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Introduction to Business

CHAPTER 1

CHAPTER 4

CHAPTER 7

CHAPTER 2

CHAPTER 5

CHAPTER 8

CHAPTER 3

CHAPTER 6

Editor

Prof.Dr. Güneş Nezire ZEYTİNOĞLU

Authors

Assoc.Prof.Dr. Vichuda POLATOĞLU

Prof.Dr. Kadir VAROĞLU

Prof.Dr. Cenk SÖZEN


Prof.Dr. Deniz KAĞNICIOĞLU

Assoc.Prof.Dr. Berna TARI KASNAKOĞLU

Prof.Dr. Celal Hakan KAĞNICIOĞLU

Prof.Dr. Saime ÖNCE

Asst.Prof.Dr. Özlem SAYILIR

General Coordinator Assoc.Prof.Dr. Murat Akyıldız

Graphic Design Coordinator and Instructional Design

Assoc.Prof.Dr. Halit Turgay Ünalan

Printing and Distribution Coordinator Asst.Prof.Dr. Murat Doğan Şahin

Graphic DesignersAyşegül Dibek

Özlem ÇayırlıHilal Özcan

Gülşah Karabulut

Typesetting and CompositionMehmet Emin Yüksel

Gül KayaMurat Uzun

Burak ArslanGülşah Sokum

Sinem Yüksel

T.C.ANADOLU

UNIVERSITYPUBLICATION NO: 3537

OPEN EDUCATION FACULTY

PUBLICATION NO: 2371

INTRODUCTION TO BUSINESS

E-ISBN: 978-975-06-2416-2

Copyright © 2017 by Anadolu University

All rights reserved.

This publication is designed and produced based on “Distance Teaching” techniques.

No part of this book may be reproduced or stored in a retrieval system, or transmitted in any form or by any

means of mechanical, electronic, photocopy, magnetic tape, or otherwise, without the written permission of Anadolu

University.

All rights of this book belong to Anadolu University.

ESKİŞEHİR, August 2018

3183-0-0-0-1909-V01

iii

Contents

CHAPTER 1Foundations ofBusiness

THE CONCEPTS OF BUSINESS .................... 3Business – Terms and Definition ......... 3Benefits of Businesses .......................... 5Types of Businesses .............................. 5Major Functional Areas in a Business... 6

THE EXTERNAL ENVIRONMENTS OF BUSINESS ....................................................... 7

The Economic Environment ................ 7The Technological Environment ......... 8The Social Environment ....................... 9The Legal Environment ........................ 9The Market Environment..................... 9The Global Environment ...................... 10

UNDERSTANDING THE BASICS OF ECONOMICS .................................................. 10

Factors of Production ........................... 11Economic Systems ................................ 12Forces of Demand and Supply ............. 15Market Competition ............................. 18Economic Indicators ............................. 19Government’s Role in Managing the Economy ................................................ 23

SMALL BUSINESS, ENTREPRENEURSHİP, AND BUSINESS OWNERSHIP ..................... 24

Small Business – Definition .................. 24Entrepreneurs ....................................... 25Starting a New Business ....................... 27Types of Business Ownership .............. 29

BUSINESS ETHICS AND CORPORATE SOCIAL RESPONSIBILITY ............................. 33

Personal Ethics ...................................... 34Ethics and Businesses ........................... 34

CORPORATE SOCIAL RESPONSIBILITY ...... 35

MANAGEMENT – TERMS AND DEFINITIONS ................................................ 79

Definition of Management .................. 79MANAGEMENT FUNCTIONS ...................... 80

Planning ................................................. 81Organizing ............................................. 81Leading ................................................... 82Controlling ............................................. 82

MANAGEMENT STRUCTURE ...................... 83Management Levels ............................. 84

MANAGEMENT SKILLS ................................ 86Management Skills by Managerial Levels ..................................................... 86

MANAGERIAL ROLES ................................... 88Interpersonal Roles ............................... 88Decisional Roles .................................... 89Informational Roles .............................. 90

LEADERSHIP .................................................. 90Management and Leadership .............. 91Anatomy of Leadership ........................ 92

COMMUNICATION IN ORGANIZATIONS .. 96Communication Process ....................... 97Forms of Organizational Communication .................................... 98Non-verbal communication ................. 100Technology and Communication ........ 101Effective Communication..................... 101

CHAPTER 3 Management

THE CONCEPT OF HUMAN RESOURCE MANAGEMENT ............................................. 115ENVIRONMENT OF HUMAN RESOURCE MANAGEMENT ............................................. 116

Internal Environmental Factors Affecting Human Resource Management ......................................... 117External Environmental Factors Affecting Human Resource Management ......................................... 117

HUMAN RESOURCE MANAGEMENT ACTIVITIES TO GET THE RIGHT PEOPLE ....... 119

Human Resources Planning ................ 119Recruiting ............................................. 122Selection ................................................ 126Orientation ............................................ 128

HRM ACTIVITIES THAT MAXIMIZE PERFORMANCE ............................................ 129

Training .................................................. 129Performance Appraisal ......................... 132Compensation ....................................... 136

CHAPTER 4Managing HumanResources

INTERNATIONAL TRADE ............................ 53Globalization ........................................ 54Balance of Trade ................................... 56Multinational Corporations ................. 57International Competition ................... 59Emerging Markets ................................ 61

POWER TACTICS AND ORGANIZATIONAL SURVIVAL STRATEGIES IN FOREIGN MARKETS ....................................................... 62

Features of Multinational Competition .. 62Competitive Strategies in Foreign Markets .................................................. 65Strategic Alliances ................................. 66

BUSINESS IN A MULTICULTURAL ENVIRONMENT ............................................ 68

Cultural Diversity .................................. 68International Management and Culture .. 70

CHAPTER 2Business in theGlobal Context

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PRODUCTION, PRODUCTION SYSTEM, AND PRODUCTION MANAGEMENT ......... 183

Production System ................................ 184Production Management ..................... 186

TYPES OF PRODUCTION PROCESSES ........ 187Flow Process .......................................... 187Job-Shop Process ................................... 189Cellular Process ..................................... 190Project Process ...................................... 191

THE HISTORICAL EVOLUTION OF PRODUCTION MANAGEMENT ................... 191NEW TRENDS IN PRODUCTION PROCESSES . 194

Flexible Manufacturing System ........... 194Lean Production System ....................... 195Just-In-Time Production System ........ 196Computer Integrated Manufacturing ... 196Mass Customization ............................. 197E-manufacturing ................................... 198

THE SCOPE OF PRODUCTION MANAGEMENT .. 198Product Design ...................................... 199Capacity Planning and Process Design .... 200Facility Location and Layout ............... 200Aggregate Planning and Master Production Schedule ............................. 201Inventory Management and Materials Requirement Planning .......................... 202Quality Management ........................... 203Supply Chain Management .................. 204

MANAGING INFORMATION ....................... 205Data and Information ........................... 207Databases, Data Warehousing, and Data Mining ................................... 208

INFORMATION TECHNOLOGY ................... 209Hardware ............................................... 210Software................................................. 210Computer Networks ............................. 211

INFORMATION SYSTEMS ............................ 212Operations Support Systems ............... 213Management Support Systems ............ 213

INFORMATION SYSTEMS FOR DECISION MAKING ............................................................ 214

Management Information Systems .... 214Decision Support Systems .................... 215Executive Information Systems ........... 216Expert Systems ...................................... 216

CHAPTER 6

Production Management and Managing Information Systems

FOUNDATIONS OF MARKETING ............... 149Definition of Marketing ....................... 149

STRATEGIC MARKETING MANAGEMENT 151Generic Marketing Strategy ................. 151Strategic Segmentation and Target Customers ............................................. 153

MARKETING MIX .......................................... 156Product ................................................... 157Price ........................................................ 159Place (Distribution) .............................. 160Promotion .............................................. 162

BRANDING .................................................... 164Positioning ............................................. 164Key Issues in Branding .......................... 167

NEW TRENDS IN MARKETING ................... 168MARKETING ETHICS .................................... 170

CHAPTER 5Marketing Management

ACCOUNTING – TERMS ANDDEFINITIONS ................................................ 229

Definition of Accounting ...................... 229Definition of Bookkeeping ................... 231

USERS OF ACCOUNTING INFORMATION . 231Internal Users ........................................ 231External Users ....................................... 232

AREAS OF ACCOUNTING ............................. 232Financial Accounting ............................ 232Managerial Accounting ........................ 233

ACCOUNTANTS AND ACCOUNTING PROFESSION ................................................. 234

Governing Organizations ..................... 235Ethics in Accounting ............................. 235The Role of Auditors in Ensuring Proper Reporting ................................... 236

RECORDING BUSINESS TRANSACTIONS ... 236The Accounting Cycle ........................... 237The Accounting Equation..................... 237Transaction Analysis ............................. 238Using Accounts to Record Transactions .......................................... 239Debit-Credit Rules and Double Entry Accounting ............................................ 240Steps in the Recording Process ............ 241The Recording Process Illustrated ....... 241Chart of Accounts ................................. 242

BASIC FINANCIAL STATEMENTS ................ 242The Balance Sheet ................................. 242Income Statement ................................ 247Statement of Cash Flows...................... 250

ANALYZING FINANCIAL STATEMENTS ..... 250Measures and Evaluation of Liquidity 251Measures of Efficiency ......................... 253Measures and Evaluation of Long-Term Solvency ......................................................... 255Measures and Evaluation of Profitability ........................................... 256

CHAPTER 7Accounting and Financial Analysis

OVERVIEW OF BUSINESS FINANCE .......... 269Investment Decisions ........................... 270Financing Decisions .............................. 270Operating Decisions .............................. 271

FINANCIAL MARKETS .................................. 271Functions of Financial Markets ........... 272Structure of Financial Markets ............ 272

SHORT-TERM FINANCIAL MANAGEMENT ............................................. 273

Working Capital Management ............ 273Short-Term Financial Planning ............ 273

LONG -TERM FINANCING .......................... 274Basic Tools of Long-Term Financing ... 274

CAPITAL INVESTMENT DECISIONS ........... 276FINANCIAL RISK MANAGEMENT ............... 278

Risk and Return ..................................... 278Enterprise Risk Management .............. 279

SHAREHOLDER VALUE MANAGEMENT . 280Financial Decisions in Value Creation 280Value-Based Methodologies ................ 280

ETHICS IN FINANCIAL MANAGEMENT .... 281Corporate Governance ......................... 282Ethics and Corporate Social Responsibility ........................................ 282Internal Controls ................................... 282

CHAPTER 8Managing FinancialResources

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Preface

Dear Reader,

Doing business is one of the most ancient of human relationships. It is the connective tis-sue of local and national economies and the global market place. Although businesses are vital parts of national economies, the term bu-siness as it is known in the first quarter of the 21st century is not just confined to boundari-es that separate one country from another. The meaning is much broader and is therefore conceptually complex. Business has become a dispersed operation reflecting the economi-es, politics, social, and cultural dimensions of global integration. Today’s conception of busi-ness is therefore dynamic, flexible, innovative, and connected to the world in ways that were inconceivable just a generation ago.

The scope of business goes beyond the com-mon notion of private enterprise or corporate companies. It includes all sorts of organizati-ons that provide a service or a product. Even governments have much in common with business, though profitability is not one of them. Moreoever, business is more than just an abstract entity. Business is palpable. It is about individuals--consumers of goods and services on one end of the continuum and the providers on the other end. From electronics to tourism, from fashion to the automative in-dustry, goods and services fulfill all types of in-dividual needs and create jobs. Business adds value to the world through acts of social res-ponsibility and by pumping new ideas and pro-ducts into the economies of the world. Thus, this textbook’s content targets those who sha-pe business and those who are affected by the conduct of business in countless ways.

The objective of the overall content of this book is to provide a brief approach to business in general and business functions in particular. This book, therefore, aims to be as lean and in-formative as necessary. It is intended to be an introductory and fundamental source for bu-siness students at all levels as well as readers with a desire to learn about the fundamentals of business.

The introductory chapter covers the founda-tions of business which are critical, especially for entrepreneurs and business owners as they relate to the environment of business, economic systems, ethics and responsibility in the work place.

Business of any kind is a mixture of functional operations which in number and scope change by specific environments and types of orga-nizations. This book addresses main business functions that take place whether in manu-facturing or service sectors as noted by the following topics: management; human reso-urces management; marketing management; production management and management information systems; financial accounting and financial analysis; and managing financial resources. Today’s business challenges require international monitoring and a global mind-set. It is critical for business owners and ma-nagers as well as employees to acknowledge the dynamics of the international business en-vironment and design strategies accordingly. The key aspects of business in the global con-text is briefly described and explained in the second chapter.

Business topics are best digested when com-bined with the study of practical applications. This book also blends business topics with real-life examples and case studies either ge-nerally or specificaly from Turkey and other countries. In addition, key terms are defined and emphasized throughout the text; readers are challenged by commentary and test ques-tions; and answers are provided for checking their responses.

We hope that this book will be more than sa-tisfactory for students as well as all interested readers for educational and training purposes.

Enjoy! The Book Team

Editor


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Chapter 1 Foundations of Business

Lear

ning

Out

com

es

2

Define the basics of business, the benefits of business, the types of business, and functional areas of a business.

Describe the external environments of business and how they affect organizations.

Define small business and explain entrepreneurship, outline issues involved with starting a new business and explain various types of business ownership.

Define the basics of economics, explain the different economic systems and supply and demand concepts, and identify the degrees of market competition and major economic indicators.

3Define business ethics and discuss corporate social responsibility with various approaches for major stakeholders.

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1 24

Chapter OutlineThe Concepts of BusinessThe External Environments of BusinessUnderstanding the Basics of EconomicsSmall Business, Entrepreneurship, and

Business OwnershipBusiness Ethics and Corporate Social

Responsibility

Key TermsBusiness

Business environmentsFactors of production

Economic systemsMarket competitionEntrepreneurshipBusiness ethics

Corporate social responsibility

After completing this chapter, you will be able to:

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1Introduction to Business

This first chapter’s aim is to give readers solid foundations for the understanding of the business world. Whether you are a student majoring in business study or an aspiring entrepreneur wanting to start a business for yourself, business is a useful and exciting area to study. As you must have realized, business affects all of us in major ways during the course of our day-to-day living. We start with the concepts of business including an overview of what businesses do. Then we look at the external environments in which businesses operate.

Since the elements in an environment change constantly (think about changes in technologies, in particular those in information and communications technologies or ICTs, the Internet and mobile technology), business owners/managers must constantly keep up to date and adjust their businesses accordingly. We discuss the basics of economics, the types of economies, and economic forces that affect business (including individuals like us as consumers of products and services). Then we look at small business and forms of business ownerships. Lastly, we will discuss business ethics and corporate social responsibility (CSR) as they are important issues for all of today’s businesses large and small.

THE CONCEPTS OF BUSINESSIn this section, we will discuss basic concepts of business which are applied to organizations of all sizes.

Although we focus on profit-making organizations, most of the concepts included here also apply to not-for-profit organizations as well.

Business – Terms and DefinitionA business is any organization that provides goods or services to satisfy customers’ needs and wants for

a profit. In this text, a business is also referred to as an organization, a firm, a company or an enterprise. A business must be organized to provide products by combining resources such as materials, human, financial

and information resources. For a patisserie, material resources include flour, eggs, sugar, butter and other raw materials used to produce cakes and cookies. Human resources such as bakers provide labor to produce the products. The patisserie is organized by the owner/manager to produce tangible goods. A business can also produce services which are intangible products such as dental services and financial

advice. Some businesses like restaurants offer both products (food and drinks) and services (preparing and serving food and drinks). Although there are organizations that are not-for-profits, most businesses operate to earn profits. Not-for-profit organizations often service local communities through educational and social means such as public schools, charity groups, and government agencies. Profits are earned when a firm gets larger revenues (the money it brings in from the sales of its goods and services) than expenses (the money it pays out to labor, raw materials and others). If the expenses exceed revenues then the firm experiences a loss.

An entrepreneur is an individual who starts a business and risks losses (in terms of money, time and reputation) for profits. Therefore, profits are the rewards entrepreneurs receive for producing goods and services that consumers want. Keep in mind that profits generated by businesses also benefit various stakeholders. Stakeholders are the groups of people that have a stake in or are affected by the decisions, activities and policies made by an organization. Major organizational stakeholders are owners (shareholder/stockholders), customers, employees, investors, suppliers

A business is any organization that provides goods or services to satisfy customers’ needs and wants for a profit.

An entrepreneur is an individual who starts a business and risks losses for profits.

Stakeholders are the groups of people that have a stake in or are affected by the decisions, activities and policies made by an organization.

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1 Foundations of Business

and communities (shown in Figure 1.1). Stockholders or shareholders own a part of a company through ownership of a company’s stocks or shares. Owners benefit from profits while shareholders receive dividends. Suppliers are businesses that supply material resources or services to other businesses.

Suppliers are businesses that supply material resources or services to other businesses.

OwnersStockholdersShareholders

Investors

Communities Customers

Suppliers Employees

Figure 1.1 Major Stakeholder Groups

Businesses must create value-added products in order to attract and satisfy customers. People generally buy goods or services to satisfy certain needs. The baker made delicious cakes from raw materials and in the process, added value to the final products. We may seek valuable advice about financial products from a financial consulting service firm because we want to grow and protect our money and investments. They can give expert

advice on where to put our money and which stocks to buy and how much, in order to maximize the gains and minimize potential losses.

Keep in mind that other firms are also trying to sell their products and services, often to the same groups of customers. The result is competition among those firms. Competition is the rivalry among businesses for the same resources, customers or markets. In an economic system such as Turkey, consumers have choices to buy from few or several competitors in terms of price, level of customer service and product quality. Since consumers have limited resources (i.e. money), companies therefore, need to focus on what customers want in order to be successful and make profits. A firm that is able

Competition is a crucial element for businesses in market economies like the Turkish economy.

Competition is the rivalry among businesses for the same resources, customers or markets.

Most businesses should attempt to be responsible for all groups of organizational stakeholders especially the ones that are the most important to the organization and try to address their needs well.

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to offer products that are more appealing or less expensive to its target customers has an advantage over its competitors. Competition benefits consumers as firms are motivated to offer varieties of products and services at reasonable prices. We will discuss how firms convince buyers that they should choose one company’s products over another’s in Chapter 5 (Marketing Management). Table 1.1 summarizes why competition is also good for business.

Innovation: With several companies competing to win over customers, a firm can succeed with innovative products. Innovation can come from technology, product modifications or by improving customer experience. Further, firms would need to consistently better themselves and to encourage employees to push themselves also.

Customer Service: If a product on offer is similar from one firm to the next, each firm is forced to improve customer service to compete.

Education: Competitors can teach each other about the business, the state of the markets and what does and does not work in the marketplace.

Benefits of BusinessesBusinesses contribute to a society in several ways. A successful business not only generates income

from its sales for the owner(s), it also employs working people with wages and salaries and other potential benefits such as health care, training and retirement. Businesses produce most of the goods and services that we consume, generate income and spending in an economy. A healthy and successful business climate contributes to the quality of people’s lives.Therefore, businesses are one of the critical elements that contribute to our standard of living. We can generally define the standard of living as the degree of wealth and material aspects (i.e. the quantity and quality of goods and services) available to a person, a family or groups of people in an economic system.

Businesses support governments at the local and national levels by paying taxes. A government then spends the money on building a country’s infrastructure such as transportation and communication systems, water and electric; improving public safety and national defense; and funding the educational system for the country’s citizens. Many companies also support charities and engage in the improvements of local communities they belong to. However, businesses do not always operate in ways that benefit the general public. For example, a business can operate in such a way as to leave lasting harmful effects on our natural environment. Some employees need to take risks where business may operate in an unsafe workplace. Unfair or fraudulent business practices harm consumers, stockholders and ultimately the society’s interests.

Types of BusinessesOne important characteristic of a business is its type. The differences between them reflect their differing

goals and concerns while they would face different kinds of challenges because of differences in business scope. In general, we can define a local business as the ones that serve a limited geographical area and rely on local consumers.1 For example, a small family-owned restaurant that may have one or few outlets operating within a town or a city and surrounding area with small numbers of employees is a local business.

Table 1.1 The Reasons Competition is Desirable for Businesses

Source: Reasons Why Competition is Good for Your Business. Forbes. Retrieved from http://www.forbes.com/

pictures/5-reasons-why-competition-is-good-for-business

Standard of living is the degree of wealth and material aspects available to a person, a family or groups of people in an economic system.

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Regional businesses would serve a larger geographical area like Southern Turkey or the Black Sea region. However, they do not extend their businesses to the whole country. Successful local businesses may want to expand to larger regional areas but still stay within their capabilities as business conditions may not be all that different from each other.

National businesses on the other hand serve the whole country and provide products or services to the majority of its people. Many successful regional firms expand their businesses nationally by having locations in most parts of a country with each store having a similar format, offering similar goods or services. As a business expands, the operations would be more complex to support and manage. Lastly, international or multinational businesses operate, make, and/or sell goods or services in more than one country. These firms lead the

movement toward more interaction, integration, and interdependent world economies through a process called globalization. The concept of globalization (used here) means the tendency of businesses and investment funds to move to other markets around the world, increasing international trade and the culture exchange.2 Firms looking to broaden their markets often look to international markets as a way to grow. We will further discuss business in the global context in the next chapter. Table 1.2 summarizes different types of businesses.

Globalization means the tendency of businesses and investment funds to move to other markets around the world, increasing international trade and the culture exchange.

Table 1.2 Types of Businesses

Local Business Regional Business National BusinessInternational or

Multinational Business

Serves a limited geographical area such as a town or a city

Serves a larger area such as the Southern or Eastern part of a country

Serves the whole country

Operates in more than one country

Major Functional Areas in a BusinessIn a typical business, there are five major activities or functions. Most of these will be discussed in

detail in the following chapters: Human Resources or HR (Chapter 4), Marketing and Sales (Chapter 5), Production, Manufacturing, or Research and Development (Chapter 6), and Finance and Accounting (Chapter 7 & 8) areas. The human resources function deals with HR planning, staffing, training, and developing employees for the whole company.This function concerns various aspects of employees and employee relations including workplace safety and health issues. The focus is on maximizing the productivity of employees while minimizing negative issues stemming from the workforce.

According to the American Marketing Association, the marketing function involves activities to create, communicate, deliver and exchange offerings that have value for customers.3 This function provides customer service and customer support including advertising to potential customers. To provide goods and services that satisfy customers, marketing activities also include market research, product development and pricing. Production or manufacturing function for both goods and services involves making products or creating services for customers which include activities such as purchasing (of material resources) and logistics (incoming and outgoing flow of material resources and products).

Finance and accounting functions are there to ensure that a company has necessary funds to operate sufficiently and to collect and report financial information to various stakeholders. Like the HR function, financial and accounting specialists would work closely with other functional areas to ensure profitability

7


of the organization as a whole. Lastly, the research and development function is necessary for firms to develop new and innovative products to meet customers’ needs or to exceed their expectations. Many firms are also involved with using new technologies such as the use of information and communications technology and the Internet in their operations.

Table 1.3 shows a list of major functional areas of a business. Keep in mind that not all companies would formally have all of these functional areas especially in small businesses. For example, a tax accountant may be hired part-time by small firms only during the tax season. However, large companies would probably have many more activities or functional areas such as information technology and legal functions. In the next section, we will look at the external environments of business.

Table 1.3 Major Functional Areas of Business

Human Resources or HR:Deals with planning, staffing, training, and developing employees for the whole company.

Marketing and Sales:Involves the exchange and delivery of goods and services; the communication and interaction with customers or potential customers.

Production or Manufacturing:Involves making products and creating services for customers.

Finance and Accounting:Ensures necessary funds for operations and reporting of financial information.

Research and Development:Develops new innovative products for customers.

THE EXTERNAL ENVIRONMENTS OF BUSINESSIt is important that we understand the external environments that businesses operate in as each

dimension or force has the potential to affect a company and whether it will succeed or fail. There are six major forces of the environment: the economic environment, the technological environment, the legal and political environment, the social environment, and the global environment.

The Economic EnvironmentEvery business has limited resources; therefore, managers/owners must take into consideration

economic conditions when making business decisions. In particular, companies should be concerned with economic forces that impact the cost and the availability of products, services and labor which shape the actions of both the firms and their customers.4 For example during an economic crisis, material resources from suppliers may not be readily available or too expensive. When costs increase firms often pass them on to the customers. As a result, customers may not be willing or able to buy the products or services, which lowers the profitability. Economic conditions in general affect how a firm must do business. Other factors such as labor market, stock market and financial market also vary with economic conditions. We will discuss in more detail economic systems and forces in the next section.

Identify and describe the benefits of a business that produces beverages which you can purchase from a grocery store, including the benefits you receive from the company’s marketing function.

1

Business owners and managers must take into consideration current (and future) economic conditions when making business decisions.

8


The Technological EnvironmentTechnological forces from the practical applications

of information and communication technologies and other by products of scientific research have led to innovations in goods and services. The term technology does not only mean physical equipment, machines and computers but also includes work methods, techniques and knowledge used in a business. Therefore, technology would also lead to the improvements of business processes or business practices. Mobile technology platform has led to fundamental changes to companies and industries; giving rise to a large number of opportunities and also challenges for all. For example, the share of total

online time spent using mobile platform such as smartphones (instead of desktop or laptop computers) has risen to more than 70 percent in the U.S., Mexico, Brazil, and China

while 91 percent of online users in Indonesia use mobile devices to be connected to the Internet.5 More and more business transactions will occur on mobile devices.

It is important for the marketing and sales function, for example, to understand how consumers behave in the new environment. This is especially crucial for e-commerce firms. E-commerce is the use of networks (primarily the Internet) to conduct trade between business-to-consumer (B2C), business-to-business (B2B), and consumer-to-consumer (C2C). Figure 1.2 Illustrates Amazon.com which serves all 3 types of e-commerce: B2B, B2C and C2C. Note that e-government has also become an important platform for information exchanges and interactions between a government and its citizens. Market outlook for Turkey in 2017 for e-commerce is estimated at 5.85 Billion USD, up from 4.39 Billion USD known statistics in 2015.6 Note that these numbers include only B2C figures as B2B market data is more difficult to estimate. However, the majority of e-commerce transactions have been among businesses.

Technology also includes work methods, techniques and knowledge used in a business.

Mobile technology platform has seen fundamental changes to organizations and industries. More and more business transactions with customers will occur on mobile technology platform.

E-commerce is the use of networks (primarily the Internet) to conduct trade and transactions.

• Amazon is the world’s largest online retailer including its ailiates

AMAZON.COM

B2C

B2B

C2C

• Amazon AWS oers new startups to large firms access to infrastructure for computing, database and application servies• Amazon Marketplace lets individuals & businesses to sell their products on Amazon to reach hundreds of million of customers

Figure 1.2 Amazon.com e-commerce

Source: Retrieved from https://www.amazon.com/p/feature

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The applications of tools and technology in business have resulted in increasing productivity which is a major factor in economic growth globally. Productivity is a measure of the amount of output generated given the amount of input. In other words, goods or services are produced using the least amount of resources. For example, production machines along with computer technology components are used in modern manufacturing firms to automate tasks and to give intelligence to machines. This way, the outputs (goods or services) are generated much faster with less errors while using less inputs (e.g. man hours, materials used). Consumers also benefit as prices of products are likely to decrease with the same or better product quality.

The Social EnvironmentThe social environment refers to the trends and

forces in a society under which all businesses operate. Its elements include demographic factors, customs and values, and social and economic movements of the society. Demographic characteristics such as age, gender, lifestyles and income distributions, along with the values and norms acceptable to a society, impact organizations from what kinds of products to offer consumer to the ways in which they conduct their businesses. For example, the U.S. is facing aging of its population and people also live longer and healthier. Therefore, businesses can offer products and services that are geared toward this shift. However with an older population, firms may face a shortage of younger incoming workers. Turkey on the other hand, has a growing and young population which contributes to a strong labor pool, where half of its population was under the age of 31 in 2015.7

The Legal EnvironmentThe legal environment affects businesses

through all the laws and regulations imposed on them. This also includes political forces such as their policies, transparency and stability, and the relationship between government and business. The laws and regulations establish in some ways

what companies can do, cannot do or must do. For example, in order to support competition among firms in our economy, the Turkish Competition Authority put in place a Competitive Act to prevent any threats to the competitive process in the markets and to ensure the efficiency in allocation of resources in the country.8 Government agencies are tasked to regulate important business activities such as employees’ health and safety, product safety, environmental regulations and practices to safeguard consumers.

The Market EnvironmentEvery firm operates within a particular market

environment in which revenues are obtained. Important groups here include customers, employees, suppliers and competitors. Customers expect to receive value from a firm’s products. This means that a firm should offer products that have certain level of quality, at reasonable prices along with good customer service compared to its competitors’ products and customer service. Companies should establish close relationships with their suppliers because product quality, price and timeliness of delivery depend on material resources provided by suppliers.

Employees are very important in helping firms to become more effective. Frontline workers (those who have direct contacts with customers such as salespeople) should be given responsibility, authority, and freedom to do their jobs in order to quickly meet customers’ needs and expectations, i.e. to empower employees.9 Empowerment in the context of business refers to giving an employee or a team the power, information, responsibility and accountability to do the job well. In the market environment, firms need to be able to compete effectively and to distinguish themselves from their competitors to drive enough revenues for their survival and to prosper.

Productivity is a measure of the amount of output generated given the amount of input.

Empowerment refers to giving an employee or a team the power, information, responsibility and accountability to do the job well.

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The Global EnvironmentThe global environment has seen larger influences on companies around the world, even those that operate

only domestically (i.e. local, regional, and national types of business). Factors such as global economic and political conditions, international competition, a country’s exchange rate, and international trade alliances and agreements affect firms in various ways. Those factors impact a firm’s internal operations, potential customers and the level of profitability. For example, global oil prices which recently have fallen benefit business through lower energy prices and transportation costs. Lower oil prices also benefit consumers through lower energy prices as they pay less to heat their homes or drive their cars.10 Table 1.4 summarizes the dimensions of the external business environments. In the next section, we will look at basic concepts in economics.

Table 1.4 Dimensions of the External Business Environments

Economic Environment:Conditions in an economy in which an organization operates.

Technological Environment:The use of various technologies to create value for stakeholders.

Social Environment:Demographic characteristics and social forces of the society where a company functions.

Legal and Political Environment:Laws and regulations imposed on businesses by a country’s legal system and the relationship between business and government.

Market Environment:Domestic business environment where firms operate.

Global Environment:Global business environment that impacts companies.

UNDERSTANDING THE BASICS OF ECONOMICS

Economic forces affect all aspects and types of businesses, from the largest to the smallest firms. In this section, we will review from a business perspective, the elements which are concerned with the process of decision making. According to the American Economic Association, economics can be broadly defined as the study of how people

use resources or the study of decision-making.11 Resources are required to produce goods and services that consumers need or want. However, resources are limited or there is a scarcity of resources so businesses (and individuals) need to make choices within their limited resources. Economic studies range from the study of choices by individuals like what to buy from the money earned each month (called microeconomics) to the study of industries, governments and the overall economy (called macroeconomics). Next we will look at the factors of production which is a term that describes various resources used to produce goods and services.

Discuss elements of the technological environment that are important to a large manufacturing company.

2

Factors of production describes various resources used to produce goods and services.

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Factors of ProductionBusinesses focus on five essential elements of the factors of production: labor, natural and physical

resources, financial capital, entrepreneurship, and information resources as shown in Figure 1.3. The ways that these resources are used and managed differ between economic systems which reflect a country’s way of allocating resources for the production of goods and services and distributing resources among its citizens and organizations.

• Land• O�ces• Computers

Natural and PhysicalResources

• Employess• Managers

Labor

• Credits• Money

Financial Capital

• Entrepreneurs• Business Owners

Entrepreneurship

• Knowledge• Data & Information

InformationsResources

Figure 1.3 Factors of Production

Natural and physical resourcesBusinesses use natural resources such as land, oil, minerals, water, and trees. Physical resources include

raw materials used by businesses such as equipment, machines, offices, factories, and computers. Some countries have rich natural resources such as land and oil while others (e.g. Japan) have to import oil from elsewhere. Saudi Arabia, on the other hand, is one of the major exporters of oil for export around the world.

LaborLabor is the human resource which contributes time and effort (physically or intellectually) to

produce goods and services. Labor has been a major source of input for all types of businesses especially for firms in the service sector such as in education, health, financial and entertainment industries. In economically advanced nations, labor tends to be more expensive as their wages and salaries reflect high standard of living. As an economy develops, labor costs tend to rise as well. Manufacturing sector on the other hand consists of firms that produce physical goods such as food, electronics goods and machinery. The use of various technologies in this sector has seen reductions in the use of human resources over time.

Financial capitalFinancial capital refers to money or funds used to create and operate a business. It can come from one’s

personal savings, from friends and family, via business loans, from investors and through other forms of

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fund-raising such as crowdfunding. Crowdfunding is to raise capital for a new business venture from a large number of individuals who often contribute small amounts of capital.12 It is made possible by the easy access of networks of people through social media and crowdfunding websites to bring investors and entrepreneurs together.

Jeff Bezos started Amazon as an online Internet retailer in 1994 from his garage (selling books online) with financial capital from his parents’ personal savings.13 Later on, the company raised a series of funds the following years and eventually went public in 1997 for additional capital. Going public means a firm (privately held) starts to first sell company’s stocks to other investors to raise money through a stock exchange market (becoming publically held). Today, Amazon is the world’s largest online retailer with a market value of over 292 Billion USD as of May 2016.14

EntrepreneurshipSimply put, entrepreneurship is the process of

starting one’s own business. As mentioned earlier, an entrepreneur is a person who creates and operates a new business. S/he is willing to bear the risk of a new venture like Jeff Bezos who took the risk of losing most of his parent’s life savings on a new type of venture (as an early e-commerce firm). One of an entrepreneur’s roles is to act as an innovator who markets his/her innovation such as a new innovative product or using a new process or method. It cannot be overstated how important entrepreneurship is to the economic wellbeing and growth of a country.

Jeff Bezos did not invent books; he saw the huge growth in the Internet usage very early on and quit his Wall Street job to start an Internet company

distributing books because of their low cost and universal demand. As for his role as an innovator, Mr. Bezos has continued to innovate and has started different business ventures. Amazon has been named as one of the top 15 in Forbes lists of the World’s Most Innovative Companies in recent years while making him one of the richest people on the planet.15 Note that entrepreneurship encompasses tech geniuses like Mark Zuckerberg of Facebook and Jeff Bezos, and also small business owners sharing commitments for new businesses anywhere in the world.

Information resourcesInformation resources play a major role

in enabling a business to use knowledge and information effectively; to help make better decisions, to manage more efficiently, to gain specialized knowledge, and to understand the external environments. For example, Amazon is known for its high level of customer service leading to high level of customer satisfaction and loyalty. Existing customers keep coming back to buy from Amazon while gaining new customers globally. To be able to give excellent customer service, Amazon must understand them and improve their experiences. Amazon has gained this knowledge from keeping and analyzing huge amounts of information from millions of customers. Information and communications technology advances a firm’s ability to create and use information for managers and employees alike. We will discuss the details of ICT in Chapter 6.

Economic SystemsAn economic system is a country’s organized

way for allocation of its resources among its citizens. One major way that economic systems differ is the question of who has the ownership of the factors of production. For example, ownership can be held by entrepreneurs, by investors, or by businesses which is called private ownership. In certain economic systems however, all or some of the major factors of production are owned and controlled by the government.

An economic system is a country’s organized way for allocation of its resources among its citizens.

Crowdfunding is to raise capital for a new business venture from a large number of individuals who often contribute small amounts of capital.

Entrepreneurship is the process of starting one’s own business.

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Another essential way that economic systems differ has to do with the allocation of the factors of production and the decisions about production. For example, the decisions of what goods and services to be produced, how they will be produced and how much would vary in different types of economic systems. Economic systems are generally categorized as either a planned economy or free-market economy; although the distinctions between them tend to be blurry as most nations rely on the combination of the two called a mixed economy.

Planned economic systemsThe government in a planned economy exerts

a significant role in determining most or all of the decisions regarding production and allocation of goods and services such as which products to produce, how and how much. The centralized government would also control most or all of the factors of production. Examples of planned economic systems are communism and socialism. Communism is a political and economic system in which the centralized government owns and operates all of the factors of production. It would also make production and allocation decisions. Communism exists in very few countries in the world such as Cuba, North Korea and China. As an economic system, communism has largely failed though the idea exists in many countries. Although China is still governed under its communist party as a political system, its economic system has functioned more as a mixed economy.

Socialism is an economic system characterized by government control and ownership of selected

key industries that are vital to the economy. It combines this with private ownership and operations of less important industries. For example, a government would tend to own and operate transportation, health care, utilities (water and electric) and communications industries. Some advanced economies such as Italy and England have incorporated some degrees of socialism especially in the health care sector. Communist China is sometimes labelled as a strictly controlled kind of socialism as the Chinese government owns almost all factors of production with highly centralized planning while at the same time encouraging entrepreneurship with some privately owned companies.16

Free-market systemsWe can define a market as a medium or

mechanism that facilitates an exchange of a specific good or service between buyers and sellers.17 Markets can be physical market places or online market places. A free market system is characterized by a system where production and allocation decisions (such as what to produce and product prices) are largely determined by buyers and sellers. It allows both the buyers and the sellers to sell and buy largely what they choose, i.e. buyers and sellers are free to make their own decisions. This freedom of choice defines a market economy.

Capitalism or private enterprise are terms used to describe the free-market system which allows freedom of choice and also private ownership of the resources used to produce goods and services. The operation of a market determines prices of those goods and services under demand and supply

Communism is a political and economic system in which the centralized government owns and operates all of the factors of production.

A market is a medium or mechanism that facilitates an exchange of a specific good or service between buyers and sellers.

Capitalism or private enterprise are terms used to describe the free-market system which allows freedom of choice and also private ownership of the resources used to produce goods and services.

Socialism is an economic system characterized by government control and ownership of selected key industries that are vital to the economy.

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conditions (see the next section). The incentives for entrepreneurs and businesses to engage in this market system are that they can earn and keep profits or other benefits derived from the exchange. Employees benefit from the wages and salaries (which are also based on the free market system) while consumers can buy what they want at the best prices.

In summary, private enterprise under the free-market system requires the existence of four conditions:18

• Privateproperty-individualshavetherighttoownprivatepropertyandresourc-es that are used to create wealth.

• Freedomofchoice–employeescanworkwhere they choose, consumers can buy whattheywant,andfirmscanhirepeopleand produce what they choose.

• Profits–ownerscankeeptheprofitsforthemselvesasrewardsfortakingrisks.

• Faircompetition–freeandfaircompeti-tionisthebasisforafree-marketsystemtooperateefficiently.

Mixed market systemIn practice, neither the free-market nor the

planned economic systems lead to optimum conditions in most countries. For example, those who are poor, elderly and disabled are thought to not be well taken care of in free-market economies.19 Planned economies have not been able to create enough wealth for their citizens as a whole. Therefore, most countries rely on the mixed market system that combines characteristics of both planned and free-market economies. Allocation of resources and production decisions are made by both the market and some by the government in the mixed market system. For example, a government may distribute some goods and services such as social programs like social security, health care and welfare programs along with various regulations to protect the environment.

One of the tools for economic reform to bring a country closer to free-market economy is privatization which is a process that is thought to bring more efficiency to a government-owned enterprise. In short, privatization is the transfer of ownership of government enterprises to the private sector. In Turkey, as in several countries elsewhere, a series of privatizations began in the late 1980’s and is likely to continue for the foreseeable future with a focus on energy projects and other heavy industries like construction and commodities.20 Socialism can also be thought of as a form of mixed market economy as a government would own and operate selected major industries in such a system. It is common to call a country’s system as capitalism if the dominant market processes and mechanisms tend toward a free-market system.

Table 1.5 summarizes three major economic systems.

Majority of the world’s nations rely on some degree of mixed market economy where some economies strive to be more free and open while others less so.

Privatization is the transfer of ownership of government enterprises to the private sector.

Socialism can also be thought of as a form of mixed market economy as a government would own and operate selected major industries in such a system.

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Table 1.5 Major Economic Systems

Planned Economic Systems

Free-Market Systems Mixed Market Systems

Ownership and control of the factors of production

Completely or partially owned and controlled by centralized government

Owned and controlled by businesses and individuals with the focus on profitability and freedom of choice

Blend of individuals and businesses with some government involvement with the focus on a balance between private and public elements

Business decisions about: products, production, and prices

Mostly made by centralized government with emphasis on equality

Individuals and businesses make the decisions under demand and supply conditions

Blend of individuals and businesses with some government involvement depending on the degree of free market activities

Forces of Demand and SupplyIn a market economy, consumers have choices about what to buy, from whom, and at what price.

To win customers, businesses must meet their needs. Companies also need to know how much of their goods or services to produce and what prices to charge.These decisions are determined primarily by two fundamental concepts of economics: supply and demand. The supply of a particular product refers to the

quantity of the product available for purchase at various prices at any given time. Supply is determined by factors such as price, the cost of the resources required (such as labor and capital) to produce the good or service, and the availability and price of substitute products or services.

Substitute products are those that customers perceive as alternative, similar or comparable such as tea and coffee or butter and margarine. However, if we hold all these factors constant then supply is directly affected by price. Generally, producers would offer more of a product for sale as the price increases because they can make more money and higher profits; and to offer less of the product at lower prices. This is based on the assumption that a producer’s aim is to make

as much profit as possible, i.e. to maximize profits. So the amount of a product supplied will increase as the price rises; and if the price drops then less of the product will be supplied. This is the principle of the law of supply.

The law of supply - the amount of a product supplied will increase as the price rises; and if the price drops then less of the product will be supplied.

The demand for a particular product refers to the amount of the product customers will buy at various prices at a given time. Demand is also not only determined by price. Other factors that determine how many units of

The supply of a particular product refers to the quantity of the product available for purchase at various prices at any given time.

Substitute products are those that customers perceive as alternative, similar or comparable such as tea and coffee or butter and margarine.

The demand for a particular product refers to the amount of the product customers will buy at various prices at a given time.

The law of supply - the amount of a product supplied will increase as the price rises; and if the price drops then less of the product will be supplied.

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a product customers will buy include, for example, taste, income, and the price and availability of substitute products. We can also hold these factors constant and look at the relationship between price and demand. Customers will demand more of a product as the price drops; and if the price increases then less will be demanded. This is the principle of the law of demand.

To illustrate the law of supply and demand in action, let’s look at a very simple example of a market for burgers at a café in a small town. If a burger price is 2 TL, the café might be willing to supply only 50 burgers. On the other hand, if the café can sell them for 20 TL each then it might be willing to supply 500 burgers. This relationship between price and supply lets us determine how many burgers will be sold at different prices. The same example can be used to show the relationship between price and demand to determine how many burgers will be demanded at different prices. These two relationships represent the demand and supply schedules as shown in Table 1.6.

Table 1.6 Supply and Demand Schedule

Price (TL) Number of Burgers Supplied Number of Burgers Demanded

2 50 500

4 110 450

6 150 350

8 180 300

10 250 250

12 290 200

14 350 140

16 415 100

18 450 75

20 500 50

We can illustrate the demand and supply schedules with a graph that is called supply and demand curves as shown in Figure 1.4. The supply curve is upward sloping reflecting the law of supply: the quantities of burgers supplied increase as prices rise. The demand curve is downward sloping reflecting the law of demand: the quantities of burgers demanded increase as the prices drop. Because the relationships reflect the opposite directions between price and supply versus demand, what determines the final price of burgers? Again, holding all other factors constant, prices are set at which supply equals demand which is shown in Figure 1.3 where the supply and demand curves intersect.

The law of demand states that customers will demand more of a product as the price drops; and if the price increases then less will be demanded.

Demand and Supply Curves

supply demand

20

15

10

5

00 100 200 300 400 500

Figure 1.4 Demand and Supply Curves

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We call this intersection the market price or the equilibrium price at which the quantity supplied is equal to the quantity demanded at 10 TL each at the amount of 250 burgers. At any other points not on the supply and demand curves, there may be a surplus or a shortage situations of burgers. For example, if the café produces 300 burgers while still selling them at 10 TL, then it won’t be able to sell 50 burgers because only 250 burgers are demanded at that price. We call this situation a surplus where quantity supplied is larger than quantity demanded. The café would lose money by spending more for those extra but unsold burgers. However, if the café is willing to lower the price then additional customers will want to buy more burgers. For example, if the price is lowered to 8 TL then the demand would be so great that the café would run out of burgers before it can satisfy all customers who want them. We call this situation a shortage where quantity demanded is larger than quantity supplied. Therefore, the market price reflects the profit-maximizing price where there is no shortage or surplus.

One of the dangers of a shortage situation is that customers may get upset or that the unmet demand would encourage other businesses to come into the market. We should stress that there are other key determinants of supply and demand (other than price), as shown in Table 1.7. For example, the price and availability of substitute products also affect demand while the number of suppliers affect supply. Therefore, supply and demand forces are dynamic and together would impose constant changes on businesses in free-market economies. Also, the example given here is very simplistic as in the real world market economies, there would be much larger numbers of businesses that would offer many different types of products every day.

The market price (equilibrium price) at which the quantity supplied is equal to the quantity demanded.

A surplus is when quantity supplied is larger than quantity demanded.

A shortage is when quantity demanded is larger than quantity supplied.

The market price reflects the profit-maximizing price where there is no shortage or surplus.

Table 1.7 Determinants of Demand and Supply

Source: https//www.thebalance.com/five-determinants-of-demand, http://www.boundless.com/economics

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Market CompetitionFree-market systems with the existence of private enterprises must rely on various types of competition

which are also essential to the understanding of the behavior of the overall market economy. The nature or degrees of competition vary widely by characteristics of industries, categories of products, and also by geography. Four degrees of business completion are identified as: pure competition, monopolistic competition, oligopoly, and monopoly. Keep in mind that these are not absolute measures but are degrees of or points along a continuum. For this reason, many industries may fall somewhere in between.

Pure competitionPure competition exists when no single supplier is large

enough to influence prices. Therefore, prices are largely determined by supply and demand conditions. There are many small suppliers in the market and it is easy for them to enter or exit the market. Suppliers produce products that buyers view as virtually identical. There are a few examples of products that appear to be identical such as agriculture products like fruits, vegetables and grains.

Monopolistic competitionMost of the competitions that exist today in free-market economies fall in this category where firms

have unrestricted freedom of entry. Monopolistic competition exists when there are many buyers and suppliers and the products are similar although buyers perceive them as different. For example, there may

be several stores in a shopping mall that sell cotton t-shirts. Buyers often see differences in the product and prefer one over another. Therefore, suppliers have some control over prices. Businesses try to differentiate the products through brand names, advertising, design and styling. Product differentiation will be discussed in the

Marketing Management chapter. So a white cotton t-shirt from a street market may sell for 15 TL while a comparable t-shirt from a well-known chain store can easily sell for twice as much or more.

OligopolyAn industry where only a few suppliers exist, each with a large share of the market, is called an

oligopoly market. Typically, these firms are fairly large, and often require a high investment of financial capital to enter the market. Therefore, entry into the market is restricted. Examples are the steel, telecommunications and automobile industries. Competition is high as goods or services can be similar (e.g. mobile phone services from Türkcell, Avea or Vodafone). With few suppliers and similar products, prices tend to differ only slightly. When one firm lowers its price, then others would also do the same in order to protect their

market share. To avoid a price war, oligopolies often try to differentiate their products to stand out from competitors. In a globalized world, oligopolistic industries are more common. In some markets, there exist as few as two suppliers that have dominant control of the market.21 We called these duopoly such as Boeing and Airbus (in commercial aircraft market) and Coca Cola and PepsiCo.

Companies must differentiate themselves from the competitors to attract customers in a crowded market.

Pure competition exists when no single supplier is large enough to influence prices.

Monopolistic competition exists when there are many buyers and suppliers and the products are similar although buyers perceive them as different.

An industry where only a few suppliers exist,each with a large share of the market, is called an oligopoly market.

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MonopolyA monopoly exists when a supplier of goods or services has control of all (or nearly all) of its market.

Here, only one supplier dominates the market such that others are not able to compete. Therefore, the firm has considerable control over prices. However, the firm may not be able to increase prices as much as possible because demand for its products will fall as price increases. Not withstanding, the firm can still charge high prices. Monopoly lacks the important element in a free-market economy which is competition, therefore governments do have laws to forbid many monopolies. In the case of natural monopolies where one firm can most efficiently serve the whole market, then it is often regulated by the government.

For example, a company like an electric or a natural gas utility can hold monopolies to conserve resources and to supply those resources more efficiently (one town doesn’t need more than one natural gas company). In these cases, prices are regulated by governments for fair pricing to citizens. As mentioned earlier, the Turkish Competition Authority is tasked to enforce competition laws and regulations to prevent practices and operations by businesses that would distort competitive conditions.22 It is there to ensure free competition for social justice and economic efficiency. Table 1.8 summarizes the degrees of competition along important market characteristics: barriers to entry into the market or industry, numbers of buyers and buyers’ choices in the market, numbers of suppliers in the industry and price competition.

Table 1.8 Degrees of Competition

Pure CompetitionMonopolistic Competition

Oligopoly Monopoly

Many buyers and suppliers of virtually identical products; no control over prices; no barriers to market entry

Many suppliers offering similar goods; some control over prices; many buyers’ choices; some barriers to entry

Few suppliers offering similar or different goods; some control over prices; high barriers to entry into the market or industry

One supplier in a market with unique products; entry into the market and prices charged often are regulated by the government

Economic IndicatorsIn the previous sections, we have discussed the basic understandings of an economy including economic

systems, supply and demand and market competition. In a business world, manager, owners and investors need to gauge the economic health of a country. They want to know if the economy is expanding or contracting in response to various changes in the external environments such as technology, consumers’ taste or the changes in economic forces. They also want to know about the business cycle which refers to

short term fluctuations in the general economic activities (ups or downs, expansion or contractions). An economy expands when it experiences growth and consumers spend more money. Higher spending stimulates a higher level of economic activity and in turn, stimulates more buying. Economic contractions occur when an economy experiences a period of decline in economic activities. We

can use various statistical economic indicators to measure and monitor economic activity and performance. A key indicator of economic expansion and contraction is a country’s Gross Domestic Product or GDP.

The business cycle refers to short term fluctuations in the general economic activities.

A monopoly exists when a supplier of goods or services has control of all (or nearly all) of its market.

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Gross domestic productGross Domestic Product (GDP) refers to the total value of a country’s overall economic output it

produces during a given time period (usually one year) through its use of domestic factors of production. In this case, the output from locally-owned or foreign-owned companies located within the country’s boundaries are included in its GDP. Generally, a rising GDP indicates that businesses are doing well. In order to compare one economic output of one country to another, GDP per capita which is GDP divided by total population, is often used as it is more useful for comparisons. For example, GDP of China in 2015 was $11,064 Billion which is much larger than Japan’s at $4,383 Billion.23 However, GDP per capita in Japan was more than four times higher than that of China because China is one of the most populous countries in the world.

GDP per capita reflects the standard of living which is the value of all goods and services produced in an economic system that people can purchase, reflecting the level of

material wealth and comfort of its citizens. Higher standard of living results from economic growth. Since Japan’s GDP per capita is 4 times higher than China’s, therefore Japanese citizens on the average have more goods and services available to them and they are in a better position to buy those goods and services than Chinese citizens. However, very high GDP figures mean that China is one of the largest economies in the world and is an economic powerhouse to be reckoned with.

GDP figures are reported in nominal terms called nominal GDP meaning that the total output or GDP is stated in today’s currency value and at current prices. Nominal GDP figures can increase from year to year even when the total output of an economy stays the same. This can happen when prices of the output increase over the given period although the amount stays the same. Therefore, higher nominal GDP doesn’t necessarily mean the country has economic growth. For comparison purposes, we can use the real GDP (instead of nominal GDP) which is GDP adjusted for price changes. An economy experiences

an economic growth when its total output increases faster than its population. We can look at the real economic growth rate (of GDP adjusted for price changes) which is expressed as a percentage showing the rate of change for a country’s real GDP from one year to the next.24 Table 1.9 shows Turkey’s GDP for the year 2006-2015.

Standard of living is the value of all goods and services produced in an economic system that people can purchase, reflecting the level of material wealth and comfort of its citizens.

Nominal GDP - GDP is stated in today’s currency value and at current prices.

Real GDP - GDP adjusted for price changes.

Real economic growth rate is expressed as a percentage showing the rate of change for a country’s real GDP from one year to the next.

Gross Domestic Product or GDP refers to the total value of a country’s overall economic output it produces during a given time period through its use of domestic factors of production.

GDP per capita is GDP divided by total population.

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Table 1.9 Turkey GDP Statistics

Year GDP1 GDP per capita2 Real GDP: growth rate (%)

2015 1.882 24,309 3.97

2014 1.780 23,236 3.02

2013 1.690 22,314 4.19

2012 1.539 20,549 2.13

2011 1.443 19,517 8.77

2010 1.263 17,298 9.16

2009 1.106 15,349 -4.83

2008 1.130 15,901 .66

2007 1.033 14,710 4.67

2006 937 13,504 6.89

Source: OECD Data, Retrieved from data.oecd.org

1Billion of U.S. dollars

2U.S. dollars

During a period of contraction in the business cycle, a significant period of weakening in economic activity that spreads across the economy in which real GDP declines is called a recession. From Table 1.9, we can see that Turkey experienced a negative growth rate of -4.83% in 2009, with a drop in GDP and GDP per capita. In fact, most

economies experienced declines from the effects of the U.S. financial crisis in 2008-9 which spread across the world’s economies. Nominal GDP has been increasing every year (except during the recession) along with GDP per capita although the rate of growth varies from year to year. A deep or severe recession that lasts for a long period of time is called a depression. Fortunately, a depression doesn’t happen often in relatively stable economies. However, economies that are relatively unstable may face repeated recessionary periods over time.

InflationAnother important economic indicator is inflation

which occurs when there is a widespread price increase throughout an economy. Businesses and consumers have major concerns over inflation because it affects their buying power for a given amount of money. When prices rise then buying power drops as people can get less for their money. If employees’ wages and salaries do not increase as fast as the rise in prices, then they can buy less goods and services. Economists use price indexes to monitor inflation and measure price increases.

The consumer price index or CPI is used to measure the weighted average of prices of a basket of typical consumer goods and services purchased by households (living in urban areas). The basket includes common products such as food and beverages, housing costs, apparel, transportation and medical care.25 CPI is expressed as a percentage of price as compared to a baseline historical value measured monthly. Table 1.10 shows10yearsinflationrate(CPI)forTurkeyfrom2007–2016

Recession is a significant period of weakening in economic activity that spreads across the economy in which real GDP declines.

Inflation occurs when there is a widespread price increases throughout an economy.

Consumer Price Index (CPI) is used to measure the weighted average of prices of a basket of typical consumer goods and services purchased by households (living in urban areas).

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with 2010 as the base year. During the 10 years shown, the highest inflation rate is over 10% at the time of the economic downturn in 2008. Large changes in inflation create instability for an economic system, but the increases also indicate that the overall economy is growing in general (but in an erratic manner).26

UnemploymentUnemployment is another important indicator of the

health of an economy that businesses and investors focus on. Unemployment occurs when a person seeking employment is unable to find work in an economic system. There are various categories of unemployment:27 28

• Frictional unemployment results when a person isin-betweenjobs,careersandlocations.Thisisatemporaryunemploymentandalwayspresentinaneconomy,thereforeisnotconsideredserious.

• Cyclical unemploymentoccursduetothebusi-nesscycle,i.e.economicfluctuations.Itrisesduringeconomicdownturnsasbusinessescutbacktheirworkforce.Itdeclinesduringperiodsofeconomic growthwhenfirmsbegintohireagain.

• Structural unemployment occurs when peo-plelosetheirjobswhenanindustryexperiencesstructuralchangessuchthatemployees’skillsareoutdated.Inotherwords,thereisamis-matchbetweenwhatisneededbybusinessesandthekindsofworkers’skillsthatareavailable.Thiscanbereadilyseenfromunemploymentthrough technologicaladvancesfor example, the use of computerized technology like machines and robots to replace very large numbers of factory workers. Further, employees needed to operate more complex technology must also be highly skilled themselves.

• Seasonal unemployment occurswhenworkersgetlaidoffduringtheofforlow-season.For example agri-culture workers are hired only during the products’ season or workers in tourism are not needed during off-season.

A high unemployment rate in an economy can negatively affect its citizens who rely on jobs for their well-being. Prolonged unemployment may lead to crime and social unrest. Table 1.10 shows unemployment rate for the year 2007 to 2016. Notice that during an economic downturn staring in 2008 when inflation rate went up, following in 2009 when unemployment rate was the highest at more

than 12%. In a declining economy, businesses tend to reduce their workforce as a way to reduce cost, as labor often is the major expense for them. On the other hand, when an economy grows and experiences a labor shortage with a drop in unemployment rate, businesses need to compete for workers resulting in wage increases. Businesses often offset the rise in costs by passing them on to consumers in term of higher product prices. Ultimately, price increases will lead to a higher rate of inflation which is undesirable. Governments need to keep both unemployment and inflation rates low which is a difficult task as they tend to have an inverse relationship to each other. Readers can find all sorts of economic statistics from the Internet address.

Seasonal unemployment occurs when workers get laid off during the off or low-season.

http://www.turkstat.gov.tr/Start.dointernet

Structural unemployment occurs when people lose their jobs when an industry experiences structural changes such that employees’ skills are outdated.

Unemployment occurs when a person seeking employment is unable to find work in an economic system.

Frictional unemployment results when a person is in-between jobs, careers and locations.

