they have made a profit. Paying dividends is a good way for a company to attract investors. It is essentially a reward for putting money into a company so that it can fund its existing output and develop and expand the business.
How it works
Shareholders usually receive a dividend if the company in which they hold shares has retained enough profit in that financial year to make the payment. The decision to make a payment is made by the board of directors. The dividend might be paid every quarter (four times a year), or in two parts—an interim dividend may be made partway through the year, with the final dividend paid just after the end of the financial year.
Announcing retained profits At the end of the financial year, the company announces its retained profits: the sum it intends to keep for reinvesting or paying off debts rather than pay out as dividends.
Making the decision for dividends The board of directors makes a decision on whether there is enough to warrant a dividend payment, and if so, how much. It records details of each payment in dividend vouchers.
Keeping funds for growth The company keeps some of its profit to put back into the business. It needs to strike a balance between pleasing investors and expanding its operation.
Making the payment Most dividends are cash dividends. Sometimes companies distribute stock dividends, issuing more shares instead of cash to shareholders.
Paying taxes Shareholders must declare dividends on their tax return and pay taxes on them.
INTEREST RATES AND DIVIDENDS
When interest rates are low, shares with high dividend payouts become extremely attractive to investors because they provide a better return than investments that yield an interest payment. This economic climate encourages companies to pay out top-rate dividends and so attract as many investors as possible, which in turn increases the share value. Conversely, when interest rates are rising, investors may prefer to put their money into fixed-income assets, which will pay high rates as a result of the hike without the risk attached to buying shares.
HIGH INTEREST RATES Investors are attracted to pay into fixed-income assets, such as deposit accounts.
LOW INTEREST RATES Investors are attracted to buy shares as dividends give a good return for their money.
NEED TO KNOW
❯ Dividend yield ratio Measure of how much a company pays out in dividends relative to the price of each share
❯ Dividend per share Sum paid on each share after retained profits have been calculated
❯ Dividend payout ratio Percentage of a company’s net income that is paid out in the form of dividends
1602 the year the Dutch East India Company became the first company to issue stocks and bonds
When a company changes from private to public, it offers shares for sale to members of the public. This process is known as going public and enables the company to raise money for growth.
How it works
The process by which an organization goes public (also known as flotation) marks the end of its life as a private company, after which it is no longer owned by a small number of shareholders or company members. A company may choose to go public when it needs capital to finance growth. Going public usually happens over several months; the company makes legal and financial preparations before the final stage, when it releases company shares for sale, either to selected investors or to the general public, or to a combination of both. Each share represents a “stake” in the company, and the money that the company receives from the sale of shares becomes capital, or wealth, which it now owns.
Ways to list on a stock exchange
There are three primary ways to take a company public, each of which has different associated costs. The type of public offering that a company chooses will be determined by its size and how much capital it needs to raise.
Introduction A company joins a new stock exchange without raising capital, but by trading its existing shares. To do this, over 25 percent of the shares must already be in public hands (on other stock exchanges) and no one shareholder can own a majority of shares.
Placing Select groups of institutional investors are invited to buy shares. This involves fewer costs than undertaking a full public share offering (see below) but the amount of capital that can potentially be raised is limited since there are fewer shareholders.
Initial Public Offering(IPO) Institutional and private investors are invited to subscribe to or buy from the first round of shares that the company issues. This is the most expensive way to go public, but allows for a company to raise large amounts of capital.
Stock exchange A financial market in which company securities (stocks and shares) are bought and sold according to current market rates.
TEN LARGEST IPOS IN HISTORY
When a well-known private company undertakes an IPO, there is fierce competition between investors to buy its shares, and record-breaking activity can ensue. This graph shows the largest IPOs until 2014, based on proceeds from shares sold on the first day they went public.
WARNING
❯ Underestimation If the initial valuation of shares by the underwriters is too cautious, then the company will fail to realize the true value of its stock
❯ Overestimation If underwriters overestimate the value of shares newly on the market (new issue), it may flop due to lack of demand
❯ Volatility Share prices in the first few days of an IPO may fluctuate dramatically due to political or economic events
20%the typical minimum annual growth potential of public companies in the US
A closer look at IPOs
An Initial Public Offering (IPO) is the first time that shares in the company are offered for public sale. It is the most common way for a private company to go public if it needs a large injection of capital to fund major expansion. There are other reasons for going public—for example if a government wants to privatize a state-owned company, such as a national railroad, or if the members of a large family-owned enterprise want to sell their stake.
The IPO process
Before a company can issue shares, it has to be listed on a stock exchange where trading (the buying and selling of shares) can take place. The company must then fulfill the criteria necessary to secure investors. This process is lengthy, subject to strict financial regulations, and is extremely expensive to undertake. Only once all stages of the process are complete can the share offering be officially declared on a stock exchange.
1 Meet the qualifications The specific requirements are set by the stock exchange where the company plans to list. Listing conditions vary between exchanges, but typically demand:
Pretax earnings above a certain level
Three years of audited financial statements
Ability to pay the annual listing fee
1 Appoint underwriters These financial professionals will be responsible for buying and selling the shares to the public.
3 File a prospectus This document contains information about the offering, the business, and its financial history, and proposed plans. Details are still subject to change.
4 Promote the share offering Company representatives, as well as the underwriters, visit national and international destinations to pitch to potential investors.
5 Set the final offer price After ascertaining market conditions and the anticipated demand, the company decides the price and the number of shares to issue. It is then ready to launch the offering.
6 Sell on the stock market The IPO is officially declared a few days after potential investors receive the final prospectus. The declaration is made on a set day after the exchange has closed, and the shares are available for trading the following day.
NEED TO KNOW
❯ Large cap Listed company with market capitalization of more than $10 billion
❯ Mid cap Listed company with market capitalization of between $2 billion and $10 billion
❯ Small cap Listed company with market capitalization of between $250 million and $2 billion
$16.6 trillion the total market capitalization of companies listed on the New York Stock Exchange*
When business growth or unforeseen expenses cannot be met using internal sources of financing, such as retained profit, organizations must rely on finding funds from lenders or investors.
How it works
External financial support comes in various forms, including bank loans and issuing shares. The available sources of outside financing depend on the amount a company requires, and whether the money is needed to resolve a short-term issue, such as cash flow, or for the long-term growth of the business. While short-term financing is easier to secure, finding larger sums for an expansion is more challenging. A company that is either already listed on a stock exchange or is preparing to enlist will be able to raise the capital through the sale of shares. However, an unlisted company may struggle to raise a comparable amount. A company with a large amount of debt will also find it hard to raise funds, since lenders or investors will see the business as risky.
Raising external financing
Generating funds from external sources can be a challenge, especially when securing investors. However, revenue does not necessarily need to take the form of a loan. There are a number of strategies that can be implemented through working with external parties in order to provide a company with good working capital.
Short-term financing
A range of financial agreements that help provide a company with immediate funds can be made with outside parties as a way of raising cash short-term.
Bank line of credit Borrow from business checking account up to an agreed limit, with interest typically at a high rate.
Debt factoring Sell unpaid invoices to an external source for an agreed amount in order to receive immediate payment minus a commission fee.
Invoice discounting Borrow money against sales invoices customers are yet to pay (again, often at a disadvantageous rate).
Long-term financing
Putting effective measures in place to provide ongoing revenue is essential for a company’s long-term growth.
Shares Raise capital by issuing shares to finance growth. The company then retains less profit, as it pays dividends to shareholders, who also benefit from any capital gains in the company’s value
Borrowing Secure long-term loans from banks and other financial institutions, usually on better terms than a bank line of credit.
Finance leases Sell expensive assets such as computers to finance companies to release capital, and then lease them back.
Rent-to-own agreements Pay for expensive assets, such as vehicles, in installments. Overall cost may be higher, but capital is not tied up.
DEBT FACTORING PROCESS
To get money immediately, a company sells unpaid invoices (accounts receivable) to a third party, known as a “factor.” The factor advances the company a major portion of the amount, retains the rest until the account is paid, then charges a fee.
Company negotiates an agreement in which its unpaid receivables (invoices) are sold at a discount to a “factor.”
Company sends invoices out to customers, and copies these to the factor. Customer now owes payment to factor.
Factor pays company an agreed percentage of the invoices (typically 80–90 percent) within a few days of receipt.
Customer pays factor the invoice amount after 30 days (or more if terms of payment are longer).
Factor pays remaining invoice amount to company, minus a fee (usually 2–5 percent of the invoice amount).
NEED TO KNOW
❯ Term loan A bank debt repaid over a set period of time
❯ Loan note A form promising payment to the holder at an agreed future date
❯ Eurobond A bond issued in a currency other than the currency of the country in which it is issued
80% of external corporate financing is provided by domestic banks
Most companies prefer to secure funding from their own internal resources, rather than either take on debt through borrowing or give up a stake in the company by issuing shares, both of which cost more.
How it works
When a business needs funds, or capital, to pay for expansion or investment in order to maintain its current operations, it is faced with two choices: either find the money from outside sources, or find the money from within the organization itself. Since there are costs attached to bringing in funds from external sources, such as interest that has to be paid on a bank loan, the business managers must weigh up the opportunity cost of using its own funds—the profit it could earn by investing those funds—against the cost of financing.
Company
Raising internal financing
Whether a company’s need for additional funds is long- or short-term, steps can be taken to increase the level of funds within the company.
Short-term financing
For businesses wishing to raise funds without recourse to external sources, there are three main strategies they can implement to maximize the amount of cash available for day-to-day operations and capital expenditure.
Tighten credit control Actions include chasing debtors so that invoices are paid on time; ensuring new customers are creditworthy by conducting strict credit checks; and setting a 30-day payment term
Delay payment Large suppliers may offer a discount for early payment, but they may also allow a company longer terms for payment, boosting cash levels in the short term.
Reduce inventory It is expensive for a business to retain a large inventory of unsold goods. Cutting the inventory back reduces storage costs, the cost of production, and replacement of goods that go out of date or become obsolete.
Long-term financing
For a business needing long-term financial help, its own resources should act as the primary support.
Retained profits A portion of profits may be pumped back into the business. A company may also decide to sell assets to raise cash.
USING PROFITS TO FUND EXPANSION
A company seeking to grow may choose to fund the expansion with its profits. This option offers both advantages and disadvantages.
Pros
❯ The use of profits means that no interest payment has to be made, unlike on money that is borrowed
❯ Existing owners and directors are able to retain full control over the business, rather than sharing it with new investors
❯ The company is able to keep a low debt profile, which will appeal to future investors and lenders
Cons
❯ Profits can take time to build up sufficiently to fund expansion
❯ Withholding dividends may upset some shareholders who prefer to receive the profit as dividends
❯ Lost opportunity to earn funds from investing profit rather than spending it
THE RECENCY BIAS
When a company receives timely payments for its invoices, this helps maintain its levels of funds. Interestingly, invoices issued right after completion of work tend to get paid sooner than those invoices that are sent later. A theory called recency bias explains this phenomenon: the brain prioritizes recent events over those that occurred longer ago.
44 the average number of days it takes a limited company in the UK to pay a 30-day invoice
When a company needs additional funds, it can use either internal or external sources, or both, depending on whether it seeks large amounts of funding for long-term growth, such as an expansion, or smaller amounts for short-term expenses, such as to cover operating costs. In addition, the number of external sources available depends on whether the business is well established or whether it is relatively new and without much of a track record.
Sources of financing and capital
When considering the prospect of raising financing, the financial directors will first evaluate the financial health of the company. They will then decide what proportion of the company will be funded by equity (the company’s own reserves of cash and money raised from issuing shares) and what proportion will be funded by borrowing money from an outside source, such as a bank, so that the company takes on debt.
EVALUATING CAPITAL STRUCTURE
When investors consider buying shares in a company, they look at its capital structure to assess the future prospects of the business. The capital structure refers to the percentage of a company’s finances made up of funds from shares and earnings, called equity, and the percentage made up from borrowed funds, or debt. When evaluating capital structure, investors consider the following:
❯ As a general rule, companies with more equity than debt are considered less risky to invest in because their assets outweigh their liabilities. So a company with significantly more equity than debt has a low debt-to-equity ratio and is generally seen to be a low-risk investment.
❯ A company with significantly more debt than equity has a high debt-to-equity ratio and is more risky as an investment.
❯ Debt is not always bad. If interest rates are low a company could take on more debt to fund expansion, as long as the revenue it makes from the borrowed funds is greater than the interest payable. So although this company may be more risky, it may also have greater potential for growth—this is known as “gearing.”
Debt and loans
Institutional lenders Money loaned by large financial bodies, such as banks.
FUNDS IN THE FORM OF A LOAN FROM AN OUTSIDE SOURCE
Equity
Profit from business activities Proceeds of the core business.
Shareholders’ stake in company Payment received for shares in the company.
DIVIDENDS—PAID ONLY WHEN A COMPANY MAKES ENOUGH PROFIT
Bonds
Investor lenders Payments made by bondholders.
59% of US financial managers say financial flexibility is the most important factor in deciding how much debt the company takes on
For keen observers of financial statements, warning signs that indicate fraudulent business activities may be detected in overly optimistic statements and evasive attitudes of senior management.
How it works
Public companies are required to have their annual financial statements audited (checked) by an independent auditor. It is typically during this process that any financial shenanigans— creative accounting tricks used to manipulate the figures and improve the performance of a company in its financial statements—and outright fraudulent activity is uncovered. It is the auditor’s job to ensure that business records and statements are accurate and have been honestly reported. Auditors carry out a systematic examination of the company’s records and may identify any irregularities that may indicate fraud. If evidence of fraud is found, the next step is to involve forensic accountants and criminal investigators, who may prosecute the perpetrators.
Red flags indicating fraud
Auditors may be alerted to fraud by a number of recognized warning signs or “red flags”; these may be either directly to do with the behavior of the CEO or other top executives, or in the form of irregularities within the financial statements.
Suspicious figures on financial statements
❯ Cash flows that are negative for three quarters, then suddenly and dramatically become positive
❯ Sudden increase in gross margin, at odds with industry average and company’s previous performance pattern
❯ Large sales to companies with dubious track records
❯ Sales recorded before they have been made
❯ Made-up, nonexistent sources of revenue
❯ Expenses moved from one company to another, or classified as assets
❯ Ongoing, long-term growth of earnings per share
❯ High payments to executives compared to base salary
CEO behavior
❯ Evasive behavior by executives over important financial details
❯ Attempts by CEO to steer auditors away from certain documents
Technicalities
❯ Late entry of sales or earnings adjustments
❯ Missing approvals or signatures
❯ Photocopied documents presented in place of originals
How to detect fraud
Procedures should be in place to hold accountable anyone who handles expenses. When these fall short, internal and external auditors need to take more drastic measures.
Applying ratio analysis to reveal key long-term trends
Setting up confidential hotline for current and past employees or others with knowledge of the company
Using element of surprise, such as undertaking an aggressive internal audit without prior warning
Conducting a surprise cash count to determine whether current cash flow matches statements
Data mining with auditing software to detect any mismatch between past patterns and current statements
NEED TO KNOW
❯ Asset stripping Selling off the assets of a company for a profit to raise funds, often resulting in the closure of the business
❯ Tunneling A particular type of fraud in which assets and funds are illicitly transferred to management or shareholders
Predicting future business performance is necessary to estimate probable sales, income, costs, and profitability and thus gain investment and maintain confidence in the company.
How it works
Forecasting success or failure relies on historical data—financial statements, financial ratios, and Key Performance Indicators—that reflect business operation and can be tracked over time. The tracked and monitored data can provide an early warning system for potential problems. For small businesses and start-ups, accurate forecasts provide a basis for raising external financing, while for larger companies, this information provides an indication of financial strength for investors and markets. Predictions may range from conjectured costs and revenue to complex financial models. One of the most frequently used predictive models for forecasting business success is the Z-score model, devised by Edward Altman, a New York University finance professor, in 1968.
Forecasting with Z-score models
Realizing that traditional financial ratios, such as the ratio of costs to revenue, created only a partial picture of a business’s financial performance, Altman devised a set formula that combined four or five key ratios to give a Z score. The model has proven 90 percent accurate in predicting business failure over one year, and 80 percent accurate over two years.
Corporate success
Efficiently run companies with a healthy balance between assets and liabilities, and profit and debt inspire confidence in investors.
Working capital / total assets A measure of liquidity: the more working capital in a company, the more it is able to pay its bills.
Market value of equity / book value of total liabilities A measure of the market confidence in the company: a ratio of less than one means the firm is worth less than it owes—it is insolvent.
Retained earnings / total assets A measure of leverage: a high ratio indicates profits are funding growth; a low ratio indicates growth is financed by debt.
Earnings before interest and taxes / total assets A measure of return on assets: it gauges operating income generated by assets.
Sales / total assets A measure of efficiency: the sales generated by the assets.
Finding the Z score
Each of the above ratios is multiplied by a specific value, to give them weighting; results are added together to give Z score
❯ A score of 0.2 or lower means the company is highly likely to fail.
❯ A score of 0.3 or higher means the company is unlikely to fail.
Signs of corporate failure
There are many signs that a company is doing badly and perhaps sliding into insolvency. These signs make investors nervous, which is likely to lower share price if they start selling their shareholding. However, most companies that fail are in profit, but run out of cash.
Low cash flow seen in continued fashion of decline in cash holding on Balance sheet over consecutive years
Selling assets to pay off debt
Cuts to employee benefits
Reapeted devidend cut to shareholders
Top management resigning and taking jobs elsewhere
Low profitability, seen in consistent downslide in profit on profit-and-loss statements from consecutive years
High borrowing, high interest payments, and dwindling revenue
Bankruptcy occurs if the company cannot pay its debts
NEED TO KNOW
❯ Ohlson O score Alternative to Z score for predicting failure
❯ Overtrading When a company’s sales grow faster than its finance
❯ Undertrading When a company trades at low levels compared to its finance levels
❯ Zeta analysis Secondgeneration Z-score model
20% the predicted profitability increase from 2013 to 2017 for organizations using performance measurement to make business forecasts
Lenders, investors, analysts, internal management, and other interested parties calculate financial ratios to decipher what financial statements are really saying about the state of a business.
How it works
Financial ratios are used to assess the financial standing of a business and identify any problem areas that might affect its future prospects. The process involves comparing two related items in the financial statement, such as net sales to net worth or net income to net sales, and using those ratios to measure the relative performance of the company. There are many different ratios to choose from, depending on the purpose—for example, whether the purpose is to measure the company’s ability to provide a good return to shareholders, its capacity to handle debt, or the efficiency with which it operates. The ratios can also be used to compare a business with its competitors or in comparison to specific benchmarks within the company to determine how consistent its financial results are.
Top financial ratios
These are some of the ratios most commonly used by people involved with assessing businesses. They are best considered comparatively and in the context of the economic climate. The ratios are for analyzing established companies, usually public ones with shares traded on the stock exchange—start-ups and small-tomedium enterprises generally do not have a full enough range of figures to provide any kind of reliable guide.
Profitability ratios
These are used to see how effective a company is at generating profit. Profitability ratios may mirror investment valuation ratios. One example is the operating profit margin ratio. A high ratio is good, as it indicates that a high proportion of revenue (gross income) converted into operating income (profit minus costs).
Other profitability ratios
❯ Return on equity (ROE) is measured as net income after tax / shareholders’ equity. The higher the ratio, the greater the profitability, but not if a company is relying too heavily on borrowing.
❯ EBITDA to sales ratio is measured as EBITDA (earnings before interest, taxes, depreciation, and amortization) / revenue. It gauges the profitability of core business operations. The higher the margin, the greater the profits.
Efficiency ratios
These show how efficiently the company uses its assets and resources to maximize profits. An example is the sales revenue to capital employed ratio, which indicates a company’s ability to generate sales revenue by utilizing its assets. Similar ratios can examine how quickly the company settles its bills and invoices
Other efficiency ratios
❯ Accounts receivable turnover ratio is measured as net credit sales / average accounts receivable. It shows how efficiently a company turns sales into cash. The higher the ratio, the more frequently money is collected.
❯ Inventory turnover ratio is measured as the cost of goods sold / average inventory. It shows how efficiently a company manages its inventory level. A low ratio usually equates to poor sales.
Liquidity ratios
This group of ratios reveals whether or not a company has enough cash or equivalent assets to meet its debt repayments. An example is the working capital ratio (also a measure of efficiency), which indicates whether a company has enough short-term assets to cover its short-term debt.
Other liquidity ratios
❯ Cash ratio is measured as total cash (and equivalents) / current liabilities. It shows whether a company’s shortterm assets could repay its debts. A high ratio is seen as favorable.
❯ Quick ratio (acid-test ratio) is measured as current assets minus inventories / current liabilities. It shows how easily a company can repay shortterm debt from cash. The higher the ratio, the more easily it can pay.
Solvency ratios
While liquidity ratios look at a company’s short-term ability to meet loan repayments, solvency ratios indicate the likelihood of a company being able to continue indefinitely with enough cash or current assets to pay its debts in the long run. An example is the debt to equity ratio.
Other solvency ratios
❯ Interest coverage ratio is measured as EBIT (earnings before interest and tax) / interest expense. It indicates how easily a company can pay the interest on its debts. The higher the ratio, the more easily they can pay.
❯ Debt ratio is measured as total liabilities / total assets. It indicates the percentage of the company’s assets that are financed by debt. A low ratio is considered favorable.
Investment valuation ratios
Thes ratios are typically used by investors to gauge the returns they are likely to get if they buy shares in a company. An example is the dividend payout ratio. It indicates how well earnings support the dividend payments—more mature companies tend to have a higher payout ratio.
Other investment valuation ratios
❯ Net profit margin ratio is measured as profit after tax / revenue. Another measure of a company’s profitability, it is also useful for comparing a company with competitors. The higher the ratio, the more profitable the company.