Cyclical unemployment occurs due to the business cycle.

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Table 1.10 Inflation Rate (CPI) and Unemployment Rate: Turkey

YearInflation Rate1

(%)Unemployment

Rate (%)Year

Inflation Rate1

(%)

Unemployment

Rate (%)

2016 7.8 10.8 2011 6.47 8.81

2015 7.67 10.24 2010 8.57 10.68

2014 8.85 9.88 2009 6.25 12.58

2013 7.49 8.74 2008 10.44 9.73

2012 8.89 8.17 2007 8.76 8.89

Source: Inflation (CPI). Retrieved from https://data.oecd.org/price/inflation-cpi.htm, http://data.oecd.org

unemployement-rate.htm.

1CPI (2010=100)

Government’s Role in Managing the EconomyIn every type of economic system, governments have various roles in

managing the economies. The extent of their involvement though may not be agreed upon by the stakeholders within the countries.29 Governments can place laws and regulations to protect various stakeholders. For example, a smoke-free area in restaurants to protect customers’ health, financial regulations to protect investors’ and individuals’ investments, and health care standards for all citizens.Government agencies such as the Turkish Competition Board are established to protect and foster competition in free-market economies. Governments are also expected to encourage economic development in responsible ways. This includes stimulating and stabilizing the economy generally through two sets of policies: fiscal and monetary.

Fiscal policyA government manages its collection and spending of its revenues using fiscal policies. Major sources of

revenues come from taxation including income taxes earned by businesses and individuals, property taxes and sales taxes. Governments policies such as spending on the goods and services, tax cuts or tax increases,

and distributions of various payments are examples of fiscal policies. A government can stimulate the economy by increasing its spending such as spending on a nation’s transportation infrastructure like railways and highways. Therefore, discussions of fiscal policy are generally focused on the effects on the economy of the overall levels of government spending and taxation.30

Monetary policyMonetary policies involve a government’s control of the nation’s money supply. These often mean targeting

an inflation rate or interest rates (increasing rates or decreasing rates). In Turkey, the TCMB or Türkiye Cumhuriyet Markez Bankası or the Central Bank of the Republic of Turkey (CBRT) is responsible for implementing monetary and

exchange rate policy. It has an inflation targeting framework to reach its primary objective of price stability with measures to maintain the stability of the financial system.31 Together, monetary and fiscal policies are used to help stabilize an economy such as to smooth out fluctuations of a nation’s output level, unemployment and inflation.

Even in a free-market economy, the government has various roles in managing the economies in order to bring stability to the economy.

A government manages its collection and spending of its revenues using fiscal policies.

Monetary policies involve a government’s control of the nation’s money supply.

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SMALL BUSINESS, ENTREPRENEURSHIP, AND BUSINESS OWNERSHIP

The presence of small businesses are pervasive in our everyday life, whether one lives in a small town or in a big city around the world. Although many products we consume come from large businesses, the majority of our interactions with firms are with small businesses. Also, most large companies often start small.

Small Business – DefinitionGenerally, a small business is independently owned and operated and not dominant in its field of

operation, i.e. with little influence in its market.33 We can measure the size according to the number of employees or the monetary value of a business such as its balance sheet total. Business size standard

varies widely according to the industry and geography. For example in the U.S., the Small Business Administration (SBA) considers a company with fewer than 500 employees to be a small business, although a company of 1,500 employees can be labeled small in several types of manufacturing sectors.34

However, the European and Turkish standards are quite different as shown in Table 1.11 in which a small

company has less than 50 employees.35 There are slight differences in the standards in terms of monetary value in respect of balance sheet total in Euro (European standard) and net sales figures in Turkish Lira (TL) (Turkey standard - 2012).36 The issue of size is important in most countries especially when dealing with governmental agencies. There are laws and regulations, programs and benefits that are specifically aimed at small businesses. For example, there are governmental loans and credits for those who qualify as small businesses.

A small business is independently owned and operated and not dominant in its field of operation.

“Money supply is the total stock of money circulating in an economy including currency, printed notes, money in the deposit accounts and other forms of liquid assets” .32

Discuss how current economic indicators in your country affect employees.

3

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Table 1.11 European and Turkey Small and Medium-Sized Enterprise (SME) Size Standard

Company Category Staff1 Balance Sheet Total2 (€) Net Sales3 (TL)

Medium-sized <250 ≤ 43 m ≤ 40 m

Small <50 ≤ 10 m ≤ 8 m

Micro <10 ≤ 2 m ≤ 1 m

Source: https://ec.europa.eu/growth/smes/business-friendly-environment/sme-definition_en and http://www.

hurriyetdailynews.com/definition-for-smes-broadened.asp

1Total number of employees

2European standard

3Turkey standard

The importance of small businessSmall businesses are very important to most economies, even in advanced economies like the U.S.

and the U.K. For example, 99.7% of the U.S. firms are considered to be small businesses in 2012 (less than 500 employees).37 For Turkey, 99.8% of all enterprises in Turkey are made up of SMEs or those with less than 250 employees which employ more than 73% of the workforce.38 The importance of small businesses can be summarized below.

Job market. Small businesses are the major source of new jobs. Smaller firms are relatively more flexible in terms of hiring than large firms such that they often hire employees at a faster rate during economic growth. However, they also fire or cut jobs at a faster rate during an economic downturn. Many small businesses especially in advanced economies also engage in import (product made in foreign countries but sold domestically) and export (product made domestically but sold internationally) of goods and services.

Innovation. Small business flexibility also tends to favor innovations in terms of new products or introducing new business processes or methods. The SBA reported that among high-patenting firms (15 or more patents in 4 years), small businesses had 16 times more patents per employee than large patenting firms in the U.S.39 During the past several years, small companies and individuals in the computer technology sector have made a very large impact not only on businesses but on larger societies as well, for example, the invention of personal computers, the World Wide Web (WWW), Google search and Facebook to name a few.

Contributions to other businesses. Small businesses provide goods and services to other small and large companies. For example, large firms like Nike and Toyota have thousands of small suppliers for parts and other input resources. Many small retailers sell products or services to consumers for larger firms. Nike products can be found in many smaller retailers around the world. More than half of all exports from Turkey in 2015 were exported by SMEs such as textiles, chemicals products and machinery which are used by other businesses.40

Small businesses often focus narrowly; selling a few types of goods and services, selling in a few market segments or specialized in niche markets. These markets are often too small with too few customers for large firms to enter. They have much more limited financial resources than larger companies. However, they have the freedom and flexibility to do things (e.g. make decisions) quickly as small firms have much simpler structures than the more complex large organizations.

EntrepreneursPeople who start, organize, and operate a business and

assume risks are called entrepreneurs. We should emphasize that entrepreneurs are not only small business owners. They

Entrepreneurs are people who start, organize, and operate a business and assume risks.

26


are seen as innovators who market innovations and as change agents (i.e. search for change, respond to change and exploit change as opportunity).41 Small business owners, on the other hand, start their own businesses instead of working for somebody else to make a living for themselves and their families. Many do not want to develop the businesses beyond what they can manage themselves.

The aim of an entrepreneur is to grow the business, and if successful for it to become a large enterprise. Although some hugely successful entrepreneurs may not have envisioned their business as they have become today (think about Mark Zuckerberg of Facebook or Jeff Bezos of Amazon). We often call new businesses that aim to grow large and fast as new ventures or start-ups. Whether starting a small business or a start-up, we can agree that entrepreneurship is an important process for economic growth and well-being for all market economies.

Traits or characteristics of entrepreneursMost successful entrepreneurs share certain personal characteristics such as being innovative and

creative. They have ideas and imaginations to come up with innovative products or services or creative solutions to problems and opportunities. In other words, they possess the entrepreneurial spirit or the mindset, an attitude and approach to thinking that seeks change and embraces critical questioning, innovation and continuous improvement.42 Some large firms try to express and maintain entrepreneurial spirit through individuals or teams by what is known as intrapreneurship. Intrapreneurs are employees working in large companies who behave like entrepreneurs.

Entrepreneurs are willing to work hard with dedication and determination for long periods of time. They are self-motivated; money is not a major motivation for them. Success is the motivator and money is the reward for success.43 They are highly energetic and believe in what they are doing. They have the self-confidence from their expertise with passion to succeed and high tolerance to risks and uncertainty that come with change. Fortunately for potential entrepreneurs who may lack some of these traits; many skills can be learned. Also, success can happen regardless of education level and economic background. Findings show that based on the attitudes of Turkey’s population and the growing rate of entrepreneurship in the country, Turkish citizens have potential for entrepreneurial opportunities and advancement especially with improvements in the procedures to start a business and the reforms within Turkey’s financial sector.44

Entrepreneurs are very important to the market economies. They start new businesses, accept the risks, create jobs, and contribute to innovation. Dynamic economies are seen as those with many successful entrepreneurs, working in a supporting business environment that encourages and motivates entrepreneurs’ activities.

Intrapreneurs are employees working in large companies who behave like entrepreneurs.

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Starting a New BusinessSmall businesses are seen as the engine of job creation and income growth especially for emerging

economies like Turkey. There are advantages for individuals to own a new business: to be one’s own boss and the ability to develop close personal relationships with customers and employees.45 The relationships also extend to the social life of the communities they belong to. Also, being small gives businesses the ability to evolve at a faster pace and to adapt to change (i.e. flexibility).

Unfortunately, the failure rate for small businesses is fairly high as the majority do not have long-term success. For example, only slightly more than half of new businesses survive after 5 years in the U.S. and the survival rates continue to drop with time.46 Money is almost always tight in the beginning as most new businesses have limited resources and lack the ability to raise more financial capital. Some entrepreneurs and business owners may not be competent or not have enough experience managing and operating day-to-day activities. Highly successful entrepreneurs in the technology sector for example, are seen as having both technical knowledge and also having managerial competence (or at least know how to find the competence in others).

Business planTo increase the chance for success, entrepreneurs should

come up with a comprehensive business plan which defines the vision, the strategy and the implementation for the new business. A good business plan can assist with making good business decisions, goal-setting, long-term planning and help to attract investors and employees for the new venture. Writing up a plan also helps entrepreneurs to crystallize their ideas and the actions needed to start a successful business. Table 1.12 lists the elements of a business plan.

Table 1.12 Elements of a Business Plan

• INTRODUCTION: Basic information such as the name, address, dates including a title page.• EXECUTIVE SUMMARY: Overview of the entire plan including the technical, marketing, financial, and

managerial details. This section is important in that it should convince the investors that the new ventu-re is a worthy investment.

• COMPANY DESCRIPTION: Highlights the entrepreneur’s dream, vision, and goals including the industry and legal status of the new venture.

• PRODUCT/SERVICE: Details of the products or services, benefits, competitive advantage, and price.• MARKETING PLAN: Details of the industry, competitors, and target market including results from mar-

ket research.• OPERATING PLAN: Details of daily operation of the business including the location, machines, equip-

ment, people, and processes including suppliers.• MANAGEMENT AND ORGANIZATION: Roles and responsibilities of the people.• FINANCING: Expenses involved (including startup and ongoing expenses) and capital needed.

Source: Principles of Entrepreneurship. U.S. Department of State, Bureau of International Information Programs.

Retrieved from http://www.ait-org.tw/docs/enterp.pdf; Business Plan Translate for a Startup Business. Retrieved from

http://www.score.org/resource/

A business plan defines the vision, the strategy and the implementation for the new business.

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Entry optionsThere are basically three major options to start a new firm; to create a new business, to buy an existing

business, or to buy a franchise system.Creating a new business. This first option is to create a new, independent business. Depending on the

type of business, some can be started with little cash but some like those in manufacturing may need a lot of financial capital to begin with. Since the founder/owner can make all the decisions, s/he can have a lot of independence. For example, decisions such as location, equipment, suppliers and employees can be made to create all new business systems from scratch. The risks, however are high as success or failure depends on the business prospect and entrepreneur’s projection about his or her business potentials (such as the number of customers, sales figures and reputation).

Buy an existing business. Unlike the first option, buying an existing business is easier as the business should already have a customer base, employees and other support networks like suppliers. Therefore, business potentials are easier to estimate correctly as the existing business has a track record with business systems already in place. The startup costs may be considerable as the previous owner would sell the business at a profit, especially if it has been proven successful in the past. Another disadvantage for this option is that the business may suffer from the effects resulting from the previous owner’s actions such as bad reputation for customer service and any other business processes and systems errors.

Buy a franchise system. Franchising is an attractive way to start a business without having to start it from scratch. A franchise is a type of arrangement where the local owner (called franchisee) acquires

a license to have access from the parent company (called franchisor) to its business proprietary knowledge and processes in order to sell the products or to provide services under the franchise’s brand name or trademarks.47 In short, a franchise agreement is where a franchisee buys the right to sell and use the franchisor’s good or service. Well known international franchises in the world are mostly in the fast food sector such as McDonald’s, KFC, Subway, and Burger King.

Franchises are a popular way to start a business because of several advantages; most notably the expertise, experience and established names of the franchisors for the product or service on offer. Expertise especially in management and marketing that can be included in franchise agreements is very helpful to new business owners who often lack these skills. Franchising is similar to being a part of a larger firm

but with the freedom of working for one’s own business. Depending on the franchise, franchisees may get support networks along with ready-made and viable business systems. For example, a franchisor may help pick the best business locations, given market research, as well as training and other necessary assistance in starting up a successful business.

The franchisor or the parent company also benefits from some form of payments: upfront fee for the rights to use its brand name or trademark, payments for training, equipment and other business services, payments for ongoing royalties or a percentage of the business’s sales revenues.48 There are also disadvantages to franchises as the franchisors can retain considerable control over the franchisees. For example, franchisees may need to follow the exact business format of the franchisors. Therefore, decisions to respond to any changes in the business environment (such as consumer tastes) cannot be made independently. The most significant disadvantage for a franchisee is the high initial start-up costs; especially if the franchisor is one of the well-known and popular international brands. Readers may take a look at the Internet website for further information about franchising in Turkey.

http://ufrad.org.tr/anasayfainternet

A franchise agreement is where a franchisee buy the right to sell and use the franchisor good or service.

29


Types of Business OwnershipEntrepreneurs must decide on which forms of ownership is best for their companies and their goals.

There are several factors to consider including:49

• Liability–Adebtorobligationasaresultofbusinessoperations.Ownersmayhavelimitedorunlimitedliability.Unlimited liability means that the legal ownersareliable(orresponsible)forallbusinessdebtsandobligations.Limited liability means that the partnerisliableonlytotheextentofinvestments/hecontributestothecompany.

• Tax–Taxratesvaryonsalesrevenuesthatabusi-nessgeneratesandalsowhetherthetaxispersonalorbusiness.

• Start-uprequirements–Theratesofcapitalrequiredtoopenupabusinessalsovarywiththeformsofownership.

• ManagementandControl–Accordingtothetypeofownership,managementandcontrolstructurecanrestwiththeowners,partnersorwiththeboardofdirectors(isagrouptooverseecorporatemanagement,whoareelectedbystockholders).

• Capital–Theabilitytoraiseinitialandoperatingcapitalsdiffersincludingthesourcesofinvest-ment or fund.

• Succession–Theabilitytopassonortoselltheownershiptoothers,includingwhenthedeathsofownersoccur,mustbeconsidered.

Keeping these factors in mind, entrepreneurs can then choose the best form among the three major forms of legal ownership: sole proprietorships, partnerships, or corporations as shown in Figure 1.5 forms of legal ownership.

Figure 1.5 Forms of Business Ownerships

Unlimited liability means that the legal owners are liable (or responsible) for all business debts and obligations.

Limited liability means that the partner is liable only to the extent of investment s/he contributes to the company.

SOLE PROPRIETORSHIPS

CORPORATIONS

• Business owned and often operated by one person who is liable for all debts and obligations from the rm’s operations.

• Equivalent to a collective company• 2 or more partners sharing operations and liabilties

Generalpartnership

• Equivalent to a commandite company• Limited partners with limited liability• Active partners manage the rm with unlimited liability

Limitedpartnership

PARTNERSHIPS

JSC Joint Stock Company

• Equivalent to a public limited liability company• Managed by a board of directors

LLC Limited Liability Company

• Formed by a maximum of 50 real persons or legal entities

Cooperative

• Individual, companies, municipalities, and associations to operate commercial activities as legal entities.

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Sole proprietorshipsA sole proprietorship or sole trader is a business

owned by one person, therefore is suitable for a small business. It can be established easily in Turkey by filing an application with the Trade Register and registering with the local tax authorities before operating.50 There are no start-up requirements and owners are free to hire personnel. Tax laws permit sole proprietorship to pay based on individual or personal income tax. The control and management are entirely by the business owner so that a separate professional manager or director is not needed. One major disadvantage is that the owner has unlimited liability for all the debts and obligations incurred by the business. When not enough cash is generated by the business, the owner must pay out of his or her own money. Further, the ability to raise funds from banks and other financial institutions is very limited. The sources of funds primarily come from personal funds, friends and family. It is also more difficult to sell a sole proprietorship. The business ends with the passing of the owner.

PartnershipsA partnership is a non-corporate business that

is owned by two or more people. In Turkey, non-corporate forms of ownership may be established as a collective company or a commandite company as legal entities.51 Both of these forms are the equivalent of partnerships in other countries and are appropriate (but not limited to) for SMEs. Major issues involve who manages the company and how much liability each partner faces.

Collective companies. A collective company in Turkey is the same as a general partnership which means that the partners can invest equal or unequal sums of money but are equally liable for the debts

and obligations incurred by the firm’s operations. There is no minimum share capital for the partners as in sole proprietorship.

Commandite companies. A commandite company is equivalent to the limited partnership in which the partners can be active (called general partner) or dormant (called silent partner).52 Active partners manage the firm and have unlimited liability while silent partners have no role in the management of the firm but have limited liability. There is no minimum share capital required for any partners. The partners can jointly operate the company unless stated otherwise in a legal contract. Each partner pays separate personal income tax. Note that the commandite or limited partnership company can be used by foreign individuals or companies seeking a joint venture in Turkey.

A partnership is a non-corporate business that is owned by two or more people.

A general partnership (a collective company) means that the partners can invest equal or unequal sums of money but are equally liable for the debts and obligations incurred by the firm’s operations.

A commandite company is equivalent to the limited partnership in which the partners can be active (called general partner) or dormant (called silent partner).

Active partners manage the firm and have unlimited liability.

Silent partners have no role in the management of the firm but have limited liability.

A sole proprietorship or sole trader is a business owned by one person, therefore is suitable for a small business.

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With partnerships, businesses have better chances to grow and to add resources (like money and employees) as they do not depend only on one person. Partners can also rely on complimentary skills that each brings in to the partnership. Partnerships are relatively easy to start as legal requirements are few. However, the major drawback for a general partnership with unlimited liability is that all partners, regardless of their roles in the business operations, are equally liable. Therefore, the limited partnership may be used instead. Other disadvantages, similar to the sole proprietorships are the issues of succession and the difficulty in transferring ownership to others. Lastly, the chances for disagreement and conflict rise with the number of partners. Conflicts range from simple interpersonal disagreements between partners or more significant issues such as business strategy, operational procedures and division of profits and losses. Partners should learn conflict resolution skills as they will be needed at some point in time!

CorporationsThe Turkish Commercial Code (TCC) states that

corporate forms may be established under Joint Stock Company (JSC), Limited Liability Company (LLC) and Cooperative Company.53 JSC and LLC are the most common types in Turkey and globally and are appropriate (but not limited) for large businesses. Most large and global businesses take this corporate form. Although large businesses are much fewer in numbers in typical free-market economies, given their size (in terms of personnel and sales revenues), they have significant impact on most economies. For example, although less than 1% of the total number of enterprises in Turkey were considered as large (greater than 250 employees in total); they employed about 26% of total workforce, gave 46% of total wages and salaries and made 62% of total imports.54 All types of corporations have legal status under TCC as separate entities and each has property rights and obligations.

Joint stock company. A joint stock company (JSC) in Turkey (referred to as A.Ş.) is equivalent to a public limited liability company as the shareholders or stockholders are liable only for the amount of capital each contributes. There are some additional requirements; a corporation is required to have at least one shareholder who can be a real person or a legal entity, a small deposit to the Competition Authority as a percentage of the company’s capital, and a deposit with the minimum amount of 25% of the startup capital in a bank (i.e. minimum share capital requirement).55 Further, a JSC must be managed by a board of directors. Although shareholders are not required to be in the board, they have the right to appoint one. A board of directors can be made up of one or more persons or companies.

A corporation that is privately held and whose shares or stocks are not available for sale to the public, is called a closed or private corporation. Stockholders may be a family or a management group. On the other hand, a publically held or public corporation is a corporation whose ownership (shares or stocks) is dispersed and available for sale to the public. Investors can buy stocks from some of these corporations at a stock exchange such as the Istanbul Stock Exchange or Borsa Istanbul. If a public JSC has more than

If an entrepreneur decides to team up with others and form a partnership, make sure to consider each partner’s personal qualities and skills. Each must be able to make a significant contribution to the new venture.

The Turkish Commercial Code (TCC) states that corporate forms may be established under Joint Stock Company (JSC), Limited Liability Company (LLC) and Cooperative Company.

A joint stock company (JSC) in Turkey (referred to as A.Ş.) is equivalent to a public limited liability company.

A corporation that is privately held and whose shares or stocks are not available for sale to the public, is called a closed or private corporation.

A public corporation is a corporation whose ownership (shares or stocks) is dispersed and available for sale to the public.

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250 shareholders then it is further subjected to the regulations imposed by the Capital Market Board of Turkey.56

Limited liability company. A limited liability company (LLC) in Turkey (referred to as LTD) is a company formed by two or more real persons or legal entities (maximum of 50 such persons or entities).57 It can be 100% foreign owned. An LLC would have a predetermined or fixed capital and limited liability to the corporate assets (resources or things that have economic value that are owned by a corporation). Shareholders have limited liability according to their capital contributions. A minimum share capital is required although the amount is relatively small. It is governed by directors of LLC and professional managers. Compared to a JSC, the procedures to start an LLC are simpler and the amount of minimum share capital is less. For these reasons, an LLC is appropriate for SMEs and also is popular among foreign investors.58

Cooperatives. A cooperative form of business ownership allows individuals, companies, municipalities and other associations to operate commercial activities as a legal entity.59 In advanced economies like the U.S., cooperatives make up only a small percentage of the economy. It is most prevalent in the agriculture sector. In Turkey, the number of shareholders in a cooperative is unlimited and there is no minimum share capital requirement. Further, regulations of cooperatives’ business activities fall to the ministry in charge. For example, the Ministry for Agriculture would regulate activities of agricultural cooperatives. Procedures to set up are quite simple compared to the other types of corporate ownership status.

Alternatives in business ownershipIn addition to the types discussed above,

branches and liaison offices can be used as alternatives to setting up a business. Foreign companies based outside of Turkey may only set up branches and liaison offices. Branches set up by a foreign based JSC must be approved by the Ministry of Industry and Trade and must set up a legal entity to employ staff and must be in the same scope of the parent company.60 Their profits are subjected to corporate tax in Turkey. Liaison (or Representative) offices of foreign companies which are under the authority of Ministry of Economy do not perform any commercial activities that generate revenues; they only supply information about the companies to suppliers or customers.61 Recent important issues in the area of business ownership include strategic alliances and joint ventures, and mergers and acquisitions.

Strategic alliances and joint ventures. A strategic alliance is an agreement between two or more companies to pursue common goals such as project development of new products, while still remaining independent organizations. For example ICICI Bank, the largest private sector bank in India and Vodafone India announced a strategic alliance to launch a mobile money transfer and payment service for Indian customers in 2013.62 As in most alliances, both parties contribute for mutual gain. In this case, Vodafone India offers significant reach of mobile service distribution as being one of India’s largest telecom service providers. At the same time ICICI Bank provides a large customer base under the security of its financial transactions.

A cooperative form of business allows individuals, companies, municipalities and other associations to operate commercial activities as a legal entity.

A strategic alliance is an agreement between two or more companies to pursue common goals such as project development of new products, while still remaining independent organizations.

A limited liability company in Turkey (referred to as LTD) is a company formed by two or more real persons or legal entities.

33


A joint venture on the other hand, is a form of strategic alliance where the ownership of a new venture is shared among the partner firms. A new company is formed and owned jointly by partner firms. For example,

the automotive industry has seen several joint ventures, many of them internationally. In Turkey, the joint venture between Koç Holding and Ford Motors (U.S.) was formed as Ford Otosan to manufacture a few models or vehicles and related services under the Ford brand name.63 This joint venture generated around $16.7 billion in sales in 2015 and is one of the top 10 largest companies in Turkey.64

Mergers and acquisitions. Mergers and acquisitions (M&A) are often used for corporate expansion by adding new product lines or new markets in different locations or in a related or different industry. Therefore, M&A can lead to changes in the nature of businesses or their competitive positions. A merger means a combination of two corporations to form a new company. For example,

Disney and Pixar merged to create one of the best known collaborations in the entertainment industry of hugely successful movies and animations such as Frozen (an animation targeting young children) which became the 5th largest grossing movie ever made in 2015.65

An acquisition on the other hand, occurs when one firm completely buys another outright. Often a larger firm would have the ability to buy out and absorb the other smaller firm. For example, Microsoft acquired LinkedIn (the social networking firm) for over $26 billion in 2016.66 For large technology firms like Microsoft, Apple and Google, they often use acquisitions in order to gain new complementary computer hardware and software technologies from small innovative firms. M&A is one important strategic tool for

corporate expansion. In Turkey (and other countries), M&A has often been used by foreign investors to enter the Turkish market which made up as much as 70% of the total annual M&A deal volume in 2015.67 It should be noted that many M&As are not successful as these deals are complex involving every aspect of both companies. Successful M&As that create value for the companies involved, often lead to radical improvements of the firms’ performance such as cost reduction or removal of excess capacities such as obsolete factories and surplus human resources.68

BUSINESS ETHICS AND CORPORATE SOCIAL RESPONSIBILITYWe have been discussing the fundamental elements of business and we can realize that business

organizations have significant effects on our everyday lives and well beings. Therefore, the issues of business ethics and corporate social responsibility (CSR) should be front and center almost as much as issues such as sales and profits. Ethics is a system of moral principles (what is right and wrong) that governs a person’s behavior. The concepts of ethics have been derived from philosophy, religions and cultures, therefore, individual’s moral values and behaviors are determined within his or her social context. Business or corporate ethics examines moral or ethical issues in a business environment such as ethical or unethical behaviors by managers and employees in the workplace. Note that unethical behaviors are not necessarily illegal under a nation’s law; although the behaviors are seen as wrong and undesirable in the social context.

A joint venture is a form of strategic alliance where the ownership of a new venture is shared among the partner firms.

A merger means a combination of two corporations to form a new company.

An acquisition occurs when one firm completely buys another outright.

Compare and contrast different entry options when starting a new business.

4

Ethics is a system of moral principles (what is right and wrong) that governs a person’s behavior.

34


Personal EthicsEthics are based on personal beliefs within the

social context, therefore, they differ from person to person, from situation to situation, and from culture to culture.69 Since personal ethics guide each of us in making various decisions in our daily life and our work life, we need to ensure those decisions are right and proper. We can use five sources of ethical standards to help us make good ethical decisions as suggested by the Markkula Center for Applied Ethics:70

• TheUtilitarianApproach-anethicalbehaviorthatdeliversthemostgoodordoestheleastharmforallwhoareaffectedbyit.

• TheFairnessorJusticeApproach–anethicalbehaviorthattreatspeopleequallyorfairly.

• TheCommonGoodApproach–anethicalbehaviorthatisbasedonthebenefitofallinacommunityandwelfareofeveryone.

• TheVirtueApproach–anethicalbehaviorthatisconsistentwithdesirablevalueslikehonesty,courage,generosity,tolerance,fairnessandintegrity.

• TheRightsApproach–anethicalbehaviorthatrespectstherightsofthoseaffectedsuchastherighttochoosefreelyone’sownchoice.

An individual, whether as a manager, an employee or an owner in a business should be able to determine the most appropriate moral approach or approaches based on all the facts involving the decisions to be made. The more difficult the decisions, the more we should also rely on discussion with others about the dilemma, along with careful exploration of the problem and the situational context.71

Ethics and BusinessesPeople in business often face practical ethical

dilemmas within their professions. Business or corporate ethics involve ethical or unethical behaviors by employees in a business environment. Managerial ethics on the other hand, involve managers’ principles or standards of behavior in an organization. Ethical issues regarding financial and accounting practices are for example, one of the major issues for most companies. These issues relate to financial reporting, trading, compensation and payment policies.72 Desirable values in financial reporting would be to make moral choices in regard to the preparation, presentation and disclosure of financial information.73 Therefore, creative accounting and misleading financial analysis would violate desirable values such as honesty and integrity and may cause harm to investors or creditors who are affected by them. Ethical dilemmas occur in every functional area of a business including human resources, sales and marketing, production and others.

A situation where an employee’s personal interest is at the cost of others in the company would result in a conflict of interest. For example, a conflict of interest arises when an employee uses confidential information that is collected by the company for financial gains. Also a bribe, favoritism, nepotism and self-dealing are considered unethical (and in some cases, such as bribes, are illegal). Self-dealing by an employee is the conduct that consists of taking advantage of his or her position in a transaction rather than for the interests of the company.

https://www.sabanci.com/tr/sabanci-toplulugu/is-etigi-kurallari/is-etigi-kurallari/i-16

internet

Business or corporate ethics involve ethical or unethical behaviors by employees in a business environment.

Managerial ethics involve managers’ principles or standards of behavior in an organization.

A situation where an employee’s personal interest is at the cost of others in the company would result in a conflict of interest.

35


One of the best ways for a company to support ethical behavior is by the actions of its top management. Top managers must act ethically, make ethical decisions and support ethical standards for all employees. Companies can encourage ethical behavior by establishing a code of ethics and by instituting ethics programs. A code of ethics is a formal document that companies use to guide employees to conduct business fairly, honestly and with integrity. It often includes a firm mission, core principles and organizational values which identify the firm’s expectations of all employees or specifies behavioral requirements.

A code of ethics creates an ethical awareness and consistent ethical standards for all employees. For example, Iş Bank which is the leading bank in Turkey stated its values as:74

• Honestandtrustworthy,• Leading,pioneeringandinnovative,• Customerorientedwithastrongfocuson

highquality,• Respectfultosociety,humanrightsand

environment,• Transparent.Moreover, Iş Bank has also formally adopted

the Code of Banking Ethics published by the Bank Association of Turkey.

As people learn ethical behaviors through their experiences, businesses should encourage employees by initiating ethics programs such as ethics training. Such programs enable employees to recognize ethical dilemmas and have opportunities to practice applying ethical values to those problems or situations. Further, companies can have ethics help lines to discuss and to report ethical concerns and situations they or others in the company face at work.

Corporate Social ResponsibilityCorporate social responsibility (CSR) is the

concerns and obligations businesses have for the welfare of their stakeholders and the larger society. CSR goes beyond being ethical, beyond what is required by law and beyond the pursuit of profits. The obligations of businesses are often described by their commitments to various stakeholders such as customers, employees, investors and communities. We will discuss CSR according to these major stakeholder groups.

CSR and consumersA movement by individuals, groups, and

governments to put pressure on businesses to help protect consumer rights and interests is called consumerism. The steady rise in consumerism in Turkey has resulted in higher consumer protection standards in order to meet the EU levels.75 The law which came into force in 2014 concerns all kinds of consumer transactions and practices such as protection from unfair business practices, defective goods and availability of reliable information for consumers. In general, the purposes for consumer protection focus on the health, security and economic benefits of the consumer.

Upper management ethical principles and actions help direct lower level managers’ and employee’s decisions when facing ethical dilemmas.

A code of ethics is a formal document that companies use to guide employees to conduct business fairly, honestly and with integrity.

Corporate social responsibility is the concerns and obligations businesses have for the welfare of their stakeholders and the larger society.

CSR goes beyond being ethical, beyond what is required by law and beyond the pursuit of profits.

A movement by individuals, groups, and governments to put pressure on businesses to help protect consumer rights and interests is called consumerism.

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An important issue for consumers concerns unfair pricing of goods or services such as price fixing. Price fixing or collusion is an agreement among competitors in the same industry to increase or decrease prices to interfere with competition. The agreement may only be in verbal terms or even inferred from conduct among competitors (i.e. when one firm decreases/increases its prices, other firms follow). As mentioned earlier, the Turkish Competition Authority has an obligation to prevent and to enforce business practices that distort or interfere with competitive conditions in the economy.

CSR and employeesThe basis for CSR toward employees concerns

human resources activities such as recruiting, hiring, training, promoting and compensating.76 A company has obligations to fairly reward employees for their hard work, to have a chance for promotion while being treated with respect. Governments should take an active role in preventing unjust business practices and in supporting employees. Common issues in Turkey involve contributions to social security and unemployment social security fund, overtime pay, work week, minimum wage, annual leaves, and termination of employment.77 Workers also have the rights to form unions, to become members and to freely withdraw from the memberships. Another employee related issue concerns the whistleblower, an employee who reports information or activity that is illegal or unethical within the company; for example, activities that harm the environment and other violations of laws or regulations. Companies may retaliate against whistleblowers by demoting or firing them. In the U.S., there are various whistleblower protection programs to protect employees from retaliation as firms cannot take adverse action against them.78

CSR and the environmentThe environment and environmental protection

have become major issues not only for governments but also for businesses around the world as well. The public, concerned governments and socially responsible businesses have led significant efforts to tackle global warming, to reduce pollution and to fight resource depletion. Pollution is the process of injecting harmful substances into the environment and making land, water, air or other parts of the environment dirty, unsafe or unsuitable to use.79

Land pollution. Land can be polluted by industrial waste from businesses and by household garbage. Industrial waste is composed of waste materials after production which can be hazardous to human health and the environment, for example, hazardous waste from chemical production. The issue is to prevent this hazardous waste before it causes problems and also to clean up afterwards. Toxic waste disposal is a preventive response, along with improvement to production processes in order to decrease the amount of toxic waste. Another method is recycling which is the process of converting waste materials into new and useful materials and objects. It reduces the amount of waste, conserves natural resources and help sustain the environment for future generations.80 Local and national governments play important roles in preventing pollution through laws and regulations while they can also set examples as illustrate below.

Price fixing or collusion is an agreement among competitors in the same industry to increase or decrease prices to interfere with competition.

Whistleblower refers to an employee who reports information or activity that is illegal or unethical within the company.

Pollution is the process of injecting harmful substances into the environment.

Recycling is the process of converting waste materials into new and useful materials and objects.

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“In 2016, a large German city has banned single-serve coffee pods in all government-run buildings and institutions across the city. Coffee pods are expensive and they are not good for the environment as there is a lot of packaging for just a little bit of coffee. They compose of plastic and aluminum therefore, are very difficult to recycle effectively. Many items that are the sources of environmental pollution like plastic water bottles are also banned. The city sends out an important signal for individuals and businesses to take a look at the consequences of their purchasing decisions.”

Source: Doezema, M. (March 12, 2016). A German City Has Banned Single-Serve Coffee Pods and Plastic Water Bottles. Retrieved from https://news.vice.com/article/a-german-city-has-banned-single-serve-coffee-pods-and-plastic-water-bottles

Water pollution. Water pollution is caused by chemicals or dangerous foreign substances which are introduced to water such as sewage, pesticides and fertilizers and metals.81 Water pollution is a significant problem in the world as many people do not have access to clean fresh water supply. Streams, lakes, rivers, waterways and oceans can be contaminated and have large effects on their ecosystem such as plants, animals and other organisms that live in the water.

Air pollution. Air pollution occurs when several elements that are not normally in the air are released into the air to lower air quality; particles (e.g. from burning fuels) and gases (e.g. sulfur dioxide and carbon monoxide). Air pollution is an important risk factor for health worldwide. According to a 2015 study, Turkey had one of the highest rates of premature deaths due to air pollution in Europe.82 Governmental agencies such as the Ministry of Environment and Urbanization have

been working to improve the air quality management in Turkey. Laws and legislation must be put in place and enforced on businesses as air pollution (and all other forms of pollution) has serious adverse impacts on people’s health, the environment and the economy.

CSR and investorsBusiness managers are responsible to investors

and stockholders by providing them fair return on their investments. Managers need to maintain a responsible use of the firms’ financial resources. Irresponsible use of financial resources lowers shareholders’ earnings and dividends. Excessive salaries, bonuses and other benefits to managers are signs of financial mismanagement. These actions may not be illegal but probably unethical.

Managers need to maintain complete and accurate financial records and follow proper accounting standards and procedures. Further, they should provide accurate and appropriate information to investors about the health, future growth and profitability of the company. Misrepresentation of financial situations such as inflated profits or hidden losses are also unethical. Managers should also avoid other potential legal issues such as manipulation of stock prices and insider trading. Insider trading involves the use of private or special company information for financial gains, often in the form of buying or selling of stocks.

For example, if a manager has confidential information that the firm’s major client is not renewing the contract and that its stock price will significantly drop when this information becomes public and the manager goes ahead and sells his shares before the information becomes public knowledge to avoid losses. Since the manager has inside information and benefits from it then this is insider trading which is not only unethical but also illegal.

Insider trading involves the use of private or special company information for financial gains.

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“Many people need to walk around with face masks on, as air pollution worsen. For several weeks in January of 2017, Northern China has been covered in a thick toxic smog, one of the worst episodes of air pollution the country has seen, which affected over 460 million people.83 It was estimated that air pollution has killed an average of 4,000 people a day in China, mostly from coal-burning use.” 84

Approaches to CSRTraditionally, companies often view social

responsibility as philanthropic activities involve giving money (to causes like education, charitable, and humanitarian), time (such as employee community service projects), and goods and services donations by businesses. Although businesses may not receive direct benefits for philanthropy, many see it as a good thing to do as all firms are part of the community/society. Philanthropy can enhance a firm’s reputation and brand awareness; i.e. improving its social capital or goodwill within their communities. For privately held corporations, philanthropic activities are usually determined by their owners. On the other hand, boards of directors and executive management influence organizations’ philanthropic priorities.85 Governments can encourage philanthropy using tax incentives (such as tax deductible contributions to social causes) or by instituting a mandate. For example, the Companies Act (2013) by the Indian government mandates that large profitable Indian firms must contribute at least 2% of average net profits from the 3 preceding years to CSR activities.86

Instead of generic philanthropy, companies that align CSR initiatives with business objectives and overall business strategy follow a more strategic approach to CSR. A firm’s strategic CSR is often

associated with firms that have seen increasing involvement with global business activities. Firms intend to benefit as well as positively impact the environment or communities they belong to. Benefits include cost reduction and enhancing relationships with various external stakeholders. Firms can concentrate on three CSR strategies: operations-driven, compliance-driven, and customer-driven:87

• Operations-driven–Firmscanengageinactionsthatwoulddirectlyinfluencethecompetitivenatureofthegoodsandserviceswiththisstrategy.For example, a manufacturing firm can improve its operational efficiency by using new technology solutions to improve production processes (hence lower costs), to lower production waste of both hazardous and non-hazardous waste, and to decrease materials and energy usage. Allthesewouldminimizenegativeimpactsontheenvironmentwhileimprovingitsoperationalefficiencyandloweringcosts.

• Compliance-driven–Firmscanfocusonachievinghighlevelsofcompliancerequiredunderacountry’slawsandregulationswiththisstrategy.Therequirementsareaimedatissuessuchastheenvironment,health,worksafetyandproduct safety. For example, factories should not only follow minimum requirements for workers’ safety and health regulations. They can further implement training and education to update workers’ skills and offer supplementary health plan which exceed the minimum compliance requirements.

• Customer-driven–Firmscanfocusonitscustomers,employees(asinternalcustomers)andcommunitiestopromotetheirenvironmentalandsocialinitiatives

Philanthropic activities involve giving money (to causes like education, charitable and humanitarian), time (such as employee community service projects), and goods and services donations by businesses.

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withthisstrategy.Afirmthathasasignificantfootprintinitscommunityshouldespeciallyemphasizeitsinvolvementtopositivelyimpactthecommunitysuchasprovidingfairwages,producingqualityandaffordablegoodsandservices,andsupportingotheractivitiestoimprovelivingconditionslocally.

Table 1.13 summarize the three strategies. CSR ultimately reflects the companies’ values, ethical standards, and their relationship to the communities they belong to and depend upon. Strategically managing CSR activities enables firms to maximize benefits to society and the environment and at the same time create value for all the stakeholders. Many businesses large and small, should consider socially responsible actions and behavior not only because they are the right things to do. Potential advantages to firms can be seen in several areas: 88

• Createnewbusinessormarketopportunities• Increaseacompany’ssocialstanding,socialcapital,brandreputationandbrandawareness• Improveacompany’senvironmentalimpactandoperationalefficiency• Increaseemployees’motivation• Reduceoperatingcosts• Protectimportantresourcesthatacompanydependson.

Table 1.13 Strategic Approaches to CSR

Operations-driven Compliance-driven Customer-driven

Firms can engage in actions that would directly influence the competitive nature of the goods and services with this strategy.

Firms can focus on achieving high levels of compliance requirements under a country’s laws and regulations with this strategy.

Firms can focus on its customers, employees and communities to promote their environmental and social initiatives with this strategy.

Source: Which Corporate Social Responsibility Strategy is Right for Your Company? Retrieved from http://hr.blr.com/

whitepaper/hr-administration/workplace-ethics/

The “In Practice” section below illustrates a case for CSR practices by a large successful company in Turkey that reflects the topics discussed in this section.

Discuss ethical behaviors and social responsibility in small businesses.

5

40


A Journey of a Locally Operated Small Business to Become a Domestic and Global Market Leader in its Sector

Akarmak, founded in 1990 in Eskişehir was a typical small local business started by two brothers and their relatives as a partnership service business off ering small machinery maintenance services with few employees. Many people who pursue these kinds of enterprises do not necessarily want to grow much beyond their capacity to manage them. Th ough the owners have independence by working for themselves and achieved some level of financial security, after 10 years in business, there was a change in the partnership. Akarmak owners then aspired to grow beyond their current situation.

Th ey were able to identify a new product off ering and got into an expanding business of tire retreading which is a niche market in which consumer demand was not met. In addition to the tire retreading machinery and turnkey plant solutions, Akarmak has developed other highly engineered and technological machinery of autoclaves/pressure vessels and medical waste sterilization systems. Th e autoclaves are widely used in various industries including glass, composite, building material, rubber, etc. Th e company took advantage of the distinctive competencies of small businesses by identifying new market niches. Generally, small businesses have competence in three areas: an ability to identify new niches in established markets or industries, an ability to identify new markets, and an ability to quickly exploit a new opportunity.89 Small businesses like Akarmak have the fl exibility and responsiveness to customers, unlike large firms which may not have the ability to make quick decisions, or take risks.

Akarmak continued to grow and successfully entered into new related markets. From being a small machinery maintenance service firm with few employees, the firm started production facilities to meet growing demand. During the past ten years, Akarmak has also aggressively

entered into more than 30 countries around the world with its existing product lines; the majority of the business currently comes from the European market. It has now over 120 employees and has become a medium-sized enterprise. Th e success is due in large part to management and the technical competences of the owners to organically grow by penetrating new markets.

Akarmak has become the market leader domestically and continued to expand abroad. Th e firm is not competing directly with the low-cost Asian-based companies as operating cost has continued to rise in Turkey. Instead, over time the company has gained expertise by hiring highly qualifed engineers to eff iciently produce high quality products with certifications of international standards in product quality. Th e success (or failure) of businesses therefore depends on several factors such as knowing who are the customers, where they are located, and understanding the competitors and competition. Th is course should help readers build deeper understanding of business and its various business functions discussed in the remaining chapters of this text.

Source: Interview with a founding member of Akarmak (May 8, 2017). http://www.akarmak.com.tr; http://www.autoclave.com.tr

Further Reading

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Doing Well by Doing GoodEti Company was founded in 1962 by Mr.

Firuz Kanatlı in Eskişehir, Turkey. It is one of the largest firms in its sector (biscuit and chocolate sector or baked goods industry) with a reported 2.3 billion TL in net sales, ranking as the 54th largest company in Turkey in 2015.90 Recent consumer surveys of the brand indicate that Eti is a respected and leading brand of Turkey.91 Ethical behaviors and social responsibilities on the part of most companies start at the top level. The following is a quote from the current Chairman of the Board of Directors at Eti Companies, Mr. Firuzhan Kanatlı:92

“As Eti Companies, we are aware of our responsibilities to the society. For many years, we have endeavored to fulfill our duties towards our country and the society through numerouse social responsibility projects that we have directly undertaken or supported. We have adopted a social responsibility understanding of investing in our children who will play a key role in building a bright future for our country; therefore we have developed many projects for them such as “Yellow Bicycle”, “Cultural Ambassadors”, “Children’s Theater”, and workedwith Civil Society Organizations in order to maximize the social benefit. I believe wholeheartedly that we expand our children’s horizons and invest in the future of our country with these projects. One of the most important points for us in social responsibility projects is continuity. It gives us happiness to know that our long-term work will have lasting effects on future generations....”

With strong leadership in CSR practices on the part of its Board of Directors (including the owners) and top management, Eti has continued to not only delight customers with the products but also to involve with several social responsibility projects. For example, the Yellow Bicycle project was started to encourage more active life style based on physical activities which is very important to the protection and development of physical and mental health of children and adults alike. The use of bicycles is not only for health reasons, it is to bring more people and family members together and have fun.93 Additionally, bicycles are used for transportation around the world because of the

low cost (economic benefit) and also help reduce traffic congestion and therefore, air pollution.

Source: http://www.etietieti.com/eti-sari-bisiklet-projesi

Eti’s philanthropic activities for local community include opening of high schools for thousands of young people, supporting the Archeology Museum, and the Aquarium in Eskisehir among others. On the operational side, CSR practices guide Eti business processes and procedures such as in its manufacturing operations which also include many of its supply chain partners. For example, multiyear projects with the World Wildlife Fund (WWF-Turkey) has been aimed at Eti’s supply chain partners like farmers. Projects include modernization of farming methods, preservation of water sources and agricultural land use, and adaptation to future climate changes. Internally, production operational targets and logistics are made to be above and beyond governmental regulations including reduction of energy usage, waste and carbon footprint.

As a result of the firm’s commitment to CSR, the company’s definition of success is more than creating value for internal stakeholders. To be successful, a company should define its role and position in a society by carefully manage its impact on the people, the environment and the economy. A part of every employee’s job is to understand the firm’s socially responsible policies and actions, i.e. to make CSR and business ethics parts of its organizational culture.

Discuss:1) Which CSR approaches does Eti follow? Explain.2) How can external stakeholders such as local

and national governments, consumers and communities encourage ethical and social responsibility behaviors by businesses?

In Practice


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Sum

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LO 1 Defining the basics of business, the benefit of business, the types of business, and functional areas of a business

A business is any organization that provides goods or services to satisfy customers’ needs and wants for a profit. Profits are earned when a firm gets larger revenues than expenses. An individual who starts a business for profits and risks losses is called an entrepreneur. Profits generated also benefit various stakeholders who have a stake in or are affected by the decisions and actions made by an organization such as investors, employees and customers. In a market economy like in Turkey, consumers have choices of what to buy and whom to buy from. Therefore, there is a competition among firms for the same customer group. Businesses contribute to society in several ways such as generate income for owners and wages and salaries for employees. There are four different types of business: local, regional, national, and international or multinational. The types depend on which geographic markets a business serve. Major functions or activities in a typical business are human resources, marketing and sales, production or manufacturing, finance and accounting, and research and development. Keep in mind that large firms would include all of these areas and probably more such as information technology and legal functions. Small firms may not formally have all of those major functions.

LO 2 Describing the external business environments and how they affect organizations

All businesses large and small, regardless of where they are located must operate within the external environment. There are six major forces or dimensions in the business environment. The economic environment where the conditions in a country’s economy affect how a firm must do business. The technological environment includes physical equipment and machines, knowledge and work methods which affects the ways that companies create value for their stakeholders. The social environment refers to trends and forces in a society such as demographic, customs and values characteristics where a business must function and operate. The legal environment affects businesses through the laws and regulations imposed on them. The market environment refers to the environment where a firm conducts its operations and where revenues are obtained. The global environment refers to the global forces that affect a business; which has seen increasing importance as a result of globalization.


43

Sum

mary

LO 3Defining the basics of economics, explaining the different economic systems and supply and demand concepts, and identifying the degrees of market competition and major economic indicators

Economics can be broadly defined as the study of how people use resources or the study of decision-making. Resources are required to produce goods and services to meet customers’ needs and wants. These resources or the factors of production are: labor, natural and physical resources, financial capital, entrepreneurship, and information resources. An economic system is a country’s organized way for allocation of its resources among its citizens. It has three major categories as planned economy, free-market economy, and mixed-market economy

The supply of a particular product refers to the quantity of the product available for purchase at various prices at any given time. The law of supply states that sellers will offer more of a product as price increases and vice versa. The demand of a particular product refers to the amount of the product customers will buy at various prices at a given time. The law of demand states that buyers will purchase more of a product as price decreases and vice versa. The market price is the profit maximizing price in which the quantity of goods supplied is equal to the quantity of goods demanded; there is no shortage or surplus. There are four degrees of competition in a free-market economy: pure competition, monopolistic competition; oligopoly, and monopoly.

A business cycle refers to short term fluctuations in general economic activities. Businesses should know whether an economic system is expanding or contracting. The primary measure of growth (economic expansion) is gross domestic product (GDP). GDP refers to the total value of all goods and services during a given period through its use of domestic factors of production. GDP per capita is GDP divided by the total population and is a reflection of the citizens’ standard of living. Standard of living is the value of all goods and services produced in an economic system that people can purchase. Real GDP is GDP adjusted for price changes which shows real economic growth rate, expressed as a percentage rate of change of real GDP from one year to the next. Recession is a significant period of weakening in economic activities in which real GDP drops. Inflation occurs when there is a widespread price increase throughout an economy.


44

Sum

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LO 4Defining small business and explain entrepreneurship, outlining issues involved with starting a new business, and explaining various types of business ownership

A small business is independently owned and operated, and not dominant in its field of operation. In Turkey, a firm with less than 50 total employees or net sales of less than 8 million TL is considered small sized. Small businesses are very important to most economies as they are the major source of new jobs. They are more innovative and flexible and more responsive to customers. They also contribute to other businesses (e.g. as suppliers). In Turkey, 99.8% of all enterprises are made up of SMEs. Entrepreneurs start small businesses, new ventures and startups. Small businesses are seen as the engine of job creation and income growth with several advantages. However, their failure rate is also relatively high. To increase a chance for success, an entrepreneur should come up with a comprehensive business plan which defines the vision, the strategy and the implementation for the new business.

There are several factors to consider before deciding which forms of ownership that is best for entrepreneurs such as liability and tax issues, management and control issues. There are three major forms of legal ownership: A sole proprietorship is a business owned by one person, therefore is suitable for small businesses. A partnership is a non-corporate business that is owned by two or more people. A general partnership (called a collective company in Turkey) is a partnership where partners can invest equal or unequal sum of money; all partners are equally liable for its business debt and obligation. A limited partnership on the other hand, can have active partners (called general partners) who manage the business and have unlimited liability; and dormant partners (called silent partners) without a role in management but have limited liability. In Turkey, a limited partnership is the same as a commandite company.

A corporation is considered a legal entity with property rights and obligation. This form of legal ownership can be established under a Joint Stock Company (JSC), a Limited Liability Company (LLC) and a Cooperative Company. A corporative form of business allows individual, companies, municipalities and other associations to operate commercial activities as a legal entity. This form is popular in the agriculture sector. Other issues important to corporate ownership include strategic alliances and joint ventures, mergers and acquisitions. In a strategic alliance, two or more companies agree to pursue common goals. An arrangement where partner firms share ownership of a new enterprise is called a joint venture. A merger occurs when two firms combine to form a new company while an acquisition happens when one firm buys another firm outright.


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LO 5 Defining business ethics and discuss corporate social responsibility with various approaches for major stakeholders

Ethics are a system of moral principles that govern a person’s behavior. They are based on personal beliefs within the social context. Business or corporate ethics involve ethical or unethical behaviors by employees in a business environment. Managerial ethics involve managers’ principles or standards of behavior in an organization. A situation where an employee’s personal interest is at the cost of others in the company would resulted in a conflict of interest. Firms can support ethical behaviors by the actions of its top management. Companies can established a code of conduct which is a formal document that companies use to guide employees to conduct business fairly, honestly and with integrity.

Corporate social responsibility (CSR) is the concerns and obligation businesses have for the welfare of the stakeholders and for the larger society. CSR and consumers often involve with consumerism which is a movement by individuals, groups and governments to put pressure on businesses to help protect consumer rights and interests. CSR and employees concerns with human resources activities such as recruiting, hiring, training, promoting and compensating. CSR and the environment involves with efforts to tackles pollution by businesses. Pollution is the process of injecting harmful substances into the environment and making land, water, air or other parts of the environment dirty, unsafe or unsuitable to use.

Companies traditionally view social responsibility as philanthropic activities that involve giving money, time, and goods and services donations. Governments can encourage philanthropy using tax incentives. Firms concentrate on three CSR strategies: operations-driven CSR, compliance-driven CSR, and customer-driven CSR.

Sum

mary


46

Test

you

rsel

f

1 What is the term used to describe the diffe-rence between revenues and expenses?

a. Salesb. Assetc. Interestd. Profite. Income

2 Competition among businesses is desirable because it contributes to ____________.

a. Profitsb. Pricec. Innovationd. Salese. All of the above

3 The conditions in a country’s financial market are a part of a company’s __________environment.

a. Regulatoryb. Socialc. Marketd. Economice. Political

4 Which of the following is an element of the market environment where each business operates?

a. Product innovationb. Environmental regulationsc. Competitorsd. Demographic characteristicse. International trade agreements

5 In a ________, companies can decide what to produce at what price and whom to hire.

a. Planned economyb. Socialist economyc. Privatization processd. Communist economye. Free-market economy

6 A franchise agreement is a popular way to start a business because;

a. It is the least expensive way.b. The franchisee retains considerable control.c. The franchisee can quickly change with the bu-

siness environment.d. The franchisor offers expertise such as marke-

ting and management skills.e. There is no start-up costs.

7 The market price reflects__________.

a. A shortageb. The profit-maximizing pricec. A surplusd. The law of supplye. The law of demand

8 A source of ethical standard that is ba-sed on the benefit of all in a community is cal-led________.

a. The common good approachb. The strategic approachc. The virtue approachd. The rights approache. The justice approach

9 An advantage of a limited partnership over a general partnership is

a. That partners do not incur debt and obligation from the firm’s operation.

b. That active partners do not need to invest in the firm.

c. That all partners are liable for all debt and obli-gation.

d. That partners are liable only for the amount of investment contributions.

e. There is no advantage.

10 _________involves giving money, time and goods and services donations.

a. Philanthropyb. Whistleblowerc. Insider tradingd. Strategic CSRe. Consumerism


47

Answ

ers for “Test yourself” S

uggested answers for “Your turn”

If your answer is incorrect, review “The definition of a business and profits”.

1. d If your answer is incorrect, review “The franchising system”.

6. d

If your answer is incorrect, review “The economic environment”.

3. d If your answer is incorrect, review “The sources of ethical standard”.

8. a

If your answer is incorrect, review “The reasons competition is desirable for businesses”.

2. c If your answer is incorrect, review “The market or equilibrium price”.

7. b

If your answer is incorrect, review “The market environment”.

4. c

If your answer is incorrect, review “The free-market economy”.

5. e

If your answer is incorrect, review “Partnerships”.

9. d

If your answer is incorrect, review “Approaches to CSR”.

10. a

Identify and describe the benefits of businesses that produces non-alcoholic beverages which you can purchase from a grocery store; including the benefits you receive from the company’s marketing function.

your turn 1

Non-alcoholic beverage industry produces ready to drink beverages such as soda drinks, sparking water, iced tea, fruit juices etc. that consumers can buy from grocery stores. Businesses produce various types of products that we can buy from one place, in convenient packages that last for many months, and at reasonable prices. Each type or drink category, for example fruit juices, is offered in various flavors such as apple, orange, grape and various mixes. There are also choices for consumers to buy from different companies. Marketing function of those firms develop products to fulfil consumers’ wants and taste; distribute products to many stores we can buy from easily; communicate to consumers through advertising and informing about the products’ features.

your turn 2

Technology for a manufacturing firm includes physical equipment, machines, computers, work methods, techniques and knowledge used in the company. A large and modern manufacturing firm uses modern production technologies and computer technology components in order to produce quality products while minimizing costs. That is, technology should lead to improvements in the firm’s production processes. This way, it can be more competitive in the marketplace. The company can also use technology to make products that are unique or differentiate from their competitors.

Discuss elements of the technological environment that are

important to a large manufacturing company.


48

Discuss how current economic indicators in

your country affect employees.

your turn 3

Important current economic indicators that affect employees are inflation, unemployment and economic downturn (low real growth rate) in the economy. Inflation occurs when there is a widespread price increase throughout the economy. This means that buying power drops especially when wages/salaries stagnate in recent years. Therefore, employees can buy less goods and services for their money. Due to the downturn in the business cycle, businesses may cut back their workforce. Therefore, some employees will lose their jobs and people entering the workforce may not be able to find work. People have less money to spend which may in turn, negatively affect businesses in the economy.

your turn 4

There are three options to start a new business: to create from scratch, to buy an existing business or to buy a franchising system. Starting a new business from scratch is risky as the business depends on correct estimations of business prospects and potentials by the entrepreneur. For example, the owner may overestimate the number of potential customers or underestimate initial startup and operating costs. Buying existing business is therefore less risky as the business should already have a customer base, employees and other support networks like suppliers with business systems already in place. However, successful existing businesses may be expensive to purchase. Also, any negative effects from the previous owners’ actions can decrease the chance of future success. Buying a franchising system can also be expensive especially the well-known international ones. However, franchisees would get ready-made and viable business systems from the franchisors along with other supporting assistance.