❯ Price to earnings ratio is measured as market value per share / earnings per share. It indicates the value of the company’s share price. A high ratio demonstrates good growth potential.
WARNING
Investors beware Ratio analysis must be used over time—at least four years—to understand how a company has reached its current position, not just what the position is. For instance, if debt has suddenly gone up, it could be because the company is branching out into new areas of potential profit, or to limit the damage of a poor past decision.
10–14% the minimum return on investment (ROI) needed to fund a company’s future
Key performance indicators (KPIs), or key success indicators (KSIs), are based on a company’s goals and vary depending on the company and industry. KPIs are usually stated in a company’s annual report.
How it works
KPIs are the non-financial measures of a company’s performance—they do not have a monetary value but they do contribute to the company’s profitability. Any company department can adopt KPIs to gauge its performance. A KPI for an accounts department might be the percentage of overdue invoices, as this will help determine the department’s efficiency. This is an example of a lagging indicator—it is an outcome and therefore easy to measure, but not straightforward to influence. Companies also look for leading indicators, which are focused on inputs and easier to change. A leading KPI for the accounts department might be the percentage of purchase orders raised in advance.
Corporate KPIs
KPIs can be set up as dashboards on computers so that they can be checked frequently. These dashboards show examples of KPIs specific to departments in a company. Having set their KPIs, the departments are subject to managerial review, which could result in action if KPIs are sub-standard.
Sales and marketing
Net promoter score (NPS—how many Number of customer complaints; customers would recommend company); customer retention rate; customer lifetime value (total amount of money generated by one customer)
Accounting
Number of retrospectively raised purchase orders; finance report error rate (measures the quality of report); average cycle time of workflow; number of duplicate payments
Customersservices
Number of customer complaints; customers would recommend company); customer retention rate; customer lifetime value (total amount of money generated by one customer) customer satisfaction (measured over time); average email response time; number of products sold compared to total sales calls made
Human resources
Economic value of an employee’s skill set; employee satisfaction levels; revenue per employee; rate of employee turnover
Operations
Project cost (difference between budgeted cost and actual cost of work); time taken to get a product to market; optimally running operations
Environment and sustainability
Waste recycling rate; size of carbon footprint; size of water footprint (amount of water usage); energy consumption
BALANCED SCORECARD SYSTEM
This strategic system offers a different way of monitoring a company’s performance. It was proposed by Robert Kaplan and David Norton at the Harvard Business School in the 1990s, and Harvard Business Review has cited it as one of the most influential business ideas of the last 75 years; it is estimated that over 50 percent of large companies in the US, Europe, and Asia use the approach. The Balanced Scorecard consists of four ways to view an organization’s performance:
Learning and growth Employee training and corporate culture
❯ Business processes Includes specific measurements for monitoring daily performance ❯ Customer perspective Customer satisfaction
❯ Financial perspective Traditional financial data
31% of companies use a computer dashboard to monitor KPI measurements
There are two main ways of measuring a company’s performance: financial and non-financial. To assess financial performance, a company calculates financial ratios. To assess other areas of the business, a company examines its key performance indicators (KPIs), which help management and staff evaluate performance and how it can improve. KPIs also enable interested outsiders, such as investors, lenders, or analysts, to decide whether to invest in the business.
Financial and nonfinancial categories
Any company that publishes a financial report will be required to set out key figures on the revenue generated and the expenses incurred during the course of its activities. These figures can be compared using mathematical calculations called financial ratios. However, financial ratios alone may not give an accurate vision of the company’s future prospects. Non-financial ratios, or key performance indicators, do not measure financial performance, but they do reveal other important characteristics of a company that will ultimately affect its profitability, such as customer loyalty and research and development (R and D) productivity.
Tracking for forecasting
Financial and nonfinancial measures can be used forecasts company Performance and track fraud.
Financial measures
Financial ratios
❯ Used by investors and lenders to gauge financial health of an organization: if it’s likely to survive economic slump, and what prospects it has for future growth
❯ Standard set of ratios used by the financial industry
❯ Calculated based on figures provided in financial reports
Non financial measures
Key performance
❯ Used internally and by investors, as they appear in financial statement
❯ May be calculated daily or even more frequently for internal use
❯Companies can set diverse KPIs to reflect future goals
❯ Unique to each company
TREND ANALYSIS USING PERFORMANCE MEASUREMENTS
A comparison of either financial ratios or KPIs between companies in the same industry and across time is often used to track a company’s performance. Current ratios are calculated by dividing current assets by current liabilities: the higher the ratio, the more liquidity a company has.
CURRENT RATIO COMPARISON OVER TIME Fast-food chain A is shown to be a consistently better performer over time, and so has the most solid financial standing of the three companies.
THE BIGGER PICTURE
Some professional services companies, such as multinational PwC, undertake quarterly surveys, interviewing senior executives to find out how optimistic they are about their sector and the wider economy. Such surveys help companies measure their own performance objectively.
69% of multinationals link performance measures to future financial results
For a business to achieve its goals, it needs to have a process that measures the contribution and performance of each individual against those goals.
How it works
The way in which tasks are done is becoming as important as what tasks are done, as organizations recognize the importance of creating the right culture to enable workers’ performance. For any company, effective evaluation of the performance of employees should be strategic and is aimed at ensuring the maximum productivity of individuals, teams, and the organization as a whole.
Traditional performance management cycle
Performance management is an ongoing, continuous process. Some companies are now moving away from traditional performance management to “crowdsourcing” as a way for managers to collect, evaluate, and share information on employee performance.
Individual goals Set personal goals to align with business strategy
❯ Business goals drive tasks and activity.
❯ Culture enables teams and individuals to deliver.
❯ HR policies give clear benchmarks.
Discussion Ongoing communication on standards of work and behavior to improve working relationships
Coaching Feedback on performance to help individuals work efficiently
Appraisal Formal feedback from the line manager, with an opportunity for individuals to contribute
Rewards Promotions and pay raises in line with performance
A WIN-WIN SITUATION
Evaluating performance is good for both the business and the individual.
Business
❯ Aligns individual goals with company goals.
❯ Offers consistent approach, with benchmarks.
❯ Continuously enables improvement.
❯ Fosters the right behaviors and relationships.
Individual
❯ Understands what is expected of them.
❯ Has the skills to deliver on these expectations.
❯ Is supported to fill any gaps in capability.
❯ Is given feedback and allowed to discuss goals.
NEED TO KNOW
❯ Balanced scorecard Framework to measure performance against strategic goals, devised by Kaplan and Norton
❯ Competencies Defined behaviors and attributes that individuals must have to perform effectively at work
❯ Performance appraisal Process via which individual employee and their manager can discuss performance and development
Placing the right person in the right job is vital for the success of the organization—this is the process of recruitment and selection. Technology is changing traditional hiring pathways.
How it works
The human resources function manages the process. Increasingly, line managers are involved as well because the tools are often accessible via company intranet. Recruitment starts with the company identifying a vacancy— the need for someone to do a job, and pulling together information about the exact nature of the role. Aspects to consider include the job’s purpose, tasks required, and the outputs or deliverables of the job holder, as well as how the role fits into the organization’s structure. This information forms the basis of a job description and person specification. The search can then begin. The company’s own website, recruitment agencies, commercial job boards, and advertisements in the press are traditional ways of attracting the attention of people outside the organization. Internetbased routes are now common too. Today, application forms are often directly submitted online, triggering automatic responses and sorting of candidate details.
Job description and person specification
Clear written statement of the role, including job title, purpose, duties, responsibilities, scope, and reporting structure, as well as competencies and qualities required. It is used in the recruitment process to provide a clear guide for both applicants and interviewers.
Person specification Summarizes the necessary or desired criteria for candidate selection, including required skills and/or competencies for the role, experience, and educational qualifications.
Internal search Looking at internal resources first creates opportunities for career development and progression, improving employee engagement and retention.
Personal recommendation Some companies encourage existing employees to introduce friends as candidates.
External search Increasingly, companies and candidates use professional networking sites such as LinkedIn and social media such as Facebook or Twitter. External candidates diversify the workforce but cost more to attract.
Applications The curriculum vitae (CV) or résumé is the essential document, often with a cover letter. Companies may use an application form instead.
Selection After HR has drawn up a shortlist, candidates are assessed by individual faceto-face interviews, group assesssment, and psychometric testing.
Appointment Companies may ask for references and/or request a medical examination for the chosen candidate. The employment offer is a legally binding contract that sets out the terms and conditions of the job.
NEED TO KNOW
❯ Psychometric tests Often used as an initial screening method, these aim to assess attributes such as intelligence, aptitude, and type of personality, using verbal and non-verbal reasoning tests and behavior questionnaires.
From the moment a company starts the process of recruiting an employee to the time that person leaves the company, the individual is in a cycle that is managed by the human resources (HR) department.
How it works
People are a significant cost to any organization—and of great value. Many CEOs talk about staff as their most important asset, and US industrialist Henry Ford famously said: “You can take my factories, burn up my buildings, but give me my people and I’ll build the business right back again.” The HR department is there to ensure that the right people are in the right roles so that the company can deliver the business strategy and maintain its competitive edge. The complexity of the business influences the stages in the HR cycle, but the basic elements are the same.
Recruit
A business identifies the need to fill a role, and attracts applicants. CVs are assessed and interviews held to find the best candidate.
Employ
Once terms are agreed and a contract signed, the candidate becomes the company’s employee.
Reward
An induction program explains the new role and introduces the team. HR gives a briefing on pay, tax, and benefits such as leave, insurance, and pensions.
Manage performance
The company sets targets and helps individuals to improve performance so they contribute to business results and get the most out of their job.
Develop
The business has processes to help people improve their skills, competencies, and knowledge, through formal or informal learning, both on and off the job.
Transition
The company helps its employee to move into a new role, which may be in another business it owns…
Exit
…or to leave the company, which may be through resignation, redundancy, or retirement.
NEED TO KNOW
National employment laws Employment practice is regulated by a raft of laws— for example, in the US federal Equal Employment Opportunity laws prohibit any discrimination on the grounds of sex, race, disability, age, sexual orientation, or religion at any stage of the employment cycle.
“Hire people smarter than you and get out of their way.”
The human resources (HR) department is responsible for all policies and processes relating to the people employed by a business. To help the business achieve its goals, HR has to make sure that it employs the right people with the right skills, treats them consistently and fairly, and has a supporting framework to drive and deliver the required level of performance.
HR framework
The starting point for any decision in an organization is its business goals. HR supports the delivery of these goals by ensuring that there is a staffing strategy to support the business plan. Typically, an HR framework sets out a people strategy including the competencies of the people who best suit the organization. This is then implemented in a range of areas, from recruitment and selection to learning and development. HR professionals work closely with business leaders and line managers to design and implement HR systems that back up strategic business goals.
Business goals
Business goals are the driver for every business decision, and HR polices support them.
SELECTION AND RETENTION
SUCCESSION AND TALENT PLANNING
PERFORMANCE MANAGEMENT
LEARNING AND DEVELOPMENT
REWARDS AND BENEFITS
EMPLOYEE
ENGAGEMENT
Values and culture HR helps to determine principles, conduct, and how tasks are done in a business.
Organization design HR formulates the structure and formal reporting relationships that define a company’s shape.
People and performance HR is responsible for employees’ welfare and their contribution to business goals.
ESSENTIAL PEOPLE SKILLS
As well as recruiting effectively and ensuring that employees deliver, HR plays a role in nurturing essential people skills across the organization
Relating to others
❯ Some people are natural leaders, but most leaders can benefit from objective thinking about the leadership strategy they wish to follow.
❯ Even in flattened, team-based hierarchies, team leaders need to develop leadership skills to guide and support their teams.
❯ Despite the revolution in technology, people remain vital to organizations, as skills and knowledge are central to success. As a result, HR has an expanding role. One example is Google, which calls its HR function People Operations (POPS) and treats its staff as a valuable asset, offering a range of attractive perks to “find them, grow them, and keep them.”
Managing projects
❯ Project management is an essential skill for managers at all levels, whether they are running regular day-to-day activities or special projects.
Negotiating
❯ The ability to negotiate successfully is an essential skill. Awareness of strategies and styles is key to success.
A stakeholder is anyone who is affected by the performance of the company, while shareholders own one or more shares in a company, which makes each of them a part-owner of the company.
How it works
Because shareholders part-own the company, they have the right to vote on how it is managed and to receive a share of its profits. All shareholders are stakeholders, since the performance of the company has a direct impact on the value of the shares they own: when the company does well, the share value rises, and when it performs badly, the share value falls However, stakeholders can also be non-shareholders— individuals or groups who have an interest in what the company does or whose financial situation depends on the company. Some stakeholder groups are interested in a company mainly for its ethical treatment of workers, sustainable approach to the environment, and attitude to society. These are known as environmental, social, and governance (ESG) criteria.
Stakeholders’ areas of interest
Stakeholders have no direct involvement, but believe that companies have a responsibility to the communities they operate in, to respect the environment, human rights, and animal welfare.
Nongovernmental organizations
❯ Contribution to enviromental and social causes
❯ Legal compliance
Community
❯ Impact on local inhabitants
❯ Concern for broader social welfare
Stakeholders with economic and ESG concerns
Stakeholders use ESG—a recognized part of policy and reporting for most companies—to evaluate corporate behavior and to determine future financial performance. Concerns range from profits to ethics.
Government
❯ Tax payments
❯ Legal compliance
Shareholders
❯ Ability to pay dividend
❯ Increase in share value
Customers
❯ Quality product
❯ Good value
❯ Customer service
Trade unions
❯ Treatment of workers
❯ Fair pay, benefits, and working conditions
Suppliers
❯ Ability to pay debt
❯ Enough liquidity
Employees
❯ Pay and benefits
❯ Longevity of the company
❯ Employment prospects
Lenders
❯ Ability to repay loans
❯ Integrity of management
❯ Financial strengths of the company
Stakeholders in action
Compared with other stakeholders, shareholders have the most interest in the financial performance of a company. They are also forced to take an interest in how seriously the company takes its corporate social responsibility (CSR), whether or not they are socially and environmentally conscious themselves. Several high-profile cases have shown how stakeholder reaction has caused a significant decline in share prices. By using social media, stakeholders can generate a storm of public disapproval, leading to angry consumers and nervous investors
Almost every organization has a structured arrangement of levels for members, from the board of directors at the top to junior employees at the bottom. There is a trend toward reducing the number of levels.
How it works
There are five levels in the conventional corporate structure with a line of authority from top to bottom. The chief executive officer (CEO) is the highest-ranking person in the company, reporting to the board of directors and sometimes also sitting on the board. Reporting to the CEO are a number of highlevel executives, known as C-level executives—their job titles begin with a “C” and end with an “O.” Below the C-level is management, in tiers that differ from company to company, with employees forming the bottom level. As well as skilled and unskilled employees, there may be staff on fixed-term contracts, taken on for the duration of a project or for a set length of time, and casual temporary workers.
C-LEVEL VARIATIONS
The range of C-level positions varies for each company. In addition to the three top posts, there may be:
CAO Chief Administrative Officer
CIO Chief Information Officer
CTO Chief Technology Officer
CPO Chief Product/Production Officer, responsible for overseeing product development and production
CMO Chief Marketing Officer, responsible for marketing strategy and business development C-level positions are evolving, adapting to market conditions and business priorities. New roles are emerging while some traditional roles are disappearing. The role of COO, for example, is less popular in modern organizations. Some of the new roles include:
CPO Chief Privacy Officer
CSO Chief Sustainability Officer
CDO Chief Digital Officer
CKO Chief Knowledge Officer
CCO Chief Customer Officer
C-suite executives
These are the most senior jobs in the company, with the CEO at the top, the COO and CFO traditionally on the next level down, and other C-positions below that. In many companies, the C-level positions have equal authority and all report directly to the CEO.
CHIEF OPERATING OFFICER (COO) Responsible for day-to-day operations; reports to CEO and acts as second in command
CHIEF EXECUTIVE OFFICER (CEO) Decides on corporate policy and strategy
CHIEF FINANCIAL OFFICER (CFO) Manages company’s financial risk; reports to CEO
Mid-level management
Responsible for overseeing specific functions in the organization, the most senior managers at this level head up different departments or divisions. These managers are often called directors (not to be confused with the board of directors) or, in the US, vice-presidents. The exact job titles, and the number of midlevel managers, vary depending on the company.
MARKETING MANAGER Directs marketing department day to day
OPERATIONS MANAGER Oversees operations division; may also direct production department
R AND D MANAGER Heads up research and development (R and D) of new products
FINANCE MANAGER Puts CFO’s plans or directions into action, instructing junior managers
Junior management and other employees
Team leaders, such as supervisors and assistant managers, implement management plans. They also coordinate teams of skilled and unskilled workers in, for example, production, customer service, and sales to carry out the core tasks needed for the company to function efficiently and profitably.
SUPERVISORS AND TEAM LEADERS
NON-MANAGEMENT EMPLOYEES
Flattening hierarchies
The trend in management over the past few decades has been to eliminate layers from company hierarchies, which means they are becoming flatter—in other words, there are not as many levels to go through in order to reach the top. One example is the role of chief operating officer (COO), which has been disappearing in recent years. Between 2000 and 2012, there was a 10 percent decline in the number of Fortune 500 (an annual list of the top US corporations compiled by Fortune magazine) companies with COOs. Only 38 percent of the 500 have a COO position now. CEOs have also eliminated layers of middle management, and in the US there was a 300 percent increase between 1986 and 2003 in the number of division heads reporting directly to the CEO. Sometimes companies decide restructure the other way round instead —from flat to tall—by eliminating a number of senior management posts and replacing them with a greater number of junior supervisory roles. 500 have a COO position now. CEOs have also eliminated layers of middle management, and in the US there was a 300 percent increase between 1986 and 2003 in the number of division heads reporting directly to the CEO. Sometimes companies decide restructure the other way round instead —from flat to tall—by eliminating a number of senior management posts and replacing them with a greater number of junior supervisory roles.
NEED TO KNOW
❯ Span of control Number of employees reporting to a manager or other senior level; the greater the span of control, the more workers reporting to an individual above
❯ Line position Job role with responsibility for achieving the goals of the organization
❯ Staff position Job role providing expertise to assist someone in a line position
Tall vs. flat hierarchies
There are pros and cons for both types of hierarchy, and each company has to find the number of levels, and positions within each level, that suits the nature of its business.
Tall hierarchy
The traditional model is suitable for a formal chain of command as, for example, in the army.
❯ Several layers from top to bottom
❯ Fewer employees reporting to each manager; close supervision possible
❯ More room for career advancement because there are many levels to rise through
Flat hierarchy
This looser model is more flexible and suitable for companies that foster creativity.
❯ Only a few layers so mid- and low-level management are merged
❯ Large number of employees reporting to each manager; close supervision not possible
❯ More freedom for employees to make their own decisions
Public companies are required by law to appoint a board of directors to provide oversight.
How it works
All companies must have at least one director. If a company goes public and issues shares, it is legally required to have a board of directors. The board is made up of experienced business advisers who provide independent oversight of the company for shareholders and are mandated by law to govern the company responsibly. Board members may come from within the company or be independent outsiders, and should cover a range of expertise— such as legal, financial and marketing— or have specialized industry knowledge. Networkers are also highly prized for their ability to build connections with influential figures in the corporate and governmental spheres. From within their ranks, the board elects a chairman, vice-chairman, secretary, and treasurer.
Shareholders evaluate
Any person or institution that has bought shares in a publicly listed company is a shareholder. The board works for the shareholders, who effectively own the company.
Board of directors
The board of directors of a publicly listed company sits between the company and its shareholders.
Secretary
Appointed by The board Responsible for
❯ Publicly representing the company’s policies and leading board meetings
Treasurer
Appointed by The board Responsible for
❯ Presenting yearly accounts
❯ Leading audit committee
Chairman
Appointed by The board Responsible for
❯ Publicly representing the company’s policies
❯ Leading the board, conducting board meetings
❯ Determining the composition of the board
❯ Mentoring and monitoring the CEO or managing director (MD)
❯ Communicating with shareholders
Vice-chairman
Appointed by The board Responsible for
❯ Standing in for chairman
❯ Undertaking special projects for chairman
❯ Assisting chairman in balancing experience, personality, and age of directors on board
Directors
Appointed by The board Responsible for
❯ Determining strategy
❯Monitoring achievement of implemented policies
❯ Appointing managers
❯ Accounting for company’s activities to shareholders and other stakeholders
Company
Responsible for day-to-day production, sales and marketing operations, and finance. The company reports to the board via its chief executive officer (CEO), who executes the board’s decisions.
CEO
Balancing the board
The board has three clear areas of responsibility: developing business strategy, advising the company, and overseeing how the firm is run. Selecting the right mix of directors to fulfill these functions is crucial. Board members may come from inside or outside the company. Those who work for the company (executive or internal directors) have more expertise in running the business, but independent members (non-executive or external directors) are better placed to offer perspective, scrutinize the actions of company executives, and call them to account. When potential conflicts of interest arise between management and shareholders, independent directors can weigh decision-making in favor of acting in the company’s best interests. The ideal balance is a hot topic in corporate governance. In US companies, CEO and chairman roles have traditionally been combined, but following a spate of corporate scandals, the roles are now more often vested in two individuals. In Europe, keeping the roles separate has long been seen as best practice.
NEED TO KNOW
❯ NEDs Non-executive directors, also known as independent, external, or outside directors
❯ Executive directors Board members who also work for the company—not to be confused with the term executive director when used as a title for the CEO
❯ Model Business Corporation Act Developed by the American Bar Association, this model is used as the basis for corporate governance in the US
PROS AND CONS OF CEO AS CHAIRMAN
Pros
❯ Strong, central leadership Decisions hold fewer conflicts.
❯ Efficiency CEO/chairman can implement board decisions swiftly.
❯ Expertise CEO has company and industry knowledge (a CEO may become chairman after retirement).
❯ Balance of power Established hierarchy between CEO/chairman and other directors reduces risk of conflict on the board.
Cons
❯ Lack of transparency Conflicts of interest/corruption are more likely.
❯ Reduced objectivity Board headed by CEO is unable to monitor CEO’s work objectively.
❯ Higher remuneration Combined role generally commands higher pay than two separate individuals.
❯ Mentoring Chairman who is also CEO cannot offer independent mentoring and support for the role.
Board structure variations
Independent board of directors
The board sits between shareholders and company. The CEO is the main channel of communication between board and company, while the chairman is the principal conduit between shareholders and board. This structure gives the board most independence.
CEO as chairman
A setup in which the company’s CEO serves as the board’s chairman. While this offers less independent scrutiny of finances, strategy, performance, and pay, it avoids duplication of roles. This setup is found in US corporations and in many small- and medium-sized companies in other countries.
Senior management as directors
A structure in which senior managers also sit on the board. The chief financial officer (CFO) is appointed board treasurer and the chief operations officer (COO) is vice-chairman. In some countries (Germany, for example), employees must be included on the board by law.
Two-tier board
An arrangement that is made up of separate supervisory and executive boards. The supervisory board is composed of outside directors, led by a chairman. The executive board comprises senior managers, including the CEO. The two boards always meet separately.
Determining a company’s hierarchy—including how many layers of power it has, and how many staff to appoint at each level—is one of the biggest challenges of modern management. In family-run businesses, positions are usually filled by family members who answer to the head of the family. The emergence of public companies has meant that company ownership is separated from management, so that shareholder interests are prioritized.
Who’s who in an organization
Stakeholders and shareholders
Stakeholders are anyone with a vested interest in the company. Shareholders are stakeholders who have bought stock in the company.
Board of directors
The board of directors makes sure the company is run profitably to provide returns to shareholders. The board votes in a chairman, who is sometimes also the chief executive officer (CEO).
C-suite executives
The top level operates the company day to day and sets strategy. All titles of top management begin with a “C” for chief. Senior managers are headed by the CEO.
Mid-level management
Division and department heads are usually called directors or managers. Jobs at this level are often the first to go when a company downsizes or restructures.
Junior management
Supervisors, managers, or team leaders directly manage groups of employees carrying out specific tasks. Examples include a head nurse or foreman.
Non-management employees
The lowest ranks of the organization: skilled and unskilled workers carry out core tasks needed for the company to operate.
STRUCTURAL WHYS AND WHEREFORES
Overtime pay Managerial staff who are not paid for overtime hold exempt positions. Non-exempt positions usually belong to non-managerial staff who are paid by the hour and qualify for overtime pay.
Who bosses whom When one manager has formal authority (decisionmaking power) over another, it is called vertical specialization. Horizontal specialization means several managers have equal authority.
A company’s ownership may undergo a change, which can be driven either externally, known as a management buy-in, or internally, known as a management buy-out.
How it works
In a management buy-in (MBI), a group of managers or investors from outside the company raises the funds to buy a majority stake in the company and then takes over its management. This type of action occurs when a company appears to be either undervalued or underperforming. In a typical management buy-out (MBO), the company’s existing management team purchases all or part of the company they work for. Despite the name, MBOs are not restricted to managers, and they can include employees from any level of the organization who wish to make the transition from employee to owner.
BUY-IN MANAGEMENT BUY-OUT (BIMBO)
In this type of transaction, the existing management of a company stages a buy-out, but additional external management is brought in by financers to strengthen the company’s leadership and to provide expertise in particular areas that might be lacking in the original team.
Buy-in
Some companies, such as investment banks or venture capitalists, can make sizable profits by purchasing undervalued businesses and transforming them.
Buy-out
A buy-out allows a large company to sell off a part of the business it no longer wants or helps a small business owner to retire or move on.
NEED TO KNOW
❯ Earnout A percentage of the purchase price paid to the sellers after acquisition if the business has performed as expected
❯ Leveraged buy-out Acquisition of a company using equity and borrowed money, with company as collateral for loan
While a merger results in a bigger company, a divestiture reduces the size of a business by breaking it down into smaller components or divisions, which are then sold off or dissolved.
How it works
The typical scenario for a divestiture is a company that is struggling to pay off debt it has taken on to expand into new areas of business that are not yet profitable. To save the rest of the company from the burden of debt, management decides to start a divestiture. Generally, the goal is to shed the least profitable areas of operation, or from the potential buyer’s point of view, those which have promise but are not yet profitable. The process of restructuring by divestiture is designed to free the company of divisions with low return, to reduce debt and financing requirements, and to give the shareholders a stronger return. The market price of the parent company’s shares often bounces back strongly and its spin-off companies may thrive too.
Divestiture in practice
Smith Industries Inc. is one example of an industrial paint conglomerate that has grown rapidly over the past five years, due to an increase in profits from its expanding sales in China. It diversified into agricultural chemicals, textiles, and biotechnology, and set up a separate division for each. Share prices fell in response to poor financial performance.
SUCCESSFUL SPIN-OFFS
Mondelez The spin-off of Kraft Foods owns snack foods Oreos, Ritz, and Trident.
Coach Sara Lee food’s spin-off makes luxury leatherware.
Expedia Media company IAC hived off online travel to Expedia.
The shareholders benefit
Shareholders in the original company also receive the same percentage holding in shares from the three new companies.
One company becomes four
The three divisions are sold off to separate investors and become three separate companies. Shares for each are sold on the stock market. The parent company is reduced to its core business. Its share price rebounds.
NEED TO KNOW
❯ Spin-off New company formed as the result of a divestiture; also called a hive-off
❯ Tracking stock Special type of shares issued by a parent company for the division or subsidiary they will sell; tracking stock is tied to the performance of the specific division rather than the company as a whole; also known as targeted stock
❯ Letter of intent Letter stating serious intention to do business, often concerning M and A
❯ Reverse merger Not to be confused with a divestiture, this is a quick and cheap method for a private company to go public by buying a shell stock— a public company that is no longer operating because it went bankrupt or was simply closed.
❯ Demerger Term commonly used in the UK for divestiture
52% the potential rise in a parent company’s share price following a divestiture
Two of the quickest ways to accelerate expansion are for a business to buy out another—an acquisition—or to amalgamate with another business in a merger.
How it works
Mergers and acquisitions (M and A) is a general term used to describe the ways in which companies are bought, sold, and recombined. In the case of either a merger or an acquisition, two separate legal entities are unified into a single legal entity. While a merger combines two companies on a reasonably equal footing to create a new company, which will make both parties better off, an acquisition is usually a purchase of a smaller company by a larger one. This benefits the company making the purchase but may not necessarily benefit the target company. M and A can be friendly or hostile—agreed to or imposed.
REASONS TO PURSUE M AND A
❯ Improved economies of scale Wider operations streamline production and sales. ❯ Bigger market share Combining the existing markets expands share of the total market.
❯ Diversification A different product lineup gives the chance to cross-sell or create more efficient operations if the products are complementary.
FRIENDLY AND HOSTILE
❯ The target company’s board of directors and management agree to be bought out.
❯ The acquiring company makes an offer of cash or stock to the target company’s board and management. ❯ The stock or cash offer is set at a premium level.
❯ Because the offer is above actual market level, shareholders usually agree to it.
❯ The acquiring company bypasses management and goes straight to the target company’s shareholders.
❯ The target company’s management fight the deal.
❯ The buying company convinces shareholders to vote out the management (a proxy fight) or it makes an offer to shareholders to buy shares at an above-market price (a tender offer).
NEED TO KNOW
❯ Pacman strategy The target company tries to take over the very company attempting the hostile buyout
❯ Swap ratio An exchange rate between the value of the shares of two companies when merging
❯ Defensive merger Undertaken to anticipate a merger or takeover attempt that threatens a company
❯ Economies of scale Benefit to company of M and A expansion
Both private and public companies regularly change hands—they are bought, sold, and restructured to reflect changing business conditions. These deals all come under the umbrella term of mergers and acquisitions (M and A). Acquisition financing is usually needed to pay for the purchase of another company, often in the form of a loan or venture capital.
How to acquire a company
A company is typically acquired in one of two ways—either by a management team or by another company. When a company is buying, the result can be a merger, in which two companies join forces, an acquisition (outright purchase), or a divestiture, in which part of a company is hived off and sold. Management team purchases are often funded by private equity.
Management team acquiring
Private equity firms look for companies to buy and then sell their shares when profits have maximized. They fund the management team
Buy-out
The existing management team buys out the company they work for.
Buy-in
An external management team buys into the company.
Divestiture Part of company is split off to form new company; may become acquisition target
Another company acquiring
Companies may want to expand by joining with another business.
Merger The company combines with another company.
Acquisition
Horizontal The company buys another company that makes similar products.
Vertical The company buys another company that makes different products.
SIZING UP M AND A’S
Measuring a big deal
The corporate world categorizes acquisition deals according to the capitalization size (the value of the company’s shares).
Due diligence
Before any company sale, the potential buyers see a detailed report prepared by lawyers, covering key aspects of the target business.
❯ Financial Identifies problem areas that could affect the future value of the company.
❯ Legal Gauges possible legal risks attached to corporate status, assets, securities, intellectual property, and employee reshuffling.
❯ Commercial Includes industry trends, market environment, the company’s capabilities, and the competition.
❯ Environmental Uncovers potential liabilities such as land or water contamination and estimates remediation costs.
Starting a new venture can be a long process. Business (also called venture) accelerators and incubators are specialized organizations devoted to developing and supporting start-ups.
How it works
Business accelerators and incubators provide expertise and connections in the formative stages of a business in return for a percentage of ownership. They are two separate types of services. Business accelerators are short-term programs that offer wide-ranging support including mentorship, business advice, and connections to potential sources of financing. Business incubators, on the other hand, provide a supportive environment in which fledgling start-ups can develop, with technical assistance, working space, and networking opportunities.
Business accelerators
Suited to start-ups that have limited financing, accelerators offer short–term (one to three months) boot camps. Clients include web and software developers.
Seed capital
Networking
Accounting and financial services advice
Help with bank loans, funds and guarantees programs
Introduction to potential partners
Link to potential investors
Access to mentors and advisory boards
Marketing advice
Management of intellectual property
Business incubators
Often sponsored by nonprofit organizations, incubators tend to be longer term (one to five years) and cater for a variety of clients, many science-based.
Start-up introduced to incubator
Start-up pays incubator % of equity in the business. It may also pay rent to share part of the incubator’s work space. In return, it receives a range of benefits.
NEED TO KNOW
❯ Incubator networks Collaboration of incubation centers, research facilities, and science parks ❯ Virtual business incubator Online hothouse for start-ups
33 months the average time US start-ups spent in an incubator, during 1999–2002
Almost every new enterprise needs funding to get it going, and to keep afloat until it turns a profit. Financial help is at hand from a variety of sources, suitable at different stages of start-up growth.
How it works
Capital for new enterprises comes from two main sources: lenders and investors. Lenders, such as banks, provide debt capital in the form of a loan that is returned with interest. Investors, such as business angels and venture capitalists (VCs), provide equity capital in the form of a share in the business that may include a proportionate share of control and rewards. Both types of funding can be corporate—from a company—or more quirky and alternative, such as crowdfunding.
Types of start-up funding
Corporate, traditional, and substantial funding comes largely from banks and VCs, while smaller sums come from more personal sources.
Lenders
Investors
Grants
Lenders
Debt capital most often takes the form of loans paid back with interest.
Term loan Paid back regularly over a set period of time
❯ Bank Offers either personal or business loans ❯ Government Offers low-interest start-up loans ❯ Credit union Cooperative that gives members low-interest loans ❯ Peer-to-peer (P2P) lending Unsecured personal loans ❯ Friends and family May give interest-free loans
Bank overdraft or credit card Interest charged monthly if balance not paid in full
❯ Bank or credit company Financial organization that makes loans to commercial ventures
Factoring/invoice discounting Unpaid invoices sold at a discount to a company that collects them for commission
❯ Factors and discounters Companies that offer advance on unpaid invoices, for a profit
Investors
Equity capital is paid to the start-up in return for a share of the business.
Founders, friends, family (FFF) May buy shares in the company rather than lending money
Crowdfunding Large number of supporters, each contributing a small amount of money, usually online
Business angels Investors who give favorable terms because their focus is on the company’s success rather than profit
Venture capitalists (VCs) Companies that provide capital for new businesses in the hope of making a profit
Grants
Financial awards and prizes are provided by public bodies.
Local, national, global Funded by a local authority, government initiative, or international charity
NEED TO KNOW
❯ P2P lending Loans made between individuals over internet ❯ Crowdfunding Debt or equity raised via internet platforms
SUPER ANGELS
❯ What they are Serious investors in technology start-ups. Facebook was funded by super angels, some of whom are now famous in their own right. ❯ Who they are Former Silicon Valley professionals who invest their personal money in new ventures. ❯ How they differ from ordinary angels and venture capitalists (VCs) Funding level straddles the two, often reaching millions of dollars as what started out as a hobby becomes a profession. ❯ Pros and cons Super-angel investing acts like a magnet to other investors, but individual super angels can rarely provide the full funding of a VC.
Alternative models
Since the start of the economic downturn that started in 2008, several innovative and more personal types of funding, such as crowdfunding and peer-to-peer (P2P) lending, have evolved and blossomed on the internet. All involve the principle of raising small amounts of money from large numbers of individuals who pool their resources to provide the loan or equity needed.
CREDIT ANALYSIS CRITERIA FOR LENDING
Life cycle of investment
The key to successful funding is to choose the right type of finance at each stage of a company’s early growth. Start-ups usually begin modestly, with self-funding and help from friends, family, and anyone else who is prepared to take a high risk. Crowdfunders and business angels are amateurs willing the entrepreneur to succeed, while venture capitalists become interested when the level of risk goes down and they can expect a healthy profit in return for injecting substantial funds. Public markets such as stock exchanges may step in as sales soar and success looks probable. At all stages, investors will conduct credit analyis to asses a company’s ability to repay its debt.
5–10% of small and medium-sized enterprises in the UK need no start-up funding
Writing a business plan is one of the most important steps in developing a start-up. The plan sets out the new business’s goals, market analysis, and projected income and profit.
How it works
Before a start-up entrepreneur can write a business plan, they need to have done enough research to identify a clear opportunity in the market for the product or service, and to define how the proposed new business will be uniquely positioned to capture that market, given the services or products offered. An outline of existing finances and an accurate projection of sales and profit are essential components, especially if seeking external funding.
Key elements
Preparing a business plan can take several weeks, and it is worth doing thoroughly. It is a vital document for securing funding, so the financial forecast must be both realistic and accurate. If showing it to others, pare the executive summary down to two pages, write it in plain English, and explain any technical terms.
Executive summary
Fill in this section last, bearing in mind that it may be the only part a busy person reads:
❯ Business summary Company structure, name, product or service, and customer profile ❯ Business goals Three objectives over one, three, and five years ❯ Financial summary Expected sales and costs, and funding ❯ Elevator pitch Two-minute talk to sell your idea to a customer
Business background
Provide details of each person in the business:
❯ Experience Relevant work carried out to date ❯ Qualifications Credentials, such as diploma in horticulture for a gardening service ❯ Training Past and future, including business skills such as assertiveness
Products and services
Describe what the business is going to sell:
❯ Product or service With a picture if product is new ❯ Range If more than one, such as garden design and maintenance ❯ How it is different What makes the product or service stand out from the crowd?
The market
Set out specific details of your potential market:
❯ Typical customer Businesses or individuals and their profile; local, national, or international ❯ Market research What the local market is for similar products or services
Marketing strategy
Choose about three of these methods:
❯ Word of mouth
❯ Advertising
❯ Business literature
❯ Direct marketing
❯ Social media
❯ Website
Competitor analysis
Show how the business idea compares with the competition:
❯ Table of competitors Who and where they are, what they sell and for how much, how good they are ❯ SWOT analysis Including how to remedy any weaknesses and combat known threats, such as a garden center opening nearby ❯ USP Unique selling point of the product or service
Operations and logistics
Describe from start to finish how the business will run day to day:
❯ Supply and delivery How the goods or service will get from A to B ❯ Equipment Details of transportation, office items, and premises ❯ Payment, legal, and insurance How customers will pay and how that translates into salaries; compliance with the law
Costs and pricing strategy
Work out how much the product or service costs and its sale price:
❯ Cost How much each unit or batch costs to make and deliver ❯ Price How much each unit or batch will sell for ❯ Profit margin The difference between cost and price per unit
Financial forecasts
Predict sales and costs over the year, allowing for seasonal fluctuation, such as spring demand for lawn services:
❯ Sales calculations For each month, the expected number of sales ❯ Costs calculations The costs of the predicted sales each month ❯ Cash-flow forecast The money coming in and out of the business
Back-up plan
Make a Plan B in case something goes unexpectedly wrong:
❯ Short-term changes Cutting costs or boosting sales immediately
❯ Longer-term changes Shifts such as working online, not on premises
❯ Closure Lessons learned and skills acquired if the business closes
TOP FIVE REASONS TO WRITE A PLAN
❯ The process Working through each element ensures nothing is forgotten
❯ Costing The only way to find out whether the business is viable is to work out details of costs and sales.
❯ Funding A good business plan improves chances of getting a loan.
❯ Areas of expertise Making a business plan clarifies where outside help is needed—for instance, in bookkeeping or marketing.
❯ Getting to know the competition Conducting market research is the best way to give a business an edge.
NEED TO KNOW
❯ SWOT analysis Stands for Strengths, Weaknesses, Opportunities, and Threats ❯ Unique selling point (USP) The feature that makes a product different from the competition
Start-ups in the US are 2.5x more likely to go into business if they have a written plan
Well-being is not just a matter of luck: it can also, to some extent, be an attitude. If we can find ways to be open, friendly, giving, optimistic, and calm, we may tap into a mood that makes success more achievable.
Success, according to one convincing perspective on the subject, is not a finishing line we cross, but a way of living. We cannot usefully separate success from the rest of our lives, as it connects in complex ways with our happiness, our self-image, and the people we care about. In fact, it’s healthy to treat success as a process, so that we’re not so much reaching a pinnacle as walking a path. When working on our ambitions, it’s good to think of our lives as a whole. Focusing on our well-being, as well as on our individual goals, can enlarge us as individuals and make success both more meaningful to us and more reachable.
Which comes first?
STEPS TO WELL-BEING
According to American psychologists Lisa Mainiero and Sherry Sullivan, as we develop we go through specific stages (see below). How we handle each stage impacts our well-being and what we deem to be important.
■ Challenge—the key factor at the beginning of our career
■ Balance—our priority in midlife ■ Authenticity—the driving force in our late career
experienced positive emotions— the “P” in positive psychology’s PERMA scheme of well-being (see p.49)—were more likely to do well in life. These emotions didn’t have to be dramatic: in fact, the best predictor of happiness was lowlevel but regular experiences of positive feeling. For these people, happiness, either by nature or by cultivated mental practice, was a habit. The result? They met with more success. People assessed as happy were found to be more likely to earn bigger salaries a few years after the assessement. Their careers were demonstrated to be measurably more successful, as the following indicators suggest:
■ If interviewed, they were more likely to get a callback■ They were less likely to lose their jobs or become unemployed ■ If they did find themselves out of work, they were more likely to find another job
■ Their colleagues were more supportive toward them.
The reason for their success was, basically, that happiness made these people engage in successattracting behaviors. They had more energy and were friendlier. They cooperated better with others and were less confrontational. Their problem-solving was more creative, and they set themselves higher goals, persisted longer, and were more optimistic. Happiness naturally inclines us to behave in ways that make other people more willing to work with us and that improve our own performance. Taking care of well-being is, in fact,one of the soundest investments for your future that you’re likely to be able to make.
Lifelong well-being
What’s the basis for long-term wellbeing? It’s partly what American psychologists Sonja Lyubomirsky and Kennon M. Sheldon call our “chronic happiness” capacity. This is created by a mix of factors:
■ Our genetically determined setpoint, which may be relatively happy or relatively sad
■ Our life circumstances
■ The activities we engage in.
While we may not be able to do much about our genes, the pursuit of success is very much about changing our circumstances and activities for the better. As we do this, it’s wise to remember that well-being is a lifelong project. When planning our success, we can help ourselves by building the resources that we anticipate may satisfy our future needs. You can’t anticipate everything, of course, but if you treat success as a lifelong process, you can look beyond narrow forms of achievement and truly experience a successful and fulfilling life.
WHY HAPPIER PEOPLE ARE MORE EFFECTIVE
American psychologists Julia K. Boehm and Sonja Lyubomirsky, in an article entitled “The Promise of Sustainable Happiness,” have summarized some of the reasons why happy people tend to be more effective in pursuit of their goals. Below are four chains of cause and effect based on these findings, showing how happiness tends to lead to enhanced effectiveness. Unhappy people, conversely, follow negative chains, leading to diminished effectiveness.
Can we ever achieve the perfect “work-life balance”? Maybe, but only with compromises. In any case, your priorities will shift as time goes by, so you need to keep reviewing your needs as your circumstances change.
Many people find themselves struggling to balance earning a living, being part of a family, and following their dreams. The ideal is for these things to support each other, but this can be hard to achieve.