Compare and contrast different entry options when starting

a new business.

Although the focus of corporate social responsibility is on large businesses including multinational corporations, small businesses should also participate. Small businesses are located everywhere and in many locations there exists only small businesses. They are also much closer to customers as they have higher interactions with them and often with the local communities where they are located. Therefore, the issues of ethical and CSR that apply to large firms also apply to small firms. The difference would be the scale and the scope of the issues. Also the issues of ethics primarily rest on individuals in a company so the size of the firm is not critical. Top management in large firms and owners in small firms would have in large part to do with how employees behave and how to deal with ethical problems. For large firms, ethical and CSR can be institutionalized while in small firms, it can be less formal.

your turn 5

Discuss ethical behaviors and social responsibility in small

businesses.

Sug

gest

ed a

nsw

ers

for

“You

r tu

rn”


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1Solomon, M. R., Poatsy, M. A., & Martin, K. (2016). Better Business. Pearson Education Limited, pp. 46-49.

2What is Globalization? Retrieved from http://www.investopedia.com

3American Marketing Association. Retrieved from http://www.ama.org/about-ama/marketing-definition

4Bovee,C.L.&Thill,J.V.(2017).Business in Action (8th ed.). Pearson Education Limited, pp. 56-59.

5Chaffey, D. (April 11, 2017). Mobile Share of Online Time Percent 2017 – US, UK, China, Canada, Mexico. Retrieved from http://www.smartmsignts.com

6E-Commerce – Turkey Statista Market Forecast. Retrieved from https://www.statista.com/outlook/turkey

7Demographics – Invest in Turkey. Retrieved from http://www.invest.gov.tr/

8Turkish Competition Authority. Retrieved from http://www.rekabet.gov.tr/...../pages/turkish-competition-authority

9Dias, L. P. & Shah, A. J. (2009). Introduction to Business. McGraw-Hill Higher Education, pp. 22-23.

10Bowler, T. (January 19, 2015). Falling oil prices: Who are the Winners and Losers? Retrieved from http://bbc.co.uk

11What is Economics? – American EconomicAssociation. Retrieved from http://www.aeaweb.org/students/what-is-economics

12Crowdfunding. Retrieved from http://www.investopedia.com

13Amazon Startup Story. Retrieved from http://www.fundable.com/startup-stories/

14The Forbes World’s Most Innovative Companies. Retrieved from http://www.forbes.com/

15Ibid.16Pride, W. M., Hughes, R. J., & Kapoor, J. R. (2009).

Introduction to Business. Cengage Learning, p. 15.17Market – Investopedia. Retrieved from http://www.

investopedia.com/terms/market18Ebert, R. J. & Griffin, R. W. (2017). Business Essentials

(11th ed.). Pearson Education Limited, p. 50.19Dias, op. cit., p.53.

20The Legal Framework for Privatization in Turkey – Government, Public Sector (March 2010). Retrieved from http://www.mondaq.com

21Duopoly – Wikipedia. Retrieved from https://wwwen.m.wikipedia.org/wiki/duopoly

22Turkish Competitive Authority, op. cit.23Gross Domestic Product (GDP). Retrieved from data.

worldbank.org/indicator24Real Economic Growth Rate. Retrieved from

h t tp : / /www. inve s toped i a . com/ t e rms / r /realeconomicrate.asp

25Consumer Price Index – CPI. Retrieved from h t tp : / /www. inve s toped i a . com/ t e rms / c /consumerpriceindex.asp

26Ebert, op. cit., p. 56.27Solomon, op. cit., pp. 46-49.28Unemployment. Retrieved from http://www.

investopedia.com/terms/u/unemployment.asp29Bovee, op. cit., pp. 85-87.30Weil, D. N. The Concise Encyclopedia of Economics

Fiscal Policy. Retrieved from http://www.econlib.org/library/Enc/FiscalPolicy.html

31Monetary Policy. Retrieved from http://w w w. t c m b . g o v. t r / w p s / w c m / c o n n e c t /T C M B + E N / T C M B + E N / M a i n + M e n u /MONETARY+POLICY

32Definition of Money Supply. Retrieved from http:// http://economictimes.indiatimes.com/definition/money-supply

33Small Business Size Standard. Retrieved from http://www.sba.gov/size

34Ibid.35What is an SME? Retrieved from https://ec.europa.

eu/growth/smes/business-friendly-environment/sme-definition_en

36Definition for SMEs Broadened (November 5, 2012). Retrieved from http://www.hurriyetdailynews.com/definition-for-smes-broadened.asp

37Small Business and the Economy. Retrieved from http://sbecouncil.org/about-us/facts-and-data/

38Definition for SMEs Broadened, op. cit.39FAQ (2014). Retrieved from http://www.sba.gov/

advocacy/.../FAQ-March-2014.pdf

endnotes


50

40Small and Medium Sized Enterprises Statistics, 2016. Retrieved from http://www.turkstat.gov.tr/PreHaberBultenleri

41Principles of Entrepreneurship. U.S. Department of State, Bureau of International Information Programs, Retrieved from http://www.ait-org.tw/.../docs/enterp.pdf

42Smith, J. (October 22, 2013). How to Keep Your Entrepreneurial Spirit Alive as the Company You Work for Grows. Retrieved from http://www.forbes.com/sites/jacquelynsmith/2013

43Principles of Entrepreneurship, op. cit.44Tracy, M. (May 1, 2013). The State of Entrepreneurship

in Turkey. Wilson Center for Social Entrepreneurship. Retrieved from http://digitalcommons.pace.edu

45Pride, op. cit., p. 144.46Survival Rates of Establishments, 1994-2015. Bureau

of Labor Statistics. Retrieved from http://www.bis.gov/bdm/entrepreneursips/

47Franchise. Retrieved from http://www.investopedia.com/terms/f/franchise.asp

48Ibid.49Dussean, D. & Wilson, D. (2013). Introduction to

Business (8th ed.). Pearson Education Limited, p. 169.

50Types of Turkish Companies (April 4, 2017). Retrieved from http://www.companyformationturkey.com

51Establishing a Business in Turkey. Retrieved from http://www.invest.gov.tr/en-us/investmentguide/establishingabusinessinTR.aspx

52Types of Turkish Companies, op. cit.53Establishing a Business in Turkey, op. cit.54Small and Medium Sized Enterprises Statistics, op. cit.55Ibid.56Ibid.57Mavioğlu, O. Y. Turkey Forms of Doing Business.

Retrieved from http://www.adnrdlaw.com/turkey-forms-of-doing-business

58Ibid.59Types of Turkish Companies, op. cit.60Branches and Liaison Offices of Foreign Companies in

Turkey. Retrieved from http://www.turkishlaborlaw.com

61Ibid.

62India InfolineNewsService–Mumbai.Retrievedfrom http://www.indiainfoline.com/article/news/ICICI-bank-and-vodafone-india-announces-strategic-alliances-to-launch-m-pesa

63Articles of Corporation. Retrieved from http://www.fordotosan.com.tr/en/articles-of-corporation.htm

64Fortune 500 – Turkey. Retrieved from http://www.fortuneturkey.com/fortune500

65Ruesink, M. (September 28, 2015). Top Corporate Mergers: The Good, The Bad, & The Ugly. Retrieved from http://www.rasmussen.edu/degrees/business/blog/best-and-worst-corporate-mergers/

66Chen, L. (June 13, 2016). These Are the 12 Biggest Mergers and Acquisitions of 2016. Retrieved from http://fortune.com/2016/.../12-biggest-mergers-and-acquisitions-of-2016

67Annual Turkish M&A Review 2015 – Deloitte(2015). Retrieved from http://www2.deloitte.com/content/deloitte/tr/documents/mergers-acquisitions/annual-turkish-ma-review=2015.pdf

68Goedhart, M., Koller, T., & Wessels, D. (May 2017). The Six Types of Successful Acquisitions. McKinsey&Company.

69Ebert, op. cit. p. 70.70A Framework for Ethical Decision Making (August

1, 2015). Retrieved from http://www.scu.edu/ethics/ethics-resources/ethical-decision-making/a-framework-for-ethical-decision-making

71Ibid.72Dussean, op. cit., p. 163.73Freedman, J. What is an “Ethical Issue” in Financial

Accounting? Retrieved from http://smallbusiness.chron.com

74Vision and Objectives. Retrieved from http://www.isbank.com.tr/en/about-isbank/investor-re la t ions/corporate-overv iew/corporate-information/vision-and-objectives/

75Lachman, G., Hamevi, H., & Mutaf, F. (May 30, 2014). Turkey: Enhanced Protection for Consumers: The New Turkish Consumer Protection Law. Retrieved from http://www.mondaq.com/turkey/consumer-law/

76Ebert, op. cit., p. 84.77Bereket & Baltaci (January 7, 2016). Turkey:

Overview of Turkish Labour Code and Employment in Turkey. Retrieved from http://www.mondaq.com/turkey/employee+rights+labour+relations/


51

78Whistleblower Protection Program. Retrieved from http://www.whistleblowers.gov

79Bradford, A. (October 2015). Pollution Facts & Types of Pollution. Retrieved from http://www.livescience.com/22718-pollution-facts.html

80Recycling Basic. Retrieved from http://www.epa.gov/recycle/recycling-basics

81Bradford, op. cit.82Air Pollution and Health in Turkey: Facts, Figures and

Recommendations (February 2015). Retrieved from http://env-health.org/img/pdf/150220-factsheet-air-and-health-turkey.pdf

83Carney, M. China’s Air Pollution Crisis Shows No Sign of Ending As Nation Fails To Lower Coal Use. Retrieve form http:// http://www.abc.net.au/news/2017-01-08/chinese-air-pollution-crisis-caused-by-ongoing-coal-use/

84Morales, A. (August 13, 2015). China Air Pollution Kills 4,000 People a Day: Researchers. Retrieved from https://www.bloomberg.com/news/articles/2015-08-13/china-air-pollution-kills-4-000-people-a-day-researchers

85Rangan, K., Chase, L., & Karim, S. (April 2012). Why Every Company Needs a CSR Strategy and How to Build It. Working paper 12-088, Harvard Business School.

86Jayakumar, T. (2016). From philanthropy to strategic corporate sustainability: a case study in India. Journal of Business Strategy, 37, pp. 39-50.

87Which Corporate Social Responsibility strategy is Right for Your Company? Retrieved from http://hr.blr.com/whitepaper/hr-administration/workplace-ethics/

88Rangan, op. cit., p. 23.89Ebert, op. cit., p. 112.90Fortune 500-1015: Turkiye’nin En Büyük 500 Şirketi.

Retrieved from http://www.fortuneturkey.com91Message from the Chairman of the Board. Retrieved

from http://www.etietieti.com/eti-message-from-the-chairman-of-the-board/

92Ibid.93Eti Yellow Bicycle. Retrieved from http://www.

etietieti.com/eti-yello-bicycle

52

Chapter 2 Business in the Global Context

Lear

ning

Out

com

es

Identify important and relative aspects of management in different cultures.

Understand basic aspects and important issues that need to be considered for international trade.

Explain power tactics and organizational survival strategies in foreign markets.

31 2

Chapter OutlineInternational TradePower Tactics and Organizational Survival in

Foreign MarketsBusiness in a Multi-Cultural Environment

Key TermsInternational trade

GlobalizationEconomies of scale

Competitive strategiesJoint ventures

Multinational corporations Emerging markets

Cross-cultural differences


53


“...Advancement and victory field for us is in economics and trade. If you appreciate this, you have to work a lot. Otherwise you cannot persuade anybody even if you indicate that you are the owner of this country....” Mustafa Kemal Atatürk / A speech in Mersin, 17. 03. 19231

It is evident from the relevant literature that firms show a tendency to access foreign markets via joint ventures, mergers, acquisitions, and various types of trade agreements after reaching a certain organizati-onal size. New specialized trade ventures may also be established to meet the export and import demands of various groups. High profit potential of the emerging international markets may motivate local entrep-reneurs to organize their business abroad. Becoming an international player may contribute to reputation, power, legitimacy, and brand image of a company. International business environment comprises of tho-usands of multinational corporations, different types of economic systems, restrictive regulations, various cultural features, and changing competitive requirements. Therefore an entrepreneur who wants to expand his business to international markets must be equipped with sufficient knowledge and skills to survive and to compete in such a complex business context.

This chapter aims at defining necessary knowledge and skills that will be required to manage business in global context. The topics such as globalization and trade, balance of trade, multinational organizations, and emerging markets will be explained initially. Differences between local and international competiti-on, legal and political barriers, export versus import, social and cross-cultural factors, and adaptation to technological change will be discussed later. Dimensions of power tactics and organizational survival will also be examined. Information regarding international trade agreements will be provided for the potential readers. Finally, contingencies concerning management in a multi-cultural business environment are emp-hasized at the end of the chapter.

INTERNATIONAL TRADERapid developments during the recent years in communication and transportation technologies have

increased the tendency of firms to search for the low cost production alternatives around the world.2 Besides that, local firms had several opportunities for marketing their products globally after the free trade agreements signed by the numerous countries during 90’s. Collapse of the Eastern Block has also increased international trade possibilities and several new markets have emerged in such countries which were in the initial stages of adopting free market economy. The the-ory of international trade suggests that increasing number of countries participating in international trade serves to socio-economic expansion of these countries.3 Therefore local entrepreneurs have to find ways to expand their busi-ness abroad. However, this is a challenging process due to complex nature of the global business life.

A firm that is involved in international trade must cope with several factors:• Roleofstateasaregulatoryinstitutionandlevelofstateinterventioninatargetcountryhaveto

be analyzed carefully. • Managinginteractionsamonggeographicallydispersedfirmsisanotheraspectofinvolvingglobal

business.4• Marketinggoodsandservicesindifferentcountriesandworkingwithlocalemployeesrequire

examiningvalues,norms,beliefsandexpectationsofforeigncultures.

The theory of international trade suggests that increasing number of countries participating in international trade serves to socio-economic expansion of these countries.

54

2 Business in the Global Context

• Workinginabusinessecosystemconsistsofbigandsmallplayersmayalsorequiredevelopmentofuniquestrategiesfororganizationalsurvival.

• Entrepreneurs as well as managers who have an intentiontocarryoutfirm’soperationsabroadhavetounderstandandexaminetheconceptofglobalizationcarefully.

Globalization Globalization refers to the integration of economic,

political, technological, social, and cultural systems aro-und the world, also discussed in Chapter 1. Globalizati-on differs than the internationalization process which is basically described as operating across national borders. The story of globalization begun with the tendency of first industrial firms to market their goods to other countri-es during the late 19th century.5Modernorganizations,which emerged after the first industrial revolution to meet the consumption demands of the increasing urban population, had to find ways for marketing excess suppli-estoothercountries.Westerneconomiesthatwereintheinitial phases of capitalism developed tools and regulati-ons to meet international trade needs of their industries.

Some authors highlight that history of globalization over the past 100 years has revealed some realities:6 1. Context-specificpoliticalapproachtoeconomieshassupportedphasesofglobalizationsincethe

beginningofglobalizationinlate19thcentury.Thus,intentionsofcountriestoopen-uptheirbordersandtoengageincross-borderandinternationaltradehavebeeninconsistent.

2. Whenevercountrieshaveintegratedtheireconomieswiththeothers,thespeedofeconomicgrowthwithintheparticipantcountrieswasincreasedcomparedtotheperiodsconsistingofraretradeinteractionswithothereconomies.

3. At the earlystagesofglobalizationpioneersandbeneficiariesweretheWesterncountries. However,theadvantagesofglobalizationhaveshiftedtothenon-Westerndevelopingcountries.The dissolution of Soviet Union countries in the early 90’s was the mi-

lestone of globalization. The sharp difference in terms of organization of the economicregimebetweenEastandWesthasbeguntodisappearafter90’s.Low raw material and labor costs in the new economies attracted foreign investors.Westernmultinationalcorporationshaveshiftedtheirproductionoperations to Eastern part of the world and they inevitably transferred tech-nicalknow-howtotheirnewlocalpartners.Westerncountries,whicharethe pioneers of globalization currently, deal with research and development activities, strategic management and organization of international operati-ons instead of production.

ThestoryofglobalizationinTurkeyisquitedifferentfromindustrializedWesterncountries.Thestatefinanced the industrialization processes through publicbanks and import substitution policies that shaped theeconomic activities until 1980s.7 Turkey had adopted astate-dependentandaclosedeconomicregimeduringtheseyears.The frequency of global interactionswas very low.However,liberalreformpolicies,whichwereadoptedafter

Globalization differs than the internationalization process which is basically operating across national borders.

Import substitution is an economic policy which defends replacing foreign imports with domestic products.

Globalization begun with the tendency of first industrial firms to market their goods to other countries during the late 19th century.

The collapse of Eastern Block and the emergence of new independent countries in the early 90’s was the milestone of globalization.

Entrepreneurs as well as managers who have an intention to carry out firm’s operations abroad have to understand and examine the concept of globalization carefully.

55


1980,haveenabledglobaltraderelationsandtheflowofforeigninvestmentsintothecountry(seeTable 2.1).ThedecisionsconcerningliberalizationoftheeconomicregimeinTurkeyhaveinvolvedtheremovalofcontrolfromtheexchangerates(andthecreationofregulatorychanges)toattractforeigninvestmentsandliberalizationofthefinancialsystem.8

Turkey has converted its economic strategy from aprotectionist model to a market oriented and an open perspective during the recent decades.9 Turkish state has signed several agreements concerning free trade between EuropeanUnionandTurkeyaftermid90’s.

Turkish state has signed several agreements concerning free trade between European UnionandTurkeyaftermid90’s.

The liberal reform policies inTurkeywereadoptedafter1980,thushaveenabled global trade relationsandflowofforeign investments into the country.

Table 2.1 1980–1990 Direct Foreign Investments to Turkey in USD (1980-1990)

Permitted Direct Investments Real Direct Investments

Annual Cumulative Annual Cumulative

1980 97.0 97.0 35.0 35.0

1981 337.5 434.5 141.0 176.0

1982 167.0 601.5 103.0 279.0

1983 102.7 704.2 87.0 366.0

1984 271.4 975.6 162.0 528.0

1985 234.5 1,210.1 158.0 686.0

1986 364.0 1,574.1 170.0 856.0

1987 536.5 2,110.6 171.0 1,027.0

1988 824.5 2,935.1 406.0 1,433.0

1989 1,470.5 4,405.6 738.0 2,171.0

1990 1,784.0 6,419.0 739.0 2,910.0

Source: Öniş, Z. (1999). State and Market: The Political Economy of Turkey in Comparative Perspective. Bogazici

University Press. VariousdevelopingcountriessuchasTurkeyarestilltryingtointegratetheireconomicsystemswith

the rest of the world to benefit from economic advancement opportunities brought by global trade.

56


Balance of TradeBalance of trade (BOT)isthedifferencebetweenacountry’simportsanditsexportsfora“giventime

period”.10BOTisanimportantindicatorshowingstrengthofacountry’seconomy.Acountrythatex-portsmorethanitimportshasatrade surplus.Onthecontrary,ifacountryimportsmorethanitexportshas a trade deficit.

Figure 2.1 Balance of Trade (USD)

Source: The World Bank, 2014.

Figure 2.1 shows trade of balance ranking of countries. It is surprising to see that leading economies such as United States, United Kingdom, France, Canada, Japan, and Australia have considerable levels of trade deficits. Countries like China, Russia, Germany, Italy, and Nordic nations have trade surpluses. It will be quite normal to expect high levels of trade surpluses from all developed countries. However, this controversial situation reflects reality of today’s globalization.Developednations have shifted their production operations to abroad – especially to the Far East-becauseofcostfactorsasmentionedbefore.Multinationalcorporationsofthese countries have decided not to outsource only their production activities but also other functions such as customer services. This has contributed to the export performance of the emerging Eastern countries but has increased imports ofthedevelopedWesterncountries.ThedependenceofindustrializedWesterncountries on energy sources is another factor which leads to trade deficits. Therefore Russia, Iran, and Arabic countries as major energy suppliers of the world have trade surpluses.

Balance of trade is an important indicator showing strength of a country’s economy.

IndustrializedWesterncountries are dependant on energy sources which leads to trade deficits in these countries.

Balance of trade (BOT) is the difference between a country’s imports and its exports for a given time period.

A country that exports more than it imports has a trade surplus. On the contrary, if a country imports more than it exports has a trade deficit.

57


Figure 2.2 Exports and Imports - Turkey

Source: www. morevance.com/turkey_economy-review/

DespiteholdingacriticalpositionbetweenEastandWestintermsoftrade routes, the data in Figure 2.2highlightthatTurkeyisamongthecountrieswhichhavemajor tradedeficits.Turkeyneeds rawmaterials,energy sources, and technical know-how from other countries to sustain its economic growth.

Multinational CorporationsA multinational corporation (MNC) is an organizational form, which has operations in more

than two countries and it consists of a central firm – usually in the home country- and branches or subsidiaries in foreign countries.11 The convergence of customer demands, business routines, and socio-demographic characteristics in many nations due to globalization have relatively enabled operations of MNCsinforeigncountries.12MNCsvaryintermsofthenumberofcountriesinwhichtheyoperate.13 TodayexceptionallylargeMNCscanoperateinover100countriesandmayhavehundredsofthousandsemployees.

LargeMNCsfacevariousproblemsduetoorganizationalcomplexity.Theseorganizationshavetotransfertheknowledge concerning managerial principles, company policies, production techniques, brand image, company specificinstitutionalizednorms,andvaluestotheirbrancheslocatedinnumerousnumbersofcountries.Top-level managers of these organizations also face the problem of finding the appropriate geographical design for their companies. Figure 2.3 shows organizational design of Pepsi Company for international operations. As it can be seen in the organizational chart Pepsi as an American company, has primarily focused on its operations in North America and then in neighboring countries and overseas locations.

A multinational corporation (MNC) is an organizational form, which has operations in more than two countries, and it consists of a central firm – usually in the home country- and branches or subsidiaries in foreign countries.

300,0

250,0

200,0

150,0

100,0

50,0

Export(Billion USD)

Import(Billion USD)

73,5

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

116,8 139,6 170,1 140,9 185,5 240,8 236,5 251,7 242,2 207,2 198,6202,

85,5 107,3 132,0 102,1 113,9 134,9 152,5 151,8 157,6 143,8 142,6

Turkey Export-Import

Billi

ons

USD

What are the realities ofglobalization?

1

58


Figure 2.3 Geographical Design of Pepsi Company

Source: https://www.slideshare.net/abdulhadi9998/pepsico-2014-presentation

The intention of Pepsi to give priority to organize business operations in close and neighboring countries is a common tactic of MNCs. The initial steps towards internationalization of MNCs usually start with entering markets that are most familiar to the home markets.14 It is easier to analyze and to organize operations in close regions that are familiar in terms of consumer behavior, economic system, trade regulations, and logistics.ThereforeitwouldbeagooddecisiontodecreasetheriskforaMNCto start with neighboring countries.

ThecriticalsuccessfactorsforMNCsemphasizedintheliteratureare:15

• Enteringintocomplexmarketstogainnewknowledge.• Recognitionandreputation.• Keystrategicpartnerships.

International operations of MNCs invarious countries may help transferringknowledgegainedthroughtheexperiencesintotheircountryoforigin.Thus,aMNCcontributes to innovation capacity, cross-cultural business connections, and globalawarenessinitshomecountrybygatheringvaluable context specific informationthroughout the world. A MNC mustbeperceived as legitimateby a society tosustain its operations in foreign nations.Many MNCs derive required guidanceconcerningvaluesystemandnormsoftheforeignculturesbyhiringlocalemployeeseventothestrategicpositions.Ali Haydar

Bozkurt who is the CEO of Toyota Turkey states: “Turkey’s geographical position provides advantage to the firms. Turkey may become automotive base of the region with facilitation”.(http://www.dunya.com/gundem/turkiye-bolgenin-otomobil-ussu-olmaya-aday-haberi-147356).

Ali Haydar Bozkurt, CEO - Toyota, Turkey

PepsiCoAmericasBeverage

(PAB)

PepsiCoInternational

(PI)

PepsiCo

PepsiCoAmericas

Food(PAF)

Frito-LayNorth

America(FLNA)

QuakerFoodsNorth

America(QFNA)

LatinAmericas

Foods(LAF)

PepsiAmericasBottling

(PAB)

PepsiBottlingGroup(PBG)

UnitedKingdom

and Europe(UKEU)

MiddleEast,

Africa, andAsia

(MEAA)

The initial steps towards internationalization of MNCs usually start with entering markets that are most familiar to the home markets.

International operations of MNCs in various countries may help to transfer knowledge gained through the experiences into their country of origin.

59


Corporate social responsibility (CSR) isexplainedinChapter1.Organizingorgivingsupporttocorporatesocialresponsibility(CSR)projectsisanotherwaytobuildrecognitionandreputationinforeigncultures.TheseCSRprojectsmayinvolvebeingsponsorsofimportantsportseventsorfamousteams,providingscholarshipstothepoorstudentsandsupportingdevelopmentoffineartsormusic.MNCs’decisionstochoosekeystrategicpartnersamonglocalcompaniesinthetargetcountriesalsodeterminethefutureofinternationalinvestments.KeystrategicpartnersactasbrokersormediatorsbetweenMNCsandlocalauthorities.Itisimportanttoseekforatrustworthy,legitimate,establishedandapowerfulpartnerinthetargetcountry.

Table 2.2 Local Partners of some MNCs in Turkey

MNC Local Partner Sector

Ford Koç Group Automotive

Coca Cola Anadolu Group Food and Beverages

Pierre Cardin Zorlu Group Textile

Carrefour Sabancı Group Retail

Hyatt Hotels Doğuş Group Tourism

Intergen Enka Group Energy

Unicredit Koc Group Finance

Estee Lauder Vepa Group Cosmetics

Baxter Eczacıbaşı Group Health

Armani Doğuş Group Fashion Industry

As shown in Table 2.2 some well-known multinational corporations have preferred to work with large, old, well-known, and powerful local partners in Turkey.Turkishcompanies’interactionwithforeignMNCsisnotlimitedwithestablishingpartnershipinthelocalmarket.TherearealsoTurkishMNCsthathaveinternation-aloperationsinseveralcountriesbyestablishingpartnershipwiththelocalcompaniesorMNCs.

International CompetitionItisnotsomeaningfultothinkaboutastrictdistinction

between national and international competition intoday’s global economy. A local entrepreneur who owns a smallmarketmayanytimefacewithcompetitivepressuresof international retail chains. There are important factsthat shouldbe consideredby anorganization,whichhasanintentiontocompeteininternationalmarkets:sizeandproductioncapacityaresomeofthesefactors.

Strategic partners abroad act as mediators betweenMNCsandlocalauthorities.

It is not so meaningful to think about a strict distinction between national and international competition in today’s global economy.

Corporate social responsibility (CSR) projects are a way of building recognition and reputation in a foreign country. It is important to seek for a trustworthy, legitimate, established, and a powerful partner in the target country.

60


The idea of creating a local automobile brand has been one of the well-known debates in Turkey. State officials have several times announced that they are going to support the local entrepreneurs who will invest in this project. However, the efforts to find an appropriate candidate have failed due to lack of interest of the Turkish businessmen to invest in such a project. Why Turkey hasn’t been able to create a national car brand despite intensive efforts of state officials?

Weshouldexaminetherealitiesofinternationalcompetitiontofindsomeanswerstothisquestion.There are several active international car brands in Turkish automotive market and these are linked to MNCs. These MNCs are not only manufacturing cars for Turkish market but also for their branches in other countries. MNCsgenerallyhaveanadvantagetoachieveeconomiesofscale.Economies of scaleisthecostadvantagethatariseswithincreasedoutputofaproduct.16 Therefore an entrepreneurtobeinvolvedinsuchaprojecthastoreachmillionsofproductioncapacityperyeartocompetewiththeinternationalautomobilefirmsandhastofindwaystomarketthenewnationalcarbrandglobally.Thisprojectrequireshugeinvestmentsandinvolvesseveralrisksforpotentialentrepreneurs.Thecasestatedaboveisatypicalexampledefininganimportantaspectofinternationalcompetition.Itisnotpossibletothinkaboutindependentcompetitionoffirmsintheglobalcontext.Firmshavetofindpartners,collaborate,andcooperatewitheachothertocompetewithbigplayers,whichhavedominatedinternationalmarkets.So,international competition referstoacomplexnetworkofmultipletypesofrelationsandinteractions.

International competition refers to a complex network of multiple types of relations and interactions.

Economies of scale is the cost advantage that arises with increased output of a product.

Devrim was the first automobile designed and produced in Turkey, in 1961.

61


Figure 2.4 Interorganizational Relationships and International Competition

* Black lines represent strategic partnerships, red lines represent investment relations among international firms.

Source: Daft, R. (2008). Organization Theory and Design. South-Western Cengage Learning, p. 178.

As illustrated in Figure 2.4evenverylargeandwell-knownMNCsengageinstrategicpartnershipsandcollaborate with the others to compete and to survive in global business arena. It is possible to observe that someMNCsprefertocollaboratewiththeirrivals.Anentrepreneuroramanagerhastoexaminecomplexcollaborative and rival networks very carefully to compete in such an integrative business environment. Otherwise international entrepreneurial decisions based on assumptions of classic competition may lead to failure.

Emerging MarketsScholarsandpractitionershavefrequentlyusedtheconceptof“emergingmarkets”withinthelastthree

decades. It is important to understand what this term means and why it entered into the international trade literature. Dutch-born American banker Antoine vanAgtmael created this term in1981 to avoidnegativeperceptionstowardsthetermssuchas“thethirdworld”and“developing countries”. 17 18 Emerging markets are the transitioneconomiessuchasBrazil,Russia,India,Mexico,Nigeria andTurkey that are characterized by high levelsof growth despite insufficient infrastructure.19 Emerging markets are quite different from western countries in terms of their cultural context, regulations and institutional arrangements.20 Regardless of challenging conditions to penetrate and to survive in emerging markets, firm managers in industrialized western countries have focused their attention to benefit from high rates of growth in these economies.21

Emerging markets are the transition economies such as Brazil, Russia, India, Mexico,Nigeria,andTurkeythatarecharacterized by high levels of growth despite insufficient infrastructure.

62


Table 2.3 Average Annual Percentage Growth of Real GDP in Major Advanced Countries in 2009-2015 and Forecast

for 2016-2017

FORECASTNation/Area 2009 2010 2011 2012 2013 2014 2015 2016 2017China 9.2 10.6 9.5 7.7 7.7 7.3 6.9 6.5 6.2India 8.5 10.3 6.6 5.6 6.6 7.2 7.3 7.5 7.5Russia -7.8 4.5 4.3 3.5 1.3 0.7 -3.7 -1.8 0.8Brazil -0.1 7.5 3.9 1.9 3.0 0.1 -3.8 -3.8 0.0South Africa -1.5 3.0 3.2 2.2 2.2 1.5 1.3 0.6 1.2Indonesia 4.7 6.4 6.2 6.0 5.6 5.0 4.8 4.9 5.3Mexico -4.7 5.1 4.0 4.0 1.3 2.3 2.5 2.4 2.6Argentina 0.1 9.5 8.4 0.8 2.9 0.5 1.2 -1.0 2.8Turkey -4.8 9.2 8.8 2.1 4.2 2.9 3.8 3.8 3.4

Source: International Monetary Foundation, 2016

Table 2.3 shows growth rates of leading emerging markets. As manufacturing has shifted from west to the eastern parts of the world, especially India and China have significantly increased their growth rates amongallotheremergingmarkets.Turkeywasalsoclassifiedasanemergingmarketwithpositiveratesofeconomic growth.

The literature on emerging markets suggests two ways to become successful in a target market: 1. Byestablishingmanagerialtiesandnetworks,2. Byachievingsuperiorcustomervalue.22

It seems alternative managerial techniques and strategies are required to organize operations effectively in emerging markets. Scholars have tried to provide information concerning context specific managerial techniques and strategies. These techniques and strategies are discussed later in this chapter.

POWER TACTICS AND ORGANIZATIONAL SURVIVAL STRATEGIES IN FOREIGN MARKETS

Global market environment requires a strategic approach to business challenges as well as a global managerialmindset.Powerfulglobalactorseithergovernments,MNCs,orinternationalorganizationsshapethe direction of competition in the world to a large extent. Companies must formulate international strategies in accordance with their resources, expansion goals, and anticipated key developments in international markets.

Features of Multinational CompetitionThere are numerous ways that companies may work together in

international operations, such as through joint ventures, licensing agreements, management contracts, or long-term contractual arrangements.23

A global company integrates its operations that are located in different countries. A multi-domestic company, sometimes called multinational company, allows each of its foreign country operations to act fairly independent. Thus, a global company and a multi-domestic company differ in the degree of integration among company operations in different countries.

“Youhavenochoicebutto operate in a world shaped by globalization and the information revolution. There are two options: Adapt or die. Andrews S. Grove

What are the critical successfactors for multinational corporations?

2

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In multinational competition, there are four issues that need to be considered:24

1. Whethertocustomizeproductsorservicesineachlocalmarketorofferstandardizedproducts/services.

2. Whethertoemploythesamegenericcompetitivestrategyeverywhereormodifythestrategyforeach country.

3. Whethertolocateacompany’sfacilities,distributioncenters,andcustomerservicesoperationsforlocationadvantages.

4. Howtotransferacompany’sresourcestrengthsandcapabilitiesamongcountriestosecurecompetitiveadvantage.

TherewouldbemanyreasonsforMNCstoexpandintoforeign markets as a way of growth. There is a close link between competitiveness and intentions of these firms to globalize their operations. The basic contributions of global business operations to a firm’s competitiveness are; cost reduction, spread of risk across wider environments, capitalization of core competencies, gaining access to new customers, and valuable natural resources.

In the globalizing world, the business endeavor necessitates to consider many diverse factors. For example, cultures and life styles differ remarkably among countries. Other factors could be listed as follows:

• Therearedifferencesinmarketdemographicsandincomelevels.• Therearevariationsinresearch,manufacturinganddistributingcosts.• Exchangeratesarefluctuating.• Therearedifferencesinhostgovernment,economicandpoliticaldemands.Considering the differences among markets; consumer tastes, preferences, and buying habits are

generally dissimilar. In addition, market size and growth potential, distribution channels, driving forces in global context, and competitive pressures are changing from one country to another. When thedifferences among markets are examined in detail, it is possible to observe significant variability in terms of manufacturing costs. For example, wage rates, worker productivity, inflation rates, energy costs, tax rates, and government regulations -sometimes interventions- would be different. Apparently, there is also variability in the quality of business environment. There would be different types and levels of clusters bringing together the suppliers, trade associations, and manufacturers of complementary products in different countries.

Fluctuating exchange rates affect the investment decisions and company’s competitiveness. Basically, fluctuating exchange rates affect exporters dependingupon manufacturing country’s currency power in positive or negative ways. Host country trade policies are also very important in the sense that for example, local content requirements, restrictions on exports, regulations on prices of imports, import tariffs, or quotas. There would be other regulations like technical standards, product certification, prior approval of capital spending projects, withdrawal of funds and ownership by locals.25

When companies buy and sell goods and services inthe global market place, they complete the transaction by exchanging currencies. This is called foreign exchange. Exchange rate means the number of units of one currency that must be exchanged for a unit of the second currency. Exchange rates can dramatically affect a company’s financial results by increasing or decreasing the cost of supplies it imports and the price of goods it exports.

The basic contributions of global business operations to a firm’s competitiveness are; cost reduction, spread of risk across wider environments, to capitalize core competencies, access to new customers, and valuable natural resources.

Fluctuating exchange rates affect exporters depending upon manufacturing country’s currency power in positive or negative ways.

https://www.weforum.org/reports/the-global-competitiveness-report-2016-2017-1

internet

Exchange rate is the number of units of one currency that must be exchanged for a unit of the second currency.

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Figure 2.5 shows ranking of first ten countries in terms of competitiveness.When a governmentbelievesthatfreetradeisnotinthebestinterestsofitsnationalsecurity,domesticindustries,workforce,orconsumers, itcan intervene inanumberofways.Someofthesemethodsarecollectivelyknownasprotectionismbecausetheyseektoprotectaspecificindustryorgroupsofworkers.Taxes,surcharges,ordutiesarrangedagainstimportedgoodsareknownastariffs.

There are two basic aspects of internationalization ofbusinessandthecompetition:multicountry competition and global competition. Multicountry competition andmarketcontestamongrivalsinonecountryarenotcloselyconnected tomarket contest inother countries. Inotherwords,thecompetitiveenvironmentineachcountryshowsdifferent and specific attributes. Buyers and sellers varyfromonecountrytoother.Also,industryconditionsandcompetitive forces ineachnationalmarkethavedifferentaspects.Afirm’scompetitiveposition inonecountrycanbeaffectedbyitspositioninothercountries.Insuchcases,thecompetitiveadvantageisbasedonafirm’sworldwideoperationsandoverallglobalstanding.

Taxes,surcharges,ordutiesarrangedagainstimported goods are known as tariffs.

Twobasicaspectsofinternationalizationof business and the competition are multicountry competition and global competition.

Exchange rates can dramatically affect a company’s financial results by increasing or decreasing the cost of supplies it imports and the price of goods it exports.

Figure 2.5 The World’s Most Competitive Countries

Source: Courtland L. B. & Thill, J. V. (2017). Business in Action (8th ed.). Pearson, p. 96.

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Competitive Strategies in Foreign Markets

Companiesdecideforgoinginternationalaswellaswhichstrategiestofollowbasedontheresourcesthey can allocate for international operations.Following strategyoptionsare frequently used to competeinforeignmarkets:26

• Exporting• Licensing• Franchising• GlobalStrategy

Export strategies use domestic facilities as a base for exporting to foreign markets. It is excellent initial strategy to pursue international success. Basic advantages are that exporting is a safe way to test in international environment; to minimize both risk and capital requirements; and to minimize direct investments in foreign environments. On the other hand, export strategies are vulnerable when the operation costs in home country are higher than in foreign countries; when the shipping costs are high; and adversefluctuationshappenincurrencyexchangerates.

Licensing is an appropariate choice when a firm has valuable technical know-how or a patented product but lacking international capabilities for positioning in foreign markets. If a firm desires to avoid risks of committing resources to unfamiliar, volatile, unstable markets, licensing would be a good start. Basic disadvantage is the risk of providing valuable technical know-how to foreign firms and losing some control over its use.

Franchising has a better fit in global expansion efforts of service and retailing companies. Franchisers expend only the resources to recruit, train, and support franchisees. Most of the costsand risks of establishing foreign locations would be carried by franchisee. The main disadvantage is how to maintain cross-country quality.

The strategic choice for a global strategy is to employ essentially the same strategies in all countries. For example: electronics such as smart phones; cleaning supplies, or hotel chains offer standardized products and service quality as well as price for sustaining brand reputation globally. Successful application of global strategies require competitive power in global markets based on features such as price, product quality, distribution channels, and/or local partners.

There would be three options for dealing with these specific conditions and buyer preferences. They are “think local – act local”,“think global – act global”,“think global – act local”options.27 Think local – act local approach varies its offerings and basic competitive strategy for different countries. Basic characteristics of this approach are that local managers are given considerable flexibilityandthatmarketinganddistributionareadapted to fit local customs and cultures.

Export strategies use domestic facilities as a base for exporting to foreign markets.

The strategic choice for a global strategy is to employ essentially the same strategy in all countries.

Licensing is an appropariate choice when a firm has valuable technical know-how or a patented product but lacking international capabilities positioning in foreign markets.

Franchising has a better fit into global expansion efforts of service and retailing companies.

Three options for dealing with these specific conditions and buyer preferences. They are “think local – act local”, “think global – act global”, “think global – act local” options.

66


There are significant differences in customer preferences and buying habits of countries. Host governmentsenactregulationsandstrictmanufacturingspecificationsorperformancestandards.Traderestrictions of host governments are so diverse and complicated. Various countries do not provide uniform, coordinatedworldwidemarketapproach.Asaresult,“think local act-local”approachbringsproblemsof transferring competencies across borders. And also it works against building a unified competitive advantage.

The think global-act global approach necessitates the same basic competitive approach in all countries where a company operates. In other words, same products under the same brand names are sold everywhere. Same distribution channels are used in all countries. Competition is based on the same capabilities and marketingapproachesworldwide.Strategicmovesareintegratedandcoordinated.Managerialemphasisis placed on building a global brand name.Transferring ideas, new products, and capabilities amongcountries are pursued.

Thirdoption,whichis“think-global, act local”approach,createsmuchmore convenient and culturally interoperable conditions. Glocalization is a kind of synthesis between globalization and local responsiveness. Under these circumstances, a company uses the same basic competitive theme in eachcountrybutallowslocalmanagerstobemoreflexibleto:

• Incorporatewhatevercountry-specificvariationsinproductattributesareneededtosatisfybuyers.

• Makewhateveradjustmentsinproduction,distributionandmarketingareneededtocompeteunderlocalmarketconditions.

Companies operating internationally ultimately aim to take competitive advantage in foreign markets. Competitive advantage is the superiority or an edge that a company gains over its rivals. For example: same quality but lower prices; higher brand reputation; better quality; more efficient distribution mechanism; or powerful local partners.

There would be three ways to gain competitive advantage: • Locatingactivitiesamongcountriestodecreasecostsonhigh

productdifferentiation.• Efficientandeffectivetransferofcompetenciesandcapabilities

fromonecountrytoanotherforcompanies.• Coordinatingdispersedactivities.

Strategic AlliancesIn order to build a global competitive advantage, activities might be required to concentrate in certain

locations. For example, if costs of production or transportation are lower; if there is a possibility of scale economies or if there is a steep learning curve effect in certain locations, it would be beneficial not to disperse the activities. On the other hand, if it is necessary to be close to buyers; if transportation costs or trade barriers support thedecentralizationoriffluctuatingexchangerates,supplyinterruptions,andadversepoliticsshouldbebuffered, activities should be dispersed.

Global competition can be achieved via cooperation and cooperative agreements with foreign companies. Purposes of strategic alliances are; joint research efforts, sharing technology, joint use of production on distribution facilities, and marketing one another’s products and services.

Purposes of strategic alliances are: joint research efforts, sharing technology; joint use of production on distribution facilities; and marketing one another’s products and services.

Glocalization is a kind of synthesis between globalization and local responsiveness.

Whatarethebeststrategiestocompete in foreign markets?

3

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Figure 2.6 Global Business Icons

Source: http://www.istockphoto.com/tr/vector/line-global-business-icons-

gm596368340-102239397

Figure 2.6 shows the icons, which symbolize important business concepts. These icons summarize the factors that should be considered for international entrepreneur. In international business environment there are many appeals and advantages of strategic alliances. These are listed below:28

• Betteraccesstofeasiblecountriesfromhostcountrytoimportandmarketproducts/services.• Captureeconomiesofscale.• Fillmissinginformationintechnicalexpertiseoflocalmarkets.• Sharedistributionfacilitiesanddealernetwork.• Takeadvantageofpartner’slocalmarketknowledgeandnetworks.• Combinecompetitiveenergiestowarddefeatingmutualrivals.

Under some circumstances, there would be pitfalls of strategic alliances such as:• Toovercomelanguageandculturalbarriers.• Todealwithdiverseorconflictingoperatingpracticesofpartners.• Toconsumetimeformanagersintermsofcommunication,trustbuildingandcoordination

costs. • Tocreatemistrustwhencollaboratingincompetitivelysensitiveareas.• Toclashinegosandcompanycultures.• Todealwithconflictingobjectives,strategies,corporatevalues,ethicalstandards.• Tobecometoodependentonanotherfirmforessentialexpertiseinthelongterm.

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The characteristics of emerging international markets may be different and as a result, competition in these markets should be arranged accordingly. Companies have to attract buyers with bargain prices and have to achieve a better fit to local requirements. Specially designed or packaged products may be needed to accommodate local market circumstances.Management teams for these firmsmust be consist of a mix of expatriate and local managers. For emerging markets, competition should be based on low price. The companies aiming at emerging markets may need to develop new business models to accommodate local conditions.

BUSINESS IN A MULTICULTURAL ENVIRONMENTInordertounderstandthemulticulturalaspectsofbusiness,itisnecessarytoanalyzetheinternational

dimensionsofbusinessanditskeyfoundationalconcepts.Iftheobjectiveistodealwithbothglobalizationand international environment; the firm should develop supportive corporate culture, the ability todeterminelocalneeds,andgainaccesstoworldwideinformationnetworks.

Cultural DiversityThe cultural, economic, social, and political

systems differ between countries. As culture is ablend of values in a society, it shapes the way ofdoingbusinessinorganizations.Inthisregard,italsoimpacts the business environment and determinestheworkplaceattitudesandbehaviorsinacountry.

There are diversities and cultural differencesamong countries that affect companies’international operations and strategies. Culturalvalues and social structure play a significant rolein determining success or failure in internationalmanagement. Culture can affect how managers lead, hire, and compete in various countries.29

Theseoperationsaredirectimpactofculture.Anotherwords,thelifeisshapedbytheculturalorientationsofpeople.Forexample,whenestablishingacompanyorachapterofanestablishedone inadifferentcountry,talentmanagementpracticesmayneedtobemodifiedinordertosuitlocalconditions.Whenitcomes to internationalbusiness, it is remarkable to seehow different cultures approach management. There iscertainlynoonewayofdoingbusinessandastechnologynarrows borders and globalization integrates the world’seconomies,developingasensitivitytohowotherculturesoperate, generally and in business, is becoming essential.For cultural clusters see Figure 2.7.

Culture can affect how managers lead, hire, and compete in various countries.

Companies have to attract buyers with bargain prices and have to achieve a better fit to local requirements.

How strategic alliances contribute to competitiveness ofMNCs?

4

Cultural diversity is colorful!

It is about differing values, perspectives, styles, and behaviors …

69


Ontheotherhand,indirectly,cultureevenaffectsthepoliticalandlegalsysteminacountry.Lawsarethewrittencodesofconductthatconstrainandguidetheactionsofcompanies.Therearemanydifferent legalsystemsused.Atthesametime,however,a lawmaybe constrained, altered or ignored totally because ofpoliticalconcerns.Inotherwords,alegalframeworkmay be changed if political powerchanges. Although thereisacloserelationbetween a country’s legal framework and its typical politicalactivity,eachshouldbecarefullymonitored.30

Ethical values are individuals’moral judgmentsaboutwhatisrightorwrong.Cultureisalsoaffectedbytheethicalprinciplesanddefinitionsofcorporatesocialresponsibility.Theconceptofbusinessethicsisnot something universally and strictly defined.Onthe contrary, ethics is already a complicated issue,endsupbeinganevenmoreintricatewhenwemove

fromcountrytocountry.Inturn,suchphilosophiesaffectwhatpeopleindifferentculturesthinkisethicalbehavior.Finally,theseperceptionscandrivebehavior,such as questionable payments (bribery), humanrightsatwork,andstandardsfortreatingemployees.Culturalrelativismhasbecomeapopularalternativeto universalism. Cultural relativism refers to the approachthatacountry’sownuniqueculture,laws,andbusinesspracticesdetermineethicalbehaviorsin

Ethical values are individuals’ moral judgments about what is right or wrong.

Universalism is widespread and objective sets of ethical guidelines exist across countries.

Cultural relativism refers to the approach that a country’s own unique culture, laws, and business practices determine ethical behavior in a country.

NEAR EASTERN

Turkey

İran

Greece

ARAB

FAR EASTERN

LATİN AMERİKA

İNDEPENDENT

LATİN EUROPEAN

ANGLO

GERMANIC

NORDIC

Abu-DhabiBahrain

OmanKuwait

Saudi Arabia

United Arab Emirates

MalaysiaSingapore

South VietnamPhilippines

IndonesiaTaiwan

Colombia

Japan

Brazil

İndia

İsrael

Peru

Mexico Chile

Belgium

France

United States

Switzerland

Sweden

Denmark

NorwayFinland

GermanyAustria

Canada

New Zealand

United Kingdom

Ireland

South Afrika

Australia

İtaly

PortugalSpain

Venezuela

Argentina

Thailand

Hong Kong

Figure 2.7 Ronen and Shenkar’s Country Clusters

Source: Ronen, S. & Shenkar, O. (1985). Clustering countries on attitudinal dimensions: A review and

synthesis. The Academy of Management Review, 10 (3), pp. 435-454.

Culture plays a significant role in determining success or failure in international business.

70


Even there are apparent rends for multinational companies to boost toward more competitive market economies; the ethical issues of emerging countries converting to capitalism are still the same. The reasons for this are week regulations, poverty, social problems and so on. Then, the social responsibility is perceived in different perspectives as a result of cultural diversities.

International Management and Culture

The implications for international management could be explained through evaluating cultural dimensions and categorizing by country clusters. How countries are clustered based on cultural values and to what extent cultural values affect employee attitudes need to be considered primarily in internationalization decisions. Culture impacts and shapes attitudes, beliefs, and behaviors. Since it is complex and rooted in history, traditions, language, geography, economic development and religion, the cultural conditions are dynamic and constantly evolving. That is why international managers should consider the culture together with the basic managerial decision areas such as employee motivation, human resource practices, organizational structure, strategy formation and implementation,conflictmanagement,negotiationtactics, and leadership styles.

The key point in managing multicultural and in-ternational business environment is to understand cultureandturnitintoanadvantage.Mostoftheresearch results show that companies are more suc-cessful when investors and managers consider local methods. However, managing culture is not easy be-cause it is complex, dynamic and there are common exceptions. There are many studies on culture, which had provided results to be utilized in international business endeavours. For example, Ronen and Shen-kar (1985)31 as shown with Figure 2.7, Hofstede (1991),32Trompenaars(1993),33TrompenaarsandHampden-Turner(1998)34 are very comprehensive

examples of cultural studies for international ma-nagers. Country clusters show important factors to be considered in investment decisions. The level of development and technological progress, geographic proximity, language, religious values, and beliefs are basic criteria in understanding the cultural tenden-cies of country clusters.

Culture can potentially impact just about everything, from how international business strategy is formed to specific human resources management practices. For successfully managing the impact of culture on international business, managers:

• Approachotherculturesbychangingyourstereotypesandwithcaution.

• Findculturalinformantsandreviewpracticesfromunfamiliarcultures.

• Learnmentalmapsthatwillincreaseeffectivenessindifferentcultures.

Likewise suggestions for international corporations:• Appointemployeeswhohavecognitive

complexityininternationalpositionssuchasexpatriateswithcross-culturalexperience.

• Emphasizein-countrytrainingandscheduleanorientationprogramforinternationalassignments.

• Becomealearningorganizationinrelationtoculturalunderstanding.

International managers should consider the culture together with the basic managerial decision areas.

Culture can potentially impact just about everything, from how international business strategy is formed to specific human resources management practices.

https://geert-hofstede.com/national-culture.html

internet

How does cultural diversity affects international operations of firms?

5

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International Integration of Turkish Economy

As was the case in many developing countries, Turkeyconsistently implemented a policy of import-substitution. In the 1950s Turkey restricted imports ofmerchandise for which domestic production was considered adequate (Krueger, 1995).Under the importsubstitution regime, selected fields including manufactured and agricultural sectors were protected from international competition by imposing quantitative restrictions on imports, controlling scarce foreign exchange, and providing substantial state aids for domestic enterprises among others.After1980s, anoutward-orientedgrowthmodelwasadopted toopenTurkisheconomyto internationalmarkets throughseveral legaland institutionalchanges.Today, theTenthDevelopmentPlan (2014-2018), a top-level policy text, distinctly recognises that the deepening multi-dimensionalglobalization process offers important trade and growth opportunities to a country, which can take measures againstrisksandthreatsbroughtbytheglobalization.Inthisrespect,Turkeyhasactivelyparticipatedinthework and negotiations of multilateral organisations and committed to their rules and remedies.35Moreover,post-1980reforminitiativesaimedatintegratingTurkisheconomywithinternationalmarketsthroughtwochannels: first one is foreign trade, and the second is foreign direct investment. 36 37

Inthecourseofthelasttwodecades,trade-relatedpoliciesofthecountryhavebeeninfluencedbythemultilateralagreementsofWorldTradeOrganisation(WTO),provisionsoftheCustomUnionwiththeEuropeanUnion(EU),FreeTradeAgreements(FTA)andcertainregionalinitiatives.38 TurkeyisafoundingmemberofWTO.Itisasingleinternationalinstitutionwith164membersasofMarch2017 so as to develop and enforce the rules of trade between member states since 1995, and a member ofGeneralAgreementonTariffsandTrade(GATT)since1951. The country has acted in accordance withrulesandnegotiationsofWTOandcontinuestopromoteliberalisationatmultilaterallevelaspart of its trade policy.39

Source: http://www.tim.org.tr/files/downloads/Reports

http://hbswk.hbs.edu/item/is-china-about-to-overtake-the-us-for-world-trade-leadership

Further Reading


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A Journey from Tokat to London: An Interesting Story of a Turkish Entrepreneur

The story of Huseyin Özer involves several aspects of how to become an international entrepreneur. He was born and raised in a villageofTokatin1949.Whenhewasachildhe was forced to leave his hometown because of problems with his family and he decided to live in Ankara as a homeless child. He worked as a street peddler and then he found a job in a bar. He slept in a depot and a communal toilet when he was in Ankara. He never went to school, he learned reading and writing by his own during his childhood. Then he went to İstanbul to improve his career in gastronomy and to gain experience in restaurant management. He worked in Istanbul as waiter and cook in various restaurants. He expanded his social network and had a chance to learn how to cook when he was in Istanbul. He met with an army officer who taught him introductory level English.

He decided to look for possible job opportunities in London and went there by bus instead of plane due to his limited budget. He started to work in a kebab shop and he tried to improve his English

while he was working there. He planned to open his own restaurant but he didn’t have enough money for that. One of the chief cooks gave him financial support to open his own workplace. Then he bought the kebab shop, which he worked in as, an employee and he turned it into a restaurant. He searched the waystorefineTurkishcuisinethatcouldbemoreappropriate for local and international customers. The first restaurant was located in bad district of London. Therefore he decided to open another restaurant in a popular region of London to serve for high-class customers. However, he didn’t have sufficient financial resources for that. He went to a bank and applied for credit. The only property he hadwashis first restaurant.Managerof thebankapproved the high-risk credit application after a visit to his restaurant. He added extra security measures – bulletproof windows- to his new restaurant to give service to important individuals such as ambassadors, royal family and state bureaucrats. Mr.Özer had developed his own social networkand had increased his reputation in the country. After a while, UK and other countries faced with bad consequences of economic recession. He used this period to create a chain of cafes to sell healthy food with reasonable prices. He also invested a lot to corporate social responsibility projects. He gave financial support to local NGOs and acted as an important figure in terms of trade relations betweenTurkeyandUK.CurrentlyMr.ÖzerownstheonlyTurkishcuisine-focusedrestaurant,whichrecommendedbyMichelinGuide.Hepreferredtodownsize the restaurant chain because of financial control problems but he got ideas to expand his business worldwide after designing appropriate auditing systems.

From an interview with Hüseyin Özer.For further information look at the following

web page. Source: http://huseyinozer.co.uk/tr/restaurants.aspx

In Practice


73

Sum

mary

LO 1 Understanding basic aspects and important issues that need to be considered for international trade

The theory of international trade suggests that increasing number of countries participating in international trade serves to socio-economic expansion of these countries. The sharp difference in terms of organization of the economic regime between East and West has begun to disappear after 90’s.Low raw material and labor costs in the new economies have attractedforeigninvestors.Multinationalcorporationsofthesecountries have decided not to outsource only their production activities but also other functions such as customer services. It is not so meaningful to think about a strict distinction between national and international competition in today’s global economy. An entrepreneur or a manager has to examine complex collaborative and rival networks very carefully to compete in such an integrative business environment.

LO 3 Identifying important and relative aspects of management in different cultures

There are diversities among countries and cultural differences that affect the companies to become internationalize. There is no doubt that culture plays a big role in determining success or failure in international management. Culture impacts everything and shapes attitudes, beliefs and behaviors. That’s why international managers should consider the culture together with the basic managerial decision areas such as employee motivation, human resource practices, organizational structure, strategy formation and implementation, conflictmanagement,negotiation tacticsand leadership styles. The key point in managing multicultural and international business environment is to understand culture andturnitintoanadvantage.Mostoftheresearchresultsshowthat companies are more successful when investors and managers consider local methods.

LO 2 Explaining power tactics and organizational survival strategies in foreign markets

There is a close link between competitiveness and intentions of these firms to globalize their operations. The basic contributions of global business operations to a firm’s competitiveness are; cost reduction, spread of risk across wider environments, capitalization of core competencies, gaining access to new customers and valuable natural resources. Frequently used strategies to compete in foreign markets are exporting, licensing, franchising, multicountry versus global, strategic alliances and joint ventures.


74

Test

you

rsel

f

1 Whichoneisnotoneofthecritical success factorsforMNCs?

a. Enter into complex markets to gain new know-ledge

b. Recognition and reputationc. Tohiretherightemployeesd. Key strategic partnershipse. None of above

2 In which case a country has trade deficits?

a.Whenacountryexportsmorethanitimportsb.Whenacountryimportsmorethanitexportsc.Whenexportsandimportsbalancedd.Whenexchangeratesincreasee.Whenexchangeratesdecrease

3 Organizing or giving support to__________ projects is another way to increase recognition and reputation in foreign cultures.

a. Corporate social responsibilityb. Research and developmentc. Local entrepreneurshipd. Governmentale.Marketing

4 Whichoneofthefollowingcountrycannotbe defined as an emerging market?

a. Russiab. Brazilc. Argentinad. Norwaye.Mexico

5 Which one of the following is partner ofSabancıTurkishinretail sector?

a. Baxter.b. Coca colac. Carrefourd. Armanie. Estee lauder

6 Which one of the following options isthe best when more convenient and culturally interoperable conditions are required?

a. Think local-act localb. Think local-act globalc. Think global-act locald. Exportinge. Licencing

7 Franchising has better fit into global expan-sion of ________ .

a. Production facilitiesb. Service and retailingc.Technicalknow-howd.Manufacturingactivitiese.Transportation

8 Whichoneofthefollowingisthedefinitionof universalism?

a. Ethical principles of corporationb. Unique culture and business practices of a

countryc.Widespread and objectives sets of ethical

guidelinesd. Ethical issues of emerging countriese.Morecompetitivemarketeconomies

9 Which one of the following would havenegative impact on international business?

a. Learning mental mapsb. Having cultural informantsc. Changing the stereotypesd. Becoming learning organizatione. Having in-country experienced managers

10 Which one of the following factor is notaffected by culture and business orientations?

a. Computer technologyb. Attıtudes of workersc. Behaviours of managersd. Leadership stylese. Human resources practices


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If your answer is incorrect, review “Balance of Trade”.

1. c If your answer is incorrect, review “Competitive Strategies in Foreign Markets”.

6. c

If your answer is incorrect, review “Multinational Corporations”.

3. a If your answer is incorrect, review “Cultural Diversity”.

8. b


2. b If your answer is incorrect, review “Competitive Strategies in Foreign Markets”.

7. b


4. d


5. c

If your answer is incorrect, review “International Management and Culture”.

9. e

If your answer is incorrect, review “International Management and Culture”.

10. a

Answ

ers for “Test yourself”

your turn 1

Globalization has started in the late 19th century and intentions of countries to engage in international trade have been relative due to their suspicious approach. However, the numbers of countries that have trade interactions with the others have increased because of high prosperity level brought by international business. OnlyWesterncountrieshavebenefitedinitiallyfromadvantagesofglobalization.

your turn 2

The critical success factors emphasized in the literature for MNCs are to gainexperiences from foreign markets, to increase legitimacy and to find key strategic partners. Organizing or giving support to corporate social responsibility (CSR)projects is another way to increase recognition and reputation in foreign cultures. MNCs’decisionstochoosekeystrategicpartnersamonglocalcompaniesinthetargetcountries also determine the future of international investments. Key strategic partners actasbrokersormediatorsbetweenMNCsandlocalauthorities.Itisimportanttoseekfor a trustworthy, legitimate, established and a powerful partner in the target country.

What are the realities of globalization?

What are the critical success factors for multinational

corporations?

Suggested answ

ers for “Your turn”


76

your turn 4

your turn 3

your turn 5

Global competition would be achieved via cooperation and cooperative agreements with foreign companies. Purposes of these alliances are joint research efforts, sharing technology, joint use of production on distribution facilities, marketing one another’s products and services.

There are several contingencies that should be considered before deciding best strategy in global arena. However, literature highlights some strategic options. Export strategies use domestic facilities as a base for exporting to foreign markets. Licensing is a good choice when a firm has valuable technical know-how or a patented product but lacking international capabilities to get in foreign markets. Franchising has better fitintoglobalexpansioneffortsofserviceandretailingcompanies.Manyformsofstrategic alliances may also help to increase impact in foreign markets.

National culture determines attitudes, beliefs and values of societies. Culture is formed through history, traditions, language, geography, economic development and religion. Therefore international managers should consider the culture together with the basic managerial decision areas such as employee motivation, human resource practices, organizational structure, strategy formation and implementation, conflictmanagement,negotiationtacticsandleadershipstyles.

What are the best strategies to compete in foreign markets?

How strategic alliances contribute to competitiveness of

MNCs?

How does cultural diversity affects international operations

of firms?

Sug

gest

ed a

nsw

ers

for

“You

r tu

rn”

1http://www.estanbul.com/ataturkun-ticaret-ile-ilgili-sozleri-410553.html#.WPbzFzLBI_U

2Choi,J.Y.(2016).Internationaloutsourcing,termsof trade and non-immiserization. International Review of Economics and Finance, 43, pp. 222–233.

3Niroomand, F. & Nissan, E. (1997). An inquiryinto openness in international trade. Journal of Economic Studies, 24(3),pp.167-178.

4(2016). International trade and emergingmarkets:the importance of managing the key strategy drivers. Strategic Direction, 32(5),pp.22-24.

5Kunnanatt, J. T. (2011). Global business chainand twin advantage: strategic opportunities for

developing countries, Competitiveness Review: An International Business Journal, 21 (4), pp. 352-368.

6Ibid.7Özcan, B. G. & Çokgezen, M. (2003). Limits to

alternative forms of capitalization: The case of Anatolian holding companies. World Development, 31 (12),pp.2061-2084.

8Öniş, Z., (1999). State and Market: The Political Economy of Turkey in Comparative Perspective. Bogazici University Press.

9Buğra, A. (2003). The place of the economy inTurkish society. The South Atlantic Quarterly, 2 (3),pp.453-470.

endnotes


77

10http://www.investopedia.com11Kogut, B. (2001). Multinational corporations. In

N. J.Smelser,&P.B.Baltes (Eds.),International Encyclopedia of Social and Behavioral Sciences, (pp.10197–10204). Elsevier Science Ltd.

12Cleveland,M., Rojas-Méndez, J. I., Laroche,M.,& Papadopoulos, N. (2016). Identity, culture,dispositions, and behavior: A cross-national examination of globalization and culture change. Journal of Business Research, 69 (3), pp. 1090–1102.

13Kogut, op. cit.14 Callaway, S.K. (2008).Global corporate ventures: a

new trend of international corporate entrepreneurship. Multinational Business Review, 16(3),pp.1-22.

15Li,Q.&DengP.(2017).Frominternationalnewventures to MNCs: Crossing the chasm effecton internationalization paths. Journal of Business Research, 70, pp. 92–100.

16http://www.investopedia.com/terms/e/economiesofscale.asp

17Lozano,J.M.(2011).Whatemergeswhenamarketemerges? Corporate Governance: The International Journal of Business in Society, 1(4),pp.315-326.

18Rottig, D. (2016). Institutions and emergingmarkets: effects and implications for multinational corporations. International Journal of Emerging Markets, 11(1),pp.2-17.

19Tanusondjaja,A.,Greenacre,L,Banelis,M,Truong,O., & Andrews, T. (2015). International brandsin emerging markets: the myths of segmentation. International Marketing Review, 3(6),pp.783-796.

20Gruber-Muecke,T.&Hofer,K.M.(2015).Marketorientation, entrepreneurial orientation and performance in emerging markets. International Journal of Emerging Markets, 10(3),pp.560-571.

21Craig,C.S.&Douglas,P.S.(2011).Empoweringrural consumers in emerging markets. International Journal of Emerging Markets, 6(4),pp.382-393.

22Gruber-Muecke&Hofer,op.cit.23Daniels, D. J., Radebaugh, L. H., & Sullivan, D.

P.(2004).International Business: Environment and Operations(10th ed.). Pearson Prentice Hall.

24Thompson, A. A., Strickland, A. J., & Gamble, J. E. (2015). Crafting and Executing Strategy: Text and Readings (15thed.).McGrawHill,Irwin.

25Bovee,C.L.&Thill,J.V.(2017).Business in Action (8th ed.). Pearson.

26Thompson, et. al., op. cit.27Ibid.28Ibid.29Mc Farlin, D. B. & Sweeney, P. D. (2006).

International Management: Strategic Opportunities and Cultural Challenges(3rded.).HoughtonMifflinCompany.

30Ibid.31Ronen, S. & Shenkar, O. (1985). Clustering

countries on attitudinal dimensions: a review and synthesis. Academy of Management Review, 10, pp. 435-454.

32Hofstede, G. (1991). Cultures and Organizations; Software of the Mind.McGrawHill.

33Trompenaaars, F. (1993). Riding the Waves of Culture. Brealey.

34Trompenaars F. &Turner, H. (1993). Riding the Waves of Culture: Understanding Cultural Diversity in Global Business.McGrawHill.

35Ministry of Development- MoD (2014). TenthDevelopmentPlan,2014-2018.http://www.mod.gov.tr/Lists/DevelopmentPlans/Attachments/5/The%20Tenth%20Development%20Plan%20(2014-2018).pdf

36Central Bank of the Republic of Turkey-CBRT (2002). The Impact of Globalization on the Turkish Economy. http://www.tcmb.g o v. t r / w p s / w c m / c o n n e c t / 2 4 8 0 6 a 9 8 -8219-4717-a6be -d77eac f6539c /g loba l .pdf?MOD=AJPERES&CACHEID=24806a98-8219-4717-a6be-d77eacf6539c

37WorldTrade Organisation - WTO (2016). Trade Policy Review: Turkey. report by the Secretariat, WT/TPR/S/331, https://www.wto.org/english/tratop_e/tpr_e/s331_e.pdf

38Ibid.39MoD,op.cit.

78

Chapter 3 Management

Lear

ning

Out

com

es

Describe the management structure.

Understand the managerial roles that managers play in different settings.

Identify the anatomy of leadership.

Define management and relevant terms.Explain the management process and the functions of management.

Distinguish basic management skills.

Describe the leadership process in comparison to management.

Explain the communication process and forms of communication in organizations.

357

1 2468

Chapter OutlineManagement - Terms and definitionsManagement FunctionsManagement StructureManagement SkillsManagerial RolesLeadershipCommunication in Organizations

Key TermsManagement

Manager Management functions

Managerial levelsManagement skills Managerial roles

Leadership Communication


79


The concept of “management” is unavoidable in our daily lives and thereby is shaped by critical processes in environments such as governments, business organizations, and civil society organizations. Businesses—family owned or corporate entities, local or regional, national or multinational, depend on a variety of management skills and approaches to function. How well they function, depends on a multitude of factors, most of which will be discussed in this chapter.

The quickening pace of economic, political, social, and especially tecnological forces of change in the 21st century make this a vital question: How can we manage more effectively? There is no one single answer. The best management practice changes from one set of circumstances to another. Although management can be defined in simple terms such as “achieving goals through others”, it is in fact much more complicated. We have witnessed extraordinary business success stories from Eti to Arcelik, from Google to Virgin, from Alibaba to Amazon as well as examples of catastrophic mismanagement as poorly managed busineses such as Eastman Kodak succumb to the forces of global change. We expect that managers and leaders at all levels in different types of organizations strive to be ahead of others and to gain competetive advantage by possessing distinctive skills, knowledge, experience, and motivation. But this is not always the case. It depends on the environmental context that each managed entity finds itself. It is the evolutionary biology equivalent of the survival of the most fit or the most fortunate.

Attaining the desired goals require efficient deployment of resources, effective planning, organizing, a leadership process, and control of the actual results compared to the standarts or expected autcome. This chapter composes the foundational topics of management: We begin by defining management and manager; the management process and its functions of planning, organizing, leading, and controlling are introduced; management structure and management levels as well as managers’ skills and roles are explained in general terms; the basics of the leadership process is described; The chapter ends with explaning the function and significance of communication process in organizations.

Management topics will be explained and discussed with more details in the Business Management book.

MANAGEMENT – TERMS AND DEFINITIONSManaging is a complex task. It is critical to success and gaining competetive advantage. It is important

therefore to examine some of the many elements that comprise the content of the term “management”.

Definition of ManagementManagement or to manage can be defined in different terms. The simplest definition for management

is “achieving goals by the contribution of others” which applies to any formal and informal management environment with a variety of goals.

Some definitions for management in the literature include: “The design of an environment in which people working together in groups can accomplish objectives”;1 Mary Parker Follett stated that “Management is the art of getting things done through people”.2

Management is also defined as a process which reflects a more sophisticated task environment. It is “The attainment of goals by others through planning, organizing, leading, and controlling activities”. This definition is about the management functions which will be explained in the following sections.

The above-mentioned definitions emphasize elements pertinent to the management environment. These key elements are; goals, people, and activities relevant to the management environment.

Management is achieving goals by the contribution of others.

Management can be defined as a process: the attainment of goals by others through planning, organizing, leading, and controlling activities.

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3 Management

Another definition for management refers to key terms in business: “Management is coordinating and overseeing the work activities of others for completing their work efficiently and effectively”.3 This definition for management is a focus on organizational performance which is the ultimate goal of organizations of any type as well as the people managing these organizations. Organizational performance is measured by effectiveness and efficiency. Organizational effectiveness is the degree to the achievement of organizational goals based on the statements and expectations. Organizational efficiency on the other hand is about the amount of overall resources used for the achievement of an organizational goal.

Organizational performance is at the highest when effectiveness and efficieny is well balanced. A company is effective when it manufactures high quality products regarding its core competition in the market, but not fully efficient if the costs such as raw materials and labor are higher than that of its competitors. Successful companies, managers, and high- achiever CEOs are those who manage to balance these performance indicators to reach various levels organizational goals.

MANAGEMENT FUNCTIONSManagement is a process through which required resources are utilized by a sequence of functions

starting with planning, followed by organizing, leading, and controlling for attaining organizational goals. Although each of the functions takes part and contributes to the management process from a different perspective, they are interconnected and complement each other (Figure 3.1).

OrganizingDetermining tasksand departments/

units, assigning workforce, obtaining the

overalall workenvironment

ControllingMonitoring,

comparing what isplanned and what is

achieved, takingcorrective steps

PlanningIdentifying goals,

reviewing thealternatives, decidingwhich alternatives to

employ

LeadingMotivating and

guiding towards thegoals

Figure 3.1 The Management Process

Organizational effectiveness is the degree to the achievement of organizational goals.

Organizational efficiency is about the amount of overall resources used for the achievement of an organizational goal.

Compare the impact and role of effectiveness and efficieny on organizational performance.

1

Organizational performance is the highest when effectiveness and efficiency is well balanced.

81


PlanningManagerial planning is the guide function for

the management process. It provides managers the answers to: What? When? Where? and How? Planning is identifying goals and deciding which tasks that will be performed and the resources that will be utilized for reaching these goals. In other words “Managerial planning defines where the organization wants to be in the future and how to get there”.4 The planning process is carried out by identifying goal/s, reviewing the alternative ways or methods including the resources involved, and deciding which alternative/s to employ. At the end of this process plans of different types are generated, either short, medium, or long term as well as strategic plans. Planning is often mentioned with decision-making which is a process with similar approaches and steps. Also, the planning process requires certain decisions such as choosing the most applicable one amongst alternatives for attaining goals.

The basic planning process applies to any type of organizational activity that requires planning for the success of near- and long-term outcomes: An investment, a new recruitment method; a new product; geographic expansion, and similar outcomes are examples of activities that need to be planned. Planning and decision making will be detailed in the content of the Business Management course materials.

OrganizingThe organizing function of the management process

follows planning and provides the appropriate work place for implementing the plans. In other words, organizing the work place enables the managers to start the operations in alignment with the organizational goals and plans. The organizing process is determining tasks relevant to goals; grouping tasks by departments; assigning the work force for specific tasks; deciding the authority relationships, and preparing the work environment which includes allocating equipment, technology, and personnel.

Organizational structures are formed depending on the sectors, goals, resources, and environmental dynamics. For example, an advertising company must be organized in a more flexible way than a construction company; a digital start-up’s operational environment is technology based.

Management is a process through which required resources are utilized by a sequence of functions starting with planning, followed by organizing, leading, and controlling for attaining organizational goals.

Planning is identifying goals and deciding which tasks that will be performed and the resources that will be utilized for attaining these goals.

Organizing is determining tasks relevant to goals; grouping tasks by departments; assigning the work force for specific tasks; deciding the authority relationships, and preparing the work environment which includes allocating equipment, technology, and personnel.

Managerial planning is the guide function for the management process. It provides managers the answers to: What? When? Where? and How to do?

Organizing the work place enables the managers to start the operations in alignment with the organizational goals and plans.

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3 Management

LeadingLeading, also referred to as directing, is more dynamic than

planning and organizing functions. Leading, in other words the leadership process, is about guiding the organization and/or the group towards the goals. Leading involves more complex activities than what managers do.5 A manager is the person who does the managing job; a leader guides and motivates employees or groups for attaining goals.

Leading involves influencing and motivating people as well as being in constructive communication. Accordingly, “leadership is the ability to influence people for attainment of the organizational goals”.6 Leading styles differ by goals, environmental factors and leaders’ choices. The leadership process and styles will be discussed further in your Business Management book.

ControllingManagers are responsible for ensuring the achievement of goals. Controlling is the monitoring function

of the management process and is critical for the success of other management functions. The progress towards the organizational goals of any type is monitored, measured, assessed, and if necessary modified through the controlling function. Organizational performance and managerial activities, at any level, as well as decisions must be measured by standards, plans, and expectations which is achieved by the control process.

The control process involves establishing standards and/or plans for the process/es subject to controlling; measuring the outcome or performance; overseeing the match between the standarts and actual performance for a given process; and applying corrective measures, maintaining a present course of action; or formulating a new or modified plan of action as necessary. Therefore, the control process involves feedback activities which enable the managers to maintain, develop, and dig into the sources of failure correlated with results (Figure 3.2). Various level plans, departmental budgets, market share, or product quality are subject to the control process. Controlling is about measuring the organizational performance which is mostly about financial performance.7 Types of control utilized in organizations are multifaceted according to specific goals, including internal and external auditing.

The control function is not only necessary for monitoring the routine flow of operations but also critical to responding to unexpected environmental developments or incidents such as unethical internal actions, fraud, or manipulation. For example, the Volkswagen (VW) emissions scandal. It was a consequence of the willingness to engineer false results in the testing of its diesel engines in an effort to eclipse Toyata as the world’s largest car manufacture. This breach VW’s CEO Hans Dieter Potsch’s press meeting points out to a lack of internal control. According to Mr Potsch, the problem was the “misconduct and shortcomings of individual employees,” insufficient internal processes to detect such fraud, and “a mindset in some areas of the company that tolerated breaches of rules”.8 This catastrophic breach of ethics and the control process has cost VW billions of

Set up goals,plans, strategies

Measure outcome/performance

Compare what isexpected to what

is realized

Take necessaryactions

Send signals for more e�ective processes

Feedback

Figure 3.2 Control Process

Leading is about guiding the organization and/or the group towards the goals.

Leadership is the ability to influence people for attainment of the organizational goals.

A manager is the person who employs the managing job.

A leader guides and motivates employees or groups for attaining goals.

83


dollars and billions remain to be calculated. British Petroleum’s fiasco in the Gulf of Mexico is another example of a catastropic failure of the control process.

The practice of management is subject to change based on the circumstances from one period of time to another. The evolution of the management thought and practice is analyzed in several periods: Classical management; humanistic (neo-classical) approach; quantitative approach; modern approach; and post-modern management practice. For classical management thought see Chapter 6. Also, the evolution of the management thought will be explained in the Business Management course and book.

MANAGEMENT STRUCTUREThe management structure indicates the

hierarchical design of an organization. According to a study by Zitek and Tiedens9 employees may prefer hierarchical relationships to organizational equality, which is based on the opinion that hierarchical structures provide more clarity. Paradoxially, the

team-based approach of diffusing management functions among teams of employees has gained popularity in certain countries such as the United States. It flattens out hierarchical structures of decision-making, boosts the morale of professional and blue-collar workers, and makes shared responsibility more timely and responsive to the changing demands of a company’s services and products.

Organizations are managed by different approaches based on factors such as resources, sector, company type and size, sector, operational field, goals, culture, and managers’ choice. Different managerial styles lead to a range of organizational structures from vertical or highly hierarchical to flat or flexible work environments. Although different managerial approaches affect the organizational design, the management structure in general terms is hierarchical and also referred to as managerial pyramid or hierarchy. Managerial hierarchy reflects the “chain of command and the flow of coordination, communication, and control” which is reflected in organization charts.10

An organization chart is a visual diagram that shows the relationships among people and divides the organization’s work.11 Managerial hierarchy also identifies managers’ scope of authority and responsibility, power, and skills that vary by hierarchical levels.

Apple had to go through a reorganization process in the post-Steve Jobs era including the new CEO Tim Cook’s responsibilities and authority relations. Tim Cook is placed in the CEO position in the new organizational chart which would appear to be in keeping with the more traditional management pyramid.12

Control process involves establishing standarts and/or plans for the process/es subject to controlling; measuring the outcome or performance; overseeing the match between the s and performance for the given process; and taking necessary actions.

Management structure in general terms is hierarchical which is also referred to as managerial hierarchy or managerial pyramid.

An organization chart is a visual diagram that shows the relationships among people and divides the organization’s work.

Compare the management functions. Which management function contributes more to the management process?

2

Controlling is the monitoring function of the management process.

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3 Management

Management LevelsThe management structure in traditional terms involves three basic layers: Top/executive, middle, and

first line/supervisory levels (Figure 3.3). At the base of the pyramid non-managerial or non-supervisory employees reside. These three management levels are interconnected although each management level has a different set of functions and requires different managerial qualifications.

The number, title, and functions of management teams at each level differ according to the administrative choice with the highest authority as well as size and organizational or sectoral needs.

Top/executive managementTop management is at the highest level of the management structure of a corporation, a holding

company, or an institution. Top management involves key titles such as board of directors, chief executive officer (CEO), chief operating officer (COO), rector, president, vice president, or executive director. Top management teams are responsible for the entire organization and ensures the coordination of overall activities aimed at the achievement of ultimate goals. The work teams at this level oversee a company’s vision, monitor the environment, develop the strategic plans, represent the organization and establish primary relationships in the external environment in keeping with organizational goals. Research points out that top managers’, such as CEO’s individual reputation either positive or negative plays a significant role in the overall reputation of the company and has direct impact on its standing in the stock market.13

Middle managementMiddle managers are department heads, branch, or plant managers.

Middle level management is responsible for overseeing the contribution to the organizational goals and strategies developed by the top management. Middle managers encourage and support their teams for establishing division plans and attain organizational performance at the highest level in compliance with the division or department goals as well as the organization’s ulitimate goals. A top management team for a food company sets a strategy for increasing the market share for a given time;a marketing division employs market research for reaching a new customer groups as well as looking

Non-managerial / Non-supervisory employees

Top/Executive management

Middle management

First Line / supervisory management

CEO, COO, President, Vice-president, Rector,Board of directors

Division head, Plant manager, Dean

Section chief, Project leader, Supervisor, O�cemanager

Figure 3.3 Management Levels

Middle managers play a critical role as a bridge between top management and first-line management for transferring messages, reports, expectations, or directives.

85


for new distribution channels; and a finance department looks for addititonal and efficient sources for financing the manufacturing and marketing of new products.

Middle managers also play a critical role as a bridge between top management and first-line management for transferring messages, reports, expectations, or directives.

First line/supervisory managementFirst-line managers are supervisors, branch managers,

section chiefs, shift managers, or project leaders. First line management teams are primarily responsible for implementing the operations in departments, divisions, or any type of horizontal unit which they achieve by non-managerial employees (Figure 3.3). A project leader in an R&D division or a shift manager in a plant work directly with non-managerial employees, guide, motivate, and monitor their work. They are in charge of short-term action plans based on the functional strategies and plans imposed by the middle management in accordance with the ultimate goals of the company or organization.

As the business environment changes towards more dynamic sectors and more flexible organizational cultures, the hierarchical configuration becomes looser as well such as the team or project based structures. Accordingly, the management structure becomes more horizontal.

An organizational culture is shared values, beliefs, and attitudes that provides its members with a common understanding of the organizational norms and their roles. “NASA (National Aeronautics and Space Administration) is a space organization with a strong emphasis on equality in the work place and task orientation, therefore is composed of teams or project groups”.14 Shein refers to organizational culture as a pattern of basic assumptions that a group learns as it solves issues of external adaptation and internal integration.15

Compare the essentiality of different managerial tasks based on the levels in the hierarchical structure.

3

Top management teams are responsible for the entire organization and ensures the coordination of overall activities towards the achievement of ultimate goals.

Middle level management is responsible for overseeing the contribution to the goals and strategies developed by the top management.

First line management team is primarily responsible for implementing the production operations in departments or any type of horizontal unit which they achieve by non-managerial employees.

As the business environment changes towards more dynamic sectors and more flexible , the hierarchical configuration becomes looser.

Organizational culture is shared values, beliefs, and attitudes that provides its members with a common understanding of the organizational norms and their roles.

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3 Management

MANAGEMENT SKILLSManagement skill is a combination of knowledge, behaviors, and attitudes for performing a task.

The higher the quality level the more performance there is. Three basic skills were introduced by Robert Katz as conceptual, human, and technical.16 Also management skills such as communication, decision

making, and time-management skills were added to the traditional skills by Katz. We must emphasize that each one of the management skills is important for organizational performance whether in a company, university, or a governmental organization.

Conceptual skills are related to seeing the organization as a whole to reach, coordinate, and integrate resources to attain established goals throughout the organization. These goal-oriented skills are especially critical for monitoring as well as analyzing the organizational environment and developing aligned strategies which directly impact the activities of various divisions or functions of an organization.

Human skills, also referred to as soft skills, are related to establishing constructive relationships with other members of a group. Possession of such skills enables managers to effectively motivate, communicate, coordinate, and lead.

Technical skills involve job-specific knowledge, experience, and ability for performing the tasks at a proficient level. Technical skills are directly related to the use of technology, machinery, techniques, methodology, or tests for performing a specific task with high performance.

Management Skills by Managerial LevelsSkills that are most necessary for managers vary

according to managerial levels. Figure 3.4 shows the correlation between the management level and the core skill/s expected to be possesed by a manager at that level. It must be underlined that although each managerial level requires certain set of skills all managers utilize a range of skills from conceptual to technical depending on the necessities of the tasks they are performing or activities that they are managing.Conceptual skills and managers

Conceptual skill, are most critical for top/executive managers. Such analytical ability provides top managers with a strong understanding of the internal and external environment of their organizations and reinforces the quality of strategic decision policies. A CEO of a company, board of directors, or a university rector has to have a long-term vision, be innovative, coordinate the top teams’

Conceptual skills are related to seeing the organization as a whole to reach, coordinate, and integrate resources to attain established goals throughout the organization.

Human skills also referred to as soft skills, are related to establishing constructive relationships with other members of a group.

Technical skills involve job-specific knowledge, experience, and ability for performing the tasks at a proficient level.

Management skill is a combination of knowledge, behaviors, and attitudes for performing a task.

Top /Executive

MiddleManagement

First Line /SupervisoryManagement

Strategic, analytical, monitoring, decision making,representing, resource allocation

Conceptual skills

Leading, inspiring, coordinating,communicating, motivating, listening

Human skills

Job speci�c knowledge,experience, expertise

Technical kills

Conceptual skills

Human skills

Technical skills

Conceptual skills

Human skills

Technical skills

Figure 3.4 Management Skills and Levels of Management

87


activities, and be able to see the big picture. In this way, he or she creates an optimal and powerful position for the organization in the external environment.

Yemeksepeti CEO Nevzat Aydın mentions about “Leveraging 15 years of know-how and innovative business approach to new regions with Delivery Hero” which is one of the leading companies in online and mobile food ordering.17 Conceptual skills are also important for middle management, as displayed in Figure 3.4 Skills such as having a broad vision, monitoring, or analytical ability enrich the capacity of middle management to adjust and develop the functional operations. Functional strategies and goals set at the departmental level are critical for the attainment of ultimate goals and therefore support the success of the overall organization.

Human skills and managersHuman skills (soft skills) must be most

mastered by middle level managers. The basic function of middle management is leading their departments’ activities and inspiring employees with high performance for contributing to the ultimate organizational goals. Middle managers also play a critical role as a bridge between top management and first-line management for transferring messages, expectations, or directives from top to bottom and vice versa.

Human skills are about communicating and working effectively with people from all types of backgrounds, different personalities, and cultural values. Therefore, other than middle managers, this set of skills is necessary for all managers of any type or hierarchical position. A CEO whose responsibilities include establishing relationships with

the external stakeholders or a project leader who, as a first-line manager, is in charge of completing a group of tasks at an optimum performance level must possess a blend of interpersonal competencies.

Technical skills and managersTechnical skills are directly related to the

task itself and must be possessed by the first-line managers whose task is to see jobs to completion. First-line or supervisory-level managers need not only the technical knowledge relevant to the tasks they are supervising but also must be able to monitor the performance and quality of the employees’ jobs. The expert and efficient use of technology, marketing research, HR training, or the creation of software are just some examples of technical skills that first-line managers of related departments are expected to possess.

Conceptual skills are most critical for top/executive managers.

Human skills must be most mastered by middle level managers.

Technical skills are directly related to the task itself and must be possessed by the first-line managers.

Discuss and compare technical skills regarding electronics and tourism sectors.

4

Human skills are necessary for all managers of any type or hierarchical position.

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3 Management

MANAGERIAL ROLESManagers at any level or position are responsible

for a variety of tasks, mostly during work hours but given the access to information and communication technologies (ICT), any time or place. In order to achieve high performance managers are demanded to play a range of roles from adversely critical to complementary depending on the management level and specific factors such as the work environment. A role is defined as behaviors and applications expected of someone relevant with her/his position. A manager’s most expected role is to achieve goals with and by others. However, the term manager stands for an “authority”, a “leader”, a “guide”, a “director”, a “representative”, or a “negotiator” which is in most cases a blend of expected roles. In other words, a manager needs to find her/his way out efficiently and effectively in a “management labyrinth”. We can refer to this variety of roles as “wearing different masks”.

A project director is likely to play different roles through different styles. As a first-line manager her/his primary responsibility is to guide his team to

complete the project on time at a given quality level. This requires discipline and authority to a certain extent. For the same purpose s/he needs to apply a motivating and inspiring approach as well as being a part of the team which this time requires a more flexible management approach.

The basic managerial roles are described in three groups as Interpersonal Roles, Decisional Roles, and Information Roles.18 The significance of different roles that managers perform is based on management level, environmental circumstances, and skill-sets.

Interpersonal RolesBased on the definition that “Management is

attaining goals by and with others”, a manager’s job is dealing with people inside and outside the organization. The interpersonal roles of managers are about relationships with internal and external stakeholders such as employees, customers, relevant interest groups, or suppliers - even communities where a company has its headquarters or markets its goods or services.

First of all managers are expected to act as leaders, for being role models to motivate, support, and for guiding others in their self-development and, in effect, to become part of an inspirational

A role is defined as behaviors and applications expected of someone relevant with her/his position.

Interpersonal roles are about relationships with internal and external stakeholders.

A manager needs to find her/his way out efficiently and effectively in a “management labyrinth”.

All managers utilize a range of skills from conceptual to technical depending on the necessities of the tasks they are performing or activities that they are managing.

89


work force. The leader role is more attached to first-line managers who are in one-on-one work relations with non-manager employees such as members of a work team. Middle level functional managers as well as top level management teams also depend on leadership skills. A charismatic executive is influental not only with the groups and individuals throughout the organization but also affects the external organizational image.

Managers can act as representatives for a corporation with outside stakeholders. A board member hosting a prospective partner is acting as a representative of the company.

Interpersonal roles include acting as a liaison for establishing a respectful work atmosphere. The liaison role is carried out for negotiations on partnerships, mediating between her/his own company and a trade organization, and for less formal dispute cases between employees. Top managers and executives are expected to act as liaisons of their organizations more than middle and supervisory level managers.

Decisional RolesDecisional roles are related to the decision

making behaviors of management teams. Decision making is the fundamental function of managers at any level. We can argue that decisional roles and the relevant responsibilites are the most critical compared to other group of roles that managers have to fulfil.

The entrepreneur as a decisional role is about being innovative and of paramount importance in today’s competitive environment. A focus on the entrepreneur role indicates the positive attitude towards change in an organization. Entrepreneur role is employed at all levels of management but given its importance to the organizational culture, it is promoted especially by top management teams. Amazon’s locker pick-up project which is referred to as “delivery lockers”19 is an outcome of Amazon’s innovative and entrepreneurial organizational culture which is known to be encouraged by Jeff Bezos, Amazon’s founder and the CEO who started the company with his wife in their California garage.

Another role regarding decision making is allocating resources. New initiatives and current operations need the allocation of resources in the most efficient way. Allocating work force, funds, or technology in terms of expanding or contracting operations requires intelligent and informed decision-making because it impacts the efficieny and the motivation of the entire organization. The resource allocator role is reserved more relevant for the upper echelons of an organization because of the close approximation of authority to resources. Nevertheless, access to resources can be allocated as part of decentralized activities of teams and departments.

Roles of negotiator and disturbance handler are also fulfilled as part of decisions. Decision-making is at the heart of management - either autocratic to democratic or somewhere in between. Thus decisional roles inform the primary function of managers at all levels.

The resource allocator role is reserved more relevant for the upper echelons of an organization because of the close approximation of authority to resources.

The entrepreneur as a decisional role is about being innovative and of paramount importance in today’s competitive environment.

Decisional roles are related to the decision making behaviors of management teams

The significance of different roles that managers are expected to realize is based on management level, environmental circumstances, and managers’ skills.

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Informational RolesThis group of roles directs a constant flow of information throughout the internal organization as well

as transmitting information to and from the external environment. Managers play a vital role by keeping various stakeholders connected by sharing information about developments regarding the organization. Informational roles are designated through monitoring, disseminating, and providing information to the external parties.

Monitoring roles channel information about the environmental developments, opportunities, or risks. Accumulation of such information is vital to connection of the organization to the external environment. A marketing division manager, for example, needs to know the most recent developments in the marketing world as well as having information about changes in marketing practices of competitors. The monitoring role also is vital for top management for setting long-term goals and designing strategies.

The disseminator role is about sharing updated information with relevant individuals, groups, or divisions. Efficient fulfilment of this role enables managers to obtain a harmonized and well coordinated organizational atmosphere. Managers at all levels are responsible for disseminating information.

The spokesperson role requires managers to reach out to the external parties for providing information regarding their operations. Managers mostly at top level positions of large size companies serve as spokespersons to inform customers, media, suppliers, or prospective investors about the recent developments, changes, or their future strategies.

LEADERSHIPLeadership is influencing a group of individuals

toward the accomplishment of common goals.20

A leader is the one who applies the leadership process through inspiring, motivating, encouraging, guiding, and enpowering. Atatürk at the nation-state level, Stephen Hawkins at the cosmological science level, or Sakıp Sabancı at the CEO business level are just a few examples of leaders setting examples for individuals and groups to follow.

The monitoring role generates information about the environmental developments, opportunities, or risks.

The disseminator role is about sharing updated information with relevant individuals, groups, or divisions.

The spokesperson role requires managers to reachout to the external parties for providing information about the recent developments, changes, or policies regarding their operations.

Leader is the one who applies the leadership process through inspiring, motivating, encouraging, and enpowering.

Leadership is influencing a group of individuals toward the accomplishment of common goals.

Informational roles aims a constant flow of information throughout the internal organization as well as transmitting information to and from the external environment.

Compare the managerial roles, similarities, and differences between a small family business and an international company.

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Leadership emerges through a synergistic and contextual combination of the following dimensions and elements as noted above elements as noted above: goals; followers; circumstances; and personality.

Apple, today the world’s richest corporation, faced external and internal threats of incredible magnitude. But truth can sometimes be stranger than fiction. Apple was just a few months away from bankruptcy and utter destruction when founder Steve Jobs rescued it and at a time when Michael Dell urged Jobs to liquidate the company. Steve Jobs, as the CEO of Apple had a relentless drive and ambition for success. His genius as a leader emerged in the worst of times when his company was about to collapse. Jobs did not live long enough during the best of times to enjoy the fruits of his leadership.21

Management and LeadershipLeadership and leader are terms that are often used as having the same meaning with management and

manager. However, beside the similarities of leadership and management there are differences regarding the use of authority, relationships with subordinates, goal attainment attitudes, and the characteristics of manager versus leader.

Management and leadership are similar in terms such as: focus on attaining goals; group function; and process of interaction and influence.

Beside similarities between the management and leadership roles, there are also distinguishing characteristics. Few are:

• Managementisbasedonposition;leadershipisaboutpersonalqualifications.• Managementisattaininggoalsthroughothers;leadershipispursuinggoalswithothers.• Managementauthorityisbasedonlegalauthority;leadershippowercomesfromfollowers.• Managementproducesorderandconsistency;leadershipproduceschangeandmovement.22

As we compare management to leadership we can not assess whether one is superior to another or one works better that another. Most managerial activities require both management and leadership approach for obtaining a productive outcome.

Management and leadershipare analyzed differently regarding use of authority, relationships with subordinates, the goal attainment attitudes, and the characteristics of manager and leader.

https://global-leader-index.imd.org/

internet

A leader is a role model who earns the title.

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Anatomy of LeadershipLeaders and the leadership process have been subject to scholarly research from different perspectives.

Leadership is analyzed by the traits approach, behaviorial perpective, contingency theory, and contemporary approach.

Traits approachThe traits approach was one of the first attempts to study leadership and referred more to innate

characteristics of “great people”.23 Specific traits and characteristics can distinguish a leader from a manager’s profile. The relevant studies show that the emphasis on distinctive and critical leadership traits changes by periods. Traits of earlier periods such as initiative and sociability have expanded into traits such as self-monitoring and problem solving. A business leader of the 21st century is challenged by a cyclical, multi-factor, and world-wide interconnected environment. Therefore for success, today’s business leader is a strategist, multicultural cognizant, a visionary, innovator, developer, entrepreneur, coordinator, scanner, observer, a negotiator, and is expected to possess other skills to match a changing environment. The traits approach is based on a thinking that a leader with a powerful standing can be distinguished from non-leaders.

Behavioral perspectiveThe traits approach limits the analysis of leaders based on certain characteristics. This led researchers

to study other aspects and especially to focus on behaviors of that characterize the profiles of leaders. Behaviors are also strong indicators of leaders’ efficiency and success. The behavioral perspective analyses the leadership process with a focus on how leaders act and what they do.

The behavioral approach to leadership investigates the basic features of leaders’ behaviors. The rationale was that leaders behaved somehow distinctly than others in their surrounding. During the mid-20th century, researchers from Ohio State University and Michigan University conducted behavioral studies focused on certain leadership and management characteristics.

The Michigan studies. Based on interviews with managers and employees the outcome of this group

of studies was two basic forms of leadership behaviors: Task/production oriented behaviors and people/employee oriented behaviors. Task-oriented behaviors indicate a focus on production and technical aspects of a job. Managers who were task-oriented were concerned about issues such as keeping low costs and scheduling meetings. People-oriented behaviors indicate a supportive approach to subordinates. Managers with this type of orientation dealt with high performance goals and human needs. Today, we must suggest that the success and effectiveness of different behaviors depend on the necessity of the circumstances which is influenced by constant change.

Task oriented behaviors indicate the focus on production and technical aspects of a job.

People oriented behaviors indicate a supportive approach to subordinates.

The behavioral perspective analyses the leadership process with a focus on how leaders act and what they do.

The traits approach is based on the thinking that “A leader with a powerful standing can be distinguished from non-leaders”.

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The Ohio State studies. The results of this group of research were akin to Michigan studies. The researchers from Ohio State University introduced two basic leader behaviors or styles: Initiating structure behavior and consideration behavior. Initiating structure is parallel to the task oriented behavior and shows the emphasis on formal processes such as designing roles and responsibilities. Consideration behavior is a form of people orientation and indicates the extent of concern for the relationships with subordinates and their feelings.

The Managerial Grid. This model, which was renamed as the Leadership Grid intersects two basic leadership behaviors, concern for people and concern for production. It places the leader in one of the five styles. The Managerial Grid composes five managerial or leadership styles through the combination of these two dimensions: Impoverished management –low in both dimensions; Country Club management – high in concern for people and low in concern for production; Team management – high in both con-cerns; Authority compliance – high in concern for production and low in concern for people; and Middle of the Road management – intermediate in both dimensions.

Above, early perspectives to leadership are briefly explained. Following sections comprise more flexible and conformed leadership approaches.

Contingency approachLeadership styles and the best managerial approach change according to environmental factors, which

means that there is no single “best style”. By definition the business environment is not stable. The composition of internal factors such as financial, technological, and human resources as well as external factors such as economic, political, social, and cultural dynamics shape the leadership style.

The contingency approach emphasizes that leadership style and best managerial approach change according to environmental factors. Different contingency theories examine the match between the leadership approach and the environmental composition.24 Each of the theories attempts to answer “if-then” contingencies. Fiedler’s contingency model and situational theory are amongst the models that discuss the fit between the environment and leadership style.

Initiating structure is parallel to the task oriented behavior and shows the emphasis on formal processes such as designing roles and responsibilities.

Consideration behavior is a form of people orientation and indicates the extent of concern for the relationships with subordinates and their feelings.

Managerial Grid (Leadership Grid) intersects two basic leadership behaviors, concern for people and concern for production to place the leader in one of the five styles.

The composition of internal factors such as financial, technological, and human resources as well as external factors such as economic, political, social, and cultural dynamics shape the leadership style.

Traits and behavioral approaches to leadership complement each other.

The contingency approach emphasizes that leadership style and best managerial approach change according to environmental factors.

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Fiedler’s contingency model. Fiedler’s model seeks for the appropriate combination bet-ween the leadership style and environmental cir-cumstances with an aim to determine the most effi-cient leadership outcome. The model refers to two main leadership styles: Task oriented and relations-hip or people oriented. The situation dimension is referred to as being a combination of situational factors: the degree of task structure; the extent of leader’s authority; and the quality of relationship between leader and followers.

Think of a managerial situation in a project group where the tasks are clear, the leader is respected and followed, and her or his relationship with employees are positive. This is a favorable management environment and the project leader can perform a task oriented style ensuring that all group members would fulfill their responsibilities effectively. If the variables are not as favorable where one of the factors is relatively weak, e.g. the group is not coherent enough, then the project leader might want to apply a more people oriented approach for obtaining a motivated group atmosphere.

Situational theory. This approach also emp-hasizes that the leadership style is contingent. The premise of the situational theory: Leadership is shaped by the demands of situations where emplo-yees are the situational variables.

Situational theory was originated by Hershey and Blanchard. This theory refers to two primary leadership styles which are directive and supportive. A leader will decide whether to be supportive or directive according to the competency and commitment level of employees. The critical issue

with the situational leadership process is the leader’s ability to know the approach of followers to their work and how willing they are for contributing to the organizational goals. The leader’s choice whether to apply the supportive or directive approach as well as mild forms of the two, will be based on her/his judgment about the employees’ readiness for performing the task effectively.

Let’s observe the project manager mentioned above as an example to Fiedler’s model. S/he can delegate authority to a highly prepared group, meaning they are experienced and competent enough as well as being motivated to succeed; whereas s/he will be more supportive and apply training with a group which is not as much ready for performing the tasks in order to complete the project.

Contemporary leadershipLeadership is a crucial process for successful

accomplishment of organizational goals at all times but more so in the 21st century. Research on leadership has been continuous and has introduced a range of leadership styles. Different styles and approaches have emerged. They are aligned with the recent developments in the business environment as well as emerging social and psycholgical behavioral insights. These new ideas of leadership towards the accomplishment of goals and strategies have a focus on concepts such as motivation, inspiration, support, change, risk taking, participation, ethics, and values. Some contemporary leadership models are transformational - transactional leadership, charismatic leadership, team leadership, leader-member exchange model, and authentic leadership.25 In this chapter, we will describe the transformational - transactional leadership briefly. Contemporary leadership styles will be explained furtherly in your Business Management course materials.

Fiedler’s model seeks for the appropriate combination between the leadership style and environmental circumstances with an aim to determine the most efficient leadership outcome.

The premise of the situational theory: Leadership is shaped by the demands of situations where employees are the situational variables.

The critical issue with the situational leadership process is the leader’s ability to know the followers’ approach to work and how willing they are for contributing to the organizational goals.

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Transformational - transactional leadership. Leadership environments vary according to the internal and external factors and the leadership process is affected by the leadersip factors such as goals, charisma, followers or the group, and circumstances.

Transcational leadership. This type of leadership is employed where accomplishment of organizational goals is the primary focus and the leader is fixed on the results. These types of leader behaviors are pervasive in any type of organization at any managerial level. We may as well use the title manager in a transactional process rather than a leader. A general manager asking employees to effectively fulfill requirements of a task by promising a reward means she or he is following a transactional routine. The rewards may be monetary inducement or a promotion, positive or ne-gative appraisal, or organizational support. Therefore transactional leadership has a focus on the exchanges between leaders and followers. Because of the mutual give and take relationship, transactional leadership can be viewed also as motivating followers or subordinates through responding to their expectations.

Transformational leadership. This type of leadership occurs in an area that goes well beyond the qualities of a regular leader – follower relationship. Transformational leaders are apart from others based on their personality and charisma and the ability to inspire radical change, articulate a vision, transform the thinking of individuals, bring out their creativity, engage in the organizational atmosphere, and empower followers to accomplish goals, and moreoever reach their full potential. Griffin refers to transformational leadership as a “leadership that goes beyond ordinary expectations by transmitting a sense of mission, stimulating learning experiences, and inspiring new ways of thinking”.26 The interaction between transactional and transformational has been subject to research arguing that effective leaders utilize both leadership approaches.27

Transcational leadership is employed where accomplishment of organizational goals is the primary focus and the leader is fixed on the results.

Transformational leadership goes well beyond ordinary expectations by transmitting a sense of mission, stimulating learning experiences, and inspiring new ways of thinking.

Henry Ford completed first gasoline-powered motor in 1896 at age 32 and first T-Model was sold in 1908 .

Ford models evolved since then.Apple Store in Manhattan

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Transformational leaders emerge in organizations, whether business or the nation state, during periods of radical change brought about by invention or uncertainty, or upending threats in the external environment. Atatürk, the founder of the Republic of Turkey,, Henry Ford, the founder of the Ford Motor Company, and Steve Jobs, the founder of Apple Inc., are examples of men of courage and vision that characterize transformational leaders.

Chobani yogurt sells in almost every grocery store in the US since its first launch in 2007. The founder Hamdi Ulukaya initiated the business with the purchase of a plant in 2005. He was confident in his knowledge of the manufacture of yogurt, which he learned in Turkey, would lead to his success. He inspired his workforce by offering them 10% of the company which has resulted in the sustained success of the company. He credits his employees for the success of the company.28

Donald Arnold, the CEO of Carnival Cruise Lines, is another example in business of how transformational leaders make a difference. Formerly, he was the CEO of three different industries and created billions in value. He turned Carnival around. His secret was diversity. He created diverse teams to think creatively, to think out of the box and to focus on objectives and not their differences. The teams consequently were very innovative and created value for the company’s shareholders. Arnold described his passion: “It’s bringing the world closer, it’s giving people a broader view of humanity, it’s life’s little moments,” he said. “I really believe it. I’m not a snake oil salesman”.29

COMMUNICATION IN ORGANIZATIONSAs we enter the third decade of the 21st century, well managed “Communication” is a vital necessity

for the conduct and even survival of a business. Business is now in the midst of a quickening phase of the Information Age and it shows no signs of slowing down. We are in an era of communication populated by supercomputers and vast social media networks connecting billions of people in the Internet of All Things. While advanced technologies have at once provided managers with infinite opportunities to recruit employees, raise capital, develop new markets, and connect virtual teams working 24/7 around the globe, etc., it also complicates the work of managers. In this age of instantaneous communication, the effective management of information and communication technologies (See: Chapter 6) has become a critical component for gaining competetive advantage.The new work place has no boundaries, no time and place constraints, it is multinational and dispersed. Moreover, communication is no longer a process that is limited to face-to-face communication. In fact, business and social communication is being reshaped by the forces of technology. Office meetings via Skype, Zoom, and other video conference technologies, e-company, e-mail groups, Blogs, Facebook, and Twitter are key communication pathways in today’s work environment. Business enterprises have developed communication strategies and redesigned organizational structures to position themselves for the challenges as well as emerging opportunities in the uprush of technological forces unleashed by this most recent phase of the Information Revolution. One of the recent posts added in

Discuss the applicability of transformational leadership in the global business environment.

6Transformational leaders emerge in periods of necessity such as turbulence, uncertainty, transition, or rapid change.

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senior management to adapt to the revolutionary advances in technology is the Chief Information Officer (CIO), which is anchored in creation of information through digital communication.

Communication is critical to all managers at all levels because it takes place whenever there is a managerial process whether planning, organizing, or controlling. Furthermore, management is about creating a common understanding throughout the organization, in both the internal and external environment: communication with all stakeholders, communication with a diversified workforce, and communication globally. Likewise, success can only be achieved by an atmosphere of shared values, goals, policies, and strategies.

Managers utilize techniques and a variety of instruments for obtaining a strongly shared organizational culture. An atmosphere of constructive communication is one of the powerful tools that managers can employ for creating the sense of inclusiveness and belonging. Communication can be described as the process of transmitting a message from a person, a group, or a unit to another. The message in a business environment is mostly sent in the form of a request, an appraisal, or a warning.

Communication ProcessThe communication process can take place in any type of organization, with any group of people, and

towards goals of any scope. The organizational environment that communication occurs can be a regular, unexpected, complex, dynamic, or stable one and affects how it takes place.

The communication process is composed of components each of which is key to create an efficient process (Figure 3.5): the message, source/s (sender), encoding, channel (medium), receiver/s, decoding, environmental affects, and feedback messages.30 A message, the main component and motive force of the communication is formed by a source (sender). The sender is someone occupying a managerial position, a regular employee, or a group. The message is encoded by the sender using words and/or symbols which

Communication can be described as the process of transmitting a message from a person, group, or unit to another.

Channel (Media)

Feedback message

Environmental a�ects

Environmental a�ects

Encoded messageSender

(Source)

Decoded message

Receiver

Figure 3.5 Communication Process

An atmosphere of constructive communication is a major condition for creating a common understanding throughout the organization.

The communication process is composed of components each of which is key to the success of the process: the message, source/s (sender), encoding, medium (channel), receiver, decoding, noise, and feedback.

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may be based on an information, an idea, a reaction, or a feeling. The message follows the communication channel which changes from face -to -face to long distance digital medium. The communication channel is either fortified or distracted by the environmental elements. The receiver who is a person and/or a group decodes the message which passes through the communication channel. The degree that the actual content of the message as initiated by the sender overlaps the content that is decoded by the receiver is highly important for a penetrative communication process. The efficient communication process is two directional that is the receiver becomes the sender with a feedback message which is a response based on the receiver’s interpretation for the message.

Forms of Organizational Communication Organizational goals are accomplished by the integrated contributions of internal and external parties.

Managers’ responsibility is to ensure the organizational adherence and that the parties stay connected. Managers use varying forms of communication which depend on the context: the extent of

importance; urgency of the matter; distance; availability of technology; manager’s style; and the overall organizational culture. Writtten and oral communication, vertical and horizontal communication, electronic communication, personal networks, and nonverbal communication are some of the forms that members of an organization choose to design the message for sharing an information, an idea, a reaction, or projects. The management process involves different forms of communication through different channels. The managers’ choice about the channel and the form of communication shapes the relationships with individual or groups in the organization.

Formal communicationFormal communication refers to communication

channels between formally designated positions and tasks which mainly forms at the vertical and horizontal levels. The content of formal communication comprises tasks and processes in compliance with the organizational goals.

Vertical communication. Communication channels between hierarchical levels either in the downward or upward direction are present in most of the organizations. Downward communication is the channel from top managerial levels to the rest of the organization. Downward communication covers a content such as the transmission of the rationale of organizational goals, directives, overall strategies, values, principles, performance assessment results, developments in the external environment, and changes. Written documents, emails, group discussions, in-person meetings, or handbooks are some of the channels that

Formal communication refers to communication channels between formally structured positions and tasks which mainly forms at the vertical and horizontal levels.

Forms of communication depend on the context: the extent of importance; urgency of the matter; distance; availability of technology; manager’s style; and the overall organizational culture.

The efficient communication process is two directional that is the receiver becomes the sender with a feedback message which is a response based on the receiver’s interpretation for the message.

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managers can utilize for downward communication. The constant flow of downward communication is critical especially for a coherent operational atmosphere and a transparent management image. Upward communication follows a route from bottom to top, that is from employees to managers at any hierarchical level. The content of upward communication vary as suggestions, reports, demands, and complaints. Open door policy, project teams, online discussion groups, and suggestion boxes are examples of upward communication channels.

The efficient flow of two- directional vertical communication channel is essential for managers to obtain motivation in the work place and to maintain their “hands-on” status. Managers need to stay connected with employees which requires two basic attitudes: Providing an organizational atmosphere that enables employees to utter their opinions and listening to what they have to say.

Horizontal communication. Flow of communication between positions and tasks at the same hierarchical level is referred to as horizontal communication. Managers and non-managerial employees at all levels are in need to contact each other for organizational and personal achievement.

Divisions and teams benefit from horizontal flow of communication by staying tangential to the others which supports horizontal coordination. Notably, this allows employees and divisions internalize overall goals and their role in the accomplishment of ultimate goals. Marketing and production departments are horizontally attached for responding to the market’s needs with the best possible quality product/s. Likewise project based companies with continuous R&D activities depend on the outcome that will be obtained from efficient team work at the horizontal level.

On the other hand, managers who focus on vertical relationships face the risk of staying out of the formal communication atmosphere occuring at the horizontal level as well as not being aware of conflicts that may arise. To avoid such a negative impact, managers stay in contact with their employees through open communication channels and approaches such as management by wandering around (MBWA). MBWA applies to all types physically suitable organizations but even more in certain sectors such as health organizations.31

Informal communicationFormal communication channels form based on the formal structure in an organization. Informal

communication occurs outside the formal communication based on personal relations in an organization. Employees as well as managers create networks and groups for various reasons such as working on the same

project, sharing hobbies, and belonging to a social group in any type of organization. Informal communication occurs for satisfying social needs which may also strenghten the formal communication flow as well causing distraction. The informal communication in organizations include channels such as personal networking and the grapevine.

Horizontal communication forms between positions and tasks at the same hierarchical level.

Vertical communication refers to communication channels between hierarchical levels either in the downward or upward direction.

Downward communication is the channel from top managerial levels to the rest of the organization.

Upward communication follows a route from bottom to top, that is from employees to managers at any hierarchical level.

The efficient flow of two- directional vertical communication channel is essential for managers to obtain motivation in the work place and to keep their “hands-on” status.

Informal communication occurs outside the formal communication based on personal relations.

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Personal networking. This type of informal communication refers to establishing relationships in and outside the organization either directly related to formal tasks or only about being a part of social incidents. Personal communication networks include relations with all stakeholders. These networks help managers and employees to get complementary information about the organizational environment as well as employees’ opinions and approach to work.

Grapevine. The grapevine is another infor-

mal formation of communication that develops as people interact in organizations. The metaphor gra-pevine indicates the spontaneous nature. This type of communicational relationship can emerge at any organizational level, usually starting at lower levels, including both managerial and non-managerial employees. Grapevine exists in every organization and due to its humane structure usually not tried to be sanctioned by formal authority. Sharing same hobbies, family ties, projects, and other social rela-tions cause the grapevine communication channels flow around the organization.

A major essential technology change is expected also to cause a change in the workforce of the Best company. The rumors start at the non-employee and first-line level of the company spreading onto the upper levels. The company CEO becomes a part of the grapevine because of a club membership and grasps the disturbance amongst the employees. Thereby, the CEO manages the crisis to minimize the negative impact of the technology change.

Non-verbal communicationCommunication without words is a strong

medium either for formal or informal purposes. Non-verbal communication is a form of interpersonal communication, intentionally or not, conveyed by body movements, facial expressions, and gestures, explicit, or tenuous. Body language is the most pervasive type of non-verbal language, including natural and artificial scents, usually used as semaphores to emphasize or hide meaning orally communicated.

Moreover, the increasing application of electronic communication expressed symbols and emoticons for transmitting reactions, emotions, and thoughts. Although each expression communicates an emotion or an opinion, non-verbal communication is more indirect and less explicit than verbal communication. Thus, it is more subject to misinterpretation. Professional and experienced managers use non-verbal communication or body language for complementing and fortifying verbal or electronic messages.

The multinational work place reveals the importance of cultural differences regarding the use of body language as much as verbal communication. Eye contact, personal space, physical contact, or greeting style differ by cultures. It is critical at incidents such as negotiations to be knowledgeable about other cultures’ body and facial gestures.

A businessperson from United Kingdom, for example may have a facial expression that can be distinguished from someone of a Mediterranean culture. Similarly, personal space is a gesture that changes from Northern Europe to Latin American cultures, from farther to closer distances, and even more so among Arabic cultures.

Non-verbal communication is a form of interpersonal communication, intentionally or not designed by body movements, facial expressions, and gestures, explicit or tenuous.

Personal communication network refers to establishing relationships in and outside the organization either directly related to formal tasks or only about being a part of social incidents.

The grapevine is an informal formation of communication that develops as people interact in organizations.

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Technology and Communication“Hello” is the motto of the electronic work place. It

gives start to an email between offices only few meters away from each other or in different parts of the world, a WhatsApp call, a board conference between partners in different continents, and more.

Rapidly advancing communication technologies not only altered the way we live but also the scope of the organizational communication. The pace of competititon in the global era requires a high-speed organizational and work atmosphere which includes relationships with all stakeholders. A skilled and well equipped use of technology for communication, regarding different functions of a business, is a significant determinant of organizational performance and adherence. Business processes such as human resources, research and development, accounting, production, supply chain and logistics, and marketing benefit by the application of advanced communication technologies and add value to the ultimate organizational goals.