Work and life
A concept psychologists have studied in recent years is that of “role accumulation”—that is, how we have to manage being different selves in different situations, such as home and work. Depending on how we handle things, this mix can be either a blessing or a burden. On the positive side, family can support work and vice versa. Studies confirm that if we’re happy in one area, we can carry a good mood into the other; likewise, skills can be transferred—parenting can make us more comfortable with responsibility, work can teach us time-management skills that help with the family calendar, and so on. At the same time, these factors can buffer each other—if work is going badly, a good social life can support us, while pride in our job can keep our self-esteem high if things aren’t going so well at home. How can we attain a good balance? A 2007 study for the Journal of Vocational Behavior argues that we need a high “CSE,” or Core Self-Evaluation. This means having:
■ High self-esteem
■ Low neuroticism—not seeing ourselves as vulnerable
■ A high internal locus of control
■ High self-efficacy
If our CSE is positive, we are better able to use our work to help in our home life, and vice versa. A negative CSE, on the other hand, leaves us feeling that each interferes with the other. It’s worth noting that people with a high CSE may seek greater challenges and put themselves under more pressure, so the ideal state of mind is to rate ourselves well but beware of overcommitting. Understanding ourselves and our goals throughout our lives helps us to make choices and take actions to maintain balance and avoid burnout.
Pain or gain?
A 2012 study for the College of Business in Florida points out that, while role accumulation can be beneficial, it also has its negative side. If we’re deeply committed to both work and home, it can be hard to avoid exhaustion. The answer is to seek authenticity: what matters to you most? If you’re reaching for your dreams, juggling roles tends to seem more worthwhile.
RETRO-PLOTTING
Psychologists Farid Muna and Ned Mansour suggest a technique for analyzing what matters to you based on reflecting on past experiences. On a graph, plot events that made you happy or sad in relation to the high-to-low happiness axis. Don’t dwell in the past, but try to understand what it was that made events either happy or sad, so you can learn the lessons and apply them to your current situation.
PLOT WHAT MATTERS TO YOU MOST
To identify which areas of your life matter to you most, American psychologists Farid Muna and Ned Mansour suggest that you draw your life as a series of interlocking circles, like in the example below. Vary the size of the circles depending on how important each area is to you, and show where areas of your life overlap.
When you’ve mapped out your life and aspirations, talk over the following questions with your partner, trusted friends, mentors, and family. If you prefer, substitute “I” for “We.”
■Do I have a long-term wish list? ■What will make me happy 10, 20, or 40 years from now?
■What do I imagine are my future goals? ■What threats, opportunities, strengths, and weaknesses do I face? ■How will these impact my success? ■What do I want to accomplish with the rest of my life?
A loving relationship does not just happen: it is grown, with attention and work from both partners. Communication skills play a big part, alongside patient acceptance of personal differences.
A key concept in the psychology of romance was developed in the mid20th century by psychologist John Bowlby. According to his “attachment theory,” our childhood relationships and subsequent experiences combine to create different attachment styles, or ways of relating to a partner (see “Attachment styles and your relationship,” opposite). People with different styles can want very different things—and if we are looking for success in our romantic partnerships, it’s important to understand these differences and be prepared to work around them.
Emotional security
Secure people tend to have the most secure relationships, but it’s also true that a bond needs only one secure partner to obtain the necessary stability. If the secure partner is content to give reassurance and is not threatened by the idea of being needed, an anxious person can relax, and is often devoted and loving. An avoidant type will often want to spend time alone, and the secret of success here is in the other partner not taking that personally.
Communication
Constant communication gives built-in protection to any relationship, providing a healthy basis for any compromises needed. Sacrifices silently endured tend to fester, whereas a willingness to talk often leads to solutions even to issues that may initially have seemed impossible to resolve. Emotional security also requires acceptance of your partner’s own personality, needs, and feelings, and a willingness to find welcoming space for all of these in your life.
Companionship
It is important to share activities, and to keep outside pressures from limiting the time available for these. Constant nurture of a relationship, mutual enjoyment, and affection contribute to a loving future.
3–6% OF HAPPINESS Haven’t found Mr. or Ms. Right? Don’t be too downhearted. According to a 2007 report for the Journal of Happiness Studies, romantic relationship quality only accounted for 3–6 percent of people’s total happiness.
ATTACHMENT STYLES AND YOUR RELATIONSHIP
Psychologist John Bowlby identified three attachment styles, or ways that you relate in a relationship: secure, anxious, and avoidant. It is possible for any permutation of these styles to work in a romantic partnership, but certain combinations are particularly well matched and others will tend to be successful only if certain pitfalls are avoided, and each partner deals patiently with the other’s tendencies. The chart below characterizes each style in terms of typical thought patterns. At the bottom of the page is guidance on how to get the best out of all six possible matches.
How can your “atttachment style” combination work well?
While working to make a success of your life, consciously attend to building and nurturing relationships and friendships. Human connection is the core of well-being, and good relationships can make us more productive.
Studies confirm that friendships aren’t just for mutual support and shared leisure: people with a good social circle tend to enjoy better mental and physical health and greater life satisfaction, and are even longerlived. If friendships are the key to well-being, productivity, and success, is there a key to friendship?
Are we all alike?
It is commonly believed that female friendships are more intimate than male ones—or that closeness between men tends to be through bonding over shared activities rather than shared revelations. This way of looking at things distinguishes between “side-byside” and ‘‘face-to-face” closeness. However, this distinction does not hold; men value and need the same dynamic in their friendships. Studies confirm that men, too, rate “self-disclosure” as an important part of friendships, and feel less satisfied when their friends are not confiding. Research suggests that when it comes to platonic.relationships, men and women’s needs are more similar than we might think. What seems clearer is that the number of our friendships shrinks as we move through adulthood. According to the studies, though, this doesn’t necessarily mean older adults are lonelier. Instead, we go through what longevity psychologist Laura Carstensen calls a “pruning effect”: in our thirties and forties, as family and work responsibilities limit our free time, we drift away from people who can’t support our “new normal” and become closer to those who do. Older social circles tend to be smaller, but also more robust: in our maturer years we replace quantity with quality.
The essence of friendship
What are the essential qualities of a friendship? Canadian psychologist Beverley Fehr, in a series of surveys in 2004 with both men and women, found that certain ideas of what a friend should provide were rated more “prototypical”—that is, closer to the core concept of friendship— than others (see “Dimensions of friendship”, right). Both men and women were more likely to be upset by violations of prototypical friendship rules than of more peripheral rules—but at the same time, more likely to forgive transgressions by friends whose prototypical support could be relied upon. Friendship seems to be a mix of support, acceptance, loyalty, and trustworthiness: if someone can give us those, other things matter less.
DIMENSIONS OF FRIENDSHIP
What are the most fundamental friend-like behaviors? Psychologist Beverley Fehr found the following statements were most “prototypical,” or essentially friend-like. Use them to assess your own friendships.
✔ If I need to talk, my friend will listen. (Women rated this higher than men, but men still put it at the top of the list.)
✔ If I’m in trouble, my friend will help me.
If I need my friend, she or he will be there for me.
✔ If I have a problem my friend will listen
✔ If someone was insulting me or saying negative things behind my back, my friend would stick up for me.
✔ If I need food, clothing, or a place to stay, my friend will help.
✔ If I have a problem or need support, my friend will help.
✔ No matter who I am or what I do, my friend will accept me.
✔ If we have a fight or an argument, we’ll work it out.
✔ Even if it feels as though no one cares, I know my friend does.
✔ If my friend has upset me, I feel I can let him or her know.
✔ If I have a secret, I can trust my friend not to tell anyone else.
Success doesn’t necessarily mean acquiring great wealth, but lack of financial resources may make you feel like an underachiever. Money can be an emotional subject, so how do you cultivate a healthy attitude?
Ever since psychologist Sigmund Freud defined the need to hoard wealth as a sign of an “anal-retentive” personality, psychologists have been studying our relationship with money. How can you get a balanced view of this difficult subject?
What does it mean?
Is money a source of stress, a moral pitfall, or a valid symbol for one of life’s winners? In the 1990s, Taiwanese psychologist Thomas Li-Ping Tang developed what he called the “Money Ethic Scale” (MES), which is a good way to judge how we value money. Tang found that people who ranked money highly as a sign of achievement tended to experience less life satisfaction, and also that people working to a modest budget tended to be more content. Hence, the evidence suggests that treating money as a practicality rather than as a measure of your worth may make you happier. He also found that people who value money highly aren’t necessarily richer than those who don’t, so giving money low priority probably won’t end up impoverishing you!
What can it buy you?
What do you see as the main purpose of money? A useful three-point scale was devised by American psychologists Kent Yamauchi and Donald Templer, alongside a questionnaire you can use for self-testing (see “Test your money focus,” opposite). These writers posit that our relationship with money can be measured by the following three factors:
Power and prestige. Using money to obtain influence over and/or impress other people.
Security. Using money to protect ourselves against various types of fear or want.
Retention. Saving for the sake of saving itself, sometimes to the point of parsimony or even obsessiveness.
They note that security and retention can overlap. Both, for example, can be apparent in a desire for “time retention,” which is when we’re motivated to be prepared for a rainy day. And both
He is rich or poor according to what he is, not according to what he has.
Henry Ward Beecher American social reformer
can be a sign of distrust, such as when we worry about someone cheating or overcharging us.
Money as opportunity
The sense of our being poised to embark on some new project or other experience can be very satisfying—especially when we’re conscious of having enough money to pursue a chosen plan. Issues, however, may arise when we aren’t yet ready to commit to— and spend money on—a particular course of action. Perhaps we haven’t made up our minds between alternatives. Having to spend cash may heighten the importance of certainty. Or even if we have decided, our sense of cutting off an alternative future for ourselves, for which the money could equally well have been used, can result in paralysis: unable to commit, we do nothing. In such situations, it’s good to reassess your relationship with money. If you believe it should be a tool, what’s the point of a tool you don’t use?
Money magnifies
All this illustrates how money can magnify our psychological issues. It can make relationship problems much harder to deal with—just think of money’s role in many celebrity divorces. And having no spare cash can further lower an already low sense of self-esteem. The message from all this is: don’t allow money to have symbolic force unless you want it to. And by extension, don’t mistake a wealthy lifestyle for happiness. True wealth lies elsewhere.
Mostly A: Power and prestige are motivators for you. Action: Avoid obsessive ambition. Be sure not to neglect love and friendship.
Mostly B: You’re motivated by security. Action: Check that you’re not neglecting opportunities. Challenge yourself. Mostly C: You have a tendency toward “retention,” or hoarding. Action: Make sure your behavior doesn’t turn to meanness. Give generously.
TEST YOUR MONEY FOCUS
Research on attitudes about money by American psychologists Kent Yamauchi and Donald Templer was based on asking participants to answer a revealing questionnaire. Use the same questions for your own self-assessment. Which of the three statements in each bubble resonates most with you? Use the concluding summary for self-assessment, and work on the action points given.
We often hope other people will approve of our character, actions, and opinions. However, this can leave us with a dilemma: to what extent should we try to win respect by doing as others wish?
Feeling community gives us peace of mind: it is one of the best boosts for our confidence and our relationships with ourselves and others. But how do we present our most admirable self while being true to who we really are?
Presenting a respectable self
Social disapproval is a powerful deterrent, and all of us, to some extent, will want to maintain a public face that people accept. Psychologists refer to the process as “impression management” (IM). This can sound rather manipulative; and indeed studies confirm that individuals with a high IM score are more willing to be economical with the truth when their reputation is on the line. Recent research, though, has argued that such people are not truly confident— instead, they are defensive, and anxious about losing face. Israeli psychologist Liad Uziel argued in 2010 that a more accurate term would be “interpersonally oriented self-control,” a useful phrase that flags the difference between negative covering up and positive self-presentation. Showing yourself worthy of respect can be a skilled performance, but it needn’t be a cynical one. At times it may even increase your creativity (see “Not so shallow,” opposite).
Respect for ourselves guides our morals; respect for others guides our manners.
Laurence Sterne Irish novelist and clergyman
Respect and giving
While it’s good to be generous, it’s also common knowledge that people don’t usually respect a pushover. When considering this aspect of your standing with others, ask yourself a few questions:
■ Do I have a hard time refusing unreasonable requests?■ Do I often feel taken for granted? ■ Do I often put my own needs last? ■ Do I do more favors for others than they do for me? ■ Do I get the low-grade work no one else wants?
■ Do I worry people will reject me if I say no?
As anthropologist David Graeber observes in Debt: The First 5,000 Years, nonreciprocal giving is a mark of hierarchy rather than equality—think of giving candy to a child or bringing a tribute to a king. In such imbalanced relationships, giving once creates the expectation that you’ll give again. If you give too much, you may actually be indicating that you consider yourself lower-status. If so, finding ways to say no (see p.131) might actually raise your standing. Respect begins with respecting yourself, so work on showing your value and following your principles.
Maintaining respect
Respect, lost in a moment, may take great effort to restore—though at times a single great effort can win over others and recover your position. Don’t skimp on what’s needed to rebuild your standing: respect is worth striving for.
NOT SO SHALLOW
There’s a tendency to think of people who pay a lot of attention to their “impression management” (IM) as more superficial than those who don’t. A 2010 study by Israeli psychologist Liad Uziel, however, found that a desire for respect may increase creativity in front of an audience. Asked to create stories in a test setting, people rated as having low IM performed better when alone. However, given an audience, it was people with high IM who carried the day.
THE EFFECT OF “IM” ON CREATIVITY
STEPPING OFF THE GUILT TRACK
If you feel under pressure to accept every responsibility pushed your way, you’re probably a decent person— but you may gain more respect if you can draw some reasonable boundaries. This may mean letting go of guilt. Here is one example, showing a possible set of negative thoughts about a situation, alongside alternative, more positive responses.
Negative responses
■ “If I say no, that’ll make things worse for them”
■ “That’s selfish of me”
■ “People don’t like selfish people”
■ “Maybe I’ll lose my friendship”
You feel guilt and anxiety
■ “OK, I guess I’ll make time” You do, and your work suffers
■ “Why am I so inadequate? Maybe people are right not to respect me.”
Positive responses
■ “This favor is something I just can’t manage right now”
■ “I don’t have to sabotage myself to be a good person” ■ “If I take care of myself, I can be more help to them another time” ■ “If they’re my friend, they’ll understand this” You feel regret combined with confidence
■ “I’ll make it up to them later.” You say no, and your own life stays under control
A reputation for being trustworthy is an essential asset. A person with low credibility misses opportunities, while a good track record wins loyalty. Each action and decision we make has an impact on our credibility.
Credible people are those whom others believe in. Without credibility, you’ll find that your judgments or even the “facts” you present are mistrusted, and that you fail to inspire confidence. The essential thing is to make sure that what you say and what you do line up. It’s easier to lose credibility than to restore it, so be mindful of how authentic you’re being, and how you appear to others. And if things do go wrong, be prepared to do the serious work necessary to address the situation directly.
Align what you say and do
Numerous studies confirm that credibility comes down to a very simple fact: if somebody’s statements don’t align with their behavior, if they profess ideals they don’t uphold, or if they make promises they don’t keep, then we don’t trust them.A 1994 US study funded by the National Institute of Mental Health and the Stern School of Business found that volunteers presented with ambiguous messages were much more likely to trust sources seen as credible—and that on relatively low-stakes decisions, credibility was the only factor people considered, no matter how strong or weak the arguments they heard. When it comes to day-to-day living, credibility may be the only currency that counts.
Amending mistakes
Hopefully your aim is to live with integrity, but everybody makes mistakes. Sometimes it’s impossible to keep a promise, or our self-control weakens and we bend our own rules. If others observe you doing this, you have a problem. If you go wrong, what can you do? Studies suggest that if you’re seen as untruthful, that extends to your “excuses,” so apologies and promises need to be carefully formulated. A 2002 study published in Organization Science found that the question, “What will it take for you to cooperate again?” proved much less effective than, “What can I do to get you to cooperate again?”—shifting the burden of action onto the wrongdoer. The same study found that offers of making amends tended to obtain forgiveness, but they didn’t need to be large: small ones worked equally well in showing goodwill, as long as they made a real attempt at reparation.
THE RATCHET EFFECT
We know from experience, and multiple studies confirm, that it’s far easier to lose trust than it is to gain it. Psychologist Tony Simons calls this the “ratchet effect.” In the same way that the angled teeth of a ratchet allow it to turn in only one direction, so each time we are perceived as unreliable, our credibility is damaged in a way that’s hard to reverse—even if most of our actions are perfectly honest.
THE TIMELINE OF TRUST
How do we decide whether we can trust someone? American psychologist Tony Simons argues that the question involves first making a judgment of someone’s “behavioral integrity,” based on their past actions. From there, we decide on their “credibility” and anticipate their future behavior—as shown in the example below. To strengthen your own credibility and inspire confidence, try to make sure that your deeds align with your words: do what you say you will. That way, you will be perceived as an honest and credible person.
A good mentor can be a precious asset. To build a strong mentoring relationship, work creatively to optimize your learning and growth, and be clear about how both sides can benefit from the process.
When a person with greater knowledge or experience takes you under their wing, it can make a positive difference to your life in a variety of areas. Mentoring is a key way for skills to be passed on, both inside and outside the professional sphere. A mentor can benefit you when you’re embarking on a new kind of activity, seeking help with life’s challenges, or trying to grow yourself creatively, intellectually, or professionally.
Finding a mentor
Good mentors don’t come along every day, so what’s the best way to recruit one? When seeking someone to be your guide, bear in mind the following factors:
■ Decide at the outset why you want a mentor. For example: do you need introductions in a particular field, a reliable critic of your performance, or someone to watch in action? Having a clear idea of your expectations can prevent disappointment.
■ Identify, and make use of, networking opportunities. Many industries offer mentoring programs: you might wish to find out where your colleagues found their mentors; look into places where the people you admire spend time and are open to socializing. Remember, no one mentor will “have it all”—to optimize your success, you will need multiple mentors.
■ When meeting people, be sensitive to their responses. If somebody doesn’t seem willing to help you, there’s no point in pushing—this will only alienate them. But don’t expect them to read your mind. Say clearly that you’d value any advice they can offer you. If they’re polite but vague, that’s probably a “no.”
■ Be open to unexpected connections. The right mentor for you might work in a field you hadn’t thought of, or have a very different personality from you. They don’t have to be the person you aspire to be yourself: all that matters is good rapport.
Maintaining the relationship
Once you’ve established a good connection with someone, put careful thought into how you can continue to get the best out of the mentor–mentee dynamic. Try out these methods:
■ Be reciprocal. Offer them any connections or introductions you can. Support and promote their work. Be prepared to assist them. A mentee with staying power knows to give something back.
■ Show initiative. It’s not very rewarding to mentor someone who seems too dependent. What a mentor values is a protégé with energy and enthusiasm, who is worth helping because they’ll make the best of what you give.
■ Accept what’s offered. Some mentors may not wish to provide emotional support, for example, but can still give good practical help. If you need something your mentor doesn’t want to give, look elsewhere to fill that need.
■ Finish the mentor–mentee dynamic when it feels right. If you’re no longer finding your mentor helpful, maybe it’s the natural time to move forward.
MENTORING CONSTELLATION
Support from those with more experience can obviously be valuable, but don’t overlook “sideways” and even “upward” mentoring. A 2013 US paper for the Center for Creative Leadership describes a “constellation” of relationships in which mutual support and guidance between equals, as well as backing from those below you in a hierarchy, can be just as fruitful as a top-down pattern.
90% VALUE FEEDBACK A 2009 US study found that more than 90 percent of mentors thought it was important to encourage candid feedback from their protégés.
Cooperating well with others means being comfortable with feedback—both giving it and receiving it. Opening channels of response, in both directions, is often the key to a successful endeavor.
Now matter how much confidence we have in our own opinions, we can all benefit from views expressed by others. Both in and out of the workplace, knowing how to gather feedback is often a significant factor in attaining success. However, you must be prepared to have your own ideas criticized— even, at times, demolished.
Taking it well
Neurological evidence suggests that we’re wired to fear criticism.There’s even some research to suggest that negative comments are processed by different, more sensitive neural circuits than those that handle positive input. Fundamentally, fear of criticism is fear of rejection. No matter how tactfully a negative comment is phrased, a part of our brain hears the threat of, “You’re fired” or, “No one will love you.” Faced with anxiety-inducing feedback—for example, a negative appraisal from your manager—try the following:
■ Listen for the facts. It’s helpful to separate fact from opinion. Even if you don’t agree with the conclusions, you can often pick up good information and store it for later use.
■ Consider the motivation. Is the speaker trying to help you, even if they’re being blunt? Or are they trying to reinforce their own authority or score points? These different motivations require different responses.
■ Make it impersonal. If you did make a mistake, present yourself as an ally with your criticizer: “Yes, I notice I sometimes do that. What can you suggest?”
■ Ask for time. If you don’t think you can respond constructively at once, say you appreciate the feedback and you’d like time to give the matter serious thought.
Giving as well as taking
Numerous studies confirm that giving feedback to people who share your goals can be at least as helpful as receiving it. Having to assess somebody else’s efforts forces our brains to think objectively about:
■ The purpose of what everyone is trying to achieve ■ What criteria this can be judged by ■ What a good example might look like ■ Possible remedies when things aren’t quite as they should be.
Such an approach will develop your critical-thinking skills in ways that can benefit all areas of your life.
BET AND BEAR
American psychologists Patricia L. Harms and Deborah Britt Roebuck describe two different models for giving positive and negative feedback—“BET” and “BEAR,” respectively. If you have to tell someone what you think of them, follow one of these approaches
85% PEER TO PEER According to a 1994 Australian study, 85 percent of students felt they learned more from peer assessments than reviews from authority figures.
Knowing the full cost of creating each product that a business sells is vital because it helps a company price its products appropriately and assess the performance of the business.
How it works
Both direct and indirect costs contribute to the production cost of a product, whether it is a manufactured good or a service being provided. In order to calculate the cost of a product, it is treated as one unit of production. The direct and indirect costs involved in creating that single unit are then assessed and added together to create the full cost.