Businesses such as Uber car service use smart phone apps for accelarating the process that customers access cab service in an increasing number of cities around the world. Similarly, businesses create blogs or facebook pages for keeping customers attached to their brands. For more examples check https://www.marketingcloud.com/

A tech-embedded workplace underscores the vital importance of the investment in technology. It links individuals and units in an organization, internally and externally. The diffusion of technology in almost all operational processes has advantages as well as drawbacks. Information and communication technologies (ICT) can

promote the timeliness and effectiveness of the decision making process, the quality of products and services as well as the overall organizational performance in different sectors.

Anadolu University’s Electronic Information Management System is a recent example of a formal use of technology augmenting organizational communication. Documents of assignments, reports, or announcements flow to and from all units of the University. Anadolu University is mega university with two main campuses besides the international branches in Europe and the United States. As challenging as it was to integrate the new electronic system in the entire organizational structure, it was an instrument to create an efficient c o m m u n i c a t i o n network.

Effective CommunicationAmazon founder and CEO Jeff Bezos is one of

the prominent CEOs who has a careful approach to making the most out of meetings. He employs the “two pizza rule”in his company to emphasize that the number of participants should be limited to ensure more productive meetings.32

A successful and effective organizational communication process has certain features: the message should reach its destination in the original form as much as possible; the message should reach

Companies use LiveChat for contacting

customers and potential customers from

one software as an efficient tool for marketing.

Information and communication technologies (ICT) can promote the timeliness and effectiveness of the decision making process, the quality of products and services as well as the overall organizational performance in different sectors.

A successful and effective organizational communication process has certain features: the message should reach its destination in the original form as much as possible; the message should reach the receiver on time; and the receiver is engaged in the process sending acknowledgment of the receipt of the message in the form of a feedback.

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the receiver on time; and the receiver is engaged in the process by sending acknowledgment of the receipt of the message in the form of a feedback. Top level managers who value communication for goal accomplishment reinforce a sustained communication atmosphere in their organizations whether a multinational corporation, a hospital, or a university. Creating a culture of communication in an organization is a unifying process initiated at the upper levels and shared with every level of the organization.

Employing an effective organizational process is an essential but difficult task for managers at all levels. The flow of communication can be subject to different effects: it can be strenghtened, encouraged, redirected, interrupted, or obstructed by a variety of environmental factors. Supporting factors for an effective communication process can be: an inclusive management approach; leadership skills; management by objectives as described in the above sections; coordination by top management; and knowledgeable use of information and communication technologies. Obstacles for obtaining a desired level of organizational communication can be: cultural differences, noise, timing, emotions, distance, ineffective media as Bezos pointed out, intentional distraction, misperception, lack of language, and incomplete messages.

Two different communication approaches: a) The marketing division manager of the international Es company holds weekly innovation meetings including Skype participation with those employees abroad, with timing determined suitable for different time zones. Ms. Şen listens to her co-workers, encourages them to generate and share ideas about how to increase customer loyalty, and makes comments if needed. She believes in the “conversation style”. b) The head of the marketing division in company Zet, another international operation, sends out messages to the division email group, whenever he needs to discuss a new development or a project. Mr. Berke asks his co-workers to give him feedback about the applicability of a project or any matter of organizational change. He believes that using communication technologies assures its quality, e.g. emailing engages everyone in the discussion, and that he can keep records of the messages as well.

https://www.youtube.com/watch?v=eVJuIZElOXEv

internetWhy effective communicati-on in a multicultural business environment, with managers and employees from different cultures, is of utmost impor-tance?

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The flow of communication can be subject to different effects: It can be strenghtened, encouraged, redirected, interrupted, or obstructed by a variety of environmental factors.

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Technology will not render managers obsolete — but they will need to be more skilled than ever before

“I’ve been thinking about technology and management for over a decade. In the process, I have written two books describing some of the ways that the practice of management will respond to rapid technological innovations. Looking back, I made four predictions about management and technology.

First, it was clear to me that the manager’s role as a coordinator of work would come under increasing pressure. Constant improvements in robotics and machine learning, in conjunction with the automation of routine tasks, make management a more unclear practice.

Next, I could see an inevitable shift in which a parent-to-child way of looking at the relationship between the manager and his or her team would be questioned and ultimately superseded by an adult-to-adult form. The nexus of this more adult relationship concerns how commitments are made and how information is shared. When technology enables many people to have more information about themselves and others, it’s easier to take a clear and more mature view of the workplace. Self- assessment tools, particularly those that enable people to diagnose what they do and how they do it, can help employees pinpoint their own productivity issues.

Third, it seemed to me obvious that technology would tip the axis of power from the vertical to the horizontal. Why learn from a manager when peer-to-peer feedback and learning can create stronger lateral forms of coaching? Moreover, technology-enabled social networking is capable of creating robust and realistic maps of influence and power — so no more hiding behind fancy job titles.

Finally, the rise of platform-based businesses such as Uber Technologies Inc. has everyone excited about platforms and how they can create a fertile arena for new businesses to be built while also acting as a conduit for flexible ways of working”....Source: Gratton, L. (July 27, 2016). Rethinking the Manager’s Role. MIT Sloan Management Review, 58, 1.

Further Reading

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What is the Best Management Structure for a Business Organization?

Business and management textbooks cover the details of different managerial approaches. Each of these approaches reflect a variety of organizational values, behaviors, and attitudes. We dig into business practices to provide illustrative examples and stories of CEOs, business leaders—transactional versus inspirational—as well as initial failures and great successes are analyzed. The Legend of Vehbi Koç and young Koç generation executives; Yıldız Holding Chairman Murat Ülker with the broad vision of expanding globally; Apple’s founder legendary Steve Jobs; Former Coca Cola CEO Muhtar Kent; or Jack Ma of Alibaba, biggest online retailer, are worldwide striking examples of managing in different contexts—social, economic, political, and cultural. Do they all follow a certain type of managerial style and organizational structure? The answer is simply one style doesn’t fit all.

Kevin Turner, climbed up the hierarchical ladder from cashier to top-level executive at Walmart, once the world’s largest corporation. He was then hired by Microsoft as the chief operating officer (COO) serving successfuly for eight years. Turner wasn’t as lucky with the Citadel Securities in the financial sector, where he was hired as the first CEO. There he lasted seven months! He appeared to be uncomfortable in meetings for lacking sufficient knowledge about Citadel’s operations and global ambitions to create a 24/7 e-commerce finance company of the first magnitude.33

The best management approach or most suitable management structure changes from one set of circumstances to another. Environmental factors such as the nature of products and services, economic and financial resources, size of the organizaton or group, timeline for attaining goals, knowledge and experience of managers and employees, type of technology, and culture determine the design of a management structure. The outcomes of the success or failure

of operations run by a manager depend on the composition of these factors, at times some dominant over others. Successful managers who create high amounts of added value for their corporations are those who make the right decisions for who can align the management structures or managerial styles to environmental challenges.

A business organization, a corporation, a regional, or a multinational enterprize have diverging goals, are run by different compositions of resources, ruled by changing imperatives, and all operate in different environmental settings. An organizational structure planned for a regional company will be insufficient as the same company expands into international markets. A media organization must be designed by teams while an automobile manufacturer is technology dominated and more vertically structured. Likewise real life business practices in different sectors around the world demonstrate the variety of managerial styles and organizational structures with similarities and differences.Discuss:

1) Compare the managerial practices of organizations in different sectors that you encounter during your daily life? To what extent and why the similarities and differences are?

2) What would your initial approach be if you were assigned for a company which operates in different sectoral circumstances than the you were previously a part of?

In Practice


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LO 1 Defining management and relevant terms

Management is achieving goals by the contribution of others. The management definitions emphasize elements pertinent to the management environment. These key elements are; goals, people, and activities relevant to the management environment. Organizational performance is a key concept in management which is obtained through organizational effectiveness and organizational efficieny. Organizational effectiveness is the degree to the achievement of organizational goals based on the statements and expectations. Organizational efficiency on the other hand is about the amount of overall resources used for the achievement of an organizational goal.

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LO 2 Explaining the management process and the functions of management

Management is a process through which required resources are utilized by a sequence of functions starting with planning, followed by organizing, leading, and controlling for attaining organizational performance. Planning is identifying goals and deciding which tasks that will be performed and the resources that will be utilized for attaining these goals. Organizing is determining tasks relevant to goals; grouping tasks by departments; assigning the work force for specific tasks; deciding the authority relationships, and preparing the work environment which includes allocating equipment and technology. Leading is about guiding the organization and/or the group towards the goals. Controlling is the monitoring function of the management process and is critical for the success of other management functions.

LO 3 Describing the management structure

The management structure indicates the hierarchical design of an organization. The managerial hierarchy identifies the scope of authority, responsibility, power, and skillsets that are pertinent to each level. The management structure in traditional terms involves three basic layers: Top/executive, middle, and first line/supervisory levels. At the base of the pyramid non-managerial or non-supervisory employees reside. These three management levels are interconnected although each management level has a different set of functions and requires different managerial qualifications.

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LO 4 Distinguishing basic management skills

Management skill is a combination of knowledge, behaviors, and attitudes for performing a task. Conceptual skills are related to seeing the organization as a whole to reach established goals by coordinating and integrating resources throughout the organization. Human skills, also referred to as soft skills, are related to establishing constructive relationships with other members of a group. Technical skills involve job-specific knowledge, experience, and ability for performing the tasks at a proficient level. Conceptual skills, are most critical for top/executive managers. Human skills (soft skills) must be most mastered by middle level managers. Technical skills are directly related to the task itself and must be possessed by the first-line managers who are in the position of getting jobs completed.

LO 5 Understanding the managerial roles that managers play in different settings

In order to achieve high performance managers are demanded to play a range of roles from critical to complementary depending on the management level and factors such as the work environment. The basic managerial roles are described in three groups as Interpersonal roles, Decisional roles, and Information roles. The significance of different roles that managers are expected to realize is based on management level, environmental circumstances, and managers’ skills. Interpersonal roles of managers are about relationships with internal and external stakeholders such as employees, customers, relevant interest groups, or suppliers - even communities where a company has its headquarters or markets its goods or services. Decisional roles are related to the decision making behaviors of management teams.

LO 6 Describing the leadership process in comparison to management

Leadership is influencing a group of individuals toward the accomplishment of common goals. A leader is the one who applies the leadership process through inspiring, motivating, encouraging, guiding, and empowering. Leadership and leader are terms that are often used as the same meaning with management and manager. However, beside the similarities management and leadership are analyzed differently regarding use of authority, relationships with subordinates, the goal attainment attitudes, and the characteristics of manager and leader.


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LO 7 Identifying the anatomy of leadership

Leaders and leadership process have been subject to scholarly research from different perspectives. Leadership is analyzed by the traits approach, behaviorial perpective, contingency theory, and contemporary approach. The traits approach was one of the first attempts to study leadership and reference was more to innate characteristics of people with remarkable success. Specific traits and characteristics can distinguish a leader from a manager’s profile. Behavioral perspective analyses the leadership process with a focus on how leaders act and what they do. The contingency approach emphasizes that leadership style and best managerial approach change according to environmental factors.

LO 8 Explaining the communication process and forms of communication in organizations

Communication is the process of transmitting a message from a person, group, or unit to another.The communication process can take place in any type of organization, with any group of people, and towards goals of any scope. The communication process composes of components each of which is key to the success of the process; message, source/s (sender), encoding, medium (channel), receiver, decoding, noise, and feedback. Managers use varying forms of communication which depend on the situation; the extent of importance, urgency of the matter, distance, availability of technology, manager’s style, and the overall organizational culture. Writtten and oral communication, vertical and horizontal flow of communication, electronic communication, personal networks, or nonverbal communication are some of the forms that members of an organization choose to design the message for sharing information, an idea, a reaction, or a project. Managers’ choice about which channel and what form of communication to use shapes the relationships with individuals or groups in the organization.

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1 What are the measures of organizational perfor-mance ?

a. Responsibility and efficiencyb. Effectiveness and efficiencyc. Effectiveness and social responsibilityd. Social responsibility and ethicse. Efficiency and ethics

2 Which one describes the “management process” in the proper content?

a. Planning, coordination, organizing, controllingb. Organizing, coordinating, leading, planningc. Planning, organizing, leading, controllingd. Leading, controlling, organizingE. Coordinating, planning, leading, controlling

3 Which one is the monitoring function of the management process and is critical for the success of other management functions?

a. Planning b. Controllingc. Organizing d. Leadinge. Decision making

4 Which organizational level managers are responsible for overseeing the contribution to the organizational goals and strategies developed by the top management?

a. Non-managerial employeesb. First organizational level managersc. Middle level managersd. Top administratione. Executive level managers

5 What set of responsibilities do the top administ-ration teams in an organization possess?

a. They encourage and support their teams for establishing division plans and attain organizational performance.

b. Oversee the contribution of a division to the organizational goals and strategies developed by the top management.

c. They are primarily responsible for implementing the operations in departments, divisions, or any type of horizontal unit which they achieve by non-managerial employees.

d. They oversee a company’s vision, monitor the environment, develop the strategic plans, and represent the organization.

e. They are responsible for leading their departments’ activities and inspiring employees with high performance.

6 Which group of management skills are critical for monitoring as well as analyzing the organizational environment and developing aligned strategies?

a. Technical skillsb. Human skillsc. Conceptual skillsd. Soft skillse. Management skills

7 Which of the below gives the correct combination for the management level and the most required skills?

a. Top management-technical skillsb. Supervisory level- conceptual skillsc. Middle level- conceptual skillsd. First-line level- human skillse. Middle level- human skills

8 Which managerial set of roles are mainly about relationships with internal and external stakeholders such as employees, customers, relevant interest groups, or suppliers?

a. Interpersonal rolesb. Decisional rolesc. Entrepreneurial roled. Informational rolese. Disseminator role

9 What is the emhasis of task oriented leadership behaviors?

a. Supportive approach to subordinatesb. Production and technical aspects of a jobc. Concern for the relationships with subordinates d. Approach to subordinates’ feelingse. Changing approach based on circumstances

10 Which one below is a form of interpersonal communication that is designed by body movements, facial expressions, and gestures?

a. Verbal communicationb. Organizational communicationc. Communicational networkd. Vertical communicatione. Non-verbal communication

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uggested answers for “Your turn”

Compare the impact and role of effectiveness

and efficieny on organizational performance.

your turn 1

Organizational performance is determined mainly by these two processes both of which are essential for measuring the success of the outcome. Organizational effectiveness is the degree of achieving organizational goals based on explicit expectations. Organizational efficiency, on the other hand, is about the amount of overall resources used for the achievement of an organizational goal. A business organization aims to have both measures fulfilled to the feasible maximum extent. The impact and role of these measures on organizational performance depend on the goals, resources, and environmental circumstances. For example, during a period of economic recession costs become priority factors; thus efficiency is more critical than effectiveness. On the other hand, if the product quality is a core competency for sustaining the market share, than the achievement of the goal for quality surpasses other production concerns. Briefly, managers seek to mainatain a balance between the effectiveneness and efficiency by assessing different aspects of a production process.

your turn 2

The management process is composed of functions starting with planning, followed by organizing, leading, and controlling for attaining organizational performance. Each function has a specific role in completion of the management process. In general terms, none of the functions is superior to another. Management functions are connected, the outcome of one function becomes an input for the others. The significance of each management function depends on the needs of certain organizational periods. For example, the establishment of a new department requires more emphasis on the planning stage before continuing with organizing and the following functions.

Compare the management functions. Which management

function contributes more to the management process?

If your answer is incorrect, review “Definition of management”.

1. b If your answer is incorrect, review “Conceptual skills”.

6. c

If your answer is incorrect, review “Controlling function”.

3. b If your answer is incorrect, review “Interpersonal roles”.

8. a

If your answer is incorrect, review “Management process”.

2. c If your answer is incorrect, review “Managemet skills by managerial levels”.

7. e

If your answer is incorrect, review “Management levels”.

4. c

If your answer is incorrect, review “Top/executive management”.

5. d

If your answer is incorrect, review “Behavioral perspective”.

9. b

If your answer is incorrect, review “Informal communication”.

10. e

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your turn 3

The management structure in traditional terms involves three basic layers which are top/executive, middle, and first line/supervisory levels. These three management levels are interconnected although each management level has a different set of functions and requires different managerial qualifications. Each of the managerial levels contributes to the organizational goals from a different perspective whether the hierarchy is applied strictly or in a more horizontal approach. The top management tasks are critical because the strategies and policies shaped at this level guide the entire organization. The middle managerial level is adhesive; it links the top management to the lower levels of the organizational structure and the reverse as well. Middle managers also fulfil the divisional responsibilites which are essential for the achievement of the ultimate goals and strategies. The first line or supervisory team tasks also are neither less important nor more essentail than the other managerial levels. The fist line managers at the lowest hierarchical level is of high importance to a company, because they supervise the production of good and/or services.

your turn 4

As we explained in the chapter, technical skills involve job-specific knowledge, experience, and ability for performing the tasks at a proficient level. The nature of these skills vary and mainly change by sectors. Likewise, electronics and tourism sectors require different types of technical skills which are related to the first level managers as well as non-managerial employees. The electronics sector is much more based on technological skills than the tourism industry. Therefore, the relevant technical requirements are more likely about the use of machinery and other technologies. The tourism sector managers and employees, on the other hand, are expected to be skilled in face-to-face tasks such as service, lodging, and transportation. The similarity between the two sectors is that both comprise technology to an extent. The difference however is broader. Electronics’s primary input is grounded in technology, whereas the tourism sector is primarily based on the behavioral dimensions of providing comfort and entertainment.

Compare the essentiality of different managerial tasks

based on the levels in the hierarchical structure.

Discuss and compare technical skills regarding electronics

and tourism sectors.


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your turn 5

your turn 6

Small business, which is usually associated with entrepreneurship, is a privately and independently owned company with a limited number of employees and revenue compared to large businesses. Also, family businesses are mostly small to medium size companies. Small and medium size businesses are commonplace throughout the world. They account for the lion’s share of employees: from barber shops to a variety stores, from a tailor shops to an electronics repair stores, from a tavernasto a small farmsteads, etc., they multiplied by the millions account for most of the globe’s economic activity. Global companies are at the opposite end, with investments around the world with vast amount of culturally diversified employees of all types keeping their enterprises running. Small businesses involve small numbers of employees. The work enviroment is often family-based where relationships are informal, and is either an older family member or a mentor for the employees. The managerial roles for small business are mostly engaged in roles which require making key decisions and adjusting to the environmental changes while often working side by side with his/her employees. Global company managers, on the other hand at every level deal with large numbers of employees who are diversified in cultural norms and values, language, and work habits. Global work atmosphere also has no time and space limits. This type of work environment demands effective decision makers and leaders but most importantly must execute their informational and monitoring roles successfully. The global business environment is geographically dispersed and subject to rapid changes with affects from all economies and cultures. Thus, channelling the right and sufficient information about the environmental developments, opportunities, or risks is key to make successful decisions.

Transformational leadership is about transmitting a sense of mission, stimulating learning experiences, and inspiring new ways of thinking. Transformational leaders emerge mostly in times of need and periods of rapid, if not chaotic change. Transformational leaders possess the ability to inspire radical change, articulate a vision, bring out the creativity in individuals, empower followers to accomplish goals, and moreoever reach their full potential. All these require unwavering determination and powerful initiative. The global business environment is relatively more complicated than local markets. It is diversified in terms of economies, politics, and cultures; it is more competitive, involves more ambiguity in a climate of constant change. International markets in the global business environment involves daunting challenges from one country to another. In this regard, international operations need to be carried out by managers with a global mind-set and multicultural vision. Such leaders are skilled in monitoring and adjusting to changes, and inspire employees from different countries to formulate new strategies when challenges arise.

Compare the managerial roles, similarities, and differences

between a small family business and an international company.

Discuss the applicability of transformational leadership in

the global business environment.

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1Koonts, H., O’Donnell, C., & Weihrich, H. (1986). Essentials of Management (4th ed.). McGraw-Hill, p.13.

2Ivancevich, J.M. & Duening, T. N. (2004). Business – Principles, Guideliness, and Practices. Atomic Dog Publishing, p. 156.

3Robbins, S. P. & Coulter, M. (2016). Management. Pearson, Inc., p. 7.

4Daft, R. L. (2016). Management (13th ed.). Cengage Learning, p. 8.

5Griffin, R. W. & Ebert, R. J. (2004). Business. Pearson, p. 170.

6Daft, op. cit., p. 512.7Griffin & Ebert, op. cit.8Boston, W. (December, 2015). Chain of mistakes’

led to Volkswagen scandal: VW chaiman, CEO. The Wall Street Journal. Retrieved from http://www.theaustralian.com.au/business/wall-street-journal/chain-of-mistakes-led-to-volkswagen-scandal-vw-chaiman-ceo/

9Zietek, E. M. & Tiedens, L. Z. (January, 2015). The fluency of social hierarchy: The ease with which hierarchical relationships are seen, remembered, learned, and liked. Journal of Personality and Social Psychology, 102, pp. 98-115.

10Ivancevich & Duening, op. cit., p. 165.11Dias Portolese, L. & Shah, A. J. (2009). Introduction

to Business. Mc GrawHill, p.184.12Elmer-Dewitt, P. (August 29, 2011). Rethinking

Apple’s org chart. Fortune. Retrieved from http://fortune.com/2011/08/29/rethinking-apples-org-chart/

13Hatch, M. J. & Schultz, M. (1997). Relations between organizational culture, identity and image. European Journal of Marketing, 31, 356-65; Tiber Leland, K. (2016). Does a company reputation rest on the shoulders of the CEO? Business Journal (Central New York), 30 (32), 5-5. 1/2p.

14Luthans, F. & Doh, J. (2009). International Management. McGraw- Hill, p. 67.

endnotes

your turn 7

Communication occurs between a sender and a receiver. Effective communication occurs when the message from the sender is received with the intended content, time, and location by the receiver. This assesment applies to all types of communication and in any type of organizational environment. The organizational factors though affect the effectiveness of the communication. They are filtered and potentially distorted by work attitudes, ethics, habits, values, technology, verbal as well as non-verbal language, and other aspects of the work environment shape the communication process. These factors get even more challenging in a multicultural business environments because of cultural collissions and cross-currents. Eastern cultures emphasize face-to-face relationships, indirect answers, or delaying feedback or not giving any at all; while western cultures relatively prefer direct answers and use of technology for connectivity. For example, Turkish communication culture generally is rich in words and body language is explicit compared to styles that restrain the use physical gestures to underscore verbal communication. Anyone working in a multicultural environment either as a manager or an employee needs to be aware of other culturally-based communication behaviors to minimize misunderstanding the messenger or the message.

Why effective communication in a multicultural business environment, with

managers and employees from different cultures, is of utmost importance?

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15Schein, E. H. (1997). Organizational Culture and Leadership. Jossey-Bass.

16Katz, R. (September 1974). Skills of an Effective Administrator. Harvard Business Review, pp. 90-102.

17Delivery Hero (2015). Delivery Hero acquires Turkish food delivery giant Yemeksepeti. Retrieved from https://www.deliveryhero.com/delivery-hero-acquires-turkish-food-delivery-giant-yemeksepeti

18Minzberg, H. (1975). The manager’s job: Folklore and fact. Harvard Business Review, pp. 49-61.

19Delivering the goods (August 25, 2012). Economist. Retrieved from http://www.economist.com/node/21560918

20Northouse, P. G. (2013). Leadership (6th Ed.). Sage Publications, p.5; Robbins & Coulter op. cit., p.491.

21Deutschman, A. (September 5, 2011). Exit the King. Newsweek.

22Northouse, op. cit., p. 12.23Ibid., p. 19.24Robbins & Coulter, op. cit., p. 495.25Northouse, op. cit.26Griffin, op. cit., p. 486.

27Avolio, B. J., Bass, B. M., & Jung, D. I. (1999). Re-examining the components of transformational and transactional leadership using the Multifactor Leadership. Journal of Occupational and Organizational Psychology, 72, pp. 441–462. doi:10.1348/096317999166789

28Joseph, M. (April 29, 2016). What Does Chobani’s Founder Get For Giving 10% Of His Company To Workers? Retrieved from https://www.forbes.com/sites/maryjosephs/2016/04/29/

29Sampson, H. (April 7, 2014). One year in, Carnival CEO Arnold Donald is working to right the ship. Retrieved from http://www.miamiherald.com/news/business/article1974194.html

30Robbins & Coulter, op. cit., p. 332.31Tucker, A. L. & Singer, S. J. (2014). The

effectiveness of MBWA. Production and Operations Management, 24(2), pp. 253–271. DOI 10.1111/poms.12226

32Giang, V. (October 29, 2013). The ‘Two Pizza Rule’ is Jeff Bezos’ secret to productive meetings. Retrieved from http://www.businessinsider.com/jeff-bezos-two-pizza-rule-for-productive-meetings-2013-10

33Leising, M. & Massa, A. (February 2017). Maybe a good manager can’t run everything. Bloomberg- Businessweek, pp.32-34.

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Chapter 4 Managing Human Resources

Lear

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Explain human resource management activities to get the right people.

Define the concept of human resource management.

Describe the internal and external environment of human resource management.

Understand human resource management activities that maximize performance.3

1 24

Chapter OutlineThe Concept of Human Resource ManagementEnvironment of Human Resource ManagementHuman Resource Management Activities to

Get the Right PeopleHuman Resource Management Activities That

Maximize Performance

Key TermsHuman resources

Human resource planningRecruitment

SelectionOrientation

TrainingPerformance appraisal

Compensation


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Selecting qualified employees is like putting money in the bank. John Boudreau

One of the most crucial features of business is the role of human resources in today’s economy because there is a growing transformation towards service-based industries. Organizations may have a lot of buildings, expensive instruments and some huge bank accounts, but organizational goals cannot be achieved without qualified human resources. It is the people who have the capacity to make a difference and create value by bringing their intelligence, commitment, knowledge and skills to the workplace. If human knowledge and skills are a strategic resource, management must be seen as an integral part of business success.

Human resource (HR) refers to the workforce within an organization responsible to perform certain duties assigned by the management for achieving organizational goals. It would be difficult to imagine any company achieving and maintaining effectiveness without efficient human resource management programs and activities. Today, because of the recognition of the crucial role of people, human resource management has become a major player in developing strategic plans and contributing to the goals and missions of the organization.

The increased strategic importance of human resource management requires that employment policies, programs and practices need to be coherent and integrated with organizational strategies. Accordingly, the human resource management function is concerned with much more than filling out documents and recordkeeping. Recruiting, selection, training, developing, rewarding, compensating and motivating the workforce is directly related to the organizational effectiveness and profitability of the firm.

Human resource management (HRM) is a part of a larger field of management. Many environmental factors and developments in business like global competition, workforce diversity, downsizing, reengineering, and outsourcing influence human resource management functions in all industries. Therefore, it is very important to become proactive and to have a long-term vision for overcoming these changes. It is necessary to create and keep new, modern and quality human resources that may effectively support the goals of business in conditions of economic uncertainty, rapid technological change and intense competition.

Today, employees demand more control of their work and daily life. They respond favorably to management activities that support their work-life balance. Consequently, human resources management should treat each employee as an individual and present services and programs to meet individual needs. By giving one of its executives the title “Vice President of Individuality”, McDonald’s could be accepted as a pioneer in the service sector.1

THE CONCEPT OF HUMAN RESOURCE MANAGEMENT

Organizations operate in a complex and dynamic work environment. With the changes occurring in technology, people performance, operating costs, and demographics human resources have become a key issue for business and industry. Moreover, these developments in work environment transformed the objectives and the strategic role of human resource management in organizations.2

Human resource management (HRM) is the process of acquiring, training, appraising, and compensating employees, and of attending to their labor relations, health and safety, and fairness concerns. As stated above, many firms realize that the human resource function has a substantial impact on a firm’s bottom-line performance. Therefore, they align the firm’s human resource management goals and policies with the strategic goals of the enterprise in order to improve business performance. Managers call this strategic human

Human resource management (HRM) consists of all the activities involved in acquiring, maintaining, and developing an organization’s human resources.

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4 Managing Human Resources

resource management. Strategic human resource management is the linking of the human resource function with the company’s strategies to achieve organizational goals.

Dealing with human resource issues is not the only the HR department’s responsibility. On the contrary, all managers are, in a sense, human resource managers because they all get involved in recruiting, interviewing, selecting, and training their employees. The success of any HRM program requires the cooperation of managers at different levels who must interpret and implement HRM policies and procedures. Even line supervisors select prospective employees, train them, make salary recommendations, and provide performance feedback. For example, an HRM department may apply a particular performance appraisal approach. The managers of other departments must also implement this approach, otherwise it will not contribute to the organization’s overall strategies. Without managerial support, HRM programs cannot succeed. Therefore, human resource managers need to understand clearly how to communicate their policies and procedures to other units of the organization.3

There is not only one and the best way for managing human resources. Based on size, sector, employee numbers, financial situation, employee skills and location, each company develops its own HRM program. For example, the human resource strategy at Google supports the needs of the company and facilitates the achievement of Google’s objectives. But this strategy would most likely not be appropriate for Apple without modification.

ENVIRONMENT OF HUMAN RESOURCE MANAGEMENTOrganizations operate in a changing environment.

Managers need to consistently observe the business environment for opportunities and threats affecting human resources and be prepared to react quickly to these challenges Figure 4.1. The environmental factors influencing organizations and human resource management can be described in two main categories. They are internal environmental factors and external environmental factors.

Strategic human resource management is the linking of the human resource function with the company’s strategies to achieve organizational goals.

What is the difference between personal management and human resource management?

1

Trends So companies must be Employers will thereforeexpect from HRM that they

• Globalization• Increased competition• Deregulation and increased indebtedness• Technological innovation• More high-tech jobs• More service jobs• More knowledge work• An aging workforce• Economic crises• Slower economic growth in many countries

• More competitive• Faster and more responsive• More cost-e�ective• Human capital• Downsized• Leaner• Organized around empowered teams• More scienti�c in how they make decisions• More �scally conservative

• Focus more on big picture issues such as helping the company achieve its strategic goals• Find new ways to provide transactional services such as benefits administration• Create high performance work systems• Take steps to help the employer better manage challenging times• Manage ethically• Have the pro�ciencies required to do these things-for instance a command of strategic management and �nancial budgeting

Figure 4.1 Trends Shaping Human Resource Management

Source: Dessler, G. (2003). Management Principles and Practices for Tomorrow’s Leaders. Pearson Prentice Hall, p. 37.

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Internal Environmental Factors Affecting Human Resource Management

Internal environmental factors are issues that can be found within an organization’s internal environment. These factors can be indicated as personal and organizational factors, job characteristics in the organization, and interpersonal relationships.

Personal characteristicsEmployees have different needs, wants and

expectations that change over time. Personal factors such as common values, employees’ perceptions of their roles and motivation affect human resource management. Every employee carries his/her cultural background to the organization. Values such as tendencies to be a hard worker, adaptable, self-oriented or cooperative can be significant characteristics affecting HRM practices. Therefore, firms need to use training and education to achieve a unified organizational culture, which orients and motivates employees to achieve purposes.4

Job characteristicsJob boundaries are becoming blurred because

of technological developments and changes in today’s business world. In the past, a worker performed a job in a specific department, working on particular job tasks with others who did similar jobs. Today’s workers are just as likely, however, to find themselves working on project teams with various people from across the organization. Others may do the majority of their work at home and rarely see any of their co-workers. Human resource management needs to adapt its politics and programs on job security, workload and working conditions according to these developments.

Organizational factorsSome organizational factors affecting

human resource management are the size of the organizations, environmental climate, top management, structure of the organization and the sector, and the characteristics of the industry that the organization operates. The size of the organization which is very important to the extent of HRM activities can be measured especially through the number of employees, amount of income for a year, or the sum of production. Accordingly, HR practices, in terms of business functions, will be higher in a large firm than a small or medium sized company. The size of the company also affects the managerial style which determines the autonomy of HRM department. Because small and medium sized organizations generally have centralized organizational structure, human resources in those firms is under close control of their managers.5

On the other hand, the competitive strategy of the organization has a greater impact on HR practices. An organization’s competitive strategy such as mergers and acquisitions, downsizing, outsourcing, or hiring trends, determine the demand for employees in correct number and qualifications.6

External Environmental Factors Affecting Human Resource Management

External factors can be defined as factors outside the organizations that cannot be controlled and changed by the organization. Managers should pay close attention to external environment for adapting an organization’s human resource strategy to the new developments occurring outside the organization. Major environmental factors include workforce diversity, government regulations, and economic change. External environmental factors affecting HRM are workforce and demographic trends, government regulations, and economic challenges and trends.

Internal environmental factors affecting HRM are personal characteristics, job characteristics, and organizational factors.

External environmental factors affecting HRM are workforce and demographic trends, government regulations, and economic challenges and trends.

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Workforce diversityOne of the most powerful forces affecting work organizations is changing worker demographics such

as gender, age, ethnicity, seniority, and occupation. The age distribution, characteristics, values, and expectations of today’s workforce are remarkably different from that of the past. For example, the number of women in the workforce in the United States and elsewhere has increased significantly as well as the proportion of different ethnic groups.

The aging workforce is another important demographic trend affecting organizations. In many European countries, there are not enough younger workers to replace retiring older workers. On the other hand, every generation has its own labor force entrants. Today’s workforce mostly consists of Generation Y employees who are different from Generation X employees in every manner. Generation Y is widely known as the generation born between 1980 and 2000. They are bringing some challenges and strengths to the work life. Their capacity for using information technology make them the most high-performing employees. For example, millenials, also known as Gen Y prefers to email or call, instead of face-to-

face meetings. They also want more flexibility in the work/life balance, compared to Gen X. They expect flexible summer hours, to be able to work from home, and paid time off if they work beyond their normal hours.7

Because of the changing workforce, human resource departments need to adopt different methods for hiring employees, by offering different types of compensation packages, and attractive policies and promotions. Knowledge of employees’ demographic differences helps the HR experts for developing HRM policies and practices that gradually increase the impact on employees.8

Government regulations

All the policies for human resource management should be in accordance with legal regulations. Organizations need to deal effectively with government regulations and HR departments play an important role by monitoring the legal environment and adapting the human resource practices. Every country has its own legislation and regulations. Equal opportunity, occupational health and safety, minimum wage, and industrial relations are affected primarily by legislation. The legality of human resources function helps to create a more powerful organizational image. For this reason, firms should take national and international legislation into account while managing their human resources.9

Economic conditionsChanges in the national economy directly and indirectly affect human resource activities of firms

in terms of recruitment, employment, redundancy implications, compensation, rewards, and salaries. Organizations should predict the future of the economy and plan their functions. In today’s changing business world, it is very difficult to foresee economic developments accurately. For instance, in the 2008 economic crises the unemployment numbers raised to 2.6 million which is the highest level in more than six decades in the United States.10

In Turkey, every HRM implementation should be in accordance with the “Labor Law No.4857”, Occupational Health and Safety Law No. 6331, and Trade Unions and Collective Labour Agreements Law No. 6356.

What is the impact of techno-logical developments to hu-man resource management?

2

Each color adds to the overall performance of a workforce

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HUMAN RESOURCE MANAGEMENT ACTIVITIES TO

GET THE RIGHT PEOPLEMany organizations look to ensure that

they have the right number of the right people at the right time and at the right place.11

Primary human resource management challenges include determining how many people are needed and for how long, and where the company can provide the employees it needs. Once the organization determines its personnel requirements, it needs to select and hire the best employees to fill the available positions.

Human Resources Planning Planning is the starting point for all kinds of

management processes including human resource management. Human resource management starts with planning which is the development of strategies to meet a firm’s future human resources requirements. Human resource planning activity is concerned with assessing the future human resource need (demand), determining the

availability of the type of people needed (supply), and creating plans for how to meet the need (fulfillment).

As displayed in Figure 4.2., human resource planning should reflect the firm’s strategic plans. HR planning goes hand in hand with an organization’s decision about what it wants to accomplish (its mission) and how it wants to go about accomplishing it. For example, if a company has set one of its goals to expand its production capabilities over the next five years, such action will require skilled employees to be available to handle the jobs. Thus, once the strategy is set, the HRM function must do its part to ensure the strategy’s success, thereby helping the organization to achieve its objectives.12

Human resource planning is the process of assessing the future human resource need, determining the availability of the type of people needed and creating plans for how to meet the need.

Strategic Planning HR Demand HR Supply

Technological forecastsEconomic forecastsOrganizational planningInvestment planning

Annual employmentrequirementsNumbersSkillsOccupation categories

Existing employmentinventoryAfter application ofexpected loss and attrition rates

Variances

If surplus If shortage

DecisionsLayo�, retirement,

etc

Decisions Overtime,recruitment

End End

Figure 4.2 Human Resource Planning Process

Source: Ivancevich, J. M. & Duening, T. N. (2004). Business Principles, Guidelines, and Practices. Atomic Dog Publishing, p. 137.

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Human resource planning generally follows four steps: (1) conducting a job analysis; (2) forecasting demand; (3) forecasting the supply human resources; and (4) matching the demand and supply of human resources.

Conducting job analysisJob analysis is the systematic process of getting detailed

information about the skills, duties, and knowledge required for performing jobs in an organization. Job analysis provides a summary of a job’s duties and responsibilities, its relationship to other jobs, the knowledge and skills required, and working conditions under which it is performed.

Job analysis is such an essential activity for HR managers that it has been called the building block of everything which personnel need. Every human resource management activity requires some type of information that is compiled from job analysis: The selection, performance appraisal, training and development, job evaluation, career planning, work redesign, and human resource planning. In human resource planning, planners analyze an organization’s human resource needs in a dynamic environment and develop activities that enable a firm to adapt to change. This planning process requires accurate information about the levels of skills required in various jobs to ensure that sufficient people are available in the organization to meet the human resource needs of the strategic plan.13

There are several methods to gather information about jobs such as questionnaires, observation, and interviews. Managers can use a job analysis questionnaire to ascertain a job’s duties and responsibilities. It requires employees to compose detailed information on what they do. Employees do this by briefly stating their main duties in their own words, describing the conditions under which they work. The HR department then works with supervisors to review this information. They decide exactly what each job entails and interview the employees. No matter what method is used to gather data, the information gathered from the job analysis process generates two outcomes: Job descriptions and job specifications.14

A job description is a written document that identifies, defines, and describes a job in terms of its duties, responsibilities, and work conditions. A common format for a job description includes the job title, the duties to be performed, the distinguishing characteristics of the job, environmental conditions, and responsibilities of the job holder.

A job specification is a document containing the minimum acceptable qualifications that a person should possess in order to perform a particular job. Job specification includes job related information such as educational requirements, experience, personality traits, and physical abilities.

After jobs have been analyzed and the descriptions written, the results should be reviewed with the supervisor and the worker to ensure that they are accurate, clear, and understandable. Reviewing the results with employees help to gain their acceptance.15

Job analysis is the systematic process of determining the skills, duties, and knowledge required for performing specific jobs in an organization.

A job description is a written document that identifies, defines, and describes a job in terms of its duties, responsibilities, and work conditions.

A job specification is a document containing the minimum acceptable qualifications that a person should possess in order to perform a particular job.

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Forecasting demandThe first human resource planning activity entails

forecasting labor demand. The key objective is to determine how many and what type of employees the firm needs at a point in the future. For example, many Japanese electronics firms estimated in the mid-1990s that the product segments of music and games would increase at double-digit rates for 20 years. Much of the assembly work of putting together the various components of the music and game playing machines would require relative low-skilled and low-cost labor.16

The basic process of forecasting personnel needs starts with estimating revenues for a given period and the size of the staff required to support the sales volume in the same period. In addition, projected turnover rates, decisions to upgrade (or downgrade) products or services, productivity changes, and financial resources must be considered by the managers. An organization might use statistical models that predict labor demand for the consequent year given relatively objective statistics on leading indicators form the previous year.17

Forecasting supply

The next step in human resource planning is to estimate how many staff will be employed by the organization in the future. Labor supply is the availability of workers with the required skills in the future. The forecast of the supply of human resources must take into account both

the present workforce and any changes that may occur within it. When forecasting the supply, planners should analyze the organization’s existing employees to determine who can be retained to perform the required tasks. For example, suppose that planners project that in five years an automobile factory that currently employs 100 engineers will need to employ a total of 200 engineers. Planners simply cannot assume that they will have to hire 100 engineers, during that period, some of the firm’s present engineers are likely to be promoted, leave the firm, or move to other jobs within the firm . Therefore, planners may project the supply of engineers in five years at 83, which means that the firm will have to hire a total of 117 new engineers.18

The two most commonly used techniques for forecasting human resources supply are the replacement chart and skills inventories. The replacement chart lists each important managerial position, who occupies it, how long that person will likely stay in the job, and who is qualified as a replacement. This technique allows sufficient time to plan developmental experiences for people identified as potential candidates to critical managerial positions.

A skills inventory (human resource information system) is a computerized databank containing information on the

Labor demand determines how many and what type of employees the organization needs in the future.

A leading indicator is an objective measure that accurately predicts future labor demand. Inventory levels, sales levels, employment levels and profit levels are the most used leading indicators for forecasting personnel demand.

Labor supply is the availability of workers with the required skills in the future.

A replacement chart lists each important managerial position, who occupies it, how long that person will likely stay in the job, and who is qualified as a replacement.

A skills inventory (human resource information system) is a computerized databank containing information on the education, skills, and experience of all present employees.

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education, skills, and experience of all present employees. When a manager needs an employee for a position, he or she uses key words to describe the position’s features in terms of skills and education. The computerized system then produces a list of qualified candidates. Thus, an employee who is qualified to fill a required position can be located quickly by human resource department.19

Matching the demand and supply of human resourcesThe main purpose of human resource planning is to bring together the

forecasts of demand and supply for human resources, both current and future. After a comparison of requirements and availability of workers, as it can be seen in Figure 4.2, there will be two results: labor shortage; labor surplus. When this is determined, the organization can assign how it is going to solve these potential problems.

In case of labor shortages or if the supply of workers is less than the demand, organizations can develop several strategies to overcome these problems. If the shortage is small and employees are willing to work overtime, it can be filled with current employees. If there is a shortage of highly skilled employees, training and promotion of current employees, together with the recruitment of less-skilled employees, are possibilities. A shortage of human resources often means that the organization needs to use new approaches for recruitment. The organization may have to recruit in different geographic areas than in the past, explore new methods, lower the employment standards and seek different kinds of candidates. For instance, instead of desiring extensive work experience, a firm may be willing to hire an inexperienced worker and train the individual to do the job.20

In case of a surplus or if the supply of workers is more than the demand, restricted hiring, reduced hours, early retirements and layoffs may be required to correct the situation. Decisions in surplus conditions are some of the most difficult that managers must make. Attrition is considered the most humane method for making personnel cutbacks. Attrition is the normal reduction in the workforce that occurs when employees leave a firm. Attrition occurs when employees who quit, die, or retire, or are not replaced. With this approach no one is cut out of a job, but those who remain must handle the same workload with fewer people. Early retirement which encourages more senior workers to leave the organization with full benefits is another option. This method is usually viewed as a way to accomplish workforce reduction without resorting to layoffs and individual firings.

As a last resort, employees are sometimes simply fired. Layoffs may be an appropriate downsizing strategy during a temporary economic downturn in an industry. However, because of its negative impact, this method generally is used only when absolutely necessary.21 Many companies, such as Hewlett-Packard, have preferred cut pay to avoid layoffs for keeping their employees.22

Recruiting Once the firm has determined its human resources needs

via human resource planning, it needs to hire the most qualified employees to fill the available positions. As Figure 4.3 shows, the hiring process has three steps: recruitment, selection, and orientation.

Recruitment, the first step in the hiring process, consists of a set of activities that improves the number and

If the company makes people work overtime because of the labor shortage, it must to take into account the labor law which is related to overtime work. As noted in Turkish Labor Law No.4857, the normal working time in a week is 45 hours. Wages for each hour of overtime is remunerated at one and a half times the normal hourly rate. Total overtime work cannot be more than 270 hours in a year.

How does a manager forecast the external supply of human resources?

3

Recruitment consists of a set of activities that improves the number and quality of people who apply for employment, as well as the probability that qualified and compatible applicants will accept employment offers.

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quality of people who apply for employment, as well as the probability that qualified and compatible applicants will accept employment offers.23 The recruitment process has become even more vital for business organizations because of shifting and competitive labor market. It is very important for an organization to make the recruitment function a part of human resource planning. For example, in the beginning of 2000, a drugstore chain Walgreens had to cut back its expansion plans to open new stores because of a shortage of trained pharmacists in the USA. This example reflects how human resource planning and recruiting issues affect organizational strategic plans.24

Recruiting strategy and policy decisions entail identifying where to recruit, whom to recruit, and how recruiting will be done. One of the first decisions is to determine the extent to which internal and external sources and methods will be used. Both promoting from within the organization (internal recruitment) or hiring from outside the organization (external

recruitment) to fill job openings have some advantages and disadvantages. Table 4.1. shows some of the major advantages of internal versus external recruiting.25

Recruiting Source Advantages Disadvantages

Internal • Moraleofpromotion• Betterassessmentofabilities• Lowercostsforsomejobs• Motivatorforgoodperformance• Causesasuccessionofpromotions• Havetohireonlyatentrylevel

• Inbreeding• Possible morale problems of those notpromoted

• “Political”infightingforpromotions• Need for a management developmentprogram

External • New “blood” brings newperspectives

• Cheaper and faster than trainingprofessionals

• Nogroupofpoliticalsupporters inorganizationalready

• Maybringnewindustryinsights

• Maynotselectsomeonewhowill“fit”thejobororganization

• May cause morale problems for internalcandidatesnotselected

• Longer“adjustment”ororientationtime.

Before deciding which source is the best, the company should focus on the aims of recruitment:26 • toobtainapoolofsuitablecandidatesforvacantposts;• touseandbeseentouseafairprocess;• toensurethatallrecruitmentactivitiescontributetocompanygoalsandadesirablecompanyim-

age; and• toconductrecruitmentactivitiesinanefficientandcost-effectivemanner.

Internal recruitmentInternal recruiting or hiring from within the organization means using various sources developed and

managed inside the organization. If an organization has been effective in recruiting and selecting employees in the past, current employees are often the best source of candidate pool. For making its employees handle larger responsibilities, the organization needs a strong employee and management development program. Hiring from within the organization generally relies on job posting and employee referrals.

Recruitment

Selection

Orientation

Figure 4.3 The Hiring Process

Table 4.1 Advantages and Disadvantages of Internal and External Recruiting Sources

Source: Mathis, R. L. & Jackson, J. H. (2003). Human Resource Management (10th ed.). Thomson South Western, p. 212.

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Job posting. Internal recruiting generally requires job posting. Job posting means publicizing the open job to employees (often by literally posting it on bulletin boards or company intranets) and listing the job’s attributes, like qu-alifications, supervisor, working schedule, and pay rate. The usual procedure of job posting is for all applications to be sent to the human resource department for an initial review. After an interview conducted by the prospective manager, a decision is made based on qualifications, performance, length of service and other criteria. Job posting can be a good practice, if it facilitates the transfer and promotion of qualified inside candidates.27

Employee referrals. One of the best sources for individuals who will perform effectively on the job is a recommendation from a current emp-loyee. Many organizations have found that their employees can serve an im-portant role in the recruitment process by actively soliciting applications from their friends and associates. These recruiting systems may be informal and operate by word–of-mouth or they may be structured with definite gu-idelines to be followed. Employee referrals can develop quite a large pool of potential employees with a very low cost. However, using only this system can violate equal employment regulations because current employees tend to refer to people who are similar to themselves. Therefore, some external recruitment might be necessary to avoid legal problems in this area.

External recruitingIf a company cannot reach new employees by internal recruiting, it needs to open up recruiting activities

to outside of the company. External recruitment becomes essential in organizations that are growing rapidly and have expanding workforce requirements. The following needs require external recruitment: (1) to fill entry-level jobs; (2) to acquire skills not possessed by current employees; and (3) to obtain employees with different backgrounds to provide a diversity of ideas.28

A number of methods are available for external recruitment methods. These are advertising, online recruitment, employment agencies, and college recruiting.

Advertising. Advertising is one of the most widely used methods of recruitment. Advertising communicates the firm’s employment needs to the public through newspa-pers, radio, television, or other electronic media. Regardless of the advertising method utilized in determining the con-tent of an advertising message, an organization must decide on the corporate image it wants to project. Studies found that people responded more frequently to advertisements from companies with a positive corporate image than to those companies with a lower corporate image.29

Advertising should contain desired qualifications, details on the job and application process, and an overview of the organization.

Online recruitment. Online recruitment is the process of using the internet to actively identify and recruit qualified candidates for an organization. The internet has quickly become one of the primary recruitment tools for organizations. Most employers use online job boards to attract candidates. On the

Job posting is publicizing the open job to employees (often by literally posting it on bulletin boards or company intranets) and listing the job’s attributes, like qualifications, supervisor, working schedule, and pay rate.

Studies have shown that employees recruited through current employee referrals tended to stay with organizations longer and displayed greater loyalty and job satisfaction than those from other recruiting sources.

Advertising is a way of communicating the firm’s employment needs to the public through media such as newspapers, radio and television.

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other hand, recruiting for professionals and ma-nagers is shifting from online job boards to social networking sites such as Facebook and LinkedIn. According to a research, social media has become an almost universally adopted hiring tool, with 92 percent of recruiters surveyed using it as part of their process. 87 percent are using LinkedIn, 55 percent are using Facebook, and 47 percent are using Twitter in USA.30

Online recruitment can also be done through a company website. Many businesses now offer an employment opportunity or career page secti-on and have created an online application, which is sent directly to human resource department.31

For example, Google has details of available jobs in every country, lists the top 10 reasons to work at the company and provides downloadable videos in which Google staff describe what it’s like to work at the Go-ogleplex.32

There are many advantages of online recruit-ment. First of all, it saves time and money. Recru-itment content is uploaded more quickly and at a much lower cost than is possible with traditional media advertisements. Besides, recruiters can res-pond to qualified candidates more quickly. It is possible to expand applicant pool globally because potential applicants in other countries or areas can see job posted on the Web.33

Employment agencies. An employ-ment agency is an organization that helps firms to recruit employees and at the same time aids indivi-duals in their attempt to locate jobs. There are two kinds of employment agencies: Private and public employment agencies.

Private employment agencies are important sources of clerical, white-collar, and managerial personnel. It offers an important service in bringing qualified applicants and open positions together. Typically, the employment agency is paid a fee based on the salary offered to the new employee. Employment agencies generally have their own Web sites to show prospective employees the array of jobs that are available through their agency.

Public employment agencies often called job service or unemployment service agencies are operated by governments. Public employment agencies are known best for recruiting blue collar and clerical workers. Some public agencies use computerized job-matching systems to aid in the recruitment process. Public employment agencies provide their services without a charge to either the employer or the prospective employee.34

For example, the public employment agency in Turkey, Turkish Labor Agency named Türkiye İş Kurumu (İŞKUR) serves job seekers finding jobs suitable to their qualities and for employers finding employees who have qualities in compliance with the job requirements.35

College recruiting. College recruitment involves sending an employer’s representatives to college campuses to prescreen applicants and cre-ate an applicant pool from the graduating classes. It is an important source for management to reach professional and technical employees. College rec-ruiting could be expensive and time consuming if the recruiters are not experienced. Employers need to train recruiters in how to interview candidates, how to explain what the company has to offer, and how to put candidates at ease.36

What are the disadvantages of Internet recruiting?

4

An employment agency is an organization that helps firms to recruit employees and at the same time aids individuals to locate jobs.

College recruitment involves sending an employer’s representatives to college campuses to prescreen applicants and create an applicant pool from the graduating classes.

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SelectionOnce the recruiting process has attracted a pool of

applicants, the next step is to select someone for hiring. The selection process is to choose the right person who can successfully perform a certain job from the pool of qualified candidates. Job analysis, human resource planning, and recruitment are necessary prerequisites to the selection process.

The selection process has a series of steps that starts with the preliminary screening and ends with a decision to hire the person. Figure 4.4 shows the steps in a typical selection process. Even though these steps are universal, every organization creates its own selection process based on the size of the organization, the types of the jobs to be filled and the number of people to be hired. It is possible to say that if the job or position is important, the organization generally use each step formally.

The selection process is to choose the right person who can successfully perform a certain job from the pool of qualified candidates.

Employmentinterview

Employment test

Physicalexamination

Selectiondecision

Reference check andbackground

investigations

Preliminary screening

Figure 4.4 The Selection Process

Source: http://managementation.com/selection-process-steps/

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Step 1: Preliminary screeningCompleting an application form is normally the first step in most selection procedures. The application

provides basic employment information for use in latter steps of the selection process and can be used to screen out unqualified applicants.

Step 2. Employment interviewThe most widely used selection technique is the employment interview. Job candidates are interviewed

by at least one member of the HRM staff and by the person for whom they will be working. Employment interviews provide an opportunity for applicants and the firm to learn more about each other. While the interviewer may get more information about the candidate’s abilities and attitudes, the candidate may be informed also about the job and work environment.

However, if it is not used properly, the interview can be a poor device in the selection process and create discrimination against other candidates. For example, according to some research most interviewers make decisions about candidates in the first two or three minutes of the interview. Snap decisions can adversely affect an interview’s validity because they are made based on limited information. In addition, interviewers may be influenced by such factors as the appearance of candidates.37

It is possible to improve interview validity by training interviewers to be aware of potential biases and by tightening the structure of the interview. Using structured interviews may also reduce the reliability and validity problem. In a structured interview, questions are written in advance and all interviewers follow the same question list with each candidate. However, for managerial and professional candidates, a somewhat less structured interviewing approach can be used in selection process. In an unstructured interview, questions are not prepared in advance and there is no attempt to guarantee that applicants are asked the same questions.38

Step 3: Employment testThe third step in the selection process is an employment

test which measures the aptitudes, skills, abilities, or knowledge of job candidates. Employment tests allow managers to choose candidates according to how they will fit into the open positions and the organizational culture. Since tests alone are not enough to make an evaluation of a candidate, firms need to use employment testing conjunction with other selection tools such as interviewing. Besides, test should be validated, administered, and scored consistently. All candidates should be given the same directions, allowed same amount of time, and offered the same environmental conditions for testing.

There are different types of tests that are used by organizations as selection tools. However, it is generally classified by whether they measure mental abilities (cognitive), physical abilities, personality and interests, and achievements.

Cognitive ability or intelligence tests measure the general intellectual abilities such as memory, verbal and numerical ability. Physical ability tests measure the motor skills such as speed and accuracy of arm movement and reaction time, manual dexterity, weight lifting, and dynamic strength. Personality or interest tests measure basic aspects of personality such as friendliness, introversion, stability, and motivation. Achievement tests measure the knowledge about the job.39

Employment tests measure the aptitudes, skills, abilities, or knowledge of job candidates.

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Step 4: Reference check and background investigationsA reference check is intended to verify what was

stated on the application is correct and accurate. It is stated that between 10 and 15 percent of applicants either lie about or exaggerate factual information. As a result, reference checking ensures that applicants have the degrees they claim from the school they cite and held the jobs with the responsibilities they describe.40

Organizations can use two methods in conducting the investigations and checks: The internal or the external investigation. In the internal investigation, HRM undertakes the task of questioning former employers and personal references indicated by the candidates. In the external investigation, HRM use reference-checking firms. Although it is costlier, such firms have a better track record of gathering pertinent information, as well as being better informed on privacy rights issues.41

Step 5: Physical examinationPhysical examination is part of the selecting process when

a job requires certain physical abilities from the employees. If HR asks the candidates to take a physical examination, it must be able to show that it is a job-related requirement. Besides, all individuals who are conditionally offered employment should be required to have one. Having a physical disability may not be enough to exclude an individual from the job. Companies may be required to make reasonable accommodations.

Step 6: Selection decisionAfter going through previous steps that help to collect

relevant information about the candidates, the company may decide to make a job offer to an applicant. The important point in this final step is that the HRM department can only make recommendations but the final decision should be made by the department manager in which the position is opened.

OrientationSelecting the best qualified employees does not mean

that selected employees adopt to the position and the organization immediately. After people are hired, they need be oriented to the organization and to their jobs.

Turkey has signed the UN Convention on the Rights of Disabled that lays down the criteria for individuals with disabilities and obligation of employing disabled persons. This is detailed in Turkish Labor Law No. 4857, Article 30. In private sector workplaces employing fifty or more people within the boundaries of a province, the employer must hire disabled persons, numbers of which cannot be less than the 3% of the total. The employer or employer’s representative who does not employ disabled persons in contravention of the provisions of Article 30 is liable to a monthly fine of 2.095 TL (for the year 2015) for each disabled person for whom this obligation is not fulfilled.

Selection decisions should be made by the department manager which the applicant will be hired.

Employee orientation is the systematic process of helping new employees learn about the company and getting emotionally attached to the firm.

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Employee orientation is the systematic process of helping new employees learn about the company (such as company cultures, policies, work rules and benefit programs) and becoming emotionally attached to the firm. Several studies suggest that formal orientation program has a significant effect on stress, turnover, and job performance. Giving realistic information about the job and the organization helps employee to cope with stress and reduces turnover.42

All types of organizations should have some type of orientation program accomplishing such goals as:43

1. Make the new employees feel welcome and at home and part of the team;2. Make sure the new employees have the basic information to function effectively, such as e-mail

access, personnel policies and benefits, and what the employer expects in terms of work behavior; 3. Help the new employees understand the organization in a broad sense (its past, present culture,

and strategies, and vision of the culture).The HR department is responsible for initiating and conducting the orientation programs with support

of the department manager for which the employee is hired. The length of the orientation program depends on its main purpose and contents. Many small firms have traditional orientation programs that take several hours. They also support the orientation process with employee handbooks that cover organizational policies, benefits and regulations. However, in many large organizations the orientation process takes up to a week and includes videos, lectures by company officers, and exercises covering matters like company history, vision and values. Some organizations use a “buddy system” in which the job orientation is conducted by one of the new employee’s coworkers. The employee chosen for this role must be carefully selected and properly trained for such orientation responsibilities.44

HRM ACTIVITIES THAT MAXIMIZE PERFORMANCEOnce employees are hired, increasing the organization needs to ensure that they are performing well. It

is the human resource manager’s job to train, motivate, appraise and see that employees are rewarded fairly.

TrainingIn today’s dynamic job environment, organizations need

to have well adjusted, trained and experienced people to perform the activities that must be done. Rapid job changes require employee skills to be transformed and frequently updated. Training is a continual process of providing employees with skills and knowledge they need to perform at a high level. Training can involve the changing of skills, knowledge, attitudes, or behavior. It may mean changing what employees know, how they work, their attitudes toward their work, or their interaction with their coworkers and superiors.45

Training begins on the employee’s first day at work with orientation and continues the rest of her/his working life. While there is much to be gained from training in terms of improved skills and productivity of the workforce, training is a costly activity. Therefore, managers need to identify who needs training, what type of training works best, and when the training is required. These questions are answered by the training needs analysis.

Training needs analysisTraining needs analysis is a systematic analysis of the specific training activities the organization requires

to achieve its objectives. An organization should commit its resources only to those training activities that can best help in achieving its objectives.

Training is a continual process of providing employees with skills and knowledge they need to perform at a high level.

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Training needs may be determined by conducting analyses on several steps (Figure 4.5):• Organizational analysis: From an overall organizational perspective, the firm’s strategic mission,

goals, and corporate plans are studied, along with the results of human resource planning.• Task analysis: The next step of training needs analysis focuses on the tasks required to achieve

organizational goals. Job descriptions are important data sources for this analysis level. • Person analysis: Determining individual training needs is the last step. The relevant questions are,

“Who needs to be trained?” and “What kind of knowledge, skills and abilities (KSAs) do employ-ees need.” Performance appraisals and interviews or surveys of supervisors and observations are helpful at this level.

Once training needs have been identified, training objectives must be established. Management should explicitly state what results are sought for each employee. It is not enough just to say the change in employee knowledge, skills, attitudes, or behavior is desirable; management needs to clarify the training objectives: What is to be change and by how much? Objectives need to be concise, accurate, timely and measurable. Both the supervisor and the employee should know what is expected from the training efforts.46

Training techniquesSeveral methods can be used to satisfy an organization’s training needs and accomplish its objectives.

Such factors as cost, available time, number of persons to be trained, background of trainees, and skill of the trainees determine the method used. Training techniques can be classified as either on-the-job- training and off-the-job-training.

On-the-job-training (OJT) refers to new or inexperienced employees learning through observing peers or managers performing the job and trying to imitate their behavior. OJT is preferred especially for training newly hired employees, upgrading experienced employees’ skills when new technology is introduced, cross training employees within a department or work unit, and orienting transferred or promoted employees to their new jobs. The most widely used OJT technique is apprenticeship which is a work-study method. Such training is a formal and long term on-the-job-learning. It traditionally involves having the learner/apprentice study under the supervision of a master craftsperson. The majority of the apprenticeship programs are in the craft jobs.

What de�ciencies, if any doincumbents have in the

skills, knowledge, orabilities required to exhibitthe necessary job behaviors

Is there aneed fortraining?

What are theorganization’ goals?

What behaviors arenecessary for each job

incumbent to complete thearranged tasks

What tasks mustbe completed to

achieve theirgoals?

Figure 4.5 Training Needs Process

Source: De Cenzo, D. A. & Robbins, S. P. (1999). Human Resource Management (6th ed.). John Wiley & Sons, Inc., p. 229.

On-the-job-training (OJT) refers to new or inexperienced employees learning through observing peers or managers performing the job and trying to imitate their behavior.

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OJT is the most widely used training methods because it needs less investment in time or money for materials, trainer’s salary, or instructional design. However, there are also several disadvantages of on-the-job-training. Its major disadvantage is that the pressures of the workplace can cause instruction of the employee to be haphazard or neglected. Besides, while employees develop their skills, it can cause low productivity.

For overcoming its disadvantages, on-the-job-training must be structured carefully. Because OJT involves learning by observing others, successful OJT is based on using credible trainer, a manager or peer who models the behavior or skills. It is also important to have the trainees try out the job to demonstrate their understanding. A well designed OJT program can reduce employee turnover and work accidents as well as it improves employee morale.47

Off-the-job-training takes place at locations away from the work site. This approach offers a controlled environment and allows focused study without interruptions. Conferences, classroom groups, mobile learning, audiovisual techniques, lectures, computer-based training and internet-based training are some of the techniques for off-the-job-training. Some of the off the job training methods have been summarized in Table 4.2.

Internet-based training is increasingly used by companies. Many firms are creating their own Internet based learning portals for their employees. These portals let the company contract with training content-providers, which offer their training content to the firms’ employees via the portal. For example, Ford Motor Company and SAE International have joined forces to provide a series of Ford’s online training courses to automotive engineers worldwide. Ford and SAE International offer six popular online courses on powertrain and problem-solving topics as a way to extend Ford engineering knowledge across the global industry.48

Off-the-job-training involves training methods such as conferences, classroom groups, mobile learning, audiovisual techniques, lectures, computer-based training, and internet-based training.

Classroom LecturesLectures designed to communicate specific interpersonal, technical, orproblem-solving.

Audiovisual TechniquesUsing various DVD’s, films, and PowerPoint, and audiotape productions todemonstratespecializedskillsthatarenoteasilypresentedbyothertrainingmethods.

Vestibule TrainingTraineeslearnontheactualorsimulatedequipmenttheywilluseonthejob,butaretrainedoffthejob.

Simulation ExercisesTrainingthatoccursbyactuallyperformingthework.Thismayincludecaseanalysis,experientialexercises,orroleplaying.

Mobile LearningDeliveringlearningcontentondemandviamobiledeviceslikecellphones,laptops, and iPads, wherever and whenever the learner has the time anddesiretoaccessit.

Table 4.2 Training Methods

Source: Dessler, G. (2013). Human Resource Management (13th ed.) Pearson, p. 286; De Cenzo, D. A. & Robbins, S.

P. (1999). Human Resource Management (6th ed.). John Wiley & Sons, p. 231.

How can human resource department evaluate the tra-ining program’s results?

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Performance AppraisalAs mentioned earlier, just because employees have the

ability and experience to do the job does not ensure that they will perform satisfactorily. Organizations need to evaluate the employees’ performance and let them know how well they have performed on established goals. Performance appraisal can be defined as the process of determining and communicating to an employee how s/he is performing on the job.

HR departments use the information collected through performance appraisals to make important decisions about HR functions. One of the most common uses of performance appraisals is for making administrative decisions relating to promotions, firings, layoffs, and merit pay increases. Performance appraisal information also provides needed input for determining both individual and organizational training and development needs. Another important use of performance appraisals is to encourage performance improvement. In this regard, performance appraisals are used as means of communicating to employees how they are doing and suggesting needed changes in behavior, attitude, skills or knowledge.49

In most organizations, the HR department is responsible for coordinating the design and implementation of performance appraisal programs. Generally, line managers play an essential role from beginning to end of this process by conducting the appraisals and giving feedback. The supervisor is usually in the best position to observe and evaluate his or her subordinate’s performance. However, relying only on supervisors’ appraisals is not always sufficient. For example, an employee’s supervisor may not understand how customers and colleagues see the employee’s performance. Therefore, methods like self-appraisal (subordinates evaluate themselves), peer appraisal (colleagues make the assessment), and appraisal by subordinates (subordinates assess the manager) can be applied as significant contemporary approaches to performance appraisal.50

Another approach in performance appraisal systems is to view an individual performance from multiple perspectives which is called 360 Degree Feedback (Figure 4.6). In this method, the employee may be rated by senior managers, the employee her/himself, supervisors, subordinates, peers, and internal or external customers. Typically, a questionnaire is sent to the people who provide the ratings as online. Computerized systems then compile all this feedback into individualized reports to rates. The evaluation process can be done so quickly and conveniently.

Performance appraisal is the process of determining and communicating to an employee how he or she is performing on the job.

360-degree feedback performance is an appraisal system in which information is gathered from top management, supervisors, peers, subordinates, and customers.

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The positive aspect of 360-degree feedback is that, because data is gathered from multiple sources, it may provide a more objective measure of an employee’s performance. The use of multiple sources results in a broader view of the employee’s performance and may minimize biases that result from limited views of behavior.

However, during the 360-degree feedback process, it takes more time and energy to collect, process, and effectively feed the data back to the individual. Nevertheless, the HR department can compete with these problems by training people who are giving and receiving feedback and monitoring the appraisal system effectiveness.51

Performance appraisal processPerformance appraisal is perhaps the most important, yet

most difficult human resource activity for most managers. For generating an accurate and reliable data, a systematic process should be followed. All managers need to understand the key factors that drive an effective performance appraisal system and be skilled at implementing them. Figure 4.7 shows the steps in the performance appraisal process.52

Establishing performance standardsStandards need to be developed in order to be able to

measure performance. There are two main methods that are currently used for developing the standards against which the employees’ performance is measured. The first method is setting targets for employees. The targets can be quantified outputs, improvements targets, or targets relating to a particular project.

TopManagement

ImmediateSuperiors

CustomersPeers

Subordinates

Self

360°Appraisal

Figure 4.6 360 Degree Feedback Performance Appraisal

Source: http://hrmpractice.com/360-degrees-performance-appraisal/

Establishing performance standards

Communicating standards andexpectations

Measuring the actual performance

Comparing to standards

Discussing results (providing feedback)

Decision making

Figure 4.7 Performance Appraisal Process

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They can also be standing targets dealing with the day-to-day operations of the job. The second method is to determine the level of competence that the individual must achieve. Competencies can be set out as required organizational behaviors for which the employee should aim.53

Communicating standards and expectationsMost employees need and expect to know ahead

of time on what basis their employer will evaluate them. Ideally, each employee’s goals should derive from and contribute to the company’s overall targets. Everyone should clearly understand what he or she is required to do to contribute to the company’s success. To create and maintain this framework, employers need to inform workers of their value, praise them for their accomplishments, establish a track record of fair and honest feedback, be consistent in their treatment of all employees, and canvass workers for their own insights into the company’s processes and operations.54 The standards should also be communicated to the evaluators and if required, the standards can also be modified at this stage according to the relevant feedback from the employees and the evaluators.

Measuring the actual performanceThe most difficult part of the performance appraisal process is measuring the actual performance of the

employees that is the work done by the employees during the specified period. It is a continuous process which involves monitoring the performance throughout the year. This stage requires the careful selection of the appropriate techniques of measurement, taking care that personal bias does not affect the outcome of the process and providing assistance rather than interfering in an employee’s work.55 Performance appraisal can be employed by trait appraisal instruments, behavioral appraisal instruments, and behavioral anchored rating scales.

Trait appraisal instruments evaluate employees based on characteristics that tend to be consistent and enduring, such as decisiveness, reliability, energy, and loyalty. Because people routinely make trait judgments about others, these instruments can be a powerful way of describing people. However, this type of appraisal instrument has several disadvantages such as ambiguity (what it takes to be loyal) and propensity for conscious or unconscious bias (the supervisor may feel that women are more emotional than men and therefore rate their traits differently). There is also some difficulty for defending legally, given that assessment of traits focuses attention on the person rather than on the job performance.56

Behavioral appraisal instruments assess certain employee behaviors, such as coming to work on time, completing assignments within stipulated guidelines, and getting along with coworkers. A behavioral observation scale is one type of behavioral appraisal instruments in which various behaviors are listed and supervisors record the frequency of their occurrence.

For creating and setting effective and useful employee goals and objectives, the acronym “SMART” can be used in the performance appraisal process. It contains the characteristics of strategic goals and objectives that will be useful for managers and employees.Specific means that the target is clearly defined.Measurable means that the target state is defined as a number.Achievable means that the staff member can take the necessary actions to meet the objective.Realistic means that the staff member has a fair chance to achieve the desired results.Time-bound means that the target state is described with a time dimension.Source: http://performance-appraisals.org/faq/smart.htm

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Behavioral anchored rating scales assess the effectiveness of the employee’s performance using specific examples of good or bad behaviors at work, often referred to as critical incidents. The main advantage of this approach is that it is closely focused on concrete aspects of job performance. Employees may more clearly understand why they received a particular rating and what they need to do to improve. This approach is also easier to defend legally. However, developing this kind of instrument is quite expensive. The use of critical incidents is more demanding of the manager since it requires for the manager to write things out when they occur.57

Outcome appraisal instruments measure workers’ performance results such as sales volume, number of units produced, number of satisfied customers, customer complaints, and meeting deadlines. The results and outcomes of work performance provide the most objective technique for collecting data for appraisal. Measurements can be taken at different points in time and comparisons made with objectives. Management by Objectives (MBO) is one strategy mostly used as an outcome-oriented approach. Under this strategy, employees and supervisors agree on a set of goals to be accomplished for a particular period. Performance is then assessed at the end of the period by comparing actual achievement against the agreed-upon goals. This approach provides clear direction to employees, reduces subjectivity, and allows individual goals to be established.59

Comparing to standardsThe actual performance is compared to the desired or the standard performance. The result can show

the actual performance being more than the desired performance or, the actual performance being less than the desired performance depicting a negative deviation in the organizational performance. It includes recalling, evaluating, and analyzing the data related to the employees’ performance.60

Discussing results (Feedback)The appraisal interview is the most important step of the entire evaluation process. The results, the

problems and the possible solutions are discussed in a way that elicits the positive behavioral responses. To provide effective performance feedback managers should pay attention to the following recommendations:61

• Providefeedbackfrequently,notonceayear.• Createtherightcontextforthediscussion.• Asktheemployeetoratehisorherperformancebeforethesession.• Encouragethesubordinatetoparticipateinthesession.• Recognizeeffectiveperformancethroughpraise.• Focusonsolvingproblems.• Focusonfeedbackonbehaviororresults,notontheperson.• Minimizecriticism.• Agreetospecificgoalsandsetadatetoreviewprocess.

Some managers encourage employees to record their own critical incidents (where the employee excelled, situations that did not go well). That’s an interesting variation that places more responsibility with the employee, and also does not require the manager to have been present when the incident occurred.58

An example of a good critical incident of a sales assistant is the following:July 20 – The sales clerk patiently attended to the customer’s complaint. He is polite, prompt, enthusiastic in solving the customers’ problem.On the other hand, the bad critical incident may appear as under:July 20 – The sales assistant stayed 45 minutes over on his break during the busiest part of the day. He failed to answer the store manager’s call thrice. He is lazy, negligent, stubborn and uninterested in work.Source: http://www.whatishumanresource.com/traditional-methods-of-performance-appraisal

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For example, Pepsi-Cola International (PCI), has devised a common performance appraisal system that focuses on motivating managers to achieve and maintain high standards of performance. Administrative consistency is achieved through the use of a performance appraisal system of five feedback mechanisms - instant feedback, coaching, accountability based performance appraisals, development feedback, and a human resource plan. The first step of instant feedback is based on the principle that any idea about any aspect of the business or about an individual’s performance is raised appropriately and discussed in a sensitive manner.62

Decision makingThe purpose of conducting employee performance appraisal is making

decisions about employees without any bias by the HR manager. The HR manager’s decisions about rewards, promotions, demotions, transfers, and sometimes suspensions/dismissal of employees should match outcome of the performance appraisal to avoid grievance or disturbances in between them, as they affect the overall performance of the organization.63

CompensationIn modern societies, money is important both economically and psychologically. It is not just about to

get what you need, but it is associated with the status and the recognition. Accordingly, one of the most important functions of the human resource management is compensation for attracting qualified employees from the labor market. Compensation can be defined as the total of all rewards provided employees in return for work and services performed. The key objectives of the compensation system for a business organization are retaining the best employees, motivate employees to perform at higher levels, and have the company achieve its strategic goals.64

Employees need to be confident that that they are being compensated fairly for the work they do. Fair pay is what employees generally view as equitable. Internal equity is obtained when employees receive pay according to the

relative value of their jobs within the same organization. Job evaluation is a primary tool for determining internal equity. Job evaluation is intended to provide a rational, orderly, and systematic judgement of how important each job is to the firm. External equity occurs when a firm’s employees receive pay comparable to workers who perform similar jobs in other firms. Firms often use market surveys to achieve external equity. It is possible to use market survey but organizations mostly purchase commercially available surveys.65

What is the most typical problem that occurs in a per-formance appraisal process?

6

Compensations is the total of all rewards provided employees in return for work and services performed.

Internal equity is obtained when employees receive pay according to the relative value of their jobs within the same organization.

External equity occurs when a firm’s employees receive pay comparable to workers who perform similar jobs in other firms.

Job evaluations rank all the jobs in the organization and places them in a hierarchy that will reflect the relative worth of each. It ranks jobs not people. Because job evaluations assume normal performance of the job by a typical employee, it ignores individual abilities or the performance of the jobholder.66

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The compensation program has three components as it is seen in Figure 4.8. The base compensation, pay incentives, and benefits.

Base compensationThe basic compensation that an employee receives,

usually as a wage or salary, is called base pay. There are two kinds of base pay categories: hourly and salaried. Wage can be defined as a compensation calculated on a weekly, monthly, or annual basis. A salary is a consistent payment made each period regardless of number of hours worked. Being salaried typically carry a higher status for employees than being paid wages.

In setting wage and salary levels, a company may search its competitors’ compensation system. Companies should pay more than their rivals to attract and retain qualified employees. Moreover, managers must also decide how its internal wage and salary levels will compare for different jobs. It is reasonable to pay more for demanding positions and better qualified employees in

an organization. For instance, even if two employees may do exactly the same job, the employee with more experience may earn more.67

Pay incentivesIn addition to the basic wage structure, organizations that are sincerely

committed to developing a compensation system may prefer to use incentive pay programs. Pay incentives can be defined as compensations that reward employees for their high performance. Pay incentives are often referred to as a variable pay because the amount is contingent on or varies according to changes in performance. Incentives may be based on the employee’s own contributions or the performance of the team, business unit, or the entire company.

Totalcompensation

Basecompensation

Payincentives Benefits

Figure 4.8 Components of Total Compensation

Source: Gomez-Mejia, L. R. & Balkin, D. B. (2002). Management. McGraw-Hill, p. 277.

Wage payment is directly calculated on the amount of time worked.

A salary is a consistent payment made each period regardless of number of hours worked.

According to Turkish Labor Law “No discrimination based on language, race, sex, political opinion, philosophical belief, religion and sex or similar reasons is permissible in the employment relationship. Differential remuneration for similar jobs or for work of equal value is not permissible.”

Pay incentives can be defined as compensations that reward employees for their high performance.

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Individual incentive plans provide income above the base salary if the individual meets a specific performance standard. The most typical individual incentives are merit pay and bonus. Bonus is an individual performance incentive in the form of a special payment made over and above the employee’s salary. For example, a sales bonus is a typical incentive. Employees receive bonuses when they sell a certain number of goods for the year. Employees who fail to reach this goal earn no bonuses. Merit salary systems link raises to performance levels in non-sales jobs. Under a merit pay plan, employees who receive merit increases have a sum of money added to their base salary. Those who perform better generally receive more merit pay. Executives commonly receive stock options as incentives. For example, Disney Company permits its CEO to buy several thousand shares of company stock each year at a predetermined price.68

Group incentives provide extra income to groups and teams for their performance above the standards. Each individual incentive option it is described above also can be used on a group basis; that is, two or more employees can be paid for their combined performance. Group incentives work better where employees’ tasks are interdependent and require competition.

Companywide incentives direct the efforts of all employees toward achieving overall organizational effectiveness. This type of incentive produces rewards for all employees based on organization-wide cost reduction or profit sharing. One of the best known companywide incentive systems is profit-sharing. Profit sharing provides employees to receive their regular compensation plus a share of the profits earned by the company. This system increases commitment and loyalty to the organization. On the other hand, employees often find it difficult to relate their efforts to the profit sharing bonus. Additionally, external environmental factors, such as economic conditions and competitors, may have a greater effect on the company’s profitability than any actions of the employees themselves.69

BenefitsAt present, employees expect more than just an hourly wage or salary from their employers; they

expect additional considerations that will enrich their lives and support work-life balance. Therefore, many organizations offer benefit programs which are almost 40 percent of the typical total compensation package for employees. A benefit is an indirect reward given to an employee or a group of employees as a part of organizational membership. Benefits are typically unrelated to employee productivity, therefore, while they may be valuable in recruiting and retaining employees, they do not directly affect a worker’s performance. However, these programs, especially the voluntary benefits, help the organizations to demonstrate their goodwill toward employees and increase loyalty to the company.

While employers provide most benefits voluntarily, some of the benefits are required by law. In Turkey, some benefits defined by the law are funeral, birth and marriage benefits, duty travel allowances, mobile duty compensation, paid vacations, severance pay, unemployment insurance, medical leave, dismissal pay or collective payment in the form of severance pay.70 Most of the companies also voluntarily provide health, life, and retirement benefits to employees. Some of the companies allow employees to use payroll deductions for buying company stocks at discounted prices. Retirement plans are also part of benefit packages that are available to many employees. Companies sponsor retirement plans which are set up to pay pensions to workers when they retire.71 For example, University of California (UC) offers comprehensive retirement benefits,

A bonus is an individual performance incentive in the form of a special payment made over and above the employee’s salary.

A benefit is an indirect reward given to an employee or a group of employees as a part of organizational membership.

For additional information about benefits required by 4857 Labor Law, go to “http://turkishlaborlaw.com/turkish-labor-law-no-4857/19-4857-labor-law-english-by-article”

internet

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including a pension plan and a choice of primary (required) retirement benefits for eligible faculty and staff. UC also offers voluntary retirement savings plans, educational resources to help employees to prepare for retirement, and retiree health insurance.72

In addition, organizations also provide non-financial voluntary services that are called fringe benefits. The purpose of such programs is to create a more convenient workplace and increase employee motivation. Some of the fringe benefit examples are recreational programs, eating facilities including company cafeterias, meal plans, housing and accommodations, company cars for managers, transport services between home and workplace, educational services, shopping discount tickets, and flexible working plans.73 For example, Arçelik, a Turkish manufacturing company, has two kinds of benefit programs: Benefits for all employees and benefits for certain positions. The company provides training support, discounts for the company’s products, lunch, workplace medical services, and transportation to all employees. Benefits for certain positions are cars, oil expenses, checkups, accident insurance and lunch tickets.74

How Microsoft Uses Social Media for Recruiting and Employer Branding “Microsoft’s old online recruiting presence had become outdated, and was a navigational nightmare

for jobseekers, who suffered from content overload and lack of an organized, central careers hub. Microsoft now takes a global approach to recruitment, rather than having different careers sites for different countries and even different business units within the same country.

Microsoft embarked on a major recruitment overhaul nearly 5 years ago, as competition from companies like Google made the battle for top talent even more challenging. The foundation of this recruitment marketing initiative was made up of key business and marketing goals such as creating a consistent global message, managing their own employer brand and improving user experience. The new and improved Microsoft Careers site is a pleasure to navigate, and the company’s online presence also includes channels like Twitter, Facebook, LinkedIn and YouTube in order to engage, impress and inspire potential job candidates. In 2010, Microsoft increased new hires by 300%, and the company is expecting continuous improvement as the social recruitment techniques and tools get more sophisticated...”

Source: http://linkhumans.com/blog/online-recruitment-employer-branding-microsoft-case-study

Further Reading

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Should You Rehire a Defector? “Ram Kapur and his brother Shayam were

returning to the home from the Holi festival in India. Ram’s phone rang just as they walked through the door, and he held up the screen to show Shayam the caller’s name: Hari Shukla. “Why is he calling you on Holi?” his brother asked, surprised.

Ram was the founder and CEO of Green Impact Consulting, a sustainable design firm, and Hari had been one of the young company’s most valued employees—until two years ago, when he’d decamped to a rival firm. “A job, I think,” Ram replied. “We’ve been back in touch.” “No way! He abandoned you! You swore you’d never speak to him again!” That was true. Hari had been Ram’s right-hand man at Green Impact, overseeing the civil engineers onsite at the firm’s residential and commercial real estate projects, while Ram led the technical analysis and design teams back at the office. But then Hari had blindsided him by resigning. He said he was leaving for “personal reasons,” only to turn up at a larger competitor: The Sustainable Build Group.

Of course, Ram knew this was a risk of being an entrepreneur in India. The talent market was so tight that strong employees were often poached from small companies by bigger-name, more successful ones. But he still couldn’t help feeling betrayed—even devastated. It was a tough year. Hari’s unexpected departure left Ram in charge of both the office and the field teams. He was stretched too thin to tackle the growth plans he’d been dreaming of. He focused on serving existing clients and retaining his employees—he even had to raise salaries across the board to make sure others didn’t follow in Hari’s footsteps—but he had no time for marketing and barely kept the business going. He put on a brave face for his employees, the customers, and his parents. Only his brother knew how hard he’d struggled and how hurt he’d been. “I can’t believe you would speak to him.” Shayam shook his head “I know, I know,” Ram said. “He really let me—and the company— down. But he was a great employee— and a friend. I have to at least consider it.”

“He stabbed you in the back,” Shayam said. “He left you for more money, without thinking twice about Green Impact’s mission or your friendship. You can’t trust him. Besides, your business is doing great now. You don’t need him anymore.” Recently, though, Ram had started to consider expansion, perhaps into the Middle East, where sustainable building wasn’t such a hard sell. But he wasn’t sure that his young team could keep the business thriving if he took his focus off day-to-day operations. With Hari back, maybe he could revive his dreams for the company. “Hari may be the only one who can help me take the business to the next level,” he told Shayam. His brother scoffed. “This city is full of talented, competent people. There is no way that that deserter is your only option.”

Three days later, Ram was back in the office. He’d returned Hari’s call, and the two finally discussed what was on Hari’s mind: He missed the tight-knit culture at Green Impact, and he was exhausted from the long hours at his new job. He had been wooed by a 75% salary increase and the opportunity to travel, he told Ram, but he wanted to feel as if he was helping to build something again, not just keep someone else’s company running.

Ram had started to get excited about the possibility of working with his old employee. But now back at the office, surrounded by the team that had so capably risen to the challenge that Hari had created, he was less sure. He wondered about the disruption it would cause”.Source: Jyotsna, B. & Gupta, N. (December 2016). Case Study: Should You Rehire a Defector? Harvard Business Review. Retrieved from https://hbr.org/2016/12/should-you-rehire-a-defector.Discuss:1. What would you do if you were Ram? Would

you give to Hari second chance in your company?

2. How would current employees react if Ram decides to take Hari back? Do you think that rehiring Hari would reward an act of disloyalty?

In Practice


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Sum

mary

LO 1 Defining the concept of human resource management

Human resource management (HRM) is the process of acquiring, training, appraising, and compensating employees, and of attending to their labor relations, health and safety, and fairness concerns. Many firms realize that human resource function has a substantial impact on the firm’s bottom-line performance. Therefore, they align the firm’s human resource management goals and policies with the strategic goals of the enterprise in order to improve business performance. Managers call this strategic human resource management.

There is not only one and the best way for managing human resources. Based on size, sector, employee numbers, financial situation, employee skills and location, each company develops its own HRM program.

LO 2 Describing the internal and external environment of human resource management

The environmental factors influencing organizations and human resource management can be divided in two categories: Internal environmental factors and external environmental factors. Internal environmental factors are the issues that can be found within an organization’s internal environment. These factors can be indicated as personal and organizational factors, job characteristics in the organization, and interpersonal relationships. External environmental factors can be defined as factors outside the organizations that cannot be controlled and changed by the organization. Managers should pay close attention to external environment for adapting organization’s human resource strategy to the new developments occurring outside the organization. Major environmental factors include workforce diversity, government regulations, and economic change. External environmental factors affecting HRM are workforce and demographic trends, government regulations, and economic challenges and trends.


142

Sum

mar

y

LO 3 Explaining human resource management activities that get the right people

Many organizations look to ensure that they have the right number of the right people at the right time and at the right place. Primary human resource management challenges include determining how many people are needed and for how long, and where the company can provide the employees it needs.

Planning is the starting point for all kinds of management processes including human resource management. Human resource management starts with planning which is the development of strategies to meet a firm’s future human resources requirements. Human resource planning activity is concerned with assessing the future human resource need (demand), determining the availability of the type of people needed (supply) creating plans for how to meet the need (fulfillment).

Once the firm has determined its staffing needs via human resource planning, it needs to hire the most qualified employees to fill the available position. The hiring process has three components: recruitment, selection, and orientation. Recruitment consists of a set of activities that improves the number and quality of people who apply for employment, as well as the probability that qualified and compatible applicants will accept employment offers. Once the recruiting process has attracted a pool of applicants, the next step is to select someone for hiring. The selection process is to choose the employee who can successfully perform the job from the pool of qualified candidates. After people are hired, they need to be oriented to the organization and to their jobs. Employee orientation is the systematic process of helping new employees learn about the company (such as company to create, policies, work rules and benefit programs) and getting emotionally attached to the firm.

LO 4 Understanding human resource management activities that maximize performance

Once employees are hired, the organization needs to ensure that they are performing well. It is the human resource manager’s job to train, motivate, appraise and see that employees are compensated fairly.

Training is a continual process of providing employees with skills and knowledge they need to perform at a high level. Training can involve the changing of skills, knowledge, attitudes, or behavior. It may mean changing what employees know, how they work, their attitudes toward their work, or their interaction with their coworkers or superior.

Organizations need to evaluate employees’ performance and let them know how well they have performed on established goals. Performance appraisal can be defined as a process of determining and communicating to an employee how he or she is performing on the job and establishing a plan of improvement.

HR departments use the information collected through performance appraisals to make important decisions about HR functions. One of the most common uses of performance appraisals is for making administrative decisions relating to promotions, firings, layoffs, and merit pay increases. Performance appraisal information also provides needed input for determining both individual and organizational training and development needs. Another important use of performance appraisals is to encourage performance improvement. In this regard, performance appraisals communicate to employees how they are doing and suggest needed changes in behavior, attitude, skills or knowledge

Compensation can be defined as the total of all rewards provided employees in return for work and services performed. The basic compensation that an employee receives, usually as a wage or salary, is called base pay. Pay incentives can be defined as compensation that rewards employees for the good performance. Many organizations also offer some benefit programs which accounts almost 40 percent of the typical total compensation package to employees.


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Test yourself

1 Which one is one of the external environmental factors affecting human resource management?

a. Cultural features of employeesb. Working conditionsc. Job characteristicsd. Aging workforcee. Competitive strategy of organization

2 Which of the below takes part in human resource planning process?

a. Performance appraisalb. Trainingc. Job analysisd. Orientatione. Compensation

3 Which one is a list of key personnel and their possible replacement within a firm?

a. Replacement chart b. Skill inventoryc. Labor supplyd. Job specificatione. Job description

4 Which one of the following is applied in the case of labor shortage?

a. Retirementb. Layoffc. Overtimed. Reduced hourse. Restricted hiring

5 Which one of the following refers to publicize job openings on bulletin boards or company intranets?

a. Employee referralsb. Advertisingc. Online recruitingd. Job postinge. Media

6 What is the first step in selection process?

a. Interviewb. Employment interviewc. Reference checkd. Physical examinatione. Preliminary screening

7 Which one of the following is an important data source for task analysis in training need analysis process?

a. Human resource planningb. Job descriptionc. Performance appraisald. Skill analysise. Replacement chart

8 Which one of the following training techniques employs the actual or simulated equipment which trainees will use on the job?

a. Vestibule trainingb. Classroom lecturesc. Mobile learningd. E-learninge. Audiovisual techniques

9 Which one of the following is a behavioral appraisal instrument?

a. Coming to work on timeb. Completing assignment on timec. Getting along with customersd. Getting along with co-workerse. Sales volume

10 Which one of the following rewards employees for the good performance?

a. Pay incentivesb. Benefitc. Base compensationd. Wagee. Salary


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If your answer is incorrect, review “Environment of Human Resource Management”.

1. d If your answer is incorrect, review “Human Resource Management Activities That Get the Right People”.

6. e

If your answer is incorrect, review “Human Resource Management Activities That Get the Right People”.

3. a If your answer is incorrect, review “Human Resource Management Activities That Maximize Performance”.

8. a


2. c If your answer is incorrect, review “Human Resource Management Activities That Maximize Performance”.

7. b


4. c


5. d

If your answer is incorrect, review “Human Resource Management Activities That Maximize Performance”

9. e

If your answer is incorrect, review “Human Resource Management Activities That Maximize Performance”

10. a

What is the difference between personnel

management and human resource management?

your turn 1

Many people think that human resource management is the new version of personnel management but there are some differences between these approaches: 1) While personnel management is a traditional approach of managing people in the organization, human resource management is a modern approach of managing people; 2) Personnel management focuses on personnel administration, employee welfare and labor relations. Human resource management focuses on selection, development and motivation of human resources; 3) Personnel management focuses on increased production and satisfied employees. Human resource management focuses on effectiveness, culture, productivity and employee’s motivation; 4) Personnel management assumes people as inputs for achieving desired outputs. Human resource management assumes people as important and valuable resources for achieving desired outputs; 5) Personnel management provides less training and development opportunities to employees than HRM does; 5) In personnel management, decisions are made by the top management. In human resource management, decisions are made collectively by participation of management and employees; and 6) Personnel management is a routine function. Human resource management is a strategic function.

your turn 2

Technology is one of the most important external factors shaping human resource management. Recruiting activity of human resource management has been significantly impacted by technology. Internet makes easier and cheaper to reach job candidates from all over the world. Information technology makes it possible for human resources professionals to train new staff members in a more quickly and efficient manner. It is also possible to assess their progress through computerized testing programs. Human resources professionals can also use information technology to evaluate employee performance and to get employee feedback effectively.

What is the impact of technological developments to

human resource management?


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Suggested answ


your turn 3

Forecasting external supply is to estimate the number and type of people who will be available for hiring from the labor market. It is not an easy task for a manager to predict availability of potential labor supply. The labor market is broad and includes everyone from high school graduates to migrants from employees returning from military service to job seekers who have been recently laid off. For getting an idea of availability of labor, managers need to rely on information from outside sources, such as government reports, employment commissions and figures supplied by universities on the number of student in major fields.

Araştır 4your turn 4

As we explained in the chapter, technical skills involve job-specific e differemary input is grounded in technology, whereas the tourism sector is primarily based on the behavioral dimensions of providing comfort and entertainment.

Many people who are not seriously looking for a job may submit resumes just to see what happens. By using online recruitment, employers may get more unqualified applicants, and HR departments have to review more resumes. Besides online recruitment creates some disadvantages for older and minority employees who have no access to internet.

How does a manager forecaste the external supply of

human resources?

What are the disadvantages of Internet recruiting?

Araştır 4your turn 5

nd transportation. The similarity between the two sectors is that both comprise technology to an extent. The difference however is broader. Electronics’s primary input is grounded in technology, whereas the tourism sector is primarily based on the behavioral dimensions of providing comfort and entertainment.

Many companies are investing millions of dollars in training programs to gain competitive advantage. Therefore, it is crucial for managers to evaluate training results. Evaluating the training programs helps to identify weaknesses of the established programs. Less effective programs can be withdrawn to save time and money. There are several criterias that can be used to evaluate the training efforts: Participants’ reactions to the program, what (if anything) the trainees learned from the program, and to what extent their on-the-job behavior or results change as a result of the program. Pretests, questionnaires, controlled experimentation, and performance evaluation results can be used to measure the success of training programs.

How can human resource department evaluate the training

program’s results?

Araştır 4your turn 6s primary input is grounded in technology, whereas the tourism sector is primarily based on the behavioral dimensions of providing comfort and entertainment.

The most typical problem associated with performance appraisals is the lack of objectivity. While measuring commonly used factors such as attitude, appearance, and personality, subjectivity could exist. On the other hand, bias can remove objectivity from appraisal process. A bias can be either positive and negative. It occurs when a manager generalizes one positive performance feature or incident to all aspects of employee performance.

What is the most typical problem that occurs in

performance appraisal process?


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1Jensen, T. (August 10, 2006). James Kuhn; VP of individuality for McDonald’s. Retrieved from https://groups.google.com/forum/#!topic/alt.obituaries/7cY6TqiGthk

2Ivancevich, J. M. & Duening, T. N. (2004). Business Principles, Guidelines, and Practices. Atomic Dog Publishing, p. 266.

3Ivancevich & Duening, op. cit., p. 267; Gomez-Mejia, L. R. & Balkin, D. B. (2002). Management. McGraw-Hill, p. 258.

4Genç, K. Y. (2014). Environmental factors affecting human resource management activities of Turkish large firms. International Journal of Business and Management, 9 (11), p. 110.

5Ibid., p. 108.6Mirze, S. K. (2002). Introduction to Business. Literatür

Yayıncılık, p. 162. 7Meier, J. (2010). Generation Y in the workforce:

managerial challenges. The Journal of Human Resource and Adult Learning, 6, (1), pp. 74, 75.

8Punia, M. & Sharma, B. (April 2015). A comprehensive review of factors influencing HRM practices in manufacturing industries. Journal of Management Engineering and Information Technology, 2 (2), p. 24. Retrieved from www.jmeit.com

9Genç, op. cit., p. 105.10Goldman, D. (January 9, 2009). Worst year for

jobs since 45. Retrieved from http://money.cnn.com/2009/01/09/news/economy/jobs_december/

11Chartered Institute of Personnel and Development-CIPD (Spring 2010). Workforce planning right people, right time, right skills. Retrieved from https://www.cipd.co.uk/Images/workforce-planning_2010-right-people-time-skills_tcm18-9058.pdf

12De Cenzo, D. A. & Robbins, S. P. (1999). Human Resource Management (6th ed.) John Wiley & Sons, Inc., p. 132; Ivancevich, J. M. (2004). Human Resource Management. (9th ed.) Mc Graw Hill, p. 137.

13Noe, R.A., Hollenbeck, J.R., Gerhart, B., & Wright, P.M. (2006). Human Resource Management Gaining a Competitive Advantage (5th ed.) McGraw-Hill Irwin, pp. 145-146.

14Dessler, G. (2003). Management Principles and Practices for Tomorrow’s Leaders. Pearson Prentice Hall, p. 225.

15Mondy, R. W. & Noe, R. M. (2005). Human Resource Management (9th ed.) Pearson Prentice Hall, p. 95; De Cenzo & Robbins, op. cit., p. 143.

16Hitt, M. A., Black, J. S., & Porter, L.W. (2005). Management. Pearson Prentice Hall, p. 528.

17Noe, et al., op. cit., p. 178.18Pride, W. M., Hughes, R. J., & Kapoor, J. R. (2009).

Introduction to Business. Cengage Learning, p. 252.

19Griffin, R.W. & Ebert, R. J. Business (7th ed.) Pearson, p. 219; Dessler, G. (2013). Human Resource Management (13th ed.). Pearson, p. 169.

20Mondy & Noe, op. cit., p. 104; Ivancevich, op. cit., p. 144.

21Pride, et al., op. cit., p. 253; Mathis, R. L. & Jakson, J. H. (2003). Human Resource Management (10th ed.) Thomson South Western, pp. 50-51.

22Mcgregor, J. (May 29, 2009). Cutting salaries instead of jobs. Retrieved from https://www.bloomberg.com/news/articles/2009-05-28/cutting-salaries-instead-of-jobs

23Hill, C. W. L. & Mc Shane, S.L. (2008). Principles of Management. McGraw-Hill Irwin, p. 294.

24Mathis & Jackson, op. cit., p. 205.25Ibid., p. 212.26Foot, M. & Hook, C. (1996). Introducing Human

Resource Management. Logman, p. 55. 27Byars, L. L. & Rue, L.W. (1997). Human Resource

Management (5th ed.). Irwin, p. 143; Dessler, 2003, op. cit., p. 227.

28Mondy & Noe, op. cit., p. 130.29Byars & Rue, op. cit., p. 145; Mondy & Noe, op.

cit., p. 133.30Morrison, K. (September 7, 2015). Social Media

to Find High-quality Candidates. Retrieved from http://www.adweek.com/digital/survey-96-of-recruiters-use-social-media-to-find-high-quality-candidates/

endnotes


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31Online Recruitment. https://www.recruiter.com/online-recruitment.html

32Wisdomjobs.com. Staffing and developing a diverse workforce/recruiting job applicants. Retrieved from https://www.wisdomjobs.com/e-university/pr inciples-of-management-tutor ia l -293/recruiting-job-applicants-9447.html

33Hill & McShane, op. cit., p. 298.34Mondy & Noe, op. cit., p. 135.35Türkiye İş Kurumu (İŞKUR). http://www.iskur.gov.

tr/en-us/corporateprofile/institution/history.aspx36Dessler, op. cit., p. 184.37Quartz. How quickly interviewers decide whether

or not to hire you? Retrieved from https://qz.com/406976/heres-how-quickly-interviewers-decide-whether-or-not-to-hire-you/

38Ivancevich, op. cit., p. 230.39Mirze, op. cit., p. 170. 40Hitt et al., op. cit., p. 535.41De Cenzo & Robbins, op. cit., p. 207.42Wisdomjobs.com. Orienting and developing employees.

Retrieved from https://www.wisdomjobs.com/e-university/principles-of-management-tutorial-293/orienting-and-developing-employees-9451.html

43Dessler, op. cit., p. 270.44Byars & Rue, op. cit., p. 206.45De Cenzo & Robbins, op. cit., p. 227.46Ibid., p. 225.47Noe et al., op. cit., p. 284; Ibid., p. 230. 48Society of Automotive Engineers (SAE). http://

training.sae.org/ford/49Byars & Rue, op. cit., p. 284. 50Mondy & Noe, op. cit, p. 258; Mirze, op. cit., p.

84.51Hitt et al., op. cit., p. 541; Mondy & Noe, op. cit.,

251. 52Ivancevich, op. cit., p. 260.53Stredwick, J. (2005). An Introduction to Human

Resource Management (2nd ed.). Elsevier, p. 296.54https://www.inc.com/encyclopedia/employee-

performance-appraisals.html55whatishumanresource.com. https://sites.google.com/

site/whatishumanresource/performance-appraisal-process

56Gomez-Mejia & Balkin, op. cit., p. 275.57Gomez-Mejia & Balkin, op. cit., p. 275.58Performance Resource Center. http://performance-

appraisals.org/faq/criticalincident.htm59Gomez-Mejia & Balkin, op. cit., p. 275.60whatishumanresource.com. https://sites.google.com/

site/whatishumanresource/performance-appraisal-process

61Noe et al., op. cit., pp. 368-369.62whatishumanresource.com. https://sites.google.com/

site/whatishumanresource/performance-appraisal-at-pepsi-cola-international

63whatishumanresource.com. https://sites.google.com/site/whatishumanresource/performance-appraisal-process

64Gomez-Mejia & Balkin, op. cit., p. 276.65Gomez-Mejia & Balkin, op. cit., p. 278; Mondy &

Noe, op. cit., p. 285.66De Cenzo & Robbins, op. cit., p. 328.67Mathis & Jackson, op. cit., p. 373; Griffin & Ebert,

op. cit., p. 224. 68Gomez-Mejia & Balkin, op. cit., p. 276; Griffin &

Ebert, op. cit., p. 225. 69De Cenzo & Robbins, op. cit., p. 337.70Turkish Labor Law. Benefits in kind and allowance.

Retrieved from https://turkishlaborlaw.com/news/business-in-turkey/341-benefits-in-kind-and-allowance

71Griffin & Ebert, op. cit., pp. 226-227; Gomez-Mejia & Balkin, op. cit., p. 276.

72UC net. http://ucnet.universityofcalifornia.edu/compensation-and-benefits/

73Mirze, op. cit., p. 199. 74Arçelik A.Ş. Compensation and Benefits. Retrieved

from http://www.arcelikas.com/page/83/Work_Life

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Chapter 5 Marketing Management

Lear

ning

Out

com

es

Develop skills necessary for an integrated management of the marketing mix elements, namely; product, pricing, place, and promotion.

Describe new trends in marketing influenced by globalization, automation, and digitalization.

Reach an accurate understanding of what marketing is and what it entails.

Explain the methods that companies follow for strategic positioning towards market segments.

Grasp the issues related to branding, which stands as the most strategic, long-term investment of the company.

Appraise how and why the marketing principles can be applied in accordance with ethical principles of doing business in a globalizing and digitalizing world.

35

1 246

Chapter OutlineFoundations of MarketingStrategic Marketing ManagementMarketing Mix BrandingNew Trends in MarketingMarketing Ethics

Key TermsMarketingBrandingProduct

Good/ServicePricingPlace

PromotionBranding


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“Make your marketing so useful people would pay you for it”, says Jay Baer, certified speaking professional (CSP) and a New York Times’ best-selling author of five books. What he means is that the product alone cannot be the basis of marketing. Marketers have to treat consumers as real people, with their thoughts and feelings including anger, fear, and love, and try to reach them on a personal basis, to the extent possible. The physical good (or the perceptible characteristics of an intangible service) is important, but not as important as consumer perceptions of that product. What marketers need to do is to understand consumers, add value to the product, and expect consumers to pay for the extra advantage or value embedded in the product.

As Simon Sinek, yet another inspirational author and speaker, puts it, “people don’t buy what you do, they buy why you do it.” In other words, it is not the buttons or the color of the smart phone per se, but the feeling of being connected to the modern world, the power of belonging to a group of millions, and perhaps the deep motivation to be liked by others, when we are choosing a specific brand. Marketing is all about making a good point using a vehicle of interaction (a.k.a the product) and convincing people to pay in return for this good cause. With this perspective in mind, a person can sell everything, including a good or a service, an ideology, an organization, as well as himself or herself.

FOUNDATIONS OF MARKETINGMarketing is not just a departmental task. Starbucks does not have a marketing department, because the

whole organization is “marketing”. The co-founder of HP, David Packard, once said “marketing is too important to be left to the marketing department” pointing out the importance of integrated and systematic communication with customers. Therefore, marketing should not be perceived as another function in the organization, not even an important or specialized activity among others. It should be the basic driving motivation across all departments in the organization. Below is a discussion on how marketing (and other important concepts) can be defined with this unifying mindset.

Definition of MarketingOne can define marketing from a variety of perspectives.

Marketing is typically defined as the creation, promotion, and delivery of goods and services directed towards consumers and businesses.1 This definition reflects upon the basic activities and functions of marketing and specifies that marketers deal with (1) identifying and creating needs, wants, and desires of consumers in B2C (business-to-consumer) and B2B (business-to-business) markets, (2) promoting the product by way of integrated communication techniques, and (3) delivering the product by appropriate sales points in either brick-and-mortar retail locations or virtual outlets.

The American Marketing Association offers the following formal definition: “Marketing is the activity, set of institutions, and processes for creating, communicating, delivering, and exchanging that have value for customers, clients, partners, and society at large” (Approved July 2013).2 This definition concentrates on the notion of an immense marketing system with different actors and processes. It would be very difficult, if not impossible, to identify, promote, and/or deliver any product without the essential organizations (such as advertising firms, producers, and wholesales) and institutions (such as the government and the “modern” exchange market structure) supporting this eco-system.

Perhaps a better definition for marketing would entail the human dimension, such as the following: marketing is managing profitable customer relationships. In this short-yet-effective definition, there are three important concepts: first, marketing is all about building a relationship with customers. Without a deep understanding of consumer behavior, marketing cannot succeed. For instance, the giant German auto maker BMW is very successful not only because the product is superb, but also because the company

Marketing is typically defined as the creation, promotion, and delivery of goods and services directed towards consumers and businesses.

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5 Marketing Management

is keen on defining, grasping, and appreciating the feelings and thoughts of its target customers. In other words, the company cannot drive markets, without being first driven by customer information. Based on this enlightenment, companies can imagine how the product and the brand can possibly create long-lasting relationships involving consumers’ minds and hearts.

Secondly, marketing is about managing customer relations. It is no coincidence that a majority of a brand’s fans agree on the basic values and advantages that the brand provides. Building a strong relationship with customers requires a proactive approach in marketing. A passive approach would not even care about what the customer thinks or feels, whereas an active approach would search for clues about that customers expect. A reactive approach would listen to customer requests, respond to complaints, and build the product accordingly, hence the word re-active. However, an ideal (proactive) marketing methodology would understand customers and build a relationship based on their expectations before the customers would be telling about their needs and expectations. Apple would not wait until customers imagine a smart phone with a lot of applications solving their everyday problems in different capacities. These are the technical details of a concrete product. What consumers desire, on the other hand, may be proactively managed by today’s marketers who base their decisions on consumer knowledge. Marketing success is (almost) never based on chance, but a careful, thoughtful, and helpful examination of target customers.

Lastly, the management of customer relationships must generate profits, not only because companies need money to pay their employees and

other shareholders, but also because they need money to invest in other opportunities. It would not be this hard for companies to understand and convince customers if they had unlimited resources including cash, people, production facilities, and so forth. But this is not the case. Companies have to build a strong, long-lasting relationship with customers, and proactively manage this relationship within limited budgets to make a profit.

Scope of marketing is not limited with products (good and services), which are intended to be commercially sold. The following are also in the scope of marketing:

• Events,suchtheOlympicswheredifferenttypes of sports are played by thousands of differentplayersfromaroundtheworld,

• Places, suchasParisas themost romanticdestinationforhoneymoon,

• Organizations, such as the World WildLife,tryingtoleadinitiativesonpreservingwildlifeonearth,

• Persons,suchasMarilynMonroe,whohasbecometheiconforbeautyandthesymbolof“dumbblonde”characterinHollywood,

• Experiences, such as Disneyland themepark,withover650millionvisitorssinceitopened,

Marketing is all about building a relationship with customers and requires a deep understanding of consumer behavior.

How would you define marketing? Explain yourreasoning.

1

Consumers may become hungry (need), want to eat vegetables because they are on a diet (want), actually want to eat a mixed pizza with all toppings (desire), and go to the cashier at the fast-food restaurant to buy a hamburger (demand) because her budget is quite short. Beware of consumer behavior from different aspects: need, want, desire, and demand!

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Consumers may need something, which is mostly common across all people regardless of culture and geography. Need is usually biological, such as thirst, hunger, and love. Want is the need directed towards an object, where brands may compete over customers. Brands may also position themselves as “desirable”, such as in the case of Magnum ice cream, an obvious example, or Coca-Cola, a less obvious example. Consumer demand emerges when the consumer pays for the product, i.e. the actualization of what the customer wants or desires.

STRATEGIC MARKETING MANAGEMENTThis section is devoted to a discussion on how and why companies should create a systematic

and working methodology to actually manage customer relationships, pointed out before. With the above-mentioned typology of consumer motivations towards different products and brands (i.e. need, want, desire, and demand), the company has to decide on its strategic positioning. Strategy can be defined as the method or the plan to achieve a desired future state. Marketing strategy, from this perspective, is the way of doing marketing towards a certain positioning. For marketers to decide on this “way,” they have to combine all marketing goals into one comprehensive plan. Two key decisions marketers have to make in this regard are (1) generic marketing strategy and (2) segmentation and targeting.

Generic Marketing StrategyFirms needs to choose a specific strategy,

a way of doing business so that they can concentrate their efforts and resources on certain areas.3 In his argument, firms failing to do this would “stuck in the middle,” vaguely perceived by consumers as a strong brand (Figure 5.1). Firms which stuck in the middle fail to develop their strategy in at least one of three dimensions: (1) cost leadership, (2) differentiation, and (3) focus. Companies should build competitive advantage in order to remain distinctive in the market and hold the advantage for a long period of time.

Cost leadershipOne of the ways to establish competitive advantage is to

produce output with the lowest cost in the industry. This can be achieved by producing in more and more efficient ways using scale economies, scope economies, and experience (learning curve) effects. Scale economies state that a company can produce at a lower cost per unit of production if it is able to use the capacity further. The company can achieve a cost advantage with increased output of a product because fixed costs can be distributed over a larger quantity of outputs, leading to a lower cost per unit.

Marketing strategy is the way of doing marketing towards a certain positioning.

Scale economies state that a company can produce at a lower cost per unit of production if it is able to use the capacity further.

STRATEGIC ADVANTAGE

Di�erentiation

Focus

Cost Leadership

STRA

TEG

IC T

ARG

ET

Unique product

Nar

row

Broa

d

Basic product

STUCK IN THEMIDDLE

Figure 5.1 Generic Marketing Strategies

Source: Porter, M. E. (1980). Competitive Strategy: Techniques for

Analyzing Industries and Competitors. Free Press, p. 39.

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According to learning (or experience) effects, one can do better if more experience accumulates. In other words, “practice makes it perfect.” Lastly, the concept of scale economies states that if the same physical or virtual facility (or resources) can be used to produce another product, this creates a cost advantage. At this point, the average total cost decreases as a result of increasing the number of different products produced.

However, these economies can continue until a certain point. A cost advantage is achieved when the company can produce larger amounts of the same or different products using the same resources. However, after a certain level of output, other problems start to arise. For instance, a large volume of output starts to accumulate higher costs of movement, storage, damage, and deterioration. Moreover, it would start to be more and more difficult to sell these items, creating additional sales costs. Additionally, managerial problems may arise because of increased production and sales efforts. For these and other reasons, companies should carefully plan their production for different products and calculate the optimum level of production with the lowest cost, especially when the generic marketing strategy is cost leadership.

The reasoning behind cost leadership strategy is that in each industry, customers are looking for a few basic things being offered in a product. For instance, a shampoo cleans the hair and an airplane

takes you from one place to another. If the product satisfies this basic function, the customer may be willing to purchase the product without looking for any extra value being offered with the product. Instead, this customer may pay a lower price with the basic value in return. This is why the strategy attempts to capture a diverse range of consumers without particularly focusing on a specific segment.

DifferentiationIn addition to cost leadership, companies may

want to offer some extra value in addition to the basic features offered in the product. For instance, a shampoo brand may claim it repairs the hair and makes it shine (beyond the fact that it actually cleans the hair) and an airline brand may assert that it gives you an extreme travelling pleasure with delicious food, comfortable chairs, and on-time schedules (in addition to the fact that it actually makes you travel from one place to another). In return for these superior product characteristics, the customer has to pay an extra amount. Companies can differentiate themselves on a variety of different points, exemplified below:

• Emphasize the competitive position; e.g.Avis:“Wearethesecondbestinthemarket”.

• Emphasize the product usage ritual; e.g.“ÇaySaati”biscuits.

• Emphasize the particular segment ofusers; e.g. Snickers emphasizing the youngadolescents who need energy.

• Emphasize the cultural symbols associatedwiththeproduct/brand,e.g.TorkuusingthehistoricOttomancapontopoftheproductbottle.

Differentiation strategy requires that the point being differentiated has specific characteristics. For instance, the so-called differentiation as the company argues may not be meaningful for the target customers. If the consumer is not willing to pay for it, then the company has to start from scratch to find a meaningful advantage.

Cost-leader companies try to minimize the cost, not the price. They can offer the product with low price (through which they maximize their profit margins) or with an ongoing, average price (through which they maximize their market share).

The reasoning behind cost leadership strategy is that in each industry, customers are looking for a few basic things being offered in a product.

Differentiation refers to offering extra value in addition to the basic features offered in the product.

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A second important factor to consider when planning based on the strategy of differentiation is the competition. If one of the competitors has already claimed a similar advantage, your position is not solid regarding that brand attribute. Similarly, if competitors can easily match or copy a similar advantage, then you are not in fact differentiating your brand.

Last but not least, the company should also be able to deliver the same advantage over a long period of time, so that the brand value does not diminish over time. If the top management cannot allocate enough resources to preserve the brand position, then the brand will die eventually.

FocusFocus strategy attempts to capture a smaller

segment in the market; however offering a veryspecific product designed according to the particular needs of this segment, it is highly possible that people with that need would buy from this focused company. Focus (or niche) strategy can be attractive for several reasons:

• Aparticularnichemarketcanallowa fewcompaniesonly(usuallyoneortwo),sothecompetitionisnotintense.Thenichemar-ketsareconsideredtobe“safer”areassincenot the basic need (cost leadership), noteventhebasicneedplusadditionalbenefitsor attributes (differentiation),but idiosyn-craticneedsanddesiresarepursued.

• Itmaybeeasiertobuildaclearpositioningstrategysincetheproduct itself isdirectedtowardsparticularattributes.Forinstance,

inthefast-foodmarket,whichisitselfhuge,focusingonafewpeoplewhoareallergictowheat and producing gluten-free productsmightbeagoodidea.Thosewhoarealler-gicwouldthenchoosethiscompanyiftheywanttoeatfast-food.Thepositioningwouldbequiteclearforthiscompany.

• Profitmarginsareusuallyhigherfor focusedcompanies.Theyoftenneedtoengagethem-selveswithintensemarketresearch(e.g.searchfor the number allergic people who wouldwant to eat fast-food and who would have an effective demand for this product withenough resources and access to the fast-food restaurant) and marketing research (e.g. thecharacteristics of these consumers purchaseprocesses,lifestyles,demographicprofiles,andbrandpreferences),aswellasscientificresearchanddevelopment(e.g.theingredientsandthenutritionalvaluesoftheproductsbeingpro-duced).Theseresearchactivitiesaddanextracostontopotherproductionandmarketing-relatedcosts, leading tohigherprices.Thosewho specifically have the need identified bythecompanyarelikelytopayforthisprice.

Strategic Segmentation and Target Customers

Deciding for the generic marketing strategygoes hand in hand with strategic segmentation, since companies have to consider the segment they are targeting when they are strategically planning their marketing activities. Population,

Companies with a focus strategy do not focus on a specific product, but rather focus on a specific segment of customers with particular needs/wants/desires.