38% the average total of US business costs that can be accounted for by indirect costs
NEED TO KNOW
❯ Absorption costing Allocation of all production costs to product
❯ Differential costing Difference between the cost of two options ❯ Incremental (marginal) costing The change in total costs incurred when one additional unit is made ❯ Throughput costing An analysis of the impact that one extra unit of production will have on sales
❯ Cost-plus pricing Product price is based on direct and indirect costs, plus markup percentage
OTHER COSTING METHODS
There are several different approaches to costing and pricing depending on the industry, the type and size of the business, and the method of production.
JOB COSTING Used for a customized order made to a client’s specifications—for example, a printing company that prints brochures for a client
BATCH COSTING Used when a batch of identical products is made—for example, an electrical goods company manufacturing television sets
CONTRACT COSTING Used for a large one-time job, often the result of a tender process (when a company bids for work) and carried out at the client’s site—for example, a construction company building homes in a new residential development
PROCESS COSTING Used for an ongoing job that often involves several manufacturing processes, making it difficult to isolate individual unit costs—for example, an oil refinery which processes crude oil into diesel oil
SERVICE COSTING Used when the product being sold is a standard service offered to customers—for example, a nail salon offering an express manicure and pedicure within a set period of time and for a fixed price
Full cost pricing
Direct costs can be measured in terms of how materials and labor are used to produce each unit. Indirect costs (overheads) are harder to assess but also need to be factored in so that the full cost of each product can be calculated. Managers and accountants must apportion indirect costs to reflect their contribution to the cost of creating a single product. Once this is ascertained, the full cost of that product can be determined. In general terms, the price is worked out by adding the direct and indirect costs of production with a profit margin that gives an appropriate selling price.
Direct costs
❯ Materials
❯ Direct labor
❯ Direct expenses
❯ All used exclusively to create a product or service for sale
Share of indirect costs
❯ Production and service overheads❯ Administrative and management overheads
❯ Sales and distribution overheads
Profit margin
❯ Must be able to generate profit for the company
❯ Must be in line with how the product has been marketed
❯ Must be
pitched realistically so that customers will buy
Selling price
❯ Low: in order to gain market share, or to match competitors
❯ Cost-based: recover direct and indirect costs and profit margin that the market will accept
❯ Service-based: flexible since no manufacturing or distribution cost
Costs are the direct or indirect expenses that a business incurs in order to carry out activities that earn revenue, such as manufacturing goods or providing a service.
How it works
There are two main ways of classifying costs: direct, or variable, costs, which increase as more goods and services are sold, and indirect costs, which contribute to the overall running of the business and can either vary with the level of production or stay fixed. There are three main costs that businesses need to account for. The first is labor—wages paid to people employed to carry out a particular task. Labor can be regarded as direct or variable, or as a fixed cost or overhead. The second is the raw materials used in production and other materials used in service industries—these costs are variable. The third is expenses, which are other costs incurred in the course of the business’s activities.
NEED TO KNOW
❯ Break-even point (BEP) The point at which total sales revenue is equal to total costs
❯ Questionable costs Costs that can be treated as fixed or variable ❯ Sunk costs Costs incurred in the past that cannot be recovered
❯ Prospective costs Costs that may be incurred in the future depending on which business decisions are made
Fixed and variable costs
One way of looking at costs is to split them into two categories: fixed costs, which do not change with the level of business activity, and variable costs, which do change with the level of business activity. This helps accountants to determine how changes in business activity (for example, cutting or increasing production) will affect costs. In reality, some fixed costs will increase once business activity reaches a certain level—these are called stepped fixed costs.
Fixed costs
RENT AND INSURANCE COSTS
LAUNDRY SERVICES
STAFF SALARIES
CLEANING BILL
A restaurant rents premises to cater for 40 diners. The fixed costs are the same whether the restaurant serves 30 or 40 diners a night.
Stepped fixed costs
HIGHER RENT AND INSURANCE COSTS
EXTRA LAUNDRY SERVICES
HIGHER STAFF COSTS
HIGHER CLEANING BILL
The restaurant becomes popular, so the owner rents the premises next door to serve an additional 40 diners a night. The costs that were fixed at a certain level have now doubled.
Variable costs
The head chef orders the ingredients that will be required each day. For peak evenings the cost of the food order is higher; for quieter nights, the food order is lower.
LARGE FOOD ORDER
PEAK EVENINGS
QUIETER EVENINGS
SMALL FOOD ORDER
40% of business owners say that payroll is their greatest expense
Setting the budget for a business involves planning the income and expenditure for the accounting year. This is usually broken down into months so that planned budget and actual figures can be compared.
How it works
Every business needs to budget for anticipated revenue and operating costs within the financial year. Unlike capital budgeting, in which senior management allocates what will be spent on specific projects or assets, revenue budgeting focuses on the overall projections for money coming in and money going out for each month of the coming financial, or accounting, year. Accountants compile operating budgets from each manager in the business, along with expected cash-flow projections for the business, to create a master budget. The master budget can also include figures for any financing that the company is expected to need over the coming year. As the year progresses, the projected budget and the actual money coming in and going out are monitored on a daily, weekly, or monthly basis, so that any deviations from the original budget can be identified, and, if necessary, remedied.
INCREMENTAL AND ZERO-BASED
There are two main approaches to setting budgets
Incremental budget
The budget for the year ahead is based on the previous year’s budget. This budget takes into account any changes, such as inflation, which could have an impact on the new calculations. The downside is that previous inaccuracies may be carried forward.
Zero-base budget
The coming year’s budget starts afresh, with no reference to previous years. This means that each item entered into the budget is carefully scrutinized and has to be justified by the department managers. This method makes it easier to see the full cost of all planned changes.
NEED TO KNOW
❯ Planning, Programming, and Budgeting Systems (PPBS) A budgeting system used in public service organizations such as city councils and hospitals ❯ Virement An amount saved under one cost heading in a budget is transferred to another cost heading to compensate for overspend ❯ Budget slack Deliberately underestimating sales or overestimating expenses in a budget
Setting and controlling budgets
Budget-setting is a process that takes place between the department managers, senior management, and finance department in a company to establish and control the cost of each department or project.
Consultation
Senior management sets out the company’s objectives to the departmental managers. Each manager is then responsible for working out the budget required by their individual department, in order to meet those objectives for the coming year.
Prepare the budget
The budget is usually based on the accounting year, but broken down into shorter periods. Departmental managers submit their budgets to senior management for approval. These may cover areas such as operating costs (salaries and supplies) and administration (office expenses).
Master budget
Once approved, the budgets from each department are combined into a master budget for the year, which includes: a budgeted profit-and-loss account, a projected balance sheet, and a budgeted cash-flow statement that typically shows a month-bymonth breakdown.
Measure performance
After each month (or equivalent time period set in the budget), the actual figures realized by the company are compared with the original budget projections. Variations are examined closely to work out whether they are significantly different from the figure in the original budget.
Take action
If necessary, the budget is revised to take into account any unforeseen and continued expenditure, or any savings that were not anticipated. If income is less than expected, action may be taken to alter departmental processes or campaigns in order to reach the targets set in the budget.
The money coming in and going out of a business is its cash flow; the balance of inflow and outflow is key to survival. Inflows arise from financing, operations, and investment, while outflows are expenses.
How it works
Cash flow is the movement of cash in and out of a business over a set period of time. Cash flows in from sales of goods and services, loans, capital investment, and other sources. Cash flows out to pay employees, rent and utilities, suppliers, and interest on loans. Timing is key—having enough cash coming in to pay bills on time keeps the company solvent.
Sales revenue
Cash for goods and services sold
❯ Revenue generated by core operation
❯ Basis of profit—does not have to be repaid, unlike loans or capital
❯ Company must be able to turn revenue into cash (get paid) to maintain cash flow
❯ Also known as cash flow from operating activities
Capital
Investment and lump sums
❯ Main source of cash inflow for start-ups
❯ Additional cash injection after initial start-up or at key stages in a company’s growt
❯Revenue from flotation of private companies (going public) and shares issued by public companies
❯ Also known as cash flow from investing activities
Loans
Bank loans and overdrafts
❯ Working capital loans to meet shortfalls, with anticipated inflows as collateral$ $CASH IN$ CASH OUT
❯ Advances on sales invoices from factoring companies
❯ Short-term overdrafts
❯ Also known as cash flow from financing activities
Other revenue
Grants, donations, and windfalls
❯ Grants from government or other institutions, usually one-time sums for research and development❯ Donations and gifts (applicable to nonprofit organizations)
❯ Sales of assets and investments
❯ Repayment of loans made to other organizations
❯ Tax refunds
“ Cash comes in, cash goes out, but the tank should never be empty.”
CASH OUT
Salaries and wages
Payments to employees
❯ Money paid to employees who are directly involved in the creation of goods or provision of services
❯ Salaries paid to staff as a fixed amount monthly or weekly (based on an annual rate)
❯ Wages paid to contractors for hours, days, or weeks worked
Overheads
Payment of bills
❯ Day-to-day running costs
❯ Rental cost of commercial property; utility bills—water, electricity, gas, telephone, and internet; office supplies and stationery
❯ Salaries and wages of employees not directly involved in creating goods and services (known as indirect labor)
Loan repayments
Debt servicing and shareholder profit
❯ Interest on long-term loans for asset purchases and on shortterm loans for working capital
❯ Repayments on capital loans
❯ Commission paid to factoring companies
❯ Cash distribution to shareholders via share repurchases and dividend payments
Suppliers
Payments for materials and services
❯ Cost of raw materials needed to manufacture goods for sale
❯ Cost of stock, imported or local
❯ Fees for services such as consulting or advertising to generate revenue
❯ Payments to contractors involved in goods and services creation
Tax
Payments to tax authorities
❯ Corporation tax based on annual financial statements
❯ Payroll tax paid by employers on behalf of employees
❯ Sales tax on goods or services
❯ Varies from country to country, depending on tax law
Equipment
Purchase of fixed assets
❯ Cost of buildings and equipment, such as computers and phones, office furniture, vehicles, plant, and machinery
❯ Offset by depreciation
Cash-flow management
The handling of cash flow determines the survival of any business. Equally important is a company’s ability to convert its earnings into cash, which is known as liquidity. No matter how profitable a business is, it may become insolvent if it cannot pay its bills on time. New businesses may become victims of their own success and fail through “insolvency by overtrading” if, for example, they spend too much on expansion before payments start coming in and run out of cash to pay debts and liabilities. In order to manage cash flow, it is essential for companies to forecast cash inflows and outflows. Sales predictions and cash conversion rates are important. A schedule of when payments are due from customers, and when a business has to pay its own wages, bills, suppliers, debts, and other costs, can help to predict shortfalls. If cash flow is mismanaged, a business may have to pay out before receiving payment, leading to cash shortages. Some businesses, such as supermarkets, receive stock on credit but are paid in cash, generating a cash surplus.
WARNING
Top five cash-flow problems
❯ Slow payment of invoices
❯ Credit terms on sales invoices set at 60 or 120 days, while credit terms on outgoings are 30 days
❯ Decline in sales due to change in economic climate or competition, or product becoming outmoded
❯ Underpriced product, especially in start-ups trying to compete
❯ Excessive outlay on payroll and overheads; buying rather than renting assets
NEED TO KNOW
❯ Factoring Transaction in which a business passes its invoices a third party (factor), which collects payment from the customer for a commission
❯ Accounts payable Payments a business has to make to others
❯ Accounts receivable Payments a business is due to receive
❯ Aging schedule A table charting accounts payable and accounts receivable according to their dates
❯ Cash-flow gap Interval between payments made and received
Cash conversion
Successful businesses convert their product or service into cash inflows before their bills are due. To make the conversion process more efficient, a business may speed up:
❯ Customer purchase ordering
❯ Order fulfillment and shipping
❯ Customer invoicing
❯ Accounts receivable collection period
❯ Payment and deposit
80% of small business start-ups across the world fail because of poor cash-flow management
Positive and negative cash flow
Positive cash flow Cash flowing into the business is greater than cash flowing out. Cash in the tank—stock—increases. A business in this position is thriving.
Stable cash flow Cash flows into the business at the same rate as it flows out. Cash stock remains stable—a sign that a business is healthy.
Negative cash flow Less cash is flowing into the business than is flowing out. Over time, the stock of cash will decrease and the business will face difficulties.
Bankruptcy If cash flowing out continues to exceed cash flowing in, cash stock levels will drop so low that the business becomes insolvent—it has no assets left to continue trading.
HANDLING THE FLOW
Managing a surplus
❯ Move excess cash into a bank account where it will earn interest, or make profitable investments.CASH IN CASH IN HAND DECREASES NO CASH IN/OUT
❯Use cash to upgrade equipment to improve production efficiency.
❯ Expand the business by taking on new staff, developing products, or buying other companies.
❯ Pay creditors early to improve credit credentials, or pay down debt before it is due.
Managing a shortage
❯ Increase sales by lowering prices, or profit margins by raising them.
❯ Issue invoices promptly and pursue overdue payments.
❯ Ask suppliers to extend credit.
❯Offer discounts on sales invoices in return for faster payment.
❯ Use an overdraft or short-term loan to pay off pressing expenses.
❯ Continue to forecast cash flow and plan to avert future problems.
For a company’s management to anticipate profit and loss, plan cash flow, and set effective goals for the business, the coming year’s incomings and outgoings need to be set out in detail. Unlike financial accounting, which is primarily for external users such as investors, lenders, or regulators, management or cost accounting takes place within a business to project expected sales revenue and expenses, so that the business can decide how to best use its available resources.
80% of accountants and financial professionals in the US are employed within a business or organization
COST ACCOUNTING PRINCIPLES
The Chartered Institute of Management Accounting (CIMA) in the UK and the American Institute of Certified Public Accountants (AICPA), with members in 177 countries, have established Global Management Accounting Principles.
❯ Communication provides insight that is influential Facilitate good decision-making through discussion.
❯ Information is relevant Source best material.
❯ Stewardship builds trust Protect financial and nonfinancial assets, reputation, and value of organization.
❯ Impact on value is analyzed Develop models to demonstrate outcomes in different scenarios.
Management accounting process
Planning is done for the financial (fiscal) year that lies ahead—this is also called the accounting year and is made up of 12 consecutive months. Start and end dates differ from country to country.
Department budgets Managers estimate what funds will be needed for expected outgoings
Purchase orders (POs) POs tell the finance department exactly how much money to reserve for payment.
Timesheets Staff employed on an hourly or daily basis fill in timesheets; these help managers to calculate overall staff costs
Invoices Invoices submitted by contractors and suppliers have to be matched against purchase orders and paid out.
Goods received Employees log receipt of merchandise, describing what the goods or services are and the quantity received.
Management
Managers create budgets and document business costs to monitor business performance, and plan for the short and medium term. The information they collate sheds light on the financial implications of ongoing projects
Information is passed to finance department
Finance department
Accountants in the finance department (or contracted from outside the business) receive information about the costs from managers. They then use these to generate reports and statements for the managers, who use this information to make decisions for the next financial year.
Profit-and-loss statement Also called an income statement, the P&L statement tells management how much money the business made or lost over a particular time period.
Balance sheet The balance sheet estimates the value of assets and inventory held, so that management can reduce it if necessary.
Cash-flow statement This shows how well the business will be able to meet its financial obligations and generate cash in the future.
Budget reports Reports help management to determine the accuracy of budgets and analyze business performance.
Cost of production report (CPR)CPR shows all of the costs that can be charged to a particular department
Similar concepts to depreciation, amortization and depletion are used by accountants to show how intangible assets and natural resources respectively are used up.
How it works
Amortization is how the cost of purchasing an intangible asset, such as copyright of an artwork, is spread over a period of time, usually its useful lifetime. It is shown as a reduction in the value of the intangible asset on the balance sheet and an expense on the income statement. In lending, amortization can also mean the paying off of debts over time. Depletion shows the exhaustion of natural resources such as coal mines, forests, or natural gas.
GOODWILL
In business, goodwill describes an intangible asset based on a company’s reputation, including loyal customers and suppliers, brand name, and public profile. Goodwill arises when one company buys another for more than its book value (total assets minus total liabilities). For example, if Company A buys Company B for $10 million but the total sum of its assets and liabilities is $9 million, the goodwill is worth $1 million. According to International Financial Reporting Standards since 2001, goodwill does not amortize, so it does not appear as amortization in financial statements. However, if the value of goodwill falls (through negative publicity, for example) it can be recorded as an impairment.
NEED TO KNOW
❯ Intangible assets Nonphysical assets, such as patents, trademarks, brand recognition, and copyright; their valuation is sometimes subjective
❯ Patent A license granted by a government or authority giving the owner exclusive rights for making or owning an invention
Amortization in practice
There are two types of amortization, one for spreading the cost of an intangible asset, the other for loan repayment. Both are calculated in similar ways, but loan repayments are worked out as a percentage.
Intangible assets
In this example, a company buys an intangible asset— a patent for a new, revolutionary type of tennis racket—for $20,000. The patent will be useful for 10 years, so its cost is recorded as a $2,000 amortization (expense) each year rather than as a one-time cost. Unlike tangible assets, a patent does not have a salvage value.
Loan percentage
If a company has an outstanding loan worth $150,000, and pays off $3,000 of this loan each year, then $3,000 of the loan has been amortized. It can also be said that 2 percent of the loan has been amortized, as it will take 50 years to repay the loan at this rate.
How to calculate depletion
Like amortization, depletion is calculated using the straight-line methods unless there is a particular reason to use another method.
In this example, a logging company buys a forest with an estimated 60,000 trees for $10 million. The original salvage value is $1.5 million, but the company spends $500,000 on road building in the forest, bringing it down to $1 million. The company cuts down 6,000 trees during each accounting period.
When a company buys an asset, its cost can be deducted from income for accounting and tax purposes. Depreciation allows the company to spread the cost, by calculating the asset’s decline in value over time.
How it works
If a business buys a long-lived asset, such as a building, factory equipment, or computer, to help it earn income, this expenditure can be offset as a cost against income earned. However, not all this income will be generated in the year of purchase and, over time, the asset will age and become less beneficial to the business, until it becomes outdated or unusable. Accountants do two things to turn the declining value into a tax advantage. Firstly, they work out how much the asset’s value decreases over a period of time—typically a year. Secondly, they match that loss in value to the amount of income earned in that period, so depreciation becomes a deduction from taxable income. There are several different ways to calculate depreciation. The method a company uses may depend on the kind of business, the type of asset, tax rules, or personal preference. In the United States, per IRS guidelines, companies must use MACRS (Modified Accelerated Cost Recovery System), a combination of straight-line and double declining balance methods.
NEED TO KNOW
❯ Fixed/tangible assets Items that enable a business to operate but are not a part of trade; assets lasting a year or more qualify for depreciation
❯ Useful/economic life Length of time an asset is fit for its purpose and has monetary value
❯ Salvage/scrap/residual value Worth of an asset once it has outlived its useful life—often set by the tax authority
❯ Book value An asset’s worth on
paper at any point between its initial purchase and salvage
TYPICAL LIFE OF FIXED ASSETS
Tax authorities often specify the typical useful (economic) life of a particular asset. This helps to standardize depreciation, and to eliminate uncertainty about value and the number of years over which an asset can be depreciated.
60%
the value the average car loses after three years
Calculating depreciation
The straight-line method is the simplest way of working out depreciation and can be applied to most assets. Depreciation is calculated along a timeline, with value loss spread evenly over the asset’s economic life. Scrap value is deducted from purchase value and the remainder is split into equal portions over time.
Applying depreciation
When calculating depreciation, there are a number of different factors to consider. For instance, a business needs to be able to predict the number of years an asset will last. Helpfully, tax authorities in most countries issue guidelines to accountants and businesses with estimates of the useful economic life of many common business assets. Companies may also wonder which of the many methods of calculating depreciation to use for a given asset. Each method reflects a different pattern of depreciation, with some being more suitable for particular categories of assets. For example, the “accelerated” methods that chart rapid depreciation at the beginning of an asset’s life are more suitable for technology, while the “activity” methods that link depreciation to actual hours of use or number of units produced are best suited to transport and production lines. Again, tax authorities in most countries offer guidelines on which method to use. Although it is technically possible for a company to use two different methods for their own accounting and for tax purposes, this is best avoided.
WARNING
Misusing depreciation
❯ The wrong method A company must choose a method that is permissible for an asset type
❯ Frontloading Opting for an accelerated method can result in a taxable gain if an asset is sold early, for more than its book value
❯ Claiming beyond useful life Depreciation cannot be claimed after an asset’s useful life
❯ Ignoring depreciation If a company fails to claim depreciation, it has to report a gain from the sale, despite the loss on deduction
Other depreciation methods
There are many different methods of calculating depreciation. Some are favored by particular tax codes, while others are specifically applicable to certain industries and types of assets, and their patterns of value loss.
Double declining balance method
A method used to claim more depreciation in the first years after purchase, which is useful for assets that lose most of their value early on. It reduces a company’s net income in the early years of an asset’s life, but generates initial tax savings.
Sum of the years’ digits method (SYD)
Depreciation is calculated by dividing each year of the asset’s life by the sum of the total years to give a percentage of the depreciable value. If the asset’s useful life is 5 years, then the sum of the years as digits is 15 (5 + 4 + 3 + 2 + 1). In year 1, it loses 33 percent (5 ÷ 15), in year 2, 27 percent (4 ÷ 15), and so on.
Units of production method
When a company uses an asset to produce quantifiable units, such as pages printed by a photocopier, it can claim depreciation with this method, which calculates depreciation according to the number of units an asset produces in a year.
Hours of service method
The asset’s decline in value is measured according to the number of actual hours it is in use. To calculate depreciation using this method, the company measures the hours of use per year as a percentage of the estimated total lifetime hours. It is particularly useful for transportation industries.
Environmental regulations force companies to consider the impact of their activities and to adopt corporate social responsibility (CSR) as they grapple with legislation, climate change, and public opinion.
How it works
Globally, there are reams of different environment acts spread across multiple jurisdictions that affect the companies operating within their borders in different ways. Areas protected by environment acts include the atmosphere, fresh water, the marine environment, nature conservation, nuclear safety, and noise pollution. International acts are usually ratified by each country individually before taking effect there. An example of a common global means of reducing greenhouse gas emissions is emissions trading (“cap and trade”), by which companies must buy a permit for each ton of CO2 they emit over a certain level. Those emitting under the agreed level can sell their permits to other companies.
Environmental credentials
Most companies include a section on environmental accounting in their financial statement. Some details are required by law, but the statement also gives an opportunity to showcase environmental credentials to stakeholders.
Product responsibility
❯ Life-cycle stages in which the health-and-safety impact of products and services are assessed for improvement
❯ Adherence to laws, standards, and voluntary
codes relating to marketing communications
Society
❯ Programs and practices that assess and manage the impact of operations on communities
❯ Fines and sanctions for noncompliance with regulations
Economic
❯ Financial implications, risks, and opportunities for the organization’s activities due to climate change
❯ Financial assistance received from the government
Human rights
❯ Investment agreements that include human right clauses or that have undergone human rights screening
❯ Suppliers and contractors that have undergone screening on human rights; actions taken to address any issues
Labor practices
❯ Workforce by employment type, contract, and region
❯ Average hours of training per year, per employee by employee category
❯ Ratio of basic salary of men to women by employment category
GREENHOUSE GAS EMISSIONS
In some countries, companies are required by law to provide details of their greenhouse gas emissions. This is usually presented as a table in the environmental accounting section of the annual report. It includes direct and indirect emissions—by the company itself and by third parties—of gas, diesel, and other fuels; sulfur oxides and nitrous oxides; methane; and other ozonedepleting substances. In this table, from the Wessex Water utility company, emissions are shown as ktCO2 equivalents.
CASE STUDY
Cleaning up rivers
Wessex Water’s impressive record on pollution is mentioned several times in its statement, including in the chairman’s introduction. This prominence shows that the company believes acting in an environmentally conscious manner is important to its investors. The company illustrates several areas where it has acted with others to positively affect the environment:
❯ Work with the charity Surfers Against Sewage, which campaigns for clean seawater
❯ Its river strategy: collaborating with pressure groups and organizations to reduce pollutants and the impact of habitat alteration, and so increase the numbers of aquatic plants, invertebrates, and fish in local rivers
❯ Improving water quality at swimming beaches in the region, in compliance with mandatory standards
The cash-flow statement shows the movement of cash during the last accounting period. It is important because it reveals a company’s liquidity—whether or not it has more money coming in than going out.
How it works The cash-flow statement is often more useful for investors assessing a business’s health than other key statements, because it shows how the core activities are performing. The profit-and-loss statement, for example, obscures this by adding in non-cash factors such as depreciation. Similarly, the balance sheet is more concerned with assets than liquidity.
How to read a cash-flow statement
The statement of cash flows, to give it its official title, answers the key question of whether a business is making enough money to sustain itself and provide surplus capital to grow in the future, pay any debts, and give out dividends. Figures in parentheses are negative numbers.
Case study: cash-flow statement
By analyzing this water utility’s statement, which includes a comparison to the previous year, decisionmakers can base future plans on past cash flows (at the time, the exchange rate was £1 = $1.58).
Three types of cash flow
Cash refers to actual money as well as cash equivalents including cash in the bank; bank lines of credit, and short-term, highly liquid investments for which there is little risk of a change in value. Cash does not include interest, depreciation, or bad debts (debts written off).
Cash flow from operating activities
The bulk of cash flow usually comes from operations, and is worked out with a formula. The change in working capital (current assets minus current liabilities) can be a negative figure.
Cash flow from investing activities
Buying or selling assets or investments is in this category. This figure is usually a cash outflow (negative figure) due to buying more than selling, but can be positive if there are significant sales.
Cash flow from financing activities
This includes buying or selling stock or debt and paying out dividends. Money made from selling something is called cash inflow; money lost through paying out is cash outflow.
Total cash flow
Adding all three cash flows gives the total. Separating out the three types shows decisionmakers the health of core activities as opposed to financing and investing, which bear little relation to day-to-day operations.
A balance sheet is a financial statement that shows what a business is worth at a specific point in time. Its primary purpose is to show assets, liabilities, and equity (capital), rather than financial results.
How it works
The balance sheet essentially shows what the company owns, what it owes, and how much is invested in it. It is based on the accounting formula, sometimes called the balance-sheet equation, which is the basis of double-entry bookkeeping. This shows the relationship between assets, liabilities, and owners’ capital— what the company owns (assets) is purchased either through debt (liability) or investment (capital). The equation always balances, as everything a company owns has to have been bought with its owner’s funds or through borrowing.
The balance-sheet equation
As the name suggests, the balance sheet must always balance. This is because everything the business owns (its assets) must be offset against the equivalent capital (or equity) and liabilities (debt).
Company has no liabilities
For example, a young business may have assets of $1,000. It currently has no liabilities so its capital is equal to its assets—that is, it is the amount of equity the owners or shareholders have invested in the business. Using the accounting formula, the equation would look like this:
Company incurs $400 in liabilities
After spending $400 on, for example, an illuminated sign for the storefront, the owner incurs $400 in liabilities and so the formula changes. However, since the sign is worth $400, and the owner has $600 remaining, the equation remains balanced—as it always does.
Case study: balance sheet
This example from Wessex Water, a UK public utility company, shows how a balance sheet works in practice (at the time, the exchange rate was £1 = $1.58).
Understanding the notes
The balance sheet is a useful indication of the health of a business, and it is important that investors know how to analyze it. It can be read in two ways—“at a glance,” as on the previous page, where general information is summarized, or in depth, with more detailed information about each element. Provided after the summary, the detailed section of the balance sheet explains the specific financial workings of the business in a number of notes. It shows exactly where money has been gained or lost, in figures, and it often includes a written commentary about potential developments that may affect the company, such as court cases, staffing, or availability of resources.
Balance-sheet notes
Investors may want to know more about the figures in the summary section, so additional notes and tables give detailed breakdowns of the figures (at the time, the exchange rate was £1 = $1.58).
Case study: debtors
Debtors are individuals or entities that owe the business money. Wessex Water has four categories of debtor.
Case study: creditors
Creditors are individuals or entities that the business owes money to. They are in credit of Wessex Water.
A profit-and-loss statement is a financial statement that shows all revenues, costs, and expenses during an accounting period. It is also known as an income statement, or an income and expense statement.
How it works
The purpose of the profit-and-loss statement is to show the profitability of a business during a given period. Along with the cash-flow statement and the balance sheet, it is the most important financial statement a business produces, as it shows investors how profitable the company is. The statement usually works by showing revenues and gains, less expenses and losses from business activities, as well as the sale and purchase of assets. Businesses that are sole proprietorships or partnerships are generally not required to submit profit-and-loss statements.
TYPICAL EXPENSES
Payroll Salaries and wages paid to staff, temporary contractors, and indirect labor
Utilities Water, electricity, and gas; postage and shipping; transportation
Insurance Insurance on fixed assets and personal liability insurance for employees
Phone/internet bills Cost of telephone, broadband internet, and mobile devices used by employees
Advertising Sales and marketing of the company and its products
Office supplies Stationery such as pens, paper, and filing systems, office printers, furniture, lighting
Legal fees and professional services Accounting and legal fees, payable to accountants, auditors, and legal advisers
Interest on loans Interest paid on money borrowed, which counts as a business expense
Tax Varying among jurisdictions, this may include payroll tax and corporation tax
Entertainment Legitimate costs of business entertaining, subject to certain criteria being met
Case study: profit-and-loss statement
This statement taken from the 2013 annual review of Wessex Water, a UK utility company, shows it was making a healthy profit (at the time, the exchange rate was £1 = $1.58)
Case study: operating costs
This table breaks down the company’s operating costs in more detail. It is important to read any notes regarding depreciation and ordinary and extraordinary costs and gains.
With increasing globalization, international accounting standards, assumptions, and principles that help to make accounting easier across borders are essential for preparing financial statements.
How it works
International Financial Reporting Standards (IFRS) are the most widely accepted standards for accounting, and they are used in more than 110 countries. Originally introduced to harmonize accounting across Europe, they have with time spread around the world. IFRS are not to be confused with International Accounting Standards (IAS), which were in use from 1973 to 2001. Generally Accepted Accounting Principles (GAAP), which are known colloquially as accounting standards or standard accounting practice, are country-specific guidelines for recording and reporting accounts. They differ from one jurisdiction to another.
A company’s financial accounts classify, quantify, and record its transactions. They are extremely useful for people outside the business, such as creditors and potential investors, as well as those currently involved with making investment decisions. For this reason, the accounts should be concise and clearly present the timing and certainty of future cash flows, so that people looking at the company can decide whether or not to invest in, lend money to, or do business with it.
$74 billion the total value lost by shareholders in the 2001 Enron accounting scandal
Key elements
The profit-and-loss account, balance sheet, and cashflow statements are the most important financial statements in an annual review, supplemented by the report’s notes. To understand these statements, a knowledge of accounting principles, depreciation, amortization, and depletion is vital. Accountants also need to understand the legal requirements that the statements must satisfy and how environmental laws can affect a business and its accounts.
Accounting standards
Generally accepted principles standardize practice worldwide to ensure accuracy and prevent fraud.
❯ International standards simplify account reporting.
❯ Companies must meet environmental accounting rules and regulations.
Profit-and-loss statement
Shows how much money a company is making and is especially useful for potential investors and stakeholders.
❯ Outlines revenues and gains minus expenses and losses or operating costs. ❯ Informs a company if a profit warning is needed.
Balance sheet
Gives a snapshot of how much a business is worth at a certain time and is a good indication of its long-term health.
❯ Balances company’s assets against its equity and liabilities. ❯ Lists different types of assets, including tangible fixed assets and current assets.
Cash-flow statement
Reveals a company’s liquidity by tracking the flow of cash— money or short-term investments—in and out of the company.
❯ Shows if a company can sustain itself, grow, and pay debts. ❯ Details cash flow from operating, investing, and financing activities.
Environmental accounting
Accounts for myriad environmental rules and regulations that oblige companies to mitigate the impact.
❯ Showcases green credentials in financial statements. ❯ Reveals compliance with environmental, social, and governance criteria.
Depreciation
Accounts for the decrease in value over time of tangible fixed assets in order to spread the cost of assets over their economic life.
❯ Can be calculated using a number of different methods. ❯ Tangible fixed assets include buildings, plant, and machinery.
Amortization and depletion
Account for the decrease in value over time of a range of intangible assets, loans, and natural resources.
❯ Intangible assets include patents, trademarks, logos and copyright. ❯ Natural resources include minerals and forests.
The formal records of a business’s financial activities are presented as financial statements. Most jurisdictions require accurate information by law, and financial directors and auditors are liable for its contents.
How it works
Financial statements summarize a company’s commercial activities clearly and succinctly, with details of the business’s performance and changes to its financial position. They are aimed at several parties, so they need to be detailed but also comprehensible to the general public. The statements are usually presented together in the form of an annual report, with in-depth accounts and footnotes to give detail. Legal requirements vary, but accounts must be exact.
CONSOLIDATED FINANCIAL STATEMENTS
In an era of globalization, large corporations are now commonly made up of multiple companies. Companies owned by a parent company are known as subsidiaries, and continue to maintain their own accounting records, but the parent company produces a consolidated financial statement, which shows the financial operations of both companies. Depending on the jurisdiction’s reporting requirements, however, if a company owns a minority stake in a second company, then the latter will not be included in the former’s consolidated financial statement.
NEED TO KNOW
❯ Subsidiary One company that is controlled by another, usually a holding company
❯ Holding company A company set up to buy shares of other companies, then control them
❯ Globalization The process of businesses developing such large multinational presences that they transcend international borders
What’s in an annual report
The contents page shows where to find the big three statements—the balance sheet, cash-flow statement, and profit-and-loss statement—and softer information such as stories about staff and opinions of other stakeholders. The annual report provides an opportunity to impress shareholders and lenders as well as fulfill legal reporting obligations. It will contain all, or most, of the following.
Chair Instructions It is common for the chairman to write an introduction focusing on the positives and explaining any negative parts of an annual report for the benefit of shareholders.
Our environment These pages contain much of the company’s information on its environmental protocols, most of which are industryspecific.
Our performance indicators Performance indicators are common across all industries. They measure areas such as customer satisfaction and the quality of goods or services provided by the company.
Director report In the directors’ report, members of the board of directors give their professional opinions on how the business has performed over the last year.
Our customers and Community This section underlines a company’s social ethos, in particular its community involvement. Different types of companies may focus on different values.
Our customers A section on employees details areas such as staff development and training, health and safety, and key statistics on staff satisfaction.
Environmental accounting The environmental accounting section contains figures that pertain to the environment, often those stipulated by law—for example, greenhouse gas emissions.
Independent auditor’s report Auditors are independent and check the accuracy of companies’ accounts. This helps to eliminate mistakes and track fraud.
Our finance A brief overview summarizes the key areas of finance for the company, including overall performance, turnover, operating costs, capital investment, depreciation, interest charges, taxation, and dividends.
Our infrastructure The infrastructure pages of an annual report are a good place to supply more detail about the company’s fixed assets and explain why the company is an attractive investment for investors
Board of directors The board of directors, governance report, and statement of directors’ responsibilities sections indicate who is leading the company, showcases their credentials and roles, and reveals their pay.
Note to accountants Notes to the accounts are a key part of financial statements. They provide extra detail, insight, and explanation of the barebones figures supplied in earlier pages of the report.
Deconstructing a financial statement
The profit and loss account shows revenues, costs, and expenses— how much money the business makes—over an accounting period. The balance sheet shows what a business is worth at the time it is published, and is relevant to investors as it reveals assets, liabilities, and shareholders’ equity—all useful for gauging business health. The cash-flow statement shows the movement of cash within a business—its liquidity. However, along with the big three financial statements, an annual review contains a wealth of information about a company’s performance, of interest to its stakeholder groups. It is often the notes that bring statements to life.
TAXES
The percentage of business taxes taken by governments varies from country to country but the generic types remain similar:
❯ Direct taxes are levied directly on profits or income and include income taxes, inheritance taxes, and taxes relating to sales or purchase of property and other capital assets.
❯ Indirect taxes are paid on goods or services, such as sales taxes. Indirect taxes are often targeted to reduce consumption of harmful goods, a factor relevant to companies working in the alcohol and tobacco industries.
❯ Green taxes are increasingly common and are often indirect. They are generally used as a way of prohibitively increasing the price of goods or services harmful to the environment, such as air travel, landfill sites, or fuel, to diminish their use.
❯ Corporation tax is only paid by companies, not by sole proprietors or partnerships. It is levied as a percentage of the company’s total profit.
NEED TO KNOW
❯ Monopoly Situation in which there is just one supplier of a particular product or service; without government control, a company with a monopoly could make prices high and quality low, as consumers would have no alternative
❯ Oligopoly Industries that have a small number of suppliers. The competition is not as intense as in the free market, so governments often impose regulations on companies to ensure quality and fair prices
❯ Remuneration Money paid for work or a service provided— the financial term for pay; may include bonuses or share options
BOARD OF DIRECTORS
Much of what might be considered personal information about directors of public companies is in the public domain. It is usually a legal obligation to disclose:
❯ Names of executive directors
❯ Names of non-executive directors, and whether they are independent or shareholders
❯ Shareholding
❯ Board attendance record
❯ Dates of directors’ terms of office
❯ Remuneration, including bonus, share options, pension plans, and benefits
❯ Notice period
❯ Termination payment
❯ Potential conflicts of interest
Case study: the details
Financial statements are presented as part of the annual report, which also publishes case studies, quotations, statistics, and profiles of customers, suppliers, employees, and directors. The notes, often running to 20 pages or so, contain tables and text that flesh out the financial information. The following examples are taken from the 2013 annual review of UK utility company Wessex Water.
Our finance
This section contains the headline financial figures of the business, such as profits, taxes paid, assets owned, liabilities, and dividends paid out, as well as some more detailed explanation of the figures.
Charitable donations
Companies vaunt their philanthropy in the annual report, detailing how much they have given away and how it has helped. They may support charities relevant to the nature of their business or let employees vote on recipients.
Customer satisfaction
Overall, this section shows how the company works with customers to improve service and support. In monopoly and oligopoly industries, customer satisfaction is particularly important, as governments often set high targets. Wessex Water’s annual review shows a customer satisfaction rating of 96 percent.
Financial statements for users
Different stakeholders are interested in different parts of the annual review. Customers of a service provider, for instance, may look at the section on customers and community while potential lenders go to the financial statements..
STATISTICS MADE EASY
Impressive statistics are often scattered through an annual report. These examples are from UK utility Wessex Water:
6% post-tax return on capital
❯ This percentage is estimated by dividing income after tax by the amount of investment. It is useful for showing shareholders the kind of returns they can expect on their investments.
64% gearing
❯ For most industries, gearing is a company’s debt compared to its equity. In the water industry, it compares a company’s net debt to its regulatory capital value (the value of the business that earns a return on investment). Gearing is expressed as a percentage.
A3/A-/BBB+ credit rating
❯ Credit ratings assess the likelihood that loans will be repaid. A3 and A- fall at the bottom of “strong capacity to meet financial commitments,” while BBB+ is at the top of the adequate range. The major ratings companies in the US are Moody’s, Standard and Poor’s, and Fitch.
The accounting cycle is a step-by-step process bookkeepers use to record, organize, and classify a company’s financial transactions. It helps to keep all accounting uniform and eliminate mistakes.
How it works
The cycle works as an aid to organize workflow into a cyclical chain of steps that are designed to reflect the way assets, money, and debts have moved in and out of a business. It progresses through eight different steps, in the same order each time, and restarts as soon as it has finished. The cycle can be based on any length of time—this is known as an accounting period—and usually lasts a month, a quarter, or a year. Accounts which deal with revenues and expenses return to zero at the end of each financial year, while accounts showing assets, liabilities, and capital carry over from year to year.
The eight-step cycle
The processes shown here are repeated in the same way for every accounting period. All businesses go through different phases, and the accounting cycle works by reflecting that. The financial statement, which is prepared toward the end of each cycle, is helpful in showing how strongly the business has performed during each period of time.
Transactions Any type of financial transaction, from buying or selling an asset to paying off a debt, can start the accounting cycle.
Journalentries Accountants then analyze the transaction and note it in the relevant journal—a book or an electronic record.
Posting Journal entries are then transferred to the general ledger—a large book or electronic record logging all the company’s accounts.
Trial balance A list of all the company’s accounts is prepared at the end of the accounting period, usually a year, quarter, or month.
Worksheet Often, trial balance calculations don’t accurately balance the books . In such cases, changes are made on a worksheet.
Adjusting journal entries Once the accounts are balanced, any adjustments are noted in journals at the end of the accounting period.
Financial statements The corrected balances are then used to prepare the company’s financial statements.
Closing the books A closing entry based on adjusted journal entries is taken, the books are closed, and the cycle restarts.
BOOKKEEPING AND ACCOUNTING
❯ Internal controls A method of deploying, measuring, and monitoring a business’s resources. This helps prevent fraud and keep track of the value of assets.
❯ Double-entry bookkeeping The process of recording all transactions twice—as a debit and as a credit. If a company buys a chair for $100, its debit account increases by $100 and its credit account decreases by $100.
❯ Bad debts Debts that cannot be or are unlikely to be recovered, so are useless to the creditor (lender), who writes them off as an expense.
NEED TO KNOW
❯ Debits Expenses—dividends, assets, and losses. In double-entry accounting, debits appear on the left-hand side of the account
❯ Credits Gains—income, revenue, owners’ equity, and liabilities. In double-entry accounting, credits appear on the right-hand side
❯ Chart of accounts List giving the names of all of a company’s accounts, used to organize records
❯ Audit trail Full history of a transaction, allowing auditors to trace it from its source, through the general ledger, and note any adjustments made
Financial reports are everywhere: a bill at a restaurant is a financial report, as are sales receipts and bank statements. In business, however, financial reporting refers to the financial statements that make up a company’s annual report and accounts. Compiled by accountants, they provide investors and lenders with information to assess a company’s profitability, and enable company managers, government, tax authorities, and other stakeholders to evaluate the business.
Types of financial reports
Financial reports take many forms and can contain a vast amount of information about a company’s finances, work, core business values, performance, employees, and its compliance with local, logistical, domestic, and international laws. The most important financial report, or statement, is usually the annual report— essentially a collection of many other, smaller reports—which sums up how the business has performed in the last year. There is a multitude of laws, regulations, and guidelines governing what should be put into this report.
TYPES OF ACCOUNTING
There are seven widely recognized types of accounting:
❯ Financial Drawn up by accountants; used by investors, creditors, and management.
❯ Management Used by managers to control cash flow and budgets, and forecast sales.
❯ Governmental Also called public finance accounting; used by public sector for noncommercial accounting.
❯ Tax Dictates exact rules that companies and individuals must follow when preparing and submitting tax returns.
❯ Forensic Engages in disputes and litigation, and in criminal investigations of fraud.
❯ Project Deals with a particular project; a useful aid for project management.
❯ Social and environmental Shows how a company makes a positive difference to the community and environment.
THE ACCOUNTING CYCLE
The eight steps of the accounting cycle are used by nearly all accountants. The cycle helps by standardizing processes and makes sure that accounting jobs are performed correctly and in the same way and order for every activity.