Focus strategy attempts to capture a smaller segment in the market.

The number of potential customers, total costs, profit margins, and the particularity of the product increase from cost leadership to differentiation to niche marketing.

Think of examples or experiences where you came across brands claiming an advantageous feature but you did not care enough.

2

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in marketing sense, is constituted by all people in the world who can potentially purchase and/or consume the product. Segmentation is the task of dividing this population into sub-groups in a way that can meaningfully separate consumers in terms of their consumption patterns. In order to talk about a useful segmentation, the following conditions must be met:

1. People in the same group should behomogenous, i.e. similar to each other inonewayofanother.Thisisinfactthebasisof effective segmentation: each segmentmustbesimilarintermsofneedsorchosencharacteristics.

2. People in different groups should beheterogeneous.Togetherwiththefirstpoint,this would demonstrate that consumersare effectivelydivided into sets of differentneeds.

3. Some data should be available for eachsegment so that measurements can be madeas regards to the sizeof themarket,the general characteristics of consumersconstituting that market, details of theirbuying behavior, and thus, the overallattractivenessofthesegment.

4. The segments shouldbe substantial eitherin termsofnumber (salespotential)or intermsprofitperunitsold(profitpotential).Eachcompanyislikelytohavea“minimum”requirementtobeprofitable.

5. The segments should also be accessibleso that an effective distribution andcommunicationstrategycanbeestablished.

Segmentation criteriaA generic market would be a market of

consumers with general needs concerning a good/service category. For instance, a generic market for the automobile would be constituted by all people who are likely to buy a car for transportation with basic features. However, companies are likely to divide consumers into groups because efforts directed towards consumers who would provide a match with the company’s resources and goals would be more effective both on the company’s side (easy conviction, more profit, concentrated marketing, etc.) and on the customer’s side (more satisfaction, less search for the right product, etc.).

The criteria for segmentation may differ from one company to another. One of the most convenient methods is geographic segmentation. With this method, marketers can easily divide the generic market into segments by identifying the geographically meaningful factors. For instance, in eastern Turkey consumers may behave differently in food consumption from consumers living on the coastal region. The former may dominantly like spicy and hot food, while the latter may like to eat green vegetables and fish. However, this type of segmentation is overly simplistic and disregards almost all variables that may eliminate the effects of geographical distance, such as taste and personal preferences.

A more sophisticated yet still simple criterion for segmentation is demographic (and in the case of B2B markets, firmographics). In this strategy, marketers divide consumers into groups based on factual information such as age, gender, education, marital status, and income. A lot of marketing research companies prefer to make segmentation on these criteria and most of them rely on the statistical tendency that at least a few criteria in this list go up and down together. For instance, it is very likely that age and education increase together, and that education are income are highly correlated. The problem with demographic segmentation is that it still remains insufficient to explain intricate consumer behavior including important details such as why consumers choose different product solutions, why they prefer different brands, and the reasons for brand loyalty or disloyalty.

A more useful approach is categorizing consumers on the basis of how they purchase and use a particular product or brand. User occasions, frequency of purchase, reasons for buying (and not buying), level of loyalty, and other relevant details about specific consumer behavior can help marketers identify points of differentiating consumers and create meaningful consumer groups. Consumers may develop a certain attitude towards a product category, a specific product, and/or a particular brand, and these idiosyncrasies can

Segmentation is the task of dividing this population into sub-groups in a way that can meaningfully separate consumers in terms of their consumption patterns.

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be used in developing different marketing strategies for different segments. In fact, companies with the intention of following a differentiation strategy discussed above must find these peculiarities. For instance, considering a commodity such as water, some consumers can be totally indifferent to the brand or the ingredients, while some others may carefully read the labels and follow the news regarding water.

The most useful approach in segmenting consumers is on the basis of psychographic information. With psychographics, marketers become able to closely “know” consumers and understand their psychological and social predispositions. One of the most important factors in psychographics is the life style approach. Lifestyle has been first studied in marketing literatureinthe1960sthroughtheconceptofAIO(activities, interests, and opinions), measuring people’s activities in terms of how they spend time. Combining the life style phenomenon with the marketing concept of segmentation, starting with the 1970s, several scholars have started to learn more about consumers’ personal lives.4 Practitioners have become involved with developing tools to more systematically make this categorization. One of these tools has been developed under the name VALS (Web Link 1), representing values and life styles. Based on a self-administered survey and a few selected demographic data, VALS attempts to categorize consumers under eight distinct groups, namely, innovators, thinkers, believers, achievers, strivers, experiencers, makers, and survivors.

Besides life styles, psychographic segmentation can also consider the individual’s personality, by investigating his or her character, shaped by

genetics and socialization. Last but not least, psychographics can attempt to identify differences based on the consumer’s “would-be” social class, discussed to have different components including economic capital (financial resources), cultural capital (education and accumulated knowledge), social capital (being part of a strong network), and physical capital (attractiveness or physical power).

TargetingAfter a careful analysis of consumers’ attitudes,

opinions, and behavior, a useful segmentation can be made. The next step after segmentation is actually choosing which segments to target. The increased availability of consumer data over the internet has made it possible to directly target a specific group of consumers or households. Proper evaluation of the data is critical in segmentation and targeting decisions. Targeting involves the careful selection of at least one segment identified in the previous step, by considering a variety of different factors. One of these factors is the measurability. As in the case of segmentation, the size and the purchasing power of the target should be measurable. A second criterion is that the target should be substantial in order to compensate for all the costs related to marketing research, strategic organization, and sales. For example, a ketchup company may choose to target business segments with international fast food chains. Additionally, the chosen target should be accessible, so that consumers in that target market can be effectively satisfied. Also, the target should be differentiable,

Psychographics enable marketers to closely “know” consumers and understand their psychological and social predispositions.

http://www.strategicbusinessinsights.com/vals/internet

Targeting involves the careful selection of at least one segment by considering a variety of different factors.

An ideal segmentation approach combines different strategies (including demographics and psychographics) to arrive at groups with the highest level of differentiation.

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i.e. separable from other segments and potential target groups. For instance, men and women can be segmented regarding a product such as shoes, but it would be very difficult to target either men or women for a musical instruments. Lastly, the targeted segment should be actionable. An obvious example might be cigarette companies which cannot directly target consumers under the age of eighteen.

Marketers can target one or all of the segments identified in previous stages. Figure 5.2 illustrates that the company can produce and sell an all-satisfying (usually a basic) product and engage in mass marketing. For instance, the well-known soda drink company Coca-Cola has been using a very similar, generic product all over the world for more than a century.

On a higher level in Figure 5.2, companies may choose to differentiate their products, prices, distribution, and communication strategies as tailored to the specific needs and expectations of the targeted segments. For example, Turkish Airlines, similar to other airline companies in regard to seating categories, uses a different product and price combination for different consumers under different names, such

as economy, business, and first class. If the company chooses to focus on only one or a few of these segments, this reflects that the company is actually focusing on the particular needs of specific consumers.

Lastly, through a micro marketing strategy, a company can focus on individual consumers, one by one. In many of the service industries, such as consultancy and medicine, the usual practice is micro targeting each particular customer.

In segmentation and targeting decisions, as in all marketing decisions, marketers should feel responsible about whom they target, how, and why. Underprivileged consumers, such as those who are financially poor, children, illiterate, or old, raise the issues of consumer vulnerability5,especially if the product in consideration is a harmful one.

MARKETING MIXMarketing mix can be considered as the tactical-level

marketing facilities, which are directed towards a certain target group, identified in the phase of strategic decisions. Four Ps are identified to be the initial letters of the most fundamental marketing actions, namely, product, price,

Marketing mix, also known as the 4Ps of marketing, constitutes the set of all marketing activities a company engages itself in pursuing its marketing goals and objectives.

Provide a hypothetical example of segmentation in sector of yourinterest.Explainhowyoudivided the market, i.e. the criteria for segmentation.

3

Di�erentiatedmarketing

Mass marketing

Focused marketing

Micro marketing

Figure 5.2 Target Marketing

Focusing as a general marketing strategy is the concentration of the needs and desires of a particular consumer group. Focusing as a targeting strategy, indicating a similar concept, is more related to the marketing mix bundle, i.e. product, price, place, promotion.

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place (distribution), and promotion. These activities have to be combined in such a way that they are meaningful and effective together in the eyes of the target customers (Figure 5.3). This is why called marketers can also be called “mixers of ingredients”.6

Marketing mix is called a mix because decisions about each different element cannot be made without considering the other elements. For instance, if the offering is of high quality (product), the price should be high to reflect this superiority. Communicating this quality (promotion) would then be managed with the idea of a smaller target market with specific characteristics. Four Ps of marketing actually represents the firm’s perspective. When evaluated from the consumer’s perspective, marketing mix is called “Four Cs”, representing customer value (product), cost to the customer (price), convenience (place), and communication (promotion), explained in each section below. To better analyze the service performance, there were three additions to the original four Ps of McCarthy7, which resulted in the expanded marketing mix (7 Ps). Additional Ps include (1) physical evidence (facilities, spatial layout, and interior design), (2) people (staff, uniforms, waiting and queuing systems, complaint management, and social interactions), and (3) process (level of standardization, service performance, resource allocation systems, and operation manuals).

ProductProduct (good or service) is the offering in the market,

created and sold in order to solve a problem or satisfy a need or want. A commodity can be a product, such as salt or bread, can be successfully branded by a company. In business terms, a product can be tangible (like soap) or intangible (like education). Tangible offerings are called goods while intangible offerings are called services, where product is a more general term reflecting both goods and services. In this chapter, too, product is meant to capture both tangible and intangible offerings. Product from the consumer’s perspective is called “customer value”, because the offering in the market is in fact something that the customer values enough to give money in return. The product solves the customer’s problem and/or creates a difference in the consumer’s life and hence produces some value. Products can be studied in terms of layers, as a complex unit consisting of different features and components (Figure 5.4).

The core product is at the center of the product category by reflecting the basic need of all brands present in the market. For instance, all automobile brands offer a basic core benefit, which is transportation.Alluniversitiesoffereducation;andall hospitals offer treatment. If the basic benefit is different for a particular brand in the market, then that is in fact a different product category. For instance, if the automobile

Product (good or service) is the offering in the market, created and sold in order to solve a problem or satisfy a need or want.

Product Price

Place Promotion

Figure 5.3 Marketing Mix (Four Ps)

Core

Generic

Expected

Augmented

Potential

Figure 5.4 Layers of a Product

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has wings and offers the advantage of air travel, then it is no longer an automobile. Therefore, companies can not differentiate themselves on the basisofthiscorebenefit;buttheycanfollowacost-leadership strategy and offer the most fundamental value which satisfies the core need/want.

The generic product reflects the most general characteristics of a product with the basic benefit, plus additional features being offered by the simplest product available. For instance, the core benefit of transportation can be satisfied with an automobile and the expected product for an automobile would be four tires, one steering wheel, and a vehicle body containing seats tailored towards an average human being. Although the generic product is quite basic, the expected product reflects the characteristics of a brand. For instance, the product can have different qualities expected by Mercedes versus Toyota.

As noted earlier in the chapter, a shampoo can wash one’s hair (core benefit), but brands are likely to differentiate themselves by adding different features. A brand may claim that the product does not only clean the hair, but also makes the hair grow, shine, and repair. For these additional features, brands usually expect a higher payment in return, resulting in a higher price. This layer is called the augmented product, since brands strive to add different features to distinguish themselves on a continuous basis. Going back to the automobile example, the sector has come a long way until today starting from Ford’s Model T introduced in 1908. Today, the core benefit is the same. However since brands heavily augmented the product throughout the years by including many features like air conditioning, road assistance, advanced electronic systems, and ABS, the generic product (and accordingly the expected product) may now represent something much more than the Model T. There are other examples of sectors in which augmentation is elevated, and hence the product has enlarged over the years.

Lastly, the potential product represents the characteristics and features which can be included

by brands in the future. For instance, a future automobile may include smart infrastructure, seamless designs, robotic components, and high-speed internet connection. Today, brands do not have these features, but these are some of the prospective attributes to be included by any brand’s augmented product.

Categorizations of a productThe most fundamental distinction is between

tangible products and intangible services. By definition, services are intangible and perishable. Consumers cannot save some part of a service to consume later, hence services are inseparable. The consumer and the service provider have to be in the same place at the same time for the service relationship to occur. Additionally, services are considered to be heterogeneous because real people are involved in the service delivery process, and the perceived quality of services can differ when different people are involved. Lastly, quality of services cannot be determined on a straightforward basis because the statistical measurements require a standardized production and/or delivery, whereas service quality can be measured on a more subjective basis due to the human factor.

A new perspective in marketing reflects that every transaction in a market is always a service relationship.8 The distinction between a product and a service does not exist, and the product is only a transmitter of the service exchange. This exchange is the reciprocal application of each partner’s (i.e. the customer and the service provider) resources for the mutual benefit of all shareholders. This leads to the idea of co-creation, through which customers and providers experientially perceive “value-in-use” that emerges from the usage or the possession of resources.9 For instance, a customer using a cell phone actually consumes “communication”, and he or she integrates his or her resources (e.g. his or her social network which makes it possible to share and comment on photos) into the exchange relationship.

It is possible to categorize products on the basis of B2B and B2C markets, too, where the former usually deals with unfinished products, components, and raw materials to be used in the production process of another product while B2C products are used by end-consumers.

A product is a customer value from the consumer’s perspective.

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Products can also be categorized in terms of the consumers’ buying behavior (Table 5.1).

Table 5.1 Product Categories

Durable Product Perishable Product Service

Convenience Shoehorn Detergent Bank

Shopping Refrigerator Pharmaceuticals Insurance

Specialty Jewelry Special winery Carrying company

Unsought Shroud Pesticide Hospital

Consumers purchase convenience products on a frequent basis. They are usually cheap products, which require minimum effort. Shopping products, on the other hand, require more effort on the part of consumers since they are less frequently purchased. Specialty products require much more time and money;therefore,consumersmaycomparebrandsandpricesandmaynecessitatedifferentpromotionand distribution strategies. Lastly, unsought products are not normally wanted by consumers, as the name implies. They are not products to be consumed with joy, but bought because of an obligation.

PriceThe second major marketing activity involves the pricing

of a product. This represents the financial compensation in return for the value provided by the product or service. This marketing mix element does not only involve the price tag attached to the product, but also the cost of search, acquisition, consumption, and even disposal of the product. This is why the price is echoed by the term “cost to the customer”, reflecting the direct cost and the indirect expenses associated with the acquisition and consumption of the product.

Setting a price is one of the major marketing decisions. There are different pricing approaches with unique advantages and disadvantages. The simplest method is called cost-based pricing where companies first figure out the cost of producing one item, and then add a profit margin to arrive the price to be used in the marketplace. Cost-oriented pricing should consider the fixed, variable, and total costs, as well as the margintobeadded.Theprofitmarginmaydependonthetopmanagers’expectations;inlinewiththegeneral marketing strategy, the company may decide to have a maximum cutoff, and decide on the specific price accordingly. Alternatively, the company can try to cover the investment made in the first place, and by dividing the investment by the number of units produced to finally arrive at the minimum price.

The cost-plus pricing is considered to be elementary,10 because it disregards important factors such as competition and consumer perceptions. Perhaps a better pricing strategy is competition-based pricing, where marketers try to understand the market conditions, a reference price by which consumers can compare other prices, and the ongoing price of different types of offerings in the same market. Price sensitivity of consumers, i.e. differences in demand when price changes, can also be captured with this type of pricing methodology.

The company, however, should always consider how consumers react not only in terms of quantity purchased, but also in terms of product quality perceptions, future intention to buy, and other types of behavior such as brand loyalty. For instance, depending on how consumers perceive the product, they may be willing to pay more than the competition-average price in the market or, inversely, may pay even below the unit cost. It is thus very important to evaluate and consider consumer appreciation for the product and act proactively. A price pyramid can be constructed to see the estimated level of quantity sold at

The simplest pricing method is cost-based pricing where companies first figure out the cost of producing one item, and then add a profit margin to arrive the price to be used in the marketplace.

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each different price, starting from a very low price where very large volumes can be sold, ending at the highest possible price where only a few consumers are willing to buy.

In considering pricing methodologies, marketers can also rely on the so-called psychological pricing tactics. One such tactic involves consumers’ reliance on price to judge the quality of the product. Price as quality signal can be increased to send the message that the product is superior, which is called the high-level pricing. Another psychological pricing tactic is ending the price with certain numbers, such as 9.99 Turkish liras for a t-shirt. This price tag implicitly conveys the message that the price is under 10 TL range rather than the next higher category. Lastly, in bundle-pricing, two or more products are generally offered at a lower price than the totality of individual items, leading to higher sales.

Psychological pricing is commonly used

Place (Distribution)Products cannot be sold if they are not in the

right place at the right time. Place is a decision regarding where the products would be purchased (and implicitly, how they are purchased), and the activity conducted by the company is called distribution. From the consumer’s perspective, this is called convenience because if the product is not available for the consumer, there is nothing else that can cover for this problem. For material goods, physical availability is a must since consumers can easily purchase another brand if the product is not on hand. For goods sold on the web, physical availability is still a concern because the products will have to be delivered on time. For intangible services, availability should be a point of interest, too, because the timely and appropriate existence of the service provider would increase chances of sales and satisfaction. Place is a specific aspect of convenience products, as the name implies.

A distribution channel is a chain of intermediaries through which products reach consumers. A supply chain represents a whole system of organizations, people, systems, and resources responsible along the way of products moving from producers to consumers. Being affected by many variables such as the size of the company, the nature of the product categories, the environment, and the characteristics of target buyers, the structure of distribution channels may differ (Figure 5.5).

Producer

(Direct)

End User

LargeWholesaler

SmallWholesaler Retailer

Wholesaler

Retailer

Distributor

Retailer

Figure 5.5 B2C Channels of Distribution

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Figure 5.5 illustrates that depending on the above-mentioned circumstances, a company may choose one alternative among others. In the case of company-owned sales force and/or through electronic mail or the internet, a company can deliver products without any intermediaries in between. Alternatively, a company may engage in a business relationship with a distributor, which generally resells products to another intermediary. However, the point of contact for producer is the distributor. Another type is between producers and retailers, which sell products directly to consumers. A company may choose to sell large volumes to a large or a small wholesaler first, which then resells products to a retailer.

A special type of distribution, called franchising, is an arrangement where a producer does not sell the products but sells the right to sell the products under certain rules. The official agreement may contain items including the ingredients of a product, the furniture and the lighting in the physical sales points, and even the behavior of the sales people. FranchiseDirect(WebLink2)declaresthataverylarge percentage of all franchisers in the world are from the food sector, followed by cleaning, automotive, and hotel sectors.

Retailing is simply the process of selling consumer goods and services to customers, also the term often refers to a physical shop with a service provider filling the small orders of a large number of individuals. Each retailer has its own

four Ps, including the range of product categories and brands to sell (Product), the price range (Price), the location, the shelf organization and the environmental layout (Place), and the style of service providers with the general atmosphere (Promotion). Based on the marketing strategy chosen, a retailer can choose from a variety of different types, briefly discussed below.

A boutique is a small store selling specialized items such as jewelry, fine wine, and accommodation (i.e. boutique hotels). On the contrary, a category killer sells a variety of different items (usually concentrating on a few product categories), and attempts to kill that category for other retailers. A convenience store usually works with extended hours and sells a limited range of product categories intended to supply items of emergency and instant purchase such as bandages and cigarettes. A department store sells a large range of products at moderate prices. A discount store offers a wide range of products at much lower prices. E-tailer refers to the selling of products on the internet through which the consumers receives products directly from the manufacturer (or the intermediary). A supermarket is self-service store where individuals buy products themselves and pays for them at the cashier. Supermarkets are usually large and they sell a wide range of products. Hypermarkets provide larger variety, higher volumes, and lower prices. A shopping mall has a range of retailers in a single (usually large) outlet. The idea behind shopping malls is that consumers can shop around for different products, compare different retailers, spend time, socialize, eat, and shop more. A vending machine automatically provides products by dispensing the product in return for money dropped into the machine (or through credit cards).

http://www.franchisedirect.com/internet

Retailing is simply the process of selling consumer goods and services to customers, also the term often refers to a physical shop with a service provider filling the small orders of a large number of individuals.

Explain your thoughts aboutthe retailer type “corner shops.” Doyouthinkitisagoodidea?Why/why not, and in what circumstances your answer would change?

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PromotionPromotion entails the activities that attempt

to establish some sort of a relationship with target customers, and all shareholders involved, and try to win the heart and loyalty of consumers. Promotion aims to promote the product in the market. To do that, it is necessary to actually know consumers closely, and act accordingly. From the consumers’ perspective, communication is an essential component in a marketing exchange relationship. See Chapter 3 for the communication process.

The simple communication model maintains that there is a sender and a receiver of the message being transmitted through a medium. The sender encodes the message using his or her own system of thinking, including factors such as culture, language, perception, and knowledge. The receiver then receives the message using his or her own resources. Still another element that might potentially influence the communication process, usually in negative ways, is the so-called “noise” element, which includes cultural differences, individual variances in perceptions, as well as physical noise. Noise prevents the receiver from decoding the message in the intended way.

The tools of communication available for marketers are: (1) advertising, (2) sales promotions, (3) public relations and publicity, and (4) personal sales. A company may choose to inform the mass public about the brand proposition and the product benefits through advertising and publicity, after which customers can demand the product. This is called the pull strategy, since customers are pulled by using one-way communication tools. Since the communication is not direct, customers make their own minds and choose to buy the product, which signals conviction on the part of consumers. The push strategy, on the other hand, creates a short-term reaction. For instance, through sales

promotions and personal sales efforts, customers are inclined to purchase the product due to incentives and more direct persuasion efforts.

Advertising is the most expensive but the most effective (in terms of the number of people reached with one message) contact method. It is the most well-known mass method of conveying a message. The most important advantage lies in the fact that marketers are able to dramatize the brand meaning, such as by having actual people play a role, having animated images, and all sorts of videos and visual effects. One disadvantage is that there is no control over who is watching the advertisement and the single reaction on each view by each viewer.

One very popular advertising method is television advertising. Commercial TV ads usually seek to increase the percentage of target customers reached and increase the sales volume. TV ads are usually a part of a media plan, in which other communications methods are also employed to provide a more significant impact. Marketers often aim to target an air time that reaches the desired consumer group. Advertising is expensive, and it constitutes a very large percentage of funding for television networks, especially during prime time, between 8 and 11 PM.

Other contact methods include sales promotions, which aim to increase sales within a certain period of time. To do this, marketers use a variety of different promotional activities. It is nowadays common to see online promotions, such as interactive games on the web, online contests, and cheaper products or product bundles sold online. More traditional promotion activities exist such as free samples, coupons, sales discounts, volume discounts, displays, contests, bundles, and rebates. These sales promotions are usually conducted at sales points (POP, point-of-purchase).

Promotion entails the activities that attempt to establish some sort of a relationship with target customers, and all shareholders involved, and try to win the heart and loyalty of consumers.

Advertising is the most expensive but the most effective (in terms of the number of people reached with one message) contact method.

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Besides POP promotions, other mechanisms to create and/or increase demand include loyalty programs, whereby consumers collect miles, points, or credits, and then use them to buy more products. One example of a very large-scale sales promotion is the so-called Black Friday, the day after Thanksgiving. It has become the busiest shopping day of the year, and statistics show that 30% of all sales in the U.S. occur between Black Friday and the Christmas. Also, other big discount days such as opening days, New Year’s day, or holidays motivate people to consume more either physically or online.

Consumers react to discount days

Another marketing communication tool is public relations and publicity. Although these two functions are enunciated together, they in fact entail different activities. Public relations (PR) involves gaining exposure in the mass media and other types of contact channels and proactively managing the dispersion of information between organizations and individuals. The difference with advertising is that it does not require direct payment, especially when the information is newsworthy, interesting, important, and/or relevant. PR specialists try to develop and maintain a strong and positive relationship between the company/brand and the target audience, the media, opinion leaders, the government, other businesses and organizations, and nongovernmental organizations. Among the activities that PR specialists do include the following:

• Preparingnewsreleases,• Managinginterviews,• Actingasthespokespersonofthe

company,• Managingthewebsiteandsocialmedia

content,• Respondingtocustomercomplaints,• Buildingoncompanyreputation,• Engagingincrisismanagementwhen

necessary,• Helpingintheprocessofevent

management.

While PR is the strategic management of the spread of information, publicity is the management of the general brand awareness. The similarity between PR and publicity is that both deal with the media. The primary focus of publicity is getting as much press coverage as possible, and good publicity is possible when the company’s PR is working effectively.

Lastly, personal sales is not only a type of distribution channel (i.e. direct sales), but also a type of promotion facility. Personal selling occurs when a representative from the company meets a potential customer. The purpose is usually making a sale, and sometimes meeting the client and providing information about the company, product, and/or brand. This sales activity can only occur with representatives in the field. Among the different roles of a salesperson are taking orders, getting orders, or building a relationship. Sometimes the salesperson can engage in cold calling when a prior appointment is not made, hence the representative may not be fully prepared for the interview.

In the sales process, there are different steps which should be studied in detail before, during, and after the sales contact. The first step is prospecting, which is trying to identify prospects (potential clients), followed by making selections

Public relations (PR) involves gaining exposure in the mass media and other types of contact channels and proactively managing the dispersion of information between organizations and individuals.

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among these prospects, which is called qualifying leads. The next step is to prepare for the interview (pre-approach), which is especially important because without proper knowledge about the product and/or the customer needs, making sales becomes very difficult. The approach stage involves actually meeting the customer, followed by sales presentation through which the sales representative demonstrates the product qualities, answers questions, and tries to capture the attention and interest of the prospect buyer. The last steps are the closing and the follow-up stages, where the representative tries to hopefully gain the sales, close the deal, and follow if the customer is satisfied or not. If the customer decides not to buy, the salesperson can try to establish a strong relationship with the lost customer for future reference and for building up the company’s client network.

BRANDINGA brand is a name, slogan, symbol, or logo associated with

a product or service. Branding is the process of differentiating the company’s offerings in the marketplace from those of the competitors. Branding involves a set of marketing and promotion activities that promote the brand, aiming to have a persistent image in consumers’ minds. Branding is the most strategic investment of the company. Brand equity is a term reflecting the brand’s worth in the eyes of consumers, usually reflected in the price. Brand identity is the set of all individual components of a brand, specifically including the imagery, slogans, colors, and all other types of imagery.

PositioningPositioning is how the brand is perceived by the

consumers and the “position” in their minds. Companies try to distinguish themselves from competitors and emphasize this differentiation point through different communication attempts. A positioning strategy has to be sustainable and create a meaningful competitive

advantage.11 Marketers can base their positioning on a variety of different factors, but overall positioning can depend on one of three bases:

• Functionalpositioning:Thebrandpromisestosolveaproblemandprovideafunctionalbenefittocustomers. For instance, Oral-B electric toothbrush claims to reach each and every spot over one’s teeth, and promises a clean, hygienic, and healthy mouth.

• Symbolicpositioning:Thebrandtriestocapturetheattentionandwintheheartsofconsumersbyfocusingonegoidentification,socialbelonging,lifemeaningfulness,andemotionalattachments.Forinstance,Dovesoaphaspositioneditselfinawaythatallwomenaroundtheworldshouldfeelbeautifulandproud.Dovedoesnotpositionitselftomakewomenbeautiful,butrathermakewomenfeelatpeacewiththeirbodies.

Branding involves a set of marketing and promotion activities that promote the brand, aiming to have a persistent image in consumers’ minds. Branding is the most strategic investment of the company.

Brand equity is a term reflecting the brand’s worth in the eyes of consumers, usually reflected in the price.

Brand identity is the set of all individual components of a brand, specifically including the imagery, slogans, colors, and all other types of imagery.

Positioning is how the brand is perceived by the consumers and the “position” in their minds.

Promoting a brand image

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• Experiential positioning: The brand triesto provide stimulation throughout thepurchasing and consumption process. Forinstance, a toy store may invite childrentoplaywithtoystounderstandwhattheylike and do not like (sensory experience);asmartphonebrandmayprovidein-storeexperienceboothswhereconsumerscanex-plore theirneedsandwants (cognitiveex-perience),andathemeparkmayattempttomakeconsumershavedifferentexperiencesstimulatingavarietyofdifferentemotionsincluding joy, happiness, excitement, andthrill(emotionalexperience).A lot of brands have experiential elements included in their brand positioning such as Starbucks (baristas taking names and chatting with customers), Doc McStuffin (Disney TV channel having children around a big toy bear inspecting it like a doctor), and Game of Thrones (different games, films, parks, and events).

Positioning (Perceptual) mapsPerceptual maps are based on consumer

perceptions showing the position of the product/brand so that the firm can see its position as perceived by consumers, take corrective action if necessary, compare its position with competitors, and make strategic, future-oriented decisions.

It is possible for brands to see their positioning using different dimensions. Software programs are available to graphically analyze this positioning. A simpler way is to decide on the two most critical factors in consumers’ minds and then draw a two-dimensional graph by placing the company’s brand and other competitors’ brands on the map. It is important to seek for consumer opinion at this point in order to obtain a realistic picture of the

situation by asking them about (1) what makes them think positive about or choose a brand in the particular product category, (2) the importance weights attached to these success factors to arrive at the critical success factors, and (3) ask consumers about each brand’s performance on these critical factors and put them on the map based on the simple coordinates logic.

The idea behind the concept of critical success factors is that consumers have certain expectations and desires pertaining to each product category and it is very important to understand what target consumers really want. Trying to be the best in other dimensions would mean loss of time and money, as well as lost customers; instead companies shouldfirst discover target buyers’ perceptions of crucial aspects, and then concentrate on these aspects. A hypothetical example of a perceptual map for restaurants is shown in Figure 5.6.

Figure 5.6 An Imaginary Perceptual (Positioning) Map

In Figure 5.6, it is clear that brands may not be able to differentiate themselves in terms of the factors that consumers value the most. The two most important factors to consider in the restaurant business in our example are the food quality (whether items are tasty and delicious with good ingredients) and the atmosphere (whether the physical environment is consumer-friendly and the atmosphere is nice).

In terms of these two criteria, firms A and B seem to be performing better compared to compared to otherfirms’positioninginthemarket.FirmsC,D,andEareperformingabitworsecomparedAand

Perceptual maps are based on consumer perceptions showing the position of the product/brand so that the firm can see its position as perceived by consumers, take corrective action if necessary, compare its position with competitors, and make strategic, future-oriented decisions.

Atmosphere

FoodQuality

GF

D

B

A

C

E

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B. These firms create two competition groups as circled in the map, indicating that firms A and B are close competitors, as are firmsC,D, and E.A new company planning to have a stance in the restaurant business may decide to compete with the better performers or the other group, depending on the marketing strategy, resources, and vision.

The red line in the map indicates whether the two factors (food and atmosphere) correlate perfectly or not. In our case, consumers are able to see the good and the bad points in each dimension, and hence provide different scores. On the other hand, companies are not completely scattered throughout the diagram. It seems that if the firm is able to provide high-quality food, it somehow manages to provide a nice atmosphere, too. This is especially true for the two big competition groups in the market. This may indicate that if the firm becomes aware of the success criteria, it may start to develop itself on different dimensions.

Another point of discussion in the map concerns the gaps (the empty spots) which a firm may want to aim. For instance, there are empty spaces in the map between two competition groups. A firm may want to open a restaurant with high food quality and a nice atmosphere, above the average of the inferior competition group, but below the average of the superior competition group. This positioning may convince the current customers of C/D/E that there is a superior option.Thismayalso convince the customers of A/B that there is now a new restaurant which can be tried for once

since people from the other group are rushing into it. Therefore the new firm would enter the market with the second-best choice after A and B.

This does not mean that all empty spaces in the map are sensible opportunities for firms. For instance, one may not expect a restaurant to be awful on the food but have a perfect atmosphere, or to have the best food but in a horrible environment. Either of these must be at least tolerable byconsumers because in our hypothetical example, research indicated that these two attributes are in fact critical for the success of firms doing restaurant business. Therefore, the spots on the right bottom and the left top should be left empty, as the logic indicates.

Looking at the map, it can easily be argued that the firm F is able to differentiate itself on the atmosphere, but not on the food. The firm can be advised to develop its capabilities on the menu and food to become a strong competitor. F can benchmark the facilities of A and B for further improvement. If there is a problem of consumer perceptions, i.e. F is in fact producing high-quality food, this means that F needs a repositioning. Repositioning refers to a major change of consumer perceptions either when the company wants to prove its intended position in consumers’ minds or it wants to change the current position towards something else. Firm G, however, seems to be much behind competition since it has strong negative perceptions on both critical success factors. Therefore, G should also try hard to reach the standard put forth by other companies. However, it can also be argued that G does not have to differentiate itself on these factors, but claim that another dimension is in fact more important than food or atmosphere. In other words, G may not try to convince consumers that “G is good on food and/or atmosphere” but try to convince consumers that “A third dimension is more important,” such as courtesy of the personnel, location, prices, cleanliness, healthiness, and so forth. Since the map is solely based on perceptions, rather than focusing on the company’s operational features, consumers’ minds can be influenced by convincing arguments about why other dimensions should receive more weight.

Perceptual maps can be used to see the current position of a brand, compare it with competition, and to discuss what to do about it. But the map does not show the sales, the market share, or the profits of any company. In Figure 5.6, firm G may be the worst on the critical dimensions, but reach a large scale of production, offer the food at a low price, and be the most profitable firm among others.

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Key Issues in BrandingOne of the key issues in branding is the concept

of brand value. The power of a brand starts from awareness, followed by being well-informed about the brand, liking, preference, conviction, purchase, and re-purchase. This is a hierarchical development, therefore the assumption is that a consumer may not like the product if she or he is not aware of it, and she or he cannot purchase the product unless she or he is convinced. Brand value is a generic term which reflects brand equity (being a well-known brand will generate more revenue) or strength of a brand, the financial strength (the net present value of the estimated future cash flows), and/or the effective attachment consumers have with the brand due to functionally, emotionally, and experientially strong aspects. The value of a brand can (and should) be stated in simple terms, through a brand value proposition, where the differentiating point of the company becomes clear.

Although there are several marketing performance metrics that companies can follow in order to understand how they are doing in the market, such as market share, sales, or profits, it is also very important to measure brand value from a more perceptual perspective. One such measure by Aaker lists ten attributes of a brand that can be important: differentiation, satisfaction/loyalty, perceived quality, leadership/popularity, perceived value, brand personality, organizational associations, brand awareness, market share and market price, and distribution coverage.12

Another popular measurement of a brand is provided by the firm Interbrand (Web Link 3).

Interbrand valuation of a brand includes three key components:13 financial analysis (overall financial return to investors), role of the brand (the portion of the purchase decision attributable to the brand as opposed to other factors such as price or convenience), and brand strength (the ability of the brand to create brand loyalty, and therefore, sustainable demand and profit in the future).

Interbrand maintains that, for a brand to be on the list of “Best Brands,” it has to meet certain requirements. For instance, at least 30% of revenue must come from outside the origin country; the firm should have a broad coverage in emerging markets (not only in developed regions); and there should be sufficient publicly available information regarding the company’s financial performance. These criteria indicate that a company cannot create a strong brand for a long time unless it disperses its operations around the globe and becomes aware of the importance of segmentation criteria that applies for a large scale of consumers. This is mainly because the brand cannot have a solid stance unless the underlying consumer motivations are studied and generalized across nations, which then requires systematic methodologies to understand the needs and desires.

It is possible for companies to develop their own brand valuation methodologies, too. Companies usually rely on financial data andmarketfactssuchassales;howevertheyshouldalso make a review of their marketing performance in terms of consumer satisfaction and loyalty. Some cost-based valuation methods are used to see the brand’s replacement value, indicating the quantitative equivalent of the brand’s worth. A similar methodology is called the income-based

Brand value reflects brand equity (being a well-known brand will generate more revenue) or strength of a brand, the financial strength (the net present value of the estimated future cash flows), and/or the effective attachment consumers have with the brand due to functionally, emotionally, and experientially strong aspects.

http://interbrand.com/internet

Companies can develop their own brand valuation methodologies.

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valuation method, where the company calculates the discounted cash flows over a certain period. A third method, the market-based method, makes a comparison of the company with other companies within the marketplace. In this method, the company should be able to access data on comparable transactions in the market.

Another key issue in studying brands is brand personality. Brand personality refers to the set of human characteristics attributable to a brand. It may be considered as a general framework through which the company can study consumer perceptions and the current positioning of the brand. Personality of a brand, just like the personality of a human being, is the way a brand speaks and behaves; therefore, brand personalityusually refers to the emotional associations of a brand, rather than its tangible and functional attributes although demographic characteristics can be used to assess brand personality. For instance, Marlboro cigarettes are considered more masculine, while Virginia Slims is feminine. IBM is older while Apple is younger. Also, certain brands may evoke certain feelings in consumer minds. Disneyland triggers the feeling of childhood, fun, and excitement, while Nike represents an outdoorsy and energetic person. Elements of the corporate identity, as well as the brand’s logo, symbol, slogan, and other symbolic and visual components, may help build a desired personality, just like Nike is doing with the swoosh logo, and Apple with the bitten apple.

One leading study on the concept of brand personality is by Jennifer Aaker 14 who came up with five dimensions through studying hundreds of different product categories and a lot of different possible brand associations. The first dimension of brand personality is sincerity, representing whether the brand is domestic, honest, genuine, and cheerful. A Turkish example would be Tofaş, which does not attempt to distinguish itself on the basis of superior performance or elegant design, but the brand is often perceived as “one of us”, inexpensive, friendly,

and candid. In Aaker’s study, a second dimension is excitement. These brands are considered to be daring, spirited, imaginative, and up-to-date. An example from Turkey might be Mavi Jeans, which has created an energetic brand community using the right celebrities and the appropriate advertising strategies. A third dimension is competence, reflecting the brand’s reliability, responsibility, dependability, and efficiency. Zeki Triko is perceived as a competent brand, because the swimsuits material is of high-quality and the products can be used for several years without deterioration. A fourth dimension is sophistication, where the brand is found to be glamorous, pretentious, charming, and perhaps, romantic. Beymen is an example for a sophisticated brand in Turkey since the brand is perceived as premium, classy, and alluring. Lastly, a brand’s personality can be perceived along the dimension of ruggedness, where the brand is considered tough, strong, outdoorsy, and rugged. For example, Arçelik is a brand perceived as strong and long-lasting.

Brand personality reveals the brand’s true stance in the minds of consumers. It is important to consider the fact that a brand should not attempt to be good in everything. Similarly, a brand’s personality should not reflect a lot of confusing (perhaps contradicting) attributes. Strong brands are able to touch consumers’ lives from different points, just like Apple which may be considered as both exciting and competent at the same time. However, not all brands are able to reach this point. Many brands are better choosing a positioning strategy and a dominant personality dimension in order to create a long-term, sustainable image. For instance, Beymen may not try hard to look “sincere” in consumers’ minds but stay sophisticated (and a bit snobbish) in order to maintain its current status.

NEW TRENDS IN MARKETINGMajor trends in the world such as globalization,

automation, and digitalization have their effects on marketing, too. In fact, marketing is a very old discipline but it has become a totally different

Brand personality refers to the set of human characteristics attributable to a brand.

Strong brands are able to touch consumers’ lives from different points.

169


concept compared to the day it first emerged. In earlier eras, slaves were subjected to further humiliation by being “branded” to signify whose slaves they were. The modern practice of marketing evolved over time: The simple trade era was dominated by commodities being exchanged for household consumption, which later progressed towards commodities exchanged for the use of larger communities and nations. The subsequent era is called the production era, where the major concern was to produce with minimum input providing the maximum output, with the smallest percentage of faults. The production concept was dominant starting from the mid-19th century until the 1920’s, which can be considered a very recent time considering the length of human history. This was followed by the product era, where managers came to realize that not only the production process, but also what is being produced is also important. This realization, however, did not prevent difficulties when products started to accumulate with even faster production processes, which then made managers start thinking about customers. But the marketing conceptualization was still primitive because all managers can do was an unsystematic combination of attempts trying to sell products already produced (called the sales era). Since managers had no idea about what customers in fact need, want, or desire, sales efforts were lacking in skill, and at times overbearing.

The modern marketing era arrived to solve the problem of a lack of connections between customers and the company, and between production and sales departments. What is produced became what the customer already wants. After this enlightenment, the marketing concept has evolved into something else in which marketers have started to feel the need to understand consumer motivations and underlying sociological and psychological processes. The marketing era was then followed by the relationship marketing era (from the 1990s to the 2010s), where the focus has changed to building a long-term, mutually-benefiting relationship with

target consumers and the intended value has started to capture the lifetime customer loyalty. Customer relationship management (CRM) has been a key concept with many software programs claiming to help firms understand what the data says about customers and facilitating the formation of a long-lasting relationship.

“Big-data” in this new era represents large and complex sets of data collected through primary data collection methods and data readily available on the web. There are a variety of challenges associated with big data, including searching for, capturing, storing, and analyzing data, visualizing, updating, and sharing the analyzed data, in addition to data privacy. Big data can be described by five characteristics:15 the volume (the quantity of data), variety (type and nature of data), velocity (the speed of data generation), variability (inconsistency of data), and veracity (the quality of data). The aim is to understand and predict consumer behavior through sophisticated analytics methods. According to Smart Insights (Web Link 4), top-rated digital marketing trends for 2017 are mainly represented by content marketing (20.3%) and big data (20.2%), followed by other developments such as marketing automation, mobile marketing, social media marketing, internet of things, and search engine optimization.

Associated with the development of more complex statistical data analysis methods, software programming, and artificial intelligence, digital technologies constitute another big development in recent years. Virtual and augmented reality, for instance, provides an effective way for marketers to get into the lives of consumers, connect with them, and have real-life experiences together. One example is the world-wide game of finding, catching, and training Pokemons all around the globe, where Pokemons do not exist in real life (or do they?).

Content marketing still remains to be the dominant digital marketing technique, instead

http://www.smartinsights.com/internet

“Big-data” in this new era represents large and complex sets of data collected through primary data collection methods and data readily available on the web.

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of the traditional search marketing. Content marketing refers to the creation, publishing, and distribution of digital content for a targeted audience online. For instance, YouTube (a subsidiary of Google) has an online video platform enabling marketers and consumers share lived or animated experiences online. A lot of quizzes by Buzzfeed (Web Link 5), as another example, make consumers discover their own realities, go through a list of exciting questions, and then share the results if they want to.

A lot of companies eagerly turn to social media marketing to create stories with customers, instead of more traditional communications channels such as TV or radio. Consumers actively use social media to make consumption decisions, hence companies feel the need to create social media content and connect with customers. Most of the social media platforms have their own built-in data analytic tools which companies can utilize. Among these platforms, social networking websites (e.g. Facebook, Twitter, Instagram, Pinterest, LinkedIn, etc.) with mobile phone applications produce the prime effect.

One specific marketing development in recent years is theuseof electroencephalograpgy (EEG)andfunctional magnetic resonance imaging techniques (fMRI) to better understand consumer motivations and theirreactionstostimuli(suchasadvertising).Despitehuge academic interest in the area because of its ability to reveal the consumer’s black box, practitioners have been often reluctant to use this technology because of its high cost and the need for expertise and time to analyze the results. This trend is also changing as it is now possible to see a lot of collaborative agreements between advertisers and marketers with universities and organizations conducting research with MRI. There are a lot of techniques used in neuro-marketing research such as eye tracking, facial emotion coding, and brain activity.

MARKETING ETHICSMarketing ethics deals with the moral principles behind marketing activities. One of the newest eras

in marketing involves the concept of societal marketing, for instance, which tries to discuss creative ways to optimize consumer satisfaction and preserve society and nature as a whole. A company is doing a

https://www.buzzfeed.com/internet

Social media can be used more passively such as by following the content related to the brand or as a PR tool (news about the company on Twitter) or direct marketing tool (selling products on Facebook), or more actively through customer engagement tools, by making customers make comments, react in various ways, and participate in different types of applications and games.

What do you think is the most significant development among the newest trends in marketing?

5

Content marketing refers to the creation, publishing, and distribution of digital content for a targeted audience online.

171


good job pleasing some consumers with particular needs and desires, and it can do this very efficiently and effectively, control the market in this regard, become the market share leader, and maintain its brand value for years. This represents good marketing performance. But what about the society at large? Would it be better if all resources spent on marketing research, advertising, and branding were used for providing consumption items, including food and shelter, for the benefit of all consumers around the world? These and other (maybe a bit existential) questions have started to trail, with the crucial doubt mind: Is marketing inherently evil?

There are a lot of issues raised as regards to marketing ethics. The following list is not exhaustive:

• Invasionofprivacyinmarketingresearch• Stereotypinginsegmentationandtargeting• Uncontrolledmarketingeffortstowards

vulnerable consumers, such as the elderly children,illiteratepeople,andfinanciallydisadvantagedpeople

• Unethicalpricingtacticssuchaspricefix-ing,pricewars,andpricecollusion

• Ethicallyquestionableandinsensitivecon-ductinadvertisingandpromotion

• Deceptiveadvertisingandmarketingtacticssuchasbystrongemotionslikefearand sex

• Productsafetyissues• Irreversiblecorruptionofthenatureand

natural resources• Misleadingpackaging• Low-qualityexport/importproducts• Bribery• Over-bookingandover-selling• Intentionallycreatinglimitedsupply• Fakeproducts• Plannedobsolescence

• Materialism• Createdneedsand• Culturalcorruption.These and other issues are being raised more

frequently each day. There are people who refuse the marketing system altogether, called the “anti-marketing” groups, and who offer to replace it with more sustainable systems for the betterment of humanity. Anti-consumerism is a more general term reflecting a sociopolitical ideology against the recurrent buying and consuming of material possessions, including advocating environmental activism, anti-globalization, and animal-rights activism. Consumer educate themselves, too, such as through buying only the necessary items, recycling, and minimalism.

Corporate social responsibility (CSR), also called corporate citizenship, denotes the integration of a self-regulation mechanism in all conducts and ideas of doing business. The basic form of CSR is philanthropy, i.e. providing monetary donations. There may be other more sophisticated and more creative ways of providing superior value for the society, respecting humanity, and sustaining nature, such IKEA’s initiative to recycle old furniture, and Bimbo’s (a bakery in Mexico) provision of resources to help employees complete their education. One specific type of CSR is called “enlightened marketing,” where companies would try to innovate not the items that would sell but the things that would recover the environment and improve upon societal values.

Do you think business ethicsis any different than the moral attitude of people managing the company?

6

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Branson, R. (2007). Screw It, Let’s Do It: Lessons in Life and Business. Random House.

Cialdini,R.B.&Cialdini,R.(2016).Pre-Suasion. Random House.

Godin, S. (2009). Purple Cow, New Edition: Transform Your Business by Being Remarkable. Penguin.

Greene, R. (2010). The Art of Seduction (Vol. 1). Profile Books.

Kim, W. C. & Mauborgne, R. (2014). Blue Ocean Strategy, Expanded Edition: How to Create Uncontested Market Space and Make The Competition Irrelevant. Harvard Business Review Press.

Klein,N.(2015).No Logo. Éditions Actes Sud.

Lindström, M. & Underhill, P. (2010). Buyology: Truth and Lies About Why We Buy. Crown Business.

Pulizzi,J. (2015).Content Inc.: How Entrepreneurs Use Content to Build Massive Audiences and Create Radically Successful Businesses. McGraw Hill Professional.

Schaefer,M.W.(2015).The Content Code: Six Essential Strategies for Igniting Your Content, Your Marketing, and Your Business. Schaefer Marketing Solutions.

Scott,D.M.(2007).The New Rules of Marketing. John Wiley & Sons.

Further Reading

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The Unavoidable Charm of Online Marketing. How Applicable Is It?

Treasure Products Inc., a company that originated in Turkey in 1986, is an excellentexample of the strategic importance of marketing in establishing and maintaining a “firm’s competitive power.” That year, the company entered the vintage jewelry market by specializing in the reproduction of simulated Ottoman diamond jewelry of good quality. Over the years, Treasure Products has scored a consistent record of success at home and in markets overseas. Key to its success has been the main marketing strategy which is product diversification. It ranged from women’s jewelry to men’s watches plated in brass, copper, and oxidized silver enriched by simulated gemstones. However, the company is now facing challenges of a shrinking retail market as new competitors employ Internet sales strategies.

Treasure Products is large company with more than a thousand employees. The company started its growth stage with the motto of “You deserve to be charming!” It has marketing and manufacturing operations in 19 countries including the United States. Other than manufacturers and distributors in different regions of the world, Treasure Products has partnerships in countries such as Malaysia and India.

Although the company’s products have been known for their fancy designs and relatively affordable prices, in recent years it has launched a newmarketinginitiative.ThecurrentCEO,Mr.Cem is highly experienced in overseas operations. He was hired by the new board formed after Mr. Bilir succeeded his father in 2016. Since thattime, Mr. Cem has focused on reaching young consumers and millennials. The branding is reflected in his hiring initiatives. One is the chief marketing officer (CMO) as well as new hires for specific departments such as product designs. Bilir believes that the newer generations of consumers are highly attracted to digital marketing practices.

In a recent study, 84% of the respondents reported that user-generated content on the company websites have a significant influence on what customer purchases.

Treasure Products conducted a SWOT analysis to evaluate its current marketing strategies. The company’s market positioning based on strengths such as brand image, product quality, presence in international markets, and price advantage as well as weaknesses such as still being dominated by traditional marketing methods, high marketing costs, and insufficient experience in digital marketing techniques. The shift in demand for vintage jewelry, internet access being available in most places, and an increasing use of digital media as well as online purchasing alternatives are some of the opportunities in the market that the company can utilize for obtaining new marketing channels. On the other hand, the company must be aware of the threats of inferior reproduction products in the international jewelry market, the ease for new entries in e- business, and governmental restrictions such as taxes for digital purchases or technological problems in certain countries which may become critical risks. Source: https://digitalmarketinginstitute.com/the-insider/05-10-16-the-evolution-of-digital-marketing-30-years-in-the-past-and-futurehttps://www.slideshare.net/globalwebindex/globalwebindex-social-q1-summary-reportDiscuss:

1. WhatarethestrategiesthatTreasureProductsInc.canformulateforoccupyingadistinctiveplaceinthedigitalvintagejewelrymarket?Doesthediversificationstrategy need to be enhanced and supported byothermarketingstrategies?Isproductasufficientdifferentiatingpoint?

2. WhatistheimpactofdigitalizedmarketingonthecurrentmarketingmixthatTreasureProductsInc.hasbeenimplementing?Canitbesustained?

In Practice


174

Sum

mar

y

LO 1 Reaching an accurate understanding of what marketing is and what it entails

Marketing should not be perceived as another function in the organization. It should be the basic driving motivation across all departments. Kotler and Keller defines marketing as the creation, promotion, and delivery of goods and services directed towards consumers and businesses, however, it should be perceived as the major driving factor in the organization, determining the strategic orientation and the foundation of branding. Another definition is “Marketing is managing profitable customer relationships”. This definition covers three important concepts: First of all, marketing is all about building a relationship with customers. Without a deep understanding of consumer behavior, marketing cannot succeed. Secondly, marketing is about managing customer relations. An ideal (proactive) marketing methodology would understand customers and build a relationship based on their expectations before the customers would be telling about their needs and expectations. Lastly, the management of customer relationships must generate profits, not only because companies need money to pay their employees and other shareholders, but also because they need money to invest in other opportunities.

LO 2 Explaining the methods that companies follow for strategic positioning towards market segments

Marketing strategy is the way of doing marketing towards a certain positioning. For marketers to decide on this “way,” they have to combine all marketing goals into one comprehensive plan. Two key decisions marketers have to make in this regard are generic marketing strategy and segmentation and targeting. According to Porter, companies should build competitive advantage in order to stand distinctive in the market and hold the advantage for a long period of time. One of the ways to establish competitive advantage is to produce output with the lowest cost in the industry. This can be achieved by producing in more and more efficient ways using scale economies, scope economies, and experience (learning curve) effects. Segmentation is the task of dividing the population into sub-groups in a way that can meaningfully separate consumers in terms of their consumption patterns. An ideal segmentation approach combines different strategies (including demographics and psychographics) to arrive at groups with the highest level of differentiation. Targeting involves the careful selection of at least one segment identified in the previous step, by considering a variety of different factors. In segmentation and targeting decisions, as in all marketing decisions, marketers should feel responsible about whom they target, how, and why.


175

Sum

mary

LO 3Developing skills necessary for an integrated management of the marketing mix elements, namely; product, pricing, place, and promotion

Marketing mix, also known as the 4Ps of marketing, constitutes the set of all marketing activities a company engages itself in pursuing its marketing goals and objectives. Product (good or service) is the offering in the market, created and sold in order to solve a problem or satisfy a need or want. The second major marketing activity involves the pricing of a product. This represents the financial compensation in return for the value provided by the product or service. Setting a price is one of the major marketing decisions. There are different pricing approaches with unique advantages and disadvantages. The simplest method is called cost-based pricing where companies first figure out the cost of producing one item, and then add a profit margin to arrive the price to be used in the marketplace. Place is a decision regarding where the products would be purchased (and implicitly, how they are purchased), and the activity conducted by the company is called distribution. From the consumer’s perspective, this is called convenience because if the product is not available for the consumer, there is nothing else that can cover for this problem. Promotion entails the activities that attempt to establish some sort of a relationship with target customers, and all shareholders involved, and try to win the heart and loyalty of consumers. From the consumers’ perspective, communication is an essential component in a marketing exchange relationship. The tools of communication available for marketers are (1) advertising, (2) sales promotions, (3) public relations and publicity, and (4) personal sales.

LO 4 Grasping the issues related to branding, which stands as the most strategic, long-term investment of the company

Branding involves a set of marketing and promotion activities that promote the brand, aiming to have a persistent image in consumers’ minds. It is the most strategic investment of the company. Brand equity is a term reflecting the brand’s worth in the eyes of consumers, usually reflected in the price. Brand identity is the set of all individual components of a brand, specifically including the imagery, slogans, colors, and all other types of imagery. Positioning is how the brand is perceived by the consumers. A positioning strategy has to be sustainable and create a meaningful competitive advantage. Positioning (Perceptual) maps are based on consumer perceptions showing the perceived position of the product/brand so that the firm can see its standing compared to competitors, take corrective action if necessary, and make strategic, future-oriented decisions. One of the key issues in branding is the concept of brand value. Brand value is a generic term which reflects brand equity (being a well-known brand will generate more revenue), the financial strength (the net present value of the estimated future cash flows), and/or the effective attachment consumers have with the brand due to functionally, emotionally, and experientially strong aspects. Another key issue in studying brands is brand personality. Brand personality refers to the set of human characteristics attributable to a brand. It may be considered as a general framework through which the company can study consumer perceptions and the current positioning of the brand. Strong brands are able to touch consumers’ lives form different points.


176

Sum

mar

y

LO 5 Describing new trends in marketing influenced by globalization, automation, and digitalization

Major trends in the world such as globalization, automation, and digitalization have their effects on marketing, too. In fact, marketing is a very old discipline but it has become a totally different concept compared to the day it was first discussed and used. The marketing concept has evolved into something else in which marketers have started to feel the need to understand consumer motivations and underlying sociological and psychological processes. Customer relationship management (CRM) has been a key concept with many software programs claiming to help firms understand what the data says about customers and facilitating the formation of a long-lasting relationship. “Big-data” in this new era represents large and complex sets of data collected through primary data collection methods and data readily available on the web. There are a variety of challenges associated with big data, including searching for, capturing, storing, and analyzing data, visualizing, updating, and sharing the analyzed data, in addition to data privacy. The aim is to understand and predict consumer behavior through sophisticated analytics methods. Onespecificmarketingdevelopmentinrecentyearsistheuseofelectroencephalograpgy(EEG)andfunctional magnetic resonance imaging techniques (fMRI) to better understand consumer motivations and their reactions to stimuli (such as advertising).

LO 6Appraising how and why the marketing principles would be applied in accordance with ethical principles of doing business in a globalizing and digitalizing world

Marketing ethics deals with the moral principles behind marketing activities. One of the newest eras in marketing involves the concept of societal marketing, for instance, which tries to discuss creative ways to optimize consumer satisfaction and preserve society and nature as a whole. A company is doing a good job pleasing some consumers with particular needs and desires, and it can do this very efficiently and effectively, control the market in this regard, become the market share leader, and maintain its brand value for years. There are a lot of issues raised as regards to marketing ethics such as invasion of privacy in marketing research, stereotyping in segmentation and targeting, uncontrolled marketing efforts towards vulnerable consumers, unethical pricing tactics such as price fixing, price wars, and price collusion, and ethically questionable and insensitive conduct in advertising and promotion. In response to unethical marketing conduct, anti marketing groups suggest more sustainable systems for the betterment of humanity. Anti-consumerism is a more general term reflecting a sociopolitical ideology against the recurrent buying and consuming of material possessions, including other advocate ideas such as environmental activism, anti-globalization, and animal-rights activism.


177

Test yourself

1 Which of the following is not an essential marketing activity?

a. Deciding on and organizing the marketing mixelements.

b. Participating in corporate social responsibility events.

c. Making profits to preserve a sustainable re-investment money.

d. Creating long-term customer relationships.e. Managing and organizing the strategic orientation

of the company.

2 What cannot be true for focus marketing strategy?

a. Marketing research costs are high.b. Strategic target is narrow.c. Strategic advantage is always a unique product.d. There should be a focused attention on the target

chosen.e. Communication with the target consumers should

be specifically planned.

3 Which of the following characteristics of segmentation is not absolutely essential?

a. People in the same group are homogenous.b. People in different groups are heterogeneous.c. The segments should be substantial. d. People should be approachable. e. All of the above are true.