The annual report
Financial statements usually appear in a company’s annual report and sum up its financial activities in a standardized way for different audiences to interpret quickly and clearly. These statements take diverse forms, and being able to deconstruct them is a vital skill for accountants and businesspeople, making it simple to see how well a business is performing and why.
$50 billion the amount hidden via loans diguised as sales by
Lehman Brothers in 2008
Financial statements
❯ What’s in an annual report? A full record of company performance according to various criteria, as well as accounts.
❯ What are the statements? The main one is financial; others include sustainability, directors’ pay, and charitable donations
Who reads which statements? Sections are relevant to banks, shareholders, government, auditors, staff, and media.
❯ What do the notes mean? Main statements are annotated in detail.
❯ What are the rules? Accounting principles regulate financial reports.
❯ Which are the most important financial statements? Profit-and-loss statements, balance sheets, and cash-flow statements contain key facts.
Skillful negotiation is vital in business when two or more sides have different viewpoints and each party wants to press for their own advantage. The ideal outcome is a compromise that resolves conflict.
How it works
Like many aspects of business, negotiation is a process to find a mutually acceptable solution. Before any discussion, each party must work to understand the other’s interests and decide on strategy; otherwise talks can end in stalemate, bad feeling, and loss of business. Being able to negotiate is vital to build strong working relationships, deliver a sustainable, well-considered solution (rather than a short-term fix), and avoid future conflicts.
65% of face-to-face communication is through non-verbal signals
Reaching agreement
Any strategy, from a wage negotiation between a trade union and employer to a sales negotiation between a customer and a supplier, depends on the relationship between the two parties. Good negotiation should leave each party feeling satisfied with the outcome of the discussion and ready to do business again.
Prepare and plan
❯ Set objectives and ideal outcome (and assess those of other party).
❯ Rank and value issues and think of possible concessions.
❯ Consider ideal agenda and meeting place. Rehearse.
Define ground rules
❯ Agree on logistics— location, room setup, agenda, schedule, number of negotiators.
❯ Define etiquette, such as no cell phones, one person speaks at a time, formal breaks.
❯ Agree on how information is to be presented and recorded.
Propose, clarify, and justify
❯ Ensure both sides have equal opportunity to put forward their case. ❯ Clarify any points of disagreement. ❯ Focus discussion on understanding rather than resolving.
Bargain to solve problems
❯ Offer alternative proposals and concessions. ❯ Discuss what is acceptable to each side. ❯ Aim to find win-win solutions.
Agree, close, and implement
❯ Conclude with an agreement that is mutually acceptable. ❯ Clearly articulate and note agreement and concessions. ❯ Formalize agreement in writing and follow up.
BODY LANGUAGE IN DIFFERENT CULTURES
With international negotiations, it can be hard to read body language signals, particularly since the meaning of gestures can vary.
Eye contact Chinese people avoid direct eye contact to show respect while American people see lack of eye contact as a sign of shiftiness.
Facial expressions When emotions are high in the US, it is acceptable to frown, even to swear, but not to cry. Japanese people might smile or laugh, but never frown or cry
Head movements In much of Europe and the US, people nod to mean yes and shake their head to mean no. But in some parts of the world, such as in Bulgaria, it is the opposite way round.
Gestures Western cultures use a hand extended towards a person to indicate “Come here”. Chinese people would see this gesture as offensive.
Posture In the US, being casual is valued; people might slouch when standing or sitting. In some European countries, such as Germany, a slouching posture is considered rude. Formality is also valued in Japan, particularly the ability to sit upright and still.
Besides day-to-day activities, a business may have projects that are one-time, temporary, specific pieces of work. Projects need to be managed to deliver on time, within budget, and to specifications.
How it works
The process of project management takes a complex project from start to finish. It requires a different set of knowledge, experience, and skills from a mainstream operation because the goals set up have to be achieved within defined limitations. These constraints include scope, time, quality, and budget. A project team might include people from different organizations, diverse disciplines, and multiple locations. Successful project management involves not only overseeing the people working towards the particular objective, but also managing the risks, schedule, relationships, individual and team input, range of stakeholders with vested interests in the project, and financial resources. Effective project management is increasingly viewed as a strategic competence (see p.85) for any business because it enables the introduction of new products, new methods, and new technology.
NEED TO KNOW
Project management tools There are many different project management tools, particularly for software development. One tool is PRINCE2®, a process-based approach to project management within a clear framework. The emphasis is on dividing the project into manageable and controllable stages with a defined structure for the project management team.
Steps in project management
Initiation
❯ Project charter, including business case, objective, scope, budget, deliverables, and schedule
❯ Roles and responsibilities
❯ Resource allocation
Planning
❯ Detailed plan of work
❯ Critical path analysis
❯ Risks
Execution
❯ Coordinating people and resources
❯ Quality assurance
❯ Communication to team and stakeholders
Monitoring and control
❯ Measuring effort and progress
❯ Managing and mitigating risk
❯ People management
Closure
❯ Finalizing all activities
❯ Communication
❯ Learning—project review
HURDLES AND HOW TO OVERCOME THEM
Every project comes up against challenges. These are some of the common ones, and the ways that effective management can keep the project on track.
Thriving organizations recognize the importance of harnessing people’s ideas and energy to provide a competitive edge, while managers are eager to gain, retain, and build employee commitment and engagement.
How it works
Employee relations and communications are, either managed by human resources (HR) or as a function in their own right, are increasingly sophisticated. Rather than just relying on face-to-face talks and word of mouth, successful firms use added communication tools to help people understand the business goals and the individual’s contribution to results. In particular,leaders no longer send only one-way messages but harness a variety of interactive media, such as videoand tele-conferencing. Individuals and teams can use customized business social media, such as Yammer, to share ideas and knowledge, but may still choose to meet in formal settings such as councils and forums.
Communication in practice
In many countries, employee communications used to focus on structured industrial relations, managed by HR. Employee relations are now based more on trust and building strong relationships. Many firms create formal works councils or employee forums. At their best, employee forums:
❯ Allow representatives from across the business to share and generate ideas for improving performance.❯ Encourage discussions on vision, changes, and plans for business.
❯ Recognize the value of employees.
CASE STUDY
John Lewis The UK-based John Lewis chain of department stores is famous for its unique employee-owned structure, in which every worker is a partner in the business. It has a number of employee communication policies.
❯ Gazette Employees can send letters directly to management through the weekly gazette. Managers publish their responses in the gazette for all to read.
❯ Partnership council Made up of 80 elected partners from across the business, the council meets four times a year. The chairman and directors report to the council, which can remove the chairman.
❯ Branch forums Elected by employees at each branch, these forums work with management to influence the running of their store and select local charities to support
$316 million the amount paid in staff bonuses by John Lewis in 2013
Top-down leadership, in which managers give orders, is not always the best way to get results. A number of different leadership styles have been identified by business experts.
How it works
Every leader is an individual with his or her own approach. However, over the years, management gurus have identified key leadership styles that can be used to achieve different results, depending on the environment. Many frameworks are based on the ideas of psychologist Kurt Lewin, who developed his theories in the 1930s with three major styles: autocratic, democratic, and laissez-faire (non-interference). In 2007, for example, business authors Eric Flamholtz and Yvonne Randle developed a leadership matrix based on Lewin’s theories, which shows the best style to use in any given situation, ranging from autocratic (one all-powerful leader) to consensus (decisions reached by general agreement. Truly inspirational leaders encourage people to believe in themselves so that they achieve results beyond even their own expectations.
“Outstanding leaders go out of their way to boost the selfesteem of their personnel.” Sam Walton
TRANSFORMATIONAL LEADERSHIP
While different styles can suit different situations, transformational leadership, in which leaders and their followers raise one another to higher levels of integrity and motivation, was identified by guru James McGregor Burns as the most effective. This has been developed by others, including industrial psychologist Bernard Bass, who listed the qualities of a transformational leader.
People work for money, but they are also motivated by other factors such as doing a good job and being valued. Non-financial rewards drive day-to-day motivation more strongly than pay and benefits.
How it works
In the past, tangible pay and benefits were the key motivational tools for employees. These financial rewards are termed extrinsic because they areexternal to the actual work and others control the amount, distribution, and timing. Employers now recognize that while extrinsic incentives are clearly important, intrinsic (psychological) rewards are crucial.
Understanding motivation in the workplace
Happy staff work well, and job satisfaction comes from subtle feel-good factors as much as a paycheck. Employees who enjoy their work tend to stay—job satisfaction and turnover move in opposite directions.
Extrinsic
Financial rewards
❯ Base pay
❯ Bonus
❯ Incentives
Benefits
❯ Pension contributions
❯ Paid holidays/vacation
❯ Health care
Intrinsic Feelings that an individual has:
❯ Purpose A sense of being able to accomplish something of value
❯ Choice Clear ownership and feeling responsible for outcome
❯ Progress As an individual, feeling and seeing evidence of moving things forward
❯ Competence Pride and satisfaction in own work
Fostering intrinsic rewards
Businesses that are successful engender trust and have employees who are passionate about what they do. All these factors contribute:
Purpose for organization and individual
❯ Clear vision for organization❯ Understanding of where individual fits in to achieve that purpose
❯ Clear goals and expectations for individual
Recognition
❯ Continuous feedback
❯ Ongoing engagement
❯ Non-cash rewards such as praise
Career development
❯ Progression and promotion
❯ Mentoring and coaching
❯ Learning opportunities
Culture
❯ Strong teamwork and consistent behaviors
❯ Open communication
❯ Sharing of knowledge and information
WHY PEOPLE DO TASKS
13% the percentage of employees who are fully committed to their jobs
Motivating yourself to keep going despite obstacles helps, but pushing yourself to the limit does not. You may need to be careful: chronic stress can hurt you— and perhaps your chances of success as well.
Stress is what happens when you perceive, or at least feel, that the demands life is placing on you are greater than your ability to cope. Sometimes stress can be helpful, giving you the impetus and focus to achieve But stress can also be a trade-off: are you toughing it out because you know the short-term strain will be worth the long-term benefits, or has the short-term harm started to become a long-term liability? In short: how much stress is too much?
The dangers of stress
We all know stress is an uncomfortable sensation; what we don’t always realize is that it can be damaging. There are many ways in which the brain’s chemistry, structure, and even physical size can be adversely affected by chronic tension (see “How stress affects the brain,” opposite). Chronic stress doesn’t just increase your risk of physical illness (though it does that, too); it also makes you less motivated and, literally, less intelligent. Our bodies are designed to respond automatically in times of threat: this makes sense if you’re fleeing a bear, since you act faster when you’re operating on instinct, but if you’ve ever found yourself freezing in an interview or getting stuck during a presentation, you’ll know there are times when it undermines you. Severe stress simply makes you do worse at the tasks you’ll need to perform well to succeed. When you consider that it also increases your chances of mental illness—something that can incapacitate the most talented— you’ll know that it’s something you need to keep in check.
72% MONEY WORRIES According to the American Psychological Association’s 2014 “Stress in America” survey, 72 percent of people say they are stressed about money at least some of the time.
What can you do?
The important question is this: when you feel you can’t cope, where does that feeling come from—the situation, or your faith in your coping abilities? Both are possible, and neither is “wrong,” but each answer calls for a different solution. If you’re in a chronically stressful situation, you may need to revise your plans:
a stressful period that will definitely end may be endurable, but you can’t succeed if you burn yourself out. If you feel you have to stick with the situation, there are ways you can at least moderate your stress levels .None of these suggestions represents a magic bullet, but try them out and see what works for you. A successful life includes a level of stress you can tolerate over the long term. You may be stronger than you believe—but it is also sensible to listen to your instincts, and to take action when necessary.
STRESS ON THE JOB
A 2014 survey by Towers Watson, a global HR and risk management professional services firm, found that:
HOW STRESS AFFECTS THE BRAIN
Stress physically changes your brain in a variety of ways:
■ Too much “white matter” (myelin) develops. In a healthy brain, this provides an insulating electrical sheath enabling nerves to send their signals efficiently. In excess, it overinsulates, slowing down connectivity between different parts of the brain
■ The protein BDNF (brain-derived neurotrophic factor) is slowed down. Because BDNF is responsible for the development and differentiation of new brain cells, this impedes the brain’s functioning and can increase the risk of mental illness, dementia, and Alzheimer’s
■ Levels of dopamine and serotonin, hormones associated with happiness and well-being, drop. In mild cases this leads to a habitually lowered mood; in more extreme cases, it increases the risk of mental illness and addiction
■ The brain’s immune cells (microglia) get overactivated, risking brain inflammation
■ The thalamus, which helps create the fear response, becomes habitually overactive
■ The sensory cortex sends stronger fear signals to the body, creating physical symptoms such as muscle tension, stomach upsets, and restlessness
■ The hippocampus shrinks, reducing self-control, memory functioning, and emotional regulation
■ The pituitary gland stimulates the adrenal glands in the torso, releasing more of the “stress hormone” cortisol.
Your brain is a physical organ, so take care of it. If you’re really stressed, remember that it’s not a sign of weakness to take a rest: it’s sound medical sense, and much better for you in the long run.
Achieving long-term goals takes persistence, which often means you need to delay short-term gratification. How can you learn to say “no” to immediate rewards if they conflict with your bigger plans?
We all have multiple goals that we seek to fulfill, and which give us the feeling of being successful. Unfortunately, many distractions can cause us to focus on short-term good feelings (“I want to buy a new car”) rather than on the longer-term goal (“I want to pay off my student loans so I can save more and buy a house”). The feelings triggered by the desire to fulfill both the shortterm desire (driving a nice car) and the long-term desire (getting on the property ladder) can evoke powerful, compelling feelings that impact our choices. The struggle comes when our long-term priorities come into conflict with other desires which, while less important to us overall, are easier to undertake and more fun in the short term.
Making choices
A 2014 study by American psychologists Angela Lee Duckworth and James Gross argues it’s partly a matter of hierarchy. We don’t just have one goal: we have big, overarching goals, and then smaller goals that tend to be more practical and action-oriented. Problems arise when these clash. At that point, we need to go back and decide which of the long-term goals is most important (see “The hierarchy of goals,” opposite). When we have to make a choice, it’s helpful to be able to distinguish between what are competing priorities and what are everyday short-term temptations.
Resisting that marshmallow
The “marshmallow test” was performed by Walter Mischel at Stanford University in the 1960s.In this test, a group of four-year-olds were offered a marshmallow and left alone in a room, having been promised that if they resisted eating it until the experimenter returned 15 minutes later, they could have the marshmallow and a second one as well. This longitudinal study followed these children over many years and found that those who had resisted the marshmallow turned out, in later life, to be doing better academically, health-wise, and indeed in life in general. The findings of this research sparked a series of studies that focused on understanding the dynamics of self-control and how people respond in different situations.
Testing the marshmallow test
In 2013, a further experiment was done by a group of American researchers to test the original marshmallow theory. In the second test, children were given the same choice of one marshmallow immediately, and, if they could resist eating it, a second one later too—but with a twist. Before the marshmallows came promises about crayons and stickers. The children were told that if they waited before they started using the crayons and stickers, the experimenters would return with better crayons and stickers. With some children, the better supplies did appear; with others, the experimenters came back empty-handed. The result? The “reliable environment” group resisted the marshmallow four times longer than children who had experienced an “unreliable environment.” The researchers surmised that the marshmallow test is more a measure of how much trust a child has in their circumstances: for children who had reason to believe a promise, resisting that marshmallow was much easier. Perhaps the key to self-control is directly related to emotional intelligence and the ability to understand how your emotions are impacting your responses and behaviors.Psychologist Daniel Goleman identifies self-regulation as one of the elements of emotional intelligence: this means you don’t make decisions on impulse, and you are able to delay gratification. Next time you need to strengthen your resolve, listen to what’s going on in your head and heart.
If we have the skills to allow us to make discriminations about when we do or don’t do something… and when we do and when we don’t wait for something, we are no longer victims of our desires. Walter Mischel Psychologist and creator of the “marshmallow test”
THE HIERARCHY OF GOALS
Even if you have a particular aspiration that outshines all the others, it’s helpful to think in terms of multiple goals. One approach is to consider them as long-term, medium-term, and short-term: that way, your long-term goal or goals can be as broad as you need, and you can keep your short-term goals practical. Draw up a chart, and see if any of your short-term goals conflict with each other—for instance, does networking with clients at a conference conflict with time spent socializing with friends and family? If you can lay it out in this way, it may be easier to decide which short- and medium-term goals best support your long-term goals, and prioritize your decisions accordingly.
Chasing your dreams can be an emotional business, and passions can ignite many feelings, ranging from excitement about the possibilities to frustrations with obstacles that get in your way.
Our emotions give us energy and are a crucial source of information that needs to be attended to and understood. Research on emotional intelligence clearly demonstrates the link between awareness about one’s own and other people’s emotions and the ability to successfully achieve goals. Understanding and managing our emotions is the key to success and effectiveness.
Creating a balance
We generally prefer to avoid uncomfortable feelings, but in fact, that’s not the most productive or effective way of dealing with them. Life will frustrate and upset us at times, no matter how successful we are, and we need to learn how to cope with the inevitable ups and downs. If you are experiencing a painful emotion, it’s better to “sit with it,” as popular author and founder of the Tiny Buddha blog Lori Deschene puts it—that is, to accept that it hurts right now, while also knowing that this feeling will pass. Meanwhile, we can “create situations for positive feelings”: if there’s something that makes you happy, make opportunities to do it regularly. We need a place in our life for both.
Managing our emotions
Much as we’d like to consider ourselves objective, our brains are rather good at shaping reality to our expectations. Take, for instance, the emotion of loneliness. A 2000 study among 2,500 students at Ohio State University found that there were really no differences in social capital between students who called themselves lonely and students who didn’t: their socioeconomic status, looks, and academic achievements were pretty much the same, and they belonged to as many groups and lived with as many roommates. The difference was in how they would “construe their self in relation to others”: they were more likely to blame other people for problems in relationships, and more likely to see themselves as victims who were already doing their best. The study didn’t look into whether this affected how other people felt about them—though it’s quite possible that people would act less warmly toward someone who always blamed them for any conflict—but it’s a useful warning. How we label ourselves and our interactions can become reality, even if the external evidence doesn’t initially seem to support it.
THE EMOTION DECODER
Ways to move forward
TAKING CHARGE
Can we be more proactive in how we deal with our emotions? According to James Gross, who specializes in emotional regulation at Stanford University, we can view our emotional responses as part of a process: if we make good decisions early on, we can achieve better outcomes. In any scenario, there are opportunities where we can change our actions, the focus of our attention, our framing of a situation, and our response to it. Suppose you’ve been invited to a short film festival, which would be good for making connections—but one of the films is by a former collaborator with whom you’ve fallen out. What are your options?
A healthy body image is one dimension of feeling successful. Being comfortable in your own skin makes for a better quality of life, and is likely to make you more attractive and impressive to others as well.
However accomplished you are, it’s hard to feel like a success if you’re not entirely happy with your physical appearance. Of course, you can exercise and be more careful about what you eat and drink, but it’s also a good idea to begin by accepting and learning to enjoy your body here and now, whatever it looks like. When we think of the body beyond mere appearance, there’s a lot it can teach us.
Positive body image
Research finds that a positive body image tends to support a variety of healthy behaviors, including:
■ Higher levels of psychological and social well-being
■ Better coping skills
■ Improved sex life
■ Intuitive eating (that is, eating appropriate quantities when hungry, rather than comfort eating or starving yourself)
If you can become more relaxed with how you feel about your body, the evidence suggests that you become better able to read its signals—and this in turn leads to more positive behaviors.
Dress for success
Getting dressed can sometimes be a fraught issue if you’re not wholly confident about how you look. The concept of “enclothed cognition” may come in handy here. A series of experiments at Northwestern University in Illinois, published in the Journal of Experimental Social Psychology in 2012, found that the clothes we wear have a symbolic meaning, and can make a difference in our level of achievement when completing a task. Preliminary research found that a white lab coat, as typically worn by scientists and doctors, is associated with being attentive and careful. In the experiment, volunteers were shown a white lab coat and given the option of putting it on or not—but first, some volunteers were told it was a doctor’s coat, while others were told that it was an artist’s coat. After making their choice, the volunteers took part in a test. Those wearing the “doctor’s coat” outperformed everyone else: the image of a doctor’s precision and intellect had heightened their concentration. (Attention levels did not increase among those whose coats had been described as belonging to an artist.) The researchers concluded that the influence of clothing depends on the symbolic meaning attached to an outfit and the act of wearing it. Certain outfits can bring out in us the positive qualities we associate with their role. When choosing our clothes, perhaps the key is to worry less about how we’ll look, and think of it more as choosing a costume for who we want to feel like.
I’ve never wanted to look like models on the cover of magazines. I represent the majority of women and I’m proud of that. Adele Singer-songwriter
Being in the world
In a society full of images of impossible physical perfection, it’s easy to feel we’re lacking. Instead of thinking of your body as an accessory, though, it’s healthier to think of it as a tool: however it looks, your body can carry you toward your goals. Confidence, dynamism, and action are more than skin deep, and these are the qualities that will help you to succeed.
LOVE YOUR BODY
Positive psychologist Kate Hefferon points out that people who feel comfortable with their bodies tend to be physically and emotionally healthier. She suggests a combined set of techniques to encourage us in the right direction:
Physical activity:Focus on how exercise and eating good food make you feel rather than how they make you look.
Media literacy:Be familiar with how advertisers feed our insecurities in order to make us more suggestible consumers.
The beauty myth:Appreciate how unrealistic ideals limit both men and women in today’s society.
Improved self-esteem:Work on liking and accepting yourself as a valuable person, no matter how you look.
Israeli health psychologist Tal Shafir observes that our physical stance gives our brains feedback that can translate into emotions. Hence, assuming a downcast posture tends to make us “feel” sad, while a confident posture picks us up—so, for instance, dancing has been proven to improve mood more than hunching over an exercise bike. Shafir’s research identifies key movements that cheer us up:
Expanding the body upward and horizontally such as stretching, jumping, and arm-raising.
Lightness.Walking or moving with a spring in your step.
Repetitive movements movements—dancing is particularly good for this.
Can we “think” our way to success? Of course hard work, skill, and luck play their part as well, but the evidence shows that positive mental habits are essential, and our attitude does make a difference.
The path toward success can be emotionally tough: there may be knocks and frustrations as well as moments of excitement and satisfaction. A positive attitude can sustain you through unpredictable times, and studies on physical well-being show that optimistic people have stronger immune systems and live longer. Psychologists also find that optimists tend to be happier, better at coping, and more persistent, have a wider network of friends, and are more successful in general. The good news is that optimism can, with practice, be cultivated.
Five steps to optimism
Over the past 20 years, positive psychology researchers have formulated a five-point plan that educators use to teach students a positive outlook. If you’re working on improving your optimism, try these approaches:
1.Identify and prioritize your top goals.
Look at the big picture. Some will be “micro” goals and some “macro” goals, so settle in your own mind which are the most important.
2.Break them down into steps.
This is especially helpful with long-term goals. The idea is not to achieve everything at one stroke: you need a series of milestones, which you can celebrate as successes as you reach them.
3.Appreciate that there’s more than one way to reach a goal.
Studies show that pessimistic students have difficulty problemsolving their way past obstacles, so flexibility is a key skill.
4.Tell your success stories, and hear other people’s.
Seek out opportunities to remind yourself that adversity can be overcome.
5.Stay light and positive.
Selfpity is the death of optimism, so keep your self-talk positive, find the funny side of your mistakes, and enjoy yourself as much as you can.
COGNITIVE DISTORTIONS
Cognitive Behavioral Therapy tells us we’re vulnerable to “cognitive distortions,” as shown here, which undermine our optimism. Combat such thinking by identifying and questioning such thoughts when they occur.
Personalization Blaming yourself when things go wrong.
All-or-nothing thinking If you aren’t always perfect, then you must be hopeless
Overgeneralization Assuming that if something happens to you once, that’s how things will always be.
Mental filter Focusing on a negative detail, screening out the broader (and more positive) context
Disqualifying the positive Finding ways to write off good news and positive feedback.
Emotional reasoning Taking your feelings for facts.
Maximizing and minimizing If it’s bad news, you “catastrophize”; if it’s good news, it’s no big deal.
Jumping to conclusions Particularly “mind reading” (assuming you know what others think) and “fortune telling” (predicting disaster
“Should” statements Making up rules to motivate yourself, and ending up feeling worse.
Labeling and mislabeling Thinking that one action sums a person up.
Clear your mind
Cognitive Behavioral Therapy teaches ways to build optimism when you find yourself thinking negatively (see “Cognitive distortions,” above). If you find yourself caught in such thinking, try the following:
■ Identify the thought that is bothering you.
■ Ask yourself how much you believe it. Assign a hypothetical percentage to reflect the amount.
■ Ask yourself if there are any cognitive distortions at play.
■ Consider alternative explanations. You don’t have to fully believe them; just try them on for size.
■ Look at the evidence as calmly as possible. Does it support your troublesome thought? Is any evidence more encouraging?
■ Ask yourself again how much you believe the negative thought. The answer doesn’t have to be “not at all”; if you’ve dropped from, say, 85 to 45 percent, that’s a significant improvement.
a significant improvement. The benefits of this strategy over the long term can be great, from improved mental health to better focus and resilience—all of which support a more successful life.
As a leader, you are likely to be inundated with communications, requests, new tasks, and initiatives. Recognizing—and focusing on— what is really important is critical to your success and that of your team; it is vital that how you spend your time reflects your priorities.
Managing your time
It is easy to get distracted from key tasks by less important, but nonetheless urgent activities. Prioritizing your actions is something you should schedule in every day, and approach with discipline. A simple solution is to write a “to do” list at the end of each day. Scrutinize this list, assessing each item against your vision, values, and key objectives; then, number each item in order of priority. Alternatively, try categorizing your tasks more systematically under the four headings shown below.
How to prioritize tasks
HIGH URGENCY: LOW IMPORTANCE
Action delegate it
LOW URGENCY: LOW IMPORTANCE
Action: Leave it
HIGH URGENCY: HIGH IMPORTANCE
Action: Do it now, but review your time planning
LOW URGENCY: HIGH IMPORTANCE
Action: Schedule it
Getting back on track
Missed or delayed deadlines and recurring problems that you never seem to get around to fixing are symptoms of faulty time management. If the root cause is not addressed, your work life could soon run out of control, sapping your energy and stifling your creativity. Stop, take some time out, and refocus your thoughts. Plan in some time to address strategic activities, and think what and how you could do to improve delegation within your team.
Delegating successfully
Delegation is a critical leadership skill, and one that—when done well—has great benefits for you and your team. It liberates your schedule, makes members of your team feel valued,and develops capabilities in people throughout the organization. Delegating well requires more than just handing a task over to a subordinate, there are many issues you need to consider carefully before you act.
Reserve at least 10 percent of overall project time for contingencies
Selecting personnel
To identify the best member of your team to take on a particular task, try using a “Plan to Delegate” table, such as the sample at right, to give a degree of objectivity when making a decision. To use the Plan to Delegate table:
• List all members of your team.
• Devise your criteria for choosing someone—those on the sample table are a good starting point.
• Rate each member of your team for all criteria from 1–10.
• Add the scores.
Add comments on the amount and type of training, development, or support each individual needs.
type of training, development, or support each individual needs. When you carry out this exercise, the best fit candidate is not always the most obvious. You may have developed the habit of just asking one experienced and skilled team member to do jobs for you. However, others on the team may have more time to devote to the task, and will benefit from the experience and responsibility.
When you are given a leadership position, you need to prepare yourself for intense learning and adaptation. From getting your feet under the desk to developing your competencies, there are many challenges in store.
Preparing to lead
When you become a leader, you need to quickly understand what is expected from you and from your team. Your employer will provide you with guidance, but don’t assume that you’ll get the complete picture. A lot of the groundwork is going to be up to you.
Giving yourself a head start
It pays to prepare for your leadership role even before your first day on the job. Do some basic groundwork and research: ask your employer where you fit into their organizational plans; ask when you will be expected to produce objectives for your team; and when and how your performance—and that of your team—will be assessed. If possible, ask to meet the outgoing leader and discuss the demands of the role and the team dynamics. Research your team: request performance figures and personnel files; ask the outgoing leader and your peers what information will be of most use.
Managing data
Throughout the first few weeks in your new role, you will be deluged with information. Unfortunately, you won’t necessarily know which of this data is of strategic importance, and which is just minor detail. Head off early errors by being systematic; file the information and make a list of everything you have received. Review this list weekly and try to place the relative significance of each piece of information in a broader context.
Managing people
You’ll also be introduced to many new people throughout the organization. Always carry a notebook and pencil with you; after each meeting, make a note of the name, position, and distinguishing features of the person you have met, along with anything memorable they said to you. When you meet them next, you’ll remember who they are and how they fit into the organization. What’s more, you’ll be able to pick up your conversation with them.
23% increase in performance may result from best management practice
Ask your employer where you fit into their organizational plans
Being realistic
Your arrival as a team’s new leader will raise expectations of change for the better. However, you may discover that some expectations are less than realistic. For example, your team’s previous leader may have provided detailed guidance on how work should be carried out; if your leadership style is more about empowering your team to make their own decisions, they may initially feel poorly supported and even resentfulof the added responsibility. Early in your tenure, ask others what assumptions they have about you and your role.
Outline what success looks like to you. Does their view match yours?
What expectations do they have of how long things will take?
Have they been made any unrealistic promises about what you will deliver?
You can then begin to address any discrepancies between their expectations and your reality.
Ask crucial questions
What are the aims of your organization or team?
Are there potential problems?
Who are your key stakeholders?
What are the processes, culture, and structure of the organization?
How are internal systems audited?
Are your findings complete and accurate?
Are you ready for anything?
86% of businesses in a global survey consider leadership to be the no.1 talent issue
Growth is built in to the vision of most organizations; and when an organization grows, its leaders must be prepared to adapt with it. Your role as a leader may become bigger and more strategic with each organizational transition, so anticipating change is a cornerstone of thinking like an effective leader.
Start-up
When an organization starts up, it is entrepreneurial—focused on delivering a new service to new customers. Often, communication is informal, and people are prepared to put in long hours. Customer feedback is quick and the small group of people responds rapidly with enthusiasm and energy. Leadership at this stage is about keeping close to customers and staff, and encouraging new ideas. As a leader, you may well be involved in frontline activities as well as decisions.
Continued growth
The next organizational transition occurs when you realize that you can no longer control everything—there are simply not enough hours in the day. You may notice that team members are complaining about how long it takes for decisions to be made. They may ask for greater freedom to make their own decisions At this point, you should begin to recognize the need to delegate— essential if you are to retain and develop staff. You should put more of your time and effort into leadership and communication and less into your original expertise—for example, accounting, sales, marketing, engineering, or operations.
Rapid growth
As the organization grows, you may start to see problems with the quality of delivery. Communication with the team may become more formal and some of the initial energy and initiative can be lost. More of your time will be spent on designing and implementing systems, structures, and standards. At this stage, you need to work hard at remaining accessible to people who seek your advice and resist retreating into a purely management role.
90% of the fastest-growing US companies are run by their founders
You should be putting increasing amounts of your time and effort into leadership and communication
Devolution
As the organization continues to grow, you may become part of a high-level leadership team directing strategy and coordination, while a group of managers in business units lead teams on a devolved basis. You need to become a strong communicator because a significant part of your role is resolving tensions between devolved units and the center. You need to manage relationships to ensure that all parts of the organization work collaboratively and are fully committed to the overall strategy. Bear in mind the development of future leaders is essential to the long-term survival of the organization and is another one of your new responsibilities
As a business leader, you will be expected to set out the values of an organization and provide its stakeholders with an emotionally appealing and achievable vision of the future. Clear, thoughtful communication at every level is needed in order to develop this vision and translate it into medium-term strategies and day-to-day action.
Setting out the vision
Leaders focus on vision and overall aims and then help their team members as they try to interpret how to achieve the agreed objectives in a way consistent with the organization’s values. Business vision is a word picture of your future as a team or organization. It describes what things will look like when we get to where we want to be. Your leadership role may be to create the vision and strategic objectives at the top of your organization, or it may be to develop your team plan in alignment with a bigger corporate strategy.
Developing the vision
Involve your team in developing the vision right from the start. Begin by writing it down. As you move forward, you will need to restate and re-create the vision by communicating with your team through open question and answer sessions, one-on-one reviews, and team meetings. Soon each person will learn how to make a meaningful individual contribution toward team goals. People are motivated by a clear understanding of what they need to do to fulfill the vision, by when, how well, and why. These are key signposts on the journey to their professional development and to the achievement of the team’s vision. Your job is to help everyone in your team plan the route, and to review their progress.
In focus
Each person will learn how to make a contribution toward team goals
Working with teams
Your key role as leader is to inspire emotional attachment to an attractive vision and to make success visible. People will then believe in cause and effect—that individual work counts and doing their best really does lead to a better life for all concerned.
> Give everyone a role to play in implementing the team vision and ask them to report back to you on what has gone exceptionally well and what not so well.
> Ask individuals to present highlights to the rest of the team so that everyone can learn about doing things in new ways. When you review these practical steps with the team, keep linking them back to the overall vision.
> Remember to say “thank you” individually and in front of the team to help them keep their momentum and motivation.
> Celebrate team successes to keep the team moving forward together. Recognize even small steps in the right direction.
> Explore with individual team members their unique mix of values, life experiences, knowledge, and skills plus potential abilities. Understand what specifically motivates each person to engage with their work and willingly release the extra they have to give.
As its name implies, a team-based organization (TBO) is made up entirely of teams. Managers and staff from different departments join to form teams handling specific projects, in the short or long term.
How it works
In a TBO, teams reach decisions through brainstorming and mutual agreement among team members, rather than a senior management member issuing orders from the top down the chain of command as in a traditional organizational structure. Communication is less formal in TBOs, often carried out on social media such as blogs and forums and using software for networking such as Groupware.One step beyond the team-based structure is a holacracy (see box, right), an unconventional type of organization in which there are no managers, and even the CEO relinquishes power, allowing employees to self-govern through regular committee meetings, which they organize themselves.
Team-based hierarchy
While TBOs still have a CEO, little other hierarchy exists. Team leaders are part of the team rather than in a chain of command. At its best, a teambased model fosters a culture of trust, so individuals take pride in their work and responsibility for carrying out tasks well and on time and budget.
CEO
Team A
Team B
Team C
HOLACRACY—BREAKING BOUNDARIES
Staff are grouped into teams that set their own roles and goals and choose their own leaders. The idea is that if power and responsibility are shared, employees will give their very best. In 2014, the Las Vegas–based online clothing retailer Zappos adopted the model for its 1,500 staff. Holacracy is a trademarked term used by the company that invented this specific management system. It follows the same principle as a flat lattice, but takes the idea one step further by presenting a comprehensive management structure with clear processes for internal operations and governance.
TRADITIONAL HIERARCHY
HOLACRACY—A STRUCTURE OF SELF-MANAGED TEAMS
TEAM-BASED: PROS AND CONS
Pros
❯ Quick decision-making and rapid response to problems and challenges❯ Reduced overheads because there is no heavy management structure Team leader Team C
❯ Open communication because there is no fear of management reaction
Cons
❯ If staff lack expertise, decisions may be flawed
❯ Limited sharing between teams may affect business performance
Also called a virtual organization or virtual corporation, a network structure is centered around a streamlined company, with digital connections linking it to external, independent businesses.
How it works
The company at the center of the structure is stripped back to basic functions that are essential to the type of business being operated—research and development, for example, in the case of a technology company. All other functions are outsourced to external specialists. The various parties can be scattered around the globe and are connected by the internet. Together, they provide all the services needed for the network to function as one entity. This type of business structure is based on the idea of the social media network, and so is known as a network enterprise.
Network structure in practice
27% of networked organizations report higher profit margins than their competitors
NEED TO KNOW
❯ Agile business Buzzword to describe a networked organization; the opposite of a traditional bureaucracy
❯ Decentralized Organization with a wide span of control and often an upward flow of ideas
VARIATION: MODULAR STRUCTURE
In a business with a modular structure, parts of a single product are outsourced (it is functions or processes, not products, that are outsourced in a network structure). A modular structure is especially suitable for organizations producing appliances, computers, cars, and mechanical consumer goods. Toyota is an example of a company with a modular structure, managing hundreds of external suppliers to produce its finished vehicles.
Pros
❯ Potential for round-the-clock work because of global locations❯ Can source the best expertise wherever it is in the world ❯ Low overheads because there are minimal staff in the core company
❯ Flexible and highly creative environment
Cons
❯ Extreme reliance on technology— network errors can stop effective performance of the business❯ Potential for misunderstandings because there is little face-to-face communication
❯ Difficult to find common time across time zones for virtual meetings
Unlike a conventional company hierarchy organized either by function or division, a matrix combines the two approaches so that staff work in both functional and divisional units, and report to two bosses.
How it works
A business that uses a matrix setup often begins with the more traditional functional structure. As the business develops, it may make sense to overlay a divisional structure to meet changes in business conditions—for example, if a company is managing several large projects for a client or expands globally and is selling its products in several regions. A matrix grid may start out as temporary—perhaps formed to manage short-term projects—and become permanent. The two chains of command in a matrix create the grid. Staff report along a vertical line to a functional manager, such as the marketing director, and along a horizontal line to the project manager of a specific business line, brand, project, or region.
Matrix structure
In this case study, an oil-exploration and production company has several oilrefining projects to manage. The matrix guardian oversees the matrix and makes sure it works efficiently.
FOUR BIG MATRIX ORGANIZATIONS
Each of the following companies has been cited as a model of success for making the matrix structure work:
❯ Procter & Gamble (P&G) To help it innovate and respond faster to the market, the consumer-product company is segmented into baby and family care, global beauty, health and grooming, and global fabric and home care.
❯ IBM Because it needs to control many global processes, the matrix at the technology and consulting corporation is structured vertically by divisions such as sales and distribution, finance and marketing, and software, and horizontally by country and region.
❯ Cisco In 2001, the IT company reorganized to enable committees to make decisions across several different functions and divisions. The idea was to stimulate ideas throughout the organization and quickly implement solutions to problems.
❯ Starbucks The coffee-shop chain is arranged by product on one axis of the matrix and business function on the other to ensure that quality and innovation meet customers’ expectations and anticipate their desires.
MATRIX: PROS AND
Pros
❯ Faster decision-making
❯ Potential for improved productivity
❯ Flexible use of staff
Cons
❯ Expensive to set up and run
❯ Possible confusion as to the reporting lineLine operations team Marketing and PR team Finance team
❯ More potential for interpersonal conflict as team goals may conflict
NEED TO KNOW
❯ Project management professional (PMP®)Qualification for project managers offered by global Project Management Institute
❯ Matrix guardian Senior professional appointed to oversee the matrix and make sure it works efficiently
❯ Mature matrix Matrix structure in which functional and divisional bosses have equal power
Some companies arrange their staff into divisions devoted to a specific product or market. Each division is a self-sufficient team employing the personnel for the various functions within it.
How it works
Under the overall control of a CEO or president, several divisions work alongside one another to design, research, produce, and sell a particular product, or to service a specific market. Each division runs its own specialized functions, such as operations and production, sales and marketing, and finance. A company may arrange its divisions according to the types of product it makes, the regions in which it operates, or the customers to whom it sells. Large companies may adopt hybrid structures—by product and geography, for example.
Division by geography
For businesses with products that need to be adapted to local markets, an organization can be structured according to each of the regional markets it serves. These may be domestic or international. Print technology and services company Xerox has successfully adopted this structure (see case study, right)
CEO
North America The company’s main market
Europe The second-largest region for sales Developing markets
Developing markets All other markets
Global services Additional division consulting across regions
Division by product
Businesses selling different types of products may pick a structure by which each division handles one category. Fast-food chain McDonald’s has been organized by product division.
CEO
FAST-FOOD PRODUCTS Burgers and fries
RESTAURANT SUPPLIES Tableware
BEVERAGES Unbranded drinks mixes
Division by customer type
Businesses with distinct customer markets may be organized by customer division. For example, the financial institution Bank of America Merrill Lynch caters to individuals, small businesses, and corporate and institutional clients.
CEO
CONSUMER Typically the original market
BUSINESS Products adapted or favorably priced
INSTITUTIONAL Large-scale provision to a single client
DIVISIONAL: PROS AND CONS
Pros
❯ If one division fails, there is no threat to the rest of the business
❯ Can respond quickly to changes in the market
❯ Focused on customer needs
❯ Performance of each division clearly measurable
Cons
❯ Duplicating resources—for example, each division employing finance personnel
❯ Lack of expertise-sharing between divisions
❯ Career path for staff restricted
Heightened sense of competition among divisions
CASE STUDY
Printer technology and services company Xerox has restructured several times to align the business with the main markets that buy its products. In 1992, Xerox’s highprofile change from a functional to a new divisional structure, with nine self-contained divisions each serving a particular customer type, hit the headlines. This also allowed the company to focus on its core business—digital publishing, color copying, and printing. Dividing the company by market location is another strategy Xerox has used successfully. In 2006, each division was organized once again, geographically, to ensure that those making the decisions were closest to the customers in each market
The classic way to organize a company is by dividing it into departments that reflect the main functions of the business, each headed by a director or manager.
How it works
The chain of command is straightforward. The business typically consists of a chief executive officer (CEO) or president at the top, with the various specialist departments or divisions, such as marketing and finance, aligned below. Each department operates as an independent unit, with its own budget, and reports directly to the CEO, who takes responsibility for the operation of all the departments. A functional structure is the most common type of organization.
Typical departmental hierarchy
The departments operate independently, with the managers reporting to the CEO or president, who has overall command. The sales and marketing department usually takes responsibility for managing product lines.
41% CEO of UK companies say the structure of their organization is a barrier to improving customer experience
CEO
Production/ operations manager
Research and development manager
Finance manager
Sales and marketing manager
Deciding what to sell
The marketing department is closest to the market and is best able to analyze which product lines may do well. The sales and marketing manager can suggest what new products the company could make.
PRODUCT A
PRODUCT B
PRODUCT C
PRODUCT D
Information technology manager
Human resources manager
Customer services manager
FUNCTIONAL: PROS AND CONS
Pros
❯ Allows for the development of specialization and expertise❯ Enables efficient use of resources and potential economies of scale ❯ Offers obvious career path for employees in each department
❯ Simple, efficient structure for manufacturers producing a limited range of goods for sale
Cons
❯ Formal lines of communication; stifles innovation and creativity ❯ Departments fail to coordinate efficiently with one another ❯ Response time on problems and queries between different departments slow ❯ Many decisions referred up to the top, creating a backlog
WARNING
Dangers of silo mentality
Silo mentality describes a scenario in which each department has a different, closed view of its role within the overall scheme and information does not get shared.
1.Sales and marketing decides to launch a special online two-for-one offer.
2.Finance is not briefed and processes the order for one item only
3.Operations is not briefed and sends customers one item instead of two.
4.Customer services is not briefed and is unprepared for calls from angry shoppers.
NEED TO KNOW
❯ Line relationship Chain of command down the structure
❯ Reporting structure Who reports to whom
❯ Silo Pejorative term for a department that works in isolation: a vertical, closed structure like a grain silo
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