4 Which is the most useful segmentation criterion?

a. Demographicsb. Psychographicsc. Geographicd. User behaviore. Income

5 When the marketers customizes the product and other marketing mix elements to satisfy the individual person, this is called ____________.

a. Mass marketingb. Focused marketingc. Differentiationmarketingd. Micro marketinge. None of the above

6 Service economies may necessitate a larger combination of marketing mix elements. Which of the following is not an appropriate addition to the original 4P’s?

a. Possessions b. Peoplec. Physical evidence d. Process e. All of the above are appropriate additions

7 For a smart phone, which combination of “product feature versus product layer” below would not be correct?

a. Touchscreen – expected productb. Ability to be worn on hand – potential productc. Calling someone – core benefit d. Capacity for a larger camera affixed on top of the

built-in camera – augmented product e. Ability to connect with a computer – potential

product

8 What is the type of positioning when a hotel makes TV advertising in which players enjoy the sun, the sea, the food, and the music, and they look all very happy?

a. Functional b. Operationalc. Experiential d. Symbolice. Practical

9 A positioning (perceptual) map would indicate all of the following, except:

a. Profitsb. Position in the minds of consumersc. Close competitors’ positiond. General competitive structure in the markete. Competitive gaps in the market

10 Modern trends in marketing force marketers to do all of the following, except:

a. Build brands based on an understanding of glo-bal segmentation.

b. Hiring social media experts to follow and lead what is being discussed about the brand.

c. Push the marketing mechanism towards selling more items to more individuals.

d. Use more sophisticated methods to analyze the data collected automatically.

e. Be responsible for all shareholders in the world, including non-customers and animals.


178

Ans

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s fo

r “T

est y

ours

elf”

If your answer is incorrect, review “Definition of Marketing”.

1. b If your answer is incorrect, review “Marketing Mix”.

6. a

If your answer is incorrect, review “Strategic Segmentation and Target Customers”.

3. e If your answer is incorrect, review “Positioning”.

8. c

If your answer is incorrect, review “Generic Marketing Strategy”.

2. c If your answer is incorrect, review “Product/Service”.

7. e

If your answer is incorrect, review “Segmentation Criteria”.

4. b

If your answer is incorrect, review “Targeting”.

5. d

If your answer is incorrect, review “Positioning (Perceptual) Maps”.

9. a

If your answer is incorrect, review “New Trends in Marketing”.

10. c

How would you define marketing? Explain your

reasoning.

your turn 1

Marketing is often defined by focusing on the activities marketing personnel run on an everyday basis, such as sales efforts or advertising. It is also defined as the movement of materials from producers to consumers in the form of final products. In recent years, marketers have come to realize that marketing is also about establishing strong relationships with consumers. Therefore, your definition may change depending on how you conceptualize marketing: As a set of activities conducted by marketing personnel (a functional perspective, which is outdated and lacking) or as a socio-psychological process of exchanges in the market, based on a relationship between brands and consumers.

your turn 2

Points of differentiation claimed by companies have the risk of being irrelevant for consumers. You are asked to find such an example. For instance, in a restaurant you may find that the menu lists a lot of healthy options such as vegetables and salad, while you are not really interested in healthy stuff, but rather seek food which is delicious and filling. At a hospital, you may find that the nurses are very nice and friendly, while in fact you give more importance to whether the physicians are qualified or not. These and other examples you may come up with point out the significance of whether and how marketers.

Think of examples or experiences where you came across brands

claiming an advantageous feature but you did not care enough.

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for

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179

Suggested answ


Provide a hypothetical example of segmentation in sector of your interest.

Explain how you divided the market, i.e. the criteria for segmentation.

your turn 3

Segmentation should be based on psychographic consumer data, since it provides the most relevant information as regards to how consumers behave the way they do. As an example, consumers in the women shoes category can be segmented based on where they live (geographic segmentation) which would then lead to shoes which are appropriate for hot and cold weather. Consumers can be segmented based on demographic data, such as shows for young women versus older women. Consumers can also be segmented based on how and why they use shoes, which might lead to products which are more suitable for work or for parties at night. In a more useful way, consumers can be segmented based on their life styles. Some women would like to wear sneakers all the time and combine them with comfortable pants, while some women wear more fashionable items, and combine those with high-heel stilettos. This last criterion is better able to differentiate among consumers in terms of their thoughts and feelings towards shoes.

your turn 4

Corner shops originated by the name “corner” because traditionally such shops are located on the corner of an intersection, where a lot of pedestrians pass by. They are sometimes called “convenience stores,” because they are small retail businesses which stock a range of everyday items such as groceries, tobacco products, water, newspapers, and other items which consumers need on a regular and frequent basis. Therefore, it might be a good idea to open corner stores because (1) corners are places where human traffic is high therefore thereisahighsalespotentialand(2)allconsumersbuyconvenienceitems;therefore, sales potentials are high. However marketers should be aware of the risks that (1) the advantage of quantity discounts is not possible since the place is too small and (2) consumers may find the prices too high and not buy enough to compensate for the costs.

Explain your thoughts about the retailer type “corner shops.”

Do you think it is a good idea? Why/why not, and in what

circumstances your answer would change?


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1Kotler, P. & Kevin, L. K. (2012). Marketing Management. Prentice Hall.2AMA (American Marketing Association). Definition of Marketing. Retrieved from

https://www.ama.org/aboutama/pages/definition-of-marketing.aspx3Porter,M.E.(1980).Competitive Strategy: Techniques for Analyzing Industries and Competitors. Free Press.4Plummer, J. T. (1974). The concept and application of life style segmentation. Journal of Marketing, 38 (1),

pp. 33-37.5Smith,N.C.&Cooper-Martin, E. (1997). Ethics and targetmarketing:The role of product harm and

consumer vulnerability. Journal of Marketing, 61 (3), pp. 1-20.6Culltion, J. W. (1948). The Management of Marketing Costs. Harvard University Press (research bulletin).

endnotes

Do you think business ethics is any different than the

moral attitude of people managing the company?

your turn 6

Both yes and no. Managers who are making strategic decisions on behalf of the brand are able to drive the company in different directions. Therefore, their personal predisposition towards ethical issues including marketing facilities (advertising towards vulnerable consumers, suitable pricing, product claims, and sales personnel behavior, etc.), is likely to directly affect the general ethical conductofthecompany.Ontheotherhand,ethicsisasystematicapproach;therefore, not only managers but also the overall system of doing business, encompassing the vision, the strategy, and all functions including the human resources, organization, financial affairs, and marketing, should be tailored in an integrated way towards maintaining a healthy, working system of ethical organization.

What do you think is the most significant development among the

newest trends in marketing?

your turn 5

One of the major developments is globalization. It affects each and every culture in similar and different ways. Production and consumption of products start to occur in distinct places around the globe, and it is very much possible for consumers in different parts of the world to be quite similar to each other in terms of their consumption. A second major development is digitalization. Marketing is now conducted on an online basis, in which consumers buy, sell,discuss,andshareproductsandstoriesabouttheproducts;andmarketerseither passively follow digital marketing content, or actively participate in the conversation, or even better, proactively create the digital content. Marketing executives are now highly driven by data collected through all sorts of digital and virtual places, specifically including social media platforms.

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7McCarthy,J.E.(1964).Basic Marketing: A Managerial Approach. Irwin.8Vargo, S.L.&Lusch,R.F. (January2004).Evolving to anewdominant logic formarketing. Journal of

Marketing, 68, pp. 1-17.9Grönroos, C. (2011). Value co-creation in service logic: A critical analysis. Marketing Theory, 11 (3), pp. 279-

301.10Stone,M.A.&Desmond,J.(2007).Fundamentals of Marketing. Routledge.11Ries,A.&Trout,J.(1986).Positioning: The Battle for Your Mind. McGraw-Hill.12Aaker,D.(1991).Managing Brand Equity: Capitalizing on the Value of a Brand Name. Free Press.13Murphy, J. (ed.). Brand Valuation: Establishing a True and Fair View. Hutchinson Business Books.14Aaker,J.(August1997).Dimensionsofbrandpersonality.Journal of Marketing Research, 34,pp.347-356.15Martin,H. (2016). Big data for development: A review of promises and challenges. Development Policy

Review, 34(1),pp.135-174.

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Chapter 6 Production Management andManaging Information Systems

Lear

ning

Out

com

es

Identify the historical evolution of production management.

Explain the scope of production management.

Define the concept of production, production system, and production management.

Explain the types of production processes.

Describe the new trends in production processes.

Describe managing information.

Identify information systems.

35

Define information technology.7

1 2468


Chapter OutlineProduction, Production System and Production ManagementTypes of Production ProcessesThe Historical Evolution of Production

ManagementNew Trends in Production ProcessesThe Scope of Production ManagementManaging InformationInformation TechnologyInformation SystemsInformation Systems for Decision Making

Key TermsProduction

Production systemProduction management

Lean productionJust-in-time

Information technologyInformation systems

Management information system

Describe the information systems for decision making.9

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Production along with marketing and finance is an essential and vital business activity in an organization. The production function in a profit-seeking company aims to produce goods and/or services to satisfy customers. In other words, it exists in order to provide goods and services demanded by customers. Without production there is no company or any other functions of the company. However, the production function by itself is not enough for the existence of companies. The other functions such as marketing and finance also are critical for the survival of a company. In this regard, the production function needs to produce goods and services that meet the needs and requirements of customers in the market. Shortly, the production function adds value to a company’s inputs by transforming them into marketable outputs. If the produced goods and services are not sold in the market the company doesn’t survive. Production management refers to the systematic design, operation, and control of the production process involving effective control of cost, performance, quality and waste requirements. While production management deals with decision making related to quality, quantity, cost, flexibility, capacity, and etc of production, it applies management principles to production.

This chapter emphasizes different aspects of the production function in a business organization. First the terms production, production systems, and production management are defined. Following parts are the types of production processes and the historical evolution of production management. Then new trends in production processes and the scope of production are introduced for better understanding the advanced level of the production function.

The chapter continues with the basics of managing information systems. In order to manage the production systems and subsytems effectively, information flow in the organisation among the functional units of a company must be fluent, seamless, accurate, and on time. Otherwise, a company cannot be successful in the market whatever its performance is in production, finance, or marketing. Especially in the information age, information systems and information technologies are essential tools to compete in the market. Companies do not only use information systems that connect all the functional units of the companies, but they also compete with the Internet-only companies via Web-based stores and online channels. All business managers are responsible for making investment and effectively utilizing these information technologies for the benefit of their companies. Many companies in the world spend billions in US dollars on information systems hardwares, softwares, and telecommunications equipment in order to be effective and efficient in business processes and compete in the highly competitive global markets. In compliance with the importance of the content for today’s business organizations; information technology, information systems, and information systems for decision making are also explained.

PRODUCTION, PRODUCTION SYSTEM, AND PRODUCTION MANAGEMENT

Briefly, production is defined as the transformation of tangible and intangible inputs into goods or services. In other words, production is the transformation or conversion of a set of inputs, such as raw materials, labor, knowledge, into one or more outputs such as tables, cars, and banking services. The production function in a business organization is specifically concerned with the activity of producing goods- that is, the design, implementation, operation and control of people, materials, equipment, money, and information to achieve specific production objectives.

Before explaining the production system, it is better to define what the system is. A system is a collection of interacting, interrelated, or interdependent elements or components that are organized for a common purpose. Organizations can be seen as systems that procure and transform inputs into outputs

Production is the transformation or conversion of a set of inputs, such as raw materials, labor, knowledge, into one or more outputs such as tables, cars, and banking services.

A system is a collection of interacting, interrelated or interdependent components that are organized for a common purpose.

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6 Production Management and Managing Information Systems

which are subsequently discharged into their external environment. The cycle of inputs, transformation, and outputs must be maintained if an organization is to exist over time. This is to say, an organization can survive only if it is capable of producing some output that can be exchanged for the energy necessary to obtain new inputs and also to maintain itself in operating order. It is generally emphasized that all companies are to some degree open systems as opposed to closed systems. That is, a typical company system depends on other systems for its inputs and thus cannot exist in isolation while closed systems do not depend on other systems for its inputs.1 Therefore, it is understood that the system is composed of inputs, process, outputs, and feedback. Companies themselves are systems made up of interacting subsystems. One of the important subsystems of companies is the production management department. The production function can offer competitive advantages to a company such as shorter new product lead time, more inventory turns, shorter manufacturing lead time, higher quality, greater flexibility, better customer service, and reduced waste.

Production SystemMost organizations, including non-profit organizations, can be described as production systems.

These organizations transform or convert a set of inputs into one or more outputs. The main purpose of production systems is to produce goods and/or services. The outputs of a production system are normally called products; these products may be tangible goods, intangible services, or a combination. The input-process-output process along with feedback, which is referred to as a production system, is characteristic of a wide variety of operating systems.

Goods are tangible items that can be touched or held. Production systems that produce goods are often referred to as manufacturing systems, and the production of goods is called manufacturing. Some examples for the manufacturing systems are automotive factories, chemical factories and furniture factories. Services are intangible products that satisfy some need of a consumer, including the enhancement of a good. Production systems that produce services are referred to as service systems. Legal assistance, banking services and transportation services are examples for the service systems.2

Products can be a combination of goods and services. A restaurant is a good example for the combination of both where they produce meals which are tangible products along with the intangible services of delivery and cleaning.

General structure of a production system is given in Figure 6.1 Inputs, process, outputs and feedback are the main elements of a production system. Inputs which are raw materials, materials, machine, energy, labor, management, capital, knowledge and enterpreneurship are transformed into outputs which are goods and services.

Figure 6.1 Production System

The main purpose of production systems is to produce goods and/or servives.

INPUT TRANSFORMATIONPROCESS

OUTPUT

Feedback

Raw materialMaterialMachineLaborManagementCapitalKnowledgeEnergyEntrepreneurship

GoodsServices

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The production system has the following characteristics:

• Productionisanorganizedactivity;thusevery production system has an objective.

• Thesystemtransformsthevariousinputsto useful outputs.

• Itdoesnotoperateinisolationfromtheother organizational systems.

• Thereexistsafeedbackabouttheproduc-tion activities, which is essential to control and improve system performance.3

The transformation process in the production system can be:

• Physical:inmanufacturingoperations,• Locational:intransportationorwarehouse

operations,• Exchange:inretailoperations,• Physiological:inhealthcare,• Psychological:inentertainment,• Informational:incommunication.

During the transformation process, the production function in the company involves four specific sub-functions which are design, scheduling, operation, and transformation control:

1. Design: Designing the transformation process involves making decisions on equipment selection, type of production process, and work flow patterns. The deci-sion on which process to utilize is based on economic considerations, volume required, and labor resources, and skills available. Managers must design transformation systems to take advantage of all existing knowledge and technology.

2. Scheduling: Once designed, the optimal process must be scheduled to produce the desired product or service at the right time. Scheduling covers the long run which forecasts product demand for developing inputs such as raw materials and labor needed and the short run which involves employees’ daily or weekly work activities.

3. Operation: Operating the transformation process involves the actual implementation of production procedures. The planning, organizing and controling of operations directly affect the output of a production system. The operating function also involves activities such as purchasing, redesigning the process (if necessary), and forecasting requirements.

4. Control: The transformation control process requires some methods for measuring the product or service before it is sold or used. For example, computers are used to monitor sales in a store. By using the computer, the store manager can monitor inventory levels so that stock reorders can be placed and outages minimized.4

Feedback mechanisms are required to monitor the performance of the transformation process. The-re may be some random disturbances hampering the transformation process of converting the inputs into desired outputs. Random disturbances can be plan-ned and are due to the internal environment.5

As it is mentioned above, production systems produce goods, services, or a combination of both. However, the production of goods and services have some important differences as well.

Some of the main differences of the production of goods and services are as follows:

• Systemsthatproducetangiblegoodsusu-ally rely more heavily on raw materials inputs than do service systems.

• Goodsusuallycanbestoredforlateruseand transported over space before the ulti-mate use, whereas services usually cannot.

• Consumersofgoodshavelittle,ifany,direct involvement with the production of the goods. In contrast, most services require close involvement of the customer with the production process and in many cases actual physical contact is essential.

• Asaresultoftheaboveitems,theproduc-tion of goods can be separated from the customer in space and time more easily than the production of services.6

However, it may be noted that a clear cut distinction between goods and services is difficult to make. In reality, all services are most likely a mixture of a service and a tangible good. Also the sale of many goods includes or requires service. For example, automobile sales have the service components of financing and transportation. The differences between goods and services are summarized in Table 6.1.7

During the transformation process, the production function in the company involves four specific sub-functions which are design, scheduling, operation, and transformation control.

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Table 6.1 The Differences Between Goods and Services

Goods (Tangible Products) Services (Intangible Products)Goods can be resold Reselling services is unusualGoods can be inventoried Many services cannot be inventoriedSome aspects of quality are measurable Many aspects of quality are difficult to measureSelling is distinct from production of goods Selling is often a part of the production of service

Goods are transportableService provider, not the service itself, is often transportable

Location of a facility is important for cost Location of a facility is not importantOften easy to automate production of goods Service is often difficult to automateRevenue is generated primarily from the tangible goods even if they are accompanied by services.

Revenue is generated primarily from the intangible services even though there are some goods which are associated with services

Production ManagementProduction management refers to the application

of management principles to the production function in a factory. In other words, production management involves application of planning, organizing, directing, and controlling the production process.

The application of management to the field of production has been the result of at least three developments:

i. First development is the creation of the factory system for producing goods. Until the emergence of the concept of manufacturing, there was not much awareness about management. Until then people operated businesses of one type or another, but for the most part, these people were busi-ness owners who did not regard themselves as managers;

ii. Essentially production management stems from the first, namely the development of the large corporation with multiple owners and the necessity to hire people for operating businesses; and

iii. Evolves from the work of many of the pioneers of scientific management who were able to dem-onstrate the value, from a performance and profit point of view, of some of the techniques they were developing.8

Following definitions explain main characteristics of production management:• Itistheprocessofeffectiveplanningandregulatingoperationsoftheproductionsectionofan

enterprise which is responsible for the act transforming materials into finished products.• Productionmanagementprovidesdecisionstotheproductionprocessforensuringthatthe

resulting goods and services are produced in accordance with the quantitative specifications and demand schedule with minimum cost.

• Productionmanagementisasetofgeneralprinciplesforproductioneconomics.Facilitydesign,job design, schedule design, quality control, inventory control, work study, and cost and budg-etary control are some application examples for the production management. This definition explains the main areas of an enterprise where the principles of production management can be applied.9

The meaning of production management for business organizations entails three main reasons: It encompasses both services and manufacturing; it’s important in effectively and efficiently managing productivity; and it plays a strategic role in an organization’s competitive success.

Production management involves the application of planning, organizing, directing, and controlling the production process.

What are the main activities of production management?

1

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TYPES OF PRODUCTION PROCESSES Production is the creation of utility and the frame-work with which the creation of utility occurs and is

termed as the production system. Production systems differ from one company to another. The production system of a company refers to how the flow of work is configured. There are inputs and outputs, operations and activities imparting values to the inputs. Production can be configured in a number of different ways, depending on the nature of the product, customer requirements, and available production technologies. There are several different processes manufacturers use to produce goods.

Although there are different types of processes, in the literature, the processes are classified according to their physical configuration, material and product flow, flexibility and volume expectations in this chapter. The four types of processes are: Flow process; Job-shop process; Cellular process; and Project process. For different classifications check the Internet.

Although the selection of a production process structure is a very important decision for a company, the nature of the product may affect determining the type of the process. For example, production of a bridge must be a project process or production of paper must be performed by using the continuous flow process.

The selection of a process structure is determined by many factors. Some of the most important ones are as follows:

• Theexpectedvolumeanddemandpatternfortheproducts.• Thenumberofdifferentproductsmanufacturedbythesystemand

the processing type that each one requires.• Thetypeofthecustomerorder,whichdefineswhethertheproduct

is made to stock or made to order.• Thephysicalcharacteristicsoftheproductsandthespecifictechnol-

ogies required to produce them. For example, manufacturing of steel requires working with large volumes of metal that must be processed at high temperatures.

Flow ProcessThe flow process is a very common method of production. This type of process is used when the

product is built up through many separated stages in a sequence. This production method is financially the most efficient and effective because there is less of a need for skilled workers.

The flow process is employed where all products require the same type of processing in the same sequence of tasks. Du-ring the flow process the overall production is decomposed into tasks or operations that must be performed and the tasks are assigned to be performed at distinct work stations which are arranged sequentially as it is shown in Figure 6.2.10

The production system of a company refers to how the flow of work is configured.

What is the difference between made to stock and made to order?

2

http://kalyan-city.blogspot.com.tr/2012/02/types-of-production-system-intermittent.html

internet

Production system may compose several subsystems, each of which may have a different process structure. For example: automobiles are designed using a project process, but many of its parts are manufactured using job-shop or cellular processes, and final assembly is done by using flow processes.

The flow process is employed where all products require the same type of processing in the same sequence of tasks.

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Figure 6.2 Flow Process Structure

Since all the products undergo the same processing at a given stage and materials flow in the same direction, equipment, tools, jobs and material handling are usually specialized for efficiency. Production of paper, assembling of automobiles and manufacturing of books are examples of flow processes.

Types of flow processesThere are three types of flow processes: continuous flow process; repetitive or discrete flow process;

and disconnected or batch flow process.1. Continuous flow process: This type of flow process is usually used in process industries such as

paper, chemicals, bulk foods, petroleum and water. This process is designed to produce large volumes of a small variety of uniform products. The type of processing is usually subject to very strict specifications and has a highly interconnected structure whereby material literally moves continuously, rather than through a sequence of discrete tasks. Most of the time it is true because the product itself is physically continuous like paper or chemicals. Continuous flow processes can also be used for discrete products such as beverages, detergent and candy.

2. Repetitive or discrete flow process: Through this type of flow process, work stations are tightly connected to each other and they are organized around the sequence of activities required to produce one general type of product like computers, automobiles or restaurant meals. The prod-ucts do not need to be continuous but generally units of product are processed and transported between work stations one by one in a synchronized manner. That is why it is called repetitive. The products themselves are physically discrete and the work required can be divided into discrete tasks. A narrow range of products are manufactured in large quantities by specialized machines and equipment and the automation is very high. A common version of a repetitive process is an as-sembly line such as computer assembly lines, where the workers or machines at each work station add components to a product moving along the line.

3. Disconnected or batch flow process: Batch flow process is used when a moderate volume of goods or serrvices as well as a moderate variety of products or services is required. In a batch flow pro-cess, volumes are higher because same or similar products are repeatedly provided. The variation in processing times and batch sizes and possibly lengthy setup times between product batches, will cause some products to wait in inventory between stages for certain periods. Some examples for the batch flow processes are ice cream, soft drinks, books and magazines. Companies can take advantage of the common flow of materials and use special equipment and jobs at each work sta-tion and have the flexibility to produce a variety of products in different volumes.

Advantages of the flow processes: Since specialized equipment is used, operations are efficient; workers can benefit from repetition of a narrow range of tasks; material handling can be simplified; work-in process inventories are small; space utilization is efficient; quality conformance is easier to achieve; and production scheduling and coordination are relatively easy.

Disadvantages of the flow processes: Initial costs are high; work can become tedious and boring; and the production system is extremely vulnerable.

ProductFlow Output1 2 3 4 5 6

Types of flow processes are continuous flow process; repetitive or discrete flow process; and disconnected or batch flow process.

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Job-Shop ProcessThe job-shop process is characterized by manufacturing of one or few quantity of products according

to the needs and requirements of customers. The job-shop process is used when a company manufactures several different products that require different types of processing and the processing for different products is performed in different sequences. Maximum flexibility can be achieved by this process. General purpose machines are suitable in job - shops because they are capable of performing many different types of operations and thus capable of producing a wide variety of products with small lot sizes. Machines which perform similar function grouped together such as lathe machines in one department, milling machines in another department, and so forth. There is a high customisation, high flexibility of equipment, and skilled labor in a job-shop process. A tool and die shop is an example of job-shop, where job process is carried out to produce one-of-a kind tools or customised printed products. Furniture, and custom-made chemicals are other examples of this type of process. Besides, in the job-shop process detailed planning is essential for sequencing the requirements of each product, capacities for each work centre and order priorities. An example for a job-shop is shown in Figure 6.3.11

Some of the important advantages of the job-shop process: Wide variety of products are produced; operators become more skilled; full potential of operators can be utilized; opportunity exists for creative methods and innovative ideas; and since machines are grouped, therefore supervision task becomes more effective.

Some of the important disadvantages of job-shop process: High material handling costs; high material flow distance; high production lead time; high levels of work in progress inventory; less efficiency of general purpose equipment, difficulty in quality conformance; and high production costs.

Figure 6.3 Job-Shop Processes

The job-shop process is used when a company manufactures several different products that require different types of processing and processing for different products is performed in different sequences.

Lathe department

Receiving andshipping Grinding department

Assembly

Milling department Drilling department

L M M D D

D D

G G

G G

G G

M M

M M

A A

A A

L

L L

L L

L L

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Cellular ProcessCellular manufacturing is a process that produces

families of parts within a single line or cell of machines operated by operators who work only within the line or the cell. A cell is a small scale, clearly-defined production unit within a larger factory. This unit has complete responsibility for producing a family of like parts or a product. All necessary machines and manpower are contained within this cell, thus giving it a degree of operational autonomy. Each worker is expected to have mastered a full range of operating skills required by her or his cell. Therefore, systematic job rotation and training are necessary conditions for effective cell development. Complete worker training is needed to ensure that flexible worker assignments can be fulfilled. Cellular manufacturing, which is actually an application of group technology, has been described as a stepping stone to achieving world class manufacturing status. The objective of cellular manufacturing is to design cells in such a way that some measure of performance is optimized. This measure of performance could be productivity, cycle time, or some other logistics measure. Measures seen in practice include pieces per man hour, unit cost, on-time delivery, lead time, defect rates, and percentage of parts made cell-complete.12

Companies often capture some of the efficiencies of flow processes and the flexibility of job-shop processes by creating hybrids of the two, which is called cellular process. A cellular process can also be a mixture of mini flow processes (work cells), and a job-shop operation. Work cell is operated like a flow cell with several activities connected in sequence.

A company divides its products into families or groups of products that require similar processing steps in the same sequence in order to create a cellular process. A work cell is then created to perform these steps in the designated sequence for all the products in the family. The output of the cell can be a finished or semifinished product. If the product is not convenient for any cell as many are, then a job-shop cell that does all the processing steps in any sequence can be applied.

Some of the most important advantages of cellular processes: Material handling and transport are reduced; setup and throughput times are reduced; in-process inventories are smaller; less space is needed; worker satisfaction is increased; and quality is improved. Despite its advantages, only a few companies can effectively utilize the cellular production process because of the difficulties in application. Successful implementation of a cellular production system requires a considerable amount of work and expertise to characterize and classify products and then design the appropriate work cells and remaining job-shop process. In Figure 6.4 process and cellular layout are shown.

Figure 6.4 Process Layout and Cellular Layout

Cell 1

Cellular manufacturing is a process that produces families of parts within a single line or cell of machines operated by operators who work only within the line or the cell.

Organizations often capture some of the efficiencies of flow processes and the flexibility of job-shop processes by creating hybrids of the two, which is called cellular process.

Cellular processes are most commonly used as substitutes for job-shop processes that need increased productivity. Also, increasingly, they are used in place of flow processes to obtain greater flexibility.

Hydraulic Presses Milling Machines Cell 1 Cell 2

Cell 3 Cell 4WeldersLathes

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Project ProcessThis type of production process is characterised

by a high degree of job customization, a large scope for each project, and need for substantial resources to complete the project. Projects are usually complex, take a long time and consist of a large number of complex activities. These processes are used when there is high customization and low product volume, because each product is unique. Equipment flexibility and labor skills can range from low to high depending on the type of project. With project processes the customer is usually involved in deciding on the design of the product. The major strength of this type of process is its flexibility to meet the individual needs of customers. Projects are usually analyzed using network-solving techniques like Critical Path Method (CPM) or Project Evaluation and Review Technique (PERT). These are expensive processes and variable costs are comparatively very high but fixed costs can be negligible. Moreover, highly skilled personnel must work independently, with minimal guidance and supervision. In addition, workers need to be well trained in a variety of tasks.

Although in project processes one-of-a-kind products are produced by utilizing similar skills and equipment, the process itself often is customized: unique skills and equipment may be required and/or combined in new ways. For example, a construction company may use iron workers, cement workers, carpenters and electricians on most jobs, but how they are used, the number used, and the sequence

in which they are used will vary from job to job. The dominant operations management issues for such processes are:

1. How to coordinate a wide variety of resources that are needed for the current project, as well as for other projects of the company,

2. How to complete the project by scheduled date and within the budget.13

Examples for the project processes are construction projects like building, highway and bridges, computer software, cargo airplanes, and ships.

THE HISTORICAL EVOLUTION OF PRODUCTION

MANAGEMENTSystems for production have existed since

ancient times. It can be said that production has started by the existence of humanbeings in order to survive. The Great Wall of China, the warships, roads, and aqueducts of the Roman Empire provide examples of the human ability to organize for production. Even so, most of these examples could be classified as “public work” projects. The production of goods for sale, at least in the modern sense, and the modern factory system had their roots in the first Industrial Revolution in the 19th century.14

Contemporary production management has its roots in the Industrial Revolution that occurred during the late eighteenth and early nineteenth centuries in England. Until that time, goods had

Cellular ProcessCellular manufacturing is a process that produces

families of parts within a single line or cell of machines operated by operators who work only within the line or the cell. A cell is a small scale, clearly-defined production unit within a larger factory. This unit has complete responsibility for producing a family of like parts or a product. All necessary machines and manpower are contained within this cell, thus giving it a degree of operational autonomy. Each worker is expected to have mastered a full range of operating skills required by her or his cell. Therefore, systematic job rotation and training are necessary conditions for effective cell development. Complete worker training is needed to ensure that flexible worker assignments can be fulfilled. Cellular manufacturing, which is actually an application of group technology, has been described as a stepping stone to achieving world class manufacturing status. The objective of cellular manufacturing is to design cells in such a way that some measure of performance is optimized. This measure of performance could be productivity, cycle time, or some other logistics measure. Measures seen in practice include pieces per man hour, unit cost, on-time delivery, lead time, defect rates, and percentage of parts made cell-complete.12

Companies often capture some of the efficiencies of flow processes and the flexibility of job-shop processes by creating hybrids of the two, which is called cellular process. A cellular process can also be a mixture of mini flow processes (work cells), and a job-shop operation. Work cell is operated like a flow cell with several activities connected in sequence.

A company divides its products into families or groups of products that require similar processing steps in the same sequence in order to create a cellular process. A work cell is then created to perform these steps in the designated sequence for all the products in the family. The output of the cell can be a finished or semifinished product. If the product is not convenient for any cell as many are, then a job-shop cell that does all the processing steps in any sequence can be applied.

Some of the most important advantages of cellular processes: Material handling and transport are reduced; setup and throughput times are reduced; in-process inventories are smaller; less space is needed; worker satisfaction is increased; and quality is improved. Despite its advantages, only a few companies can effectively utilize the cellular production process because of the difficulties in application. Successful implementation of a cellular production system requires a considerable amount of work and expertise to characterize and classify products and then design the appropriate work cells and remaining job-shop process. In Figure 6.4 process and cellular layout are shown.

Figure 6.4 Process Layout and Cellular Layout

Cell 1

The project process is characterised by a high degree of job customisation, a large scope for each project, and need for substantial resources to complete the project.

When there is a high level of customisation, low volume and one-of-a kind product like bridges or cargo airplanes, project processes are used.

What are the advantages and disadvantages of project processes?

3

During the First Industrial Revolution, many new inventions were implemented that allowed goods to be manufactured with greater ease and speed.

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been produced in small shops by artisans and their apprentices without the aid of mechanical equipment. The production system was not complex, workers were autonomous and self-employed with deep knowledge of their work and broad skills enabling them to do a job from start to finish. During the Industrial Revolution, however, many new inventions came into being that allowed goods to be manufactured with greater ease and speed. The inventions reduced the need for individual artisans and led to the development of modern factories.15 With the invention of the steam engine by James Watt in 1765, machine power replaced human power and animal labor. In the 19th century mass production began with large volumes but less variety. This production type required customers to buy what they produce rather than catering for customers’ requirements. The revolution first took hold in textile mills, grain mills, metalworking, and machine-making facilities.

Around the same time, Adam Smith’s Wealth of Nations (1776) proposed the division of labor, in which the production process was broken down into a series of small tasks, each performed by a different worker. The specialization of the workers on limited, repetitive tasks allowed them to become very proficient at those tasks and further encouraged the development of specialized machinery. The introduction of interchangeable parts by Eli Whitney (1790s) allowed the manufacture of firearms, clocks, sewing machines and other goods to shift from customized one-at-a-time production to volume production of standardized parts. Advances in technology continued through the 1800s. Cost accounting and other control systems were developed, but management theory and practice were virtually nonexistent. In the early 1900s Frederick W. Taylor approached the management of work as a science. Based on observation, measurement, and analysis, he identified the best method for performing each job. Once determined, the methods were standardized for all workers, and economic

incentives were established to encourage workers to follow the standards. Taylor’s philosophy became known as scientific management. His ideas were embraced and extended by efficiency experts Frank and Lilian Gilbreth, Henry Gannt, and others. One of Taylor’s biggest advocates was Henry Ford.16

The year 1913 saw the introduction of one of the machine age’s greatest technological innovations: The moving assembly line for the manufacture of Ford automobiles. After the application of this moving assembly line for the production of the Model T, the time required to assemble a car moved from a high of 728 hours to 1.5 hours. When the line was in its final form each worker was performing a small unit of work while the chassis was being moved along the line mechanically. This technological breakthrough, coupled with the concepts of scientific management, represents the classic application of labor specialization and still exists today in both manufacturing and service operations.17 This type of production yielded the name of mass production. Mass production is typically characterized by some type of mechanization, as with an assembly line, to achieve high volume of standard products, the detailed organization of materials flow, careful control of quality standards and division of labor.

Adam Smith’s Wealth of Nations (1776) proposed the division of labor in which the production process was broken down into a series of small tasks, each performed by a different worker.

Ford’s Model T

Ford is said to be inspired by the idea of an assembly line from observing a Swiss watch manufacturer’s use of the technology. Incidentally, all Model T Fords were painted black because black paint dried the fastest.

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American manufacturers became adept to mass production over the next 50 years and easily dominated manufacturing worldwide. The human relations movement of the 1930s, led by Elton Mayo and The Hawthorne studies, introduced the idea that worker motivation, as well as the technical aspects of work, affected productivity. Quantitaive models and techniques spawned by the operations research groups of World War II continued to develop and were applied successfully to manufacturing and services. Computers and automation led still another upsurge in technological advancements applied to operations.18

From the Industrial revolution through the 1960s, the United States was the world’s greatest producer of goods and services, as well as the major source of managerial and technical expertise. However, in the 1970s and 1980s U.S. manufacturing superiority was challenged by lower costs and higher quality from foreign manufacturers, led by Japan. The Japanese manufacturers started to dominate many industries. The robustness of the Japanese economy is especially amazing in light of Japan’s devastated condition at the end of World War II. This success has caused operations managers throughout the world to study how Japanese companies were able to develop this production dominance. The answer is the Japanese production system which is a synthesis and enhancement of relatively old ideas imported from the United States. US companies thought that mass production had solved the problem of production, so they delegated the function of manufacturing to technical specialists who ignored changes in the consumer environment and the strategic importance of operations. Decisions were made based on short-term financial goals rather than long-term starategic initiatives.

Although mass production produces large volumes of goods, it is not as simple to rapidly adapt to changes in demand. Mass production could not entirely fit in the present market conditions. Main characteristics of today’s markets are a shortened product life cycles and product development times, changes in technology, more customized products, and segmented markets. Japanese manufacturers changed the rules of production from mass production to lean production. Lean production prizes flexibility (rather than efficiency) and

quality (rather than quantity). The quality slogan has since spread across the globe and is the underlying force for successful operations today.

In 1990s by the emergence of Internet, the way of making business and the production systems were affected deeply. The Internet offers great potential for business organizations, but the potential as well as the risks must be clearly understood in order to determine if and how to exploit this potential. In many cases, The Internet has altered the way companies compete in the marketplace. Electronic business (e-business) involves the use of the Internet to transact business. E-business is changing the way companies interact with their customers and suppliers.

Production management has changed dramatically over the years. More and more activities are taking place outside the enterprise in factories, distribution centers, offices, and stores overseas, therefore companies need to develop skills in coordinating operations across a global supply chain. The field of supply chain management was born to manage the flow of information, products, and services across a network of customers, enterprises and supply chain partners. Supply chain management concentrates on input and output dimensions of transformation processes. Increasingly, however, as the transformation process is performed by suppliers who can be located around the world, the supply chain manager is also concerned with the timeliness, quality, and legalities of the suppliers’ operations.

The field of supply chain management was born to manage the flow of information, products, and services across a network of customers, enterprises and supply chain partners.

Lean production emphasizes flexibility and quality.

What are the main principles of Japanese production system?

4

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NEW TRENDS IN PRODUCTION PROCESSESThe ultimate goal of production management is to provide high-quality goods and services

instantaneously in response to customer demand by the lowest possible cost. The whole idea of classical production was to make a large number of a limited variety of products at very low costs. Over the years, low cost often came at the expense of quality and flexibility. Furthermore, suppliers didn’t always deliver when they claimed they would, so manufacturers had to carry large inventories of raw materials and components. Such inefficiencies caused incompetence for many companies in the global market dominated by multinationals. As a result of new global competition, companies had to offer a wide variety of high-quality custom-designed products at lower costs. Clearly something had to change on the production floor to make that possible. Several major developments have radically changed the production process and production management for the companies in order to compete in the global market.19

Flexible Manufacturing SystemThe concept of flexible manufacturing system (FMS)

was conceived in Britain in the early 1960s, and the first physical FMS was established around 1967 in the United States. The flexible manufacturing system was introduced in response to a new demand for more variety and for greater responsiveness to changes in products, production technology, and markets. The objective of an FMS is to carry out on a single system fabrication of several types of parts that can change over time with small conversion in time, at the required volume and quality, and with the aim of achieving productivity and flexibility at the same time.

The FMS is based on the concept of group technology, as it is designed to produce parts within a specific range of styles, sizes, and processes. Thus, FMS flexibility is limited to the production of a single part family or a limited range of part families. A part family is defined as a number of parts with similar dimensions, geometric features, and tolerances or processing requirements or both. By taking advantage of these similarities between parts in design and/or manufacture to achieve economy of scope, FMS can address changes in work orders, production schedules, part-programs, and tooling. FMS also requires a high degree of communication and cooperation among customers and employees throughout the company.

The flexible manufacturing systems are based on the concept of flexibility which can be defined as the capacity of a system to adjust itself in response to changing requirements without significant expense in terms of time, effort, cost, or performance.20 The ability to process many different parts within FMS with minimum engineering effort and change over time requires both physical and logical enablers.21 Flexible manufacturing systems typically address mid-volume and mid-variety production. If a product is required in high quantities with no style variations, then a dedicated mass production manufacturing system is most appropriate. For products characterized by low volume and high variety, then job shops with versatile machines or even manual methods would be more appropriate.22

Historically, most of the applications of FMS have been in milling and drilling operations (non-rotational parts), and more recently in turning (rotational parts), through the employment of CNC machining centers. Other implementations of FMS include assembly, inspection, sheet-metal processing (punching, shearing, bending, and forming), and forging.

The ultimate goal of production management is to provide high-quality goods and services instantaneously in response to customer demand by the lowest possible cost.

Flexible manufacturing system (FMS) was introduced in response to a new demand for more variety and for greater responsiveness to changes in products, production technology, and markets.

A part family is defined as a number of parts with similar dimensions, geometric features, and tolerances or processing requirements or both.

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FMS reduces or eliminates waste by ensuring that non-value added tasks such as load/unload, parts clamping and fixturing and set-up, gauging, tool changes, and maintenance occur outside the processing cycle, hence achieving higher productivity. Its automated features, monitoring and feedback adaptability and fault recovery strategies allow un-manned utilization of second and third shifts which increases the utilization of its expensive equipment.

Compared to conventional manufacturing systems, the benefits of FMS implementation include increased machine utilization (as high as 90 %); fewer machines required; reduction in necessary factory floor space; greater responsiveness to changes; reduced inventory requirements; reduced work-in-process (WIP); lower lead times; reduced direct labor requirements and higher labor productivity; and opportunity for un-attended production.23

Some drawbacks of FMS include: complex management of large number of products; significant capital investment; and sophisticated technology to be managed. Since flexible manufacturing systems are designed to fulfill the processing requirements for all members of the parts family, the “Flexibility” required for anticipated changes is built-in a priori. Hence, FMSs are relatively costly and some of their capabilities are often under-utilized as not all part variants are processed at the same time”.24

Lean Production SystemToday’s production management environment is very different from what it was just a few years ago.

Customers demand better quality, greater speed, and lower costs. In order to succeed, companies have to be masters of the basics of production management. To achieve this many companies are implementing a concept called lean systems.25

Lean production is the production of goods using less human effort, less manufacturing space, less investment in tools, and less engineering time to develop a new product. A company can be accepted as making lean production by continuously increasing its capacity to produce high quality goods while decreasing its need for resources. Lean production is based on the premise that nothing will be produced until it is needed. In theory, when a product is sold, the market pulls a replacement from the last position in the system, which is final assembly in a manufacturing environment. This triggers an order to the factory production line, and each worker pulls another unit from the position immediately upstream in the process-all the way back to the release of the raw materials and components needed at the first work station. Ideally, lean production is implemented throughout the supply chain, with the signal moving backward from the customer all the way back to the most basic raw materials.

Lean production systems use a highly skilled workforce and flexible equipment. In fact, they incorporate advantages of both mass production (high volume, low unit cost) and job - shop production (variety and flexibility). Quality is higher than in mass production. The skilled workers are more involved in maintaining and improving the system in lean production system. These workers can stop the production if there are any defective items and try to work together to solve the problem or defect so that it won’t recur. Since lean production systems operate with less inventories, emphasis is placed on anticipating when problems might occur before they arise, and avoiding those problems through careful planning. Workers participate in both planning and correction stages. Technical experts are still recruited, but more as consultants rather than substitutes for workers.

Lean production systems incorporate advantages of mass production and job-shop production.

What are the responsibilities of workers in a lean production system compared to traditional workers?

5

Lean production is the production of goods using less human effort, less manufacturing space, less investment in tools, and less engineering time to develop a new product.

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Just-In-Time Production System Just-In-Time (JIT) is a Japanese management philosophy

which has been applied in practice since the early 1970s in many Japanese manufacturing companies. It was first developed and perfected within the Toyota manufacturing plants by Taiichi Ohno as a means of meeting consumer demands with minimum delays. Just-In-Time production is a Japanese management philosophy applied in manufacturing which involves having the right items of the right quality and quantity in the right place and the right time. It has been widely reported that the proper use of JIT production has resulted in increases in quality, productivity, and efficiency, improved communication and decreases in costs and wastes. The potential of gaining these benefits has made many organizations question and consider this approach to manufacturing. For these reasons, JIT has become a very popular subject currently being investigated by many worldwide organizations.26

The just-in-time concept applies primarily to repetitive manufacturing processes. It does not necessarily require large volumes, but typically is restricted to operations that produce the same parts over and over again. Ideally, the finished products would be uniform, but with customized products, the repetitive seg-ments of the business may appear only at the component and subcomponent level.

Under just-in-time, the ideal size is one piece. The manufacturing process is a network of interconnected work centers, where the perfect arrangement would be to have each worker complete his task on a part and pass it directly to the next worker just as that person was ready for another piece. The idea is to drive all ques toward zero in order to minimize inventory investment, shorten production lead times, react faster to demand changes, and uncover any quality problems.

This production system makes no allowances for contingencies. Every piece is expected to be correct when received, every machine is expected to be available when needed to produce parts, and every delivery commitment is expected to be honored at the precise time it is scheduled. Just-in-time requires heavy emphasis on quality, preventive maintenance, and mutual trust among all participants in the manufacturing enterprise. The process is given top priority and everyone conscientiously adheres to it.27

Toyota created a system based on a simple idea: Production of the needed quantity of required parts each day. This is a pull system, in which employees at a given operation go to the source of the required parts, such as machining or subassembly, and withdraw the units as they need them. Only enough new parts are manufactured or procured to replace those withdrawn.

The JIT system can produce a steady rate of output to meet the sales rate in small, consistent batch sizes to level loads and stabilise the operating system. This causes the reduction of the inventory required between stages of the production process.

Computer Integrated Manufacturing Companies integrate robots, computer aided manufacturing (CAM), computer aided design (CAD),

flexible manufacturing systems, computers, and other advanced technologies to a production system called computer integrated manaufacturing (CIM). In this system computers help workers to design products, control machines, handle materials, and monitor and control the production function in an integrated fashion. It doesn’t just mean that more automation and fewer people can be used in the production, but it is a new type of automation organized around the computer. The key factor of CIM is a centralized computer system running software that integrates and controls separate processes and functions.28

Just-In-Time (JIT) production is a Japanese management philosophy applied in manufacturing which involves having the right items of the right quality and quantity in the right place and the right time.

The name just-in-time arose from the concept of making parts from upstream processes only when needed by downstream processes.

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Computer integrated manufacturing encompasses the entire range of product development and manufacturing activities with all the functions being carried out by the help of dedicated software packages. The data required for various functions are passed from one application software to another in a seamless manner. For example, the product data are created during the design process. The data have to be transferred from the modeling software to manufacturing software without any loss of data. CIM uses a common database wherever feasible and communication technologies to integrate design, manufacturing, and associated business functions that combine the automated segments of a factory or a manufacturing facility. CIM reduces the human component of manufacturing and thereby relieves the process of its slow, expensive, and error-prone component. CIM stands for a holistic and methodological approach to the activities of the manufacturing enterprise in order to achieve vast improvement in its performance.

Manufacturing engineers are required to achieve objectives to be competitive in a global context:

• Reductionininventory• Lowerthecostoftheproduct• Reducewaste• Improvequality• Increaseflexibilityinmanufacturingto

achieve immediate and rapid response to product changes, production changes, process changes, equipment changes, and the change of personnel.29

Mass CustomizationCustomization aims to make a unique product

or provide a specific service to specific individuals. Although it once may have seemed impossible, mass customization, which means tailoring products to meet the needs of a large number of individual customers, is now practiced widely. For example, The National Bicylc Industrial Company in Japan makes 18 Bicycle models in more than 2 million combinations, with each combination designed to fulfil the needs of a specific customer. The customer choses the model, size, color and design then the desired product is assembled by the robots.30

Companies prefer to produce standard products in high volumes by low costs. On the other hand, customers want to buy products among a wide variety of produts but with lowest possible cost. This situation creates a big problem for the companies and need to be solved. While companies try to solve this problem, they want to have a wide variety of products by not loosing the benefits of standardization. These include increasing the resources needed to achieve design variety; increasing variety in the production process, which would add to the skills necessary to produce products, thus causing a decrease in the productivity; creating an additional inventory burden during and after production, by having to carry replacement parts for the increased variety of parts; and adding to the difficulty of diagnosing and repairing product failures. This can be achieved by mass customization, a strategy of producing standardized goods or services, but incorporating some degree of customization in the final product or service.31

Mass customization brings the personalization and flexibility of custom-made business manufacturing together and takes it to another level of mass production with lower unit cost. Therefore, different mass customer groups are targeted in mass customization rather than targeting a single customer. Mass customization is

Companies integrate robots, computer aided manufacturing (CAM), computer aided design (CAD), flexible manufacturing systems, computers, and other advanced technologies to a production system called computer integrated manaufacturing (CIM), in which computers help workers to design products, control machines, handle materials, and monitor and control the production function in an integrated fashion.

Mass customization means tailoring products to meet the needs of a large number of individual customers

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utilized in numerous business types. For instance, in software that allow users to change or add certain functionalities according to their requirement. Similarly, Macbooks are available in different RAM sizes, hard disk capacities and the outer finish to provide users exactly what they are looking for.

E-manufacturingManufacturing have to work hard to achieve

not only high quality, productivity and low cost, but also the ability to react fast, responsively and effectively to the market, which is becoming more international, dynamic and customer-drive. Many companies design their products in a continent and manufacture them in a different continent and then sell the products at high volume in a different continent. Such global-wide manufacturing phenomena are getting to be more common in the manufacturing industry in the late 1990s. Maintaining design and manufacturing agility and working on the extended product development chain are key for these manufacturing companies to be successful and cope with such phenomena. Companies need to distribute intelligence and decision making authority as close to the points of delivery, sale and even after-sale service as possible. In order to respond easily and fast companies must integrate the design and production information with their business partners. To survive, they have to be prepared to change the definition of their core business if business goals and market conditions dictate. E-manufacturing technology is a promising enabled technology to achieve such agility in the changing manufacturing business.32

E-manufacturing is a system methodolgy that enables the manufacturing operations to successfully integrate with the functional objectives of an enterprise through the use of Internet, tether-free (i.e. wireless, web, etc.) and predictive

technologies. E-manufacturing is a recent concept developed to answer the aforementioned needs of e-business strategies and to meet the requirements for the complete integration of all business elements including the all suppliers, customer service networks, and manufacturing units through the effective use of web-enabled computational tools and tether-free technologies. E-manufacturing includes the ability to monitor the plant floor assets and predict the variation and performance loss to dynamically reschedule production and maintenance operations, and synchronize related and consequent actions to achieve a complete integration between manufacturing systems and upper-level enterprise applications.33

E-manufacturing provides a transparent, seamless, and automated information exchange process to enable an only handle information once environment improves the utılization of plant floor assets using a holistic approach. This approach combines the tools of predictive maintenance techniques and delivers customer services utilizing the latest predictive intelligence methods and tether-free technologies.

THE SCOPE OF PRODUCTION MANAGEMENT

Nowadays, companies try to produce a wide variety of products in order to meet customers’ changing and developing needs and requirements. Moreover, high competition, technological improvements, the structure of the business, source of capital, social developments, and industrial relations bring pressure on companies for paying more attention to production management. It should be emphasized that all activities in organizations are related to production function directly or indirectly, which indicates clearly that problems regarding production affect the whole company.

E-manufacturing is a system methodolgy that enables the manufacturing operations to successfully integrate with the functional objectives of an enterprise through the use of Internet, tether-free (i.e. wireless, web, etc.), and predictive technologies.

http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.98.9021&rep=rep1&type=pdf

internet

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The purpose of production management is to improve the most critical dimensions of production which are quantity, time, quality, and cost. While production management aims to achieve these goals at the maximum efficiency level, it simultaneously determines many other factors such as product types, quantity as well as quality of products, and the production facility. On the other hand, the cost of production is targeted to be minimized or profit is maximized. Besides, issues of customer satisfaction, minimum levels of inventory, and the effective and efficient usage of production resources can not be ignored.

The scope of production management ranges across the company. People working for production management are involved in product design, process selection, selection and management of technology, design of work systems, location planning, facilities planning and quality improvement of the company’s goods or services. Production function includes many interrelated activities such as forecasting, capacity planning, scheduling, managing inventories, assuring quality, motivating employees, and more.

Product DesignAt the heart of all operational decisions is the product itself. The design characteristics of the product

will affect the way the production system should be designed and operated. By considering production implications while the product is being designed, companies can make a higher-quality product at lower cost. Therefore, many companies include staff from operations as part of the product design team.

Product design typically has strategic implications for the success and prosperity of a company. Furthermore, it has an impact on future activities. The decisions about the product design are one of the most fundamental decisions of a company. The main focus of product design is customer satisfaction. Hence, it is essential for designers to understand what the customers’ expectations are and design accordingly. Marketing is the primary source of this information. It is important to note that although profit is generally the overall measure of design effectiveness, because the time interval between the design phase and profit realization is often considerable, more immediate measures come into play. These measures include development time and cost, the product or service cost, and the resulting product or service quality. Quality is among the top priorities in the product design. At one time, having high quality was enough for a product to stand out; now it is the norm, and those that fall below this norm are the ones that stand out.34

Product design and development generally proceeds in a series of phases: Idea generation; Feasibility analysis; Product specifications; Process specifications: Prototype development; Design review; Market test; Product introduction; and Follow-up evaluation.

3D printing technology is applied to different industries from food industry to manufacturing bikes, from Pokemon figures to medical surgery.

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Capacity Planning and Process DesignTwo fundamental design issues are how to produce the firm’s products and how much production

capacity to have. The design of the production process is crucial to supporting the marketing strategy of the organization. For example, if a company wants to compete primarily through its low cost, it can produce narrow range of products by huge volumes and standard products are produced by efficient but inflexible production process, whereas if the company wants to produce customized products the production process is flexible but inefficient.

The design of the production process requires decisions to be made regarding the arrangement of individual production activities, the division of work and specialization of labor, and the choice of equipment and technology. Besides, product design and selection of the production process are directly related. When the companies seek to produce types of products such as paper or some chemicals, due to the nature and structure of these products there is no need to make a selection decision for the production process. These types of products can be produced by just one kind of production process which is flow type process.

Desired production capacity is closely related to the production method. Some of the capacity decisions have great strategic importance such as deciding how many products a new factory should be able to produce per year. The capacity of the production system defines the company’s competitive boundaries. Specifically, it sets the company’s response rate to the market, its cost structure, its workforce composition, its level of technology, its management and staff support requirements, and its general inventory strategy. The objective of capacity planning is to specify which level of capacity will meet market demands in a cost efficient way. Capacity planning can be long term (more than one year), intermediate term (6 to 12 months), and short term (less than 6 months).

Facility Location and LayoutMany production management problems have important spatial aspects. The decision on where to

locate a factory or a facility have long-term strategic importance because they determine how much it will cost to make products and how well customers can be served. Facility location is the determination of the best geographic location for a company’s facilities. Facility location and layout decisions are important for two reasons: First, they require long-term commitments in buildings and facilities, which means that mistakes are difficult to correct. Secondly, these decisions require sizable financial investment and can have a large impact on operating costs and revenues.

Decisions about the internal design of facilities range from determining the layout of a complete manufacturing process to choosing where to display certain products in a retail store, how to arrange different items in a warehouse, where to locate a computer lab on a university campus, or where to locate a machine in a building. Layout planning is deciding on the best physical arrangement of all resources that consume space within a facility. These resources can be a desk, a work center, a cabinet, a person, an entire office, or even a department. It is an important decision because it can significantly affect the productivity of a business.

Facility location is the determination of the best geographic location for a company’s facilities.

Different factors can affect location decisions such as proximity to customers, transportation, source of labor, community attitude, proximity to suppliers, proximity to raw materials, government law and regulations, taxes, and culture. The nature of the company’s business will determine which factors should dominate the location decision.

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Aggregate Planning and Master Production Schedule

Aggregate planning is concerned with the determination of production, inventory, and work force levels to meet fluctuating demand requirements over a planning horizon that ranges from six months to one year. Typically the planning horizon incorporates the next seasonal peak in demand. The planning horizon is often divided into periods. For example, a one year planning horizon may be composed of six one-month periods plus two three-month periods. Normally, the physical resources of a company are assumed to be fixed during the planning horizon of interest and the planning effort is oriented toward the best utilization of those resources, given the external demand requirements.35

Aggregate planning begins with a forecast of aggregate demand for the intermediate range. This is followed by a general plan to meet the demand requirements by setting output, employment, and finished goods inventory levels. Aggregate plans are updated periodically, often monthly, to take into account the updated forecasts and other changes. Aggregate planners are concerned with the quantity and the timing of expected demand. If total expected demand for the planning period is much different from available capacity over that same period, the major approach of planners will be to obtain a balance by altering capacity, demand, or both. In some periods, expected demand may exceed projected capacity, in others expected demand may be less than projected capacity. The company’s task is to achieve rough equality of demand and capacity over the entire planning horizon.

Effective aggregate planning requires appropriate information. First, the available resources over the planning period must be known. Then, a forecast of expected demand must be available. Finally, planners must consider any policies regarding changes in employment levels.

Aggregate planning strategies can be described as proactive, reactive, or mixed. Proactive strategies involve demand options: they attempt to alter demand so that it matches the capacity. Reactive

strategies involve capacity options: they attempt to alter capacity so that it matches demand. Mixed strategies involve an element of each of these approaches.36

The master schedule is the heart of production planning and control. It determines the quantities needed from all sources to meet the demand and governs key decisions as well as activities throughout the organization. The master schedule interfaces with marketing, capacity planning, production planning, and distribution planning. A master schedule indicates the quantity and timing for a product or a group of products, but it does not show planned production. For example, a master schedule may call for delivery of 100 bottles of milk to be delivered on April 6. But this may not require any production; there may be 300 bottles of milk in inventory or if the inventory is 50 bottles of milk, then it may involve production of 50 or more bottles.

The master production schedule (MPS) indicates the quantity and timing of planned production, taking into account desired delivery quantity and delivery as well as on-hand inventory. Once a tentative master schedule has been developed, it must be validated. Validation is referred to as rough-cut capacity planning. It involves testing the feasibility of a proposed master schedule relative to available capacities, to assure that capacity is sufficient for the production.

Aggregate planning is concerned with the determination of production, inventory, and work force levels to meet fluctuating demand requirements over a planning horizon that ranges from six months to one year.

A master schedule determines the quantities needed to meet demands from all sources and governs key decisions and activities throughout the organization.

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Inventory Management and Materials Requirement Planning

The objective of inventory management has been to keep enough inventory to meet customer demand and also be cost effective. However, inventory has not always been perceived as an area to control costs. Traditionally, companies maintained “generous” inventory levels to meet long-term customer demand since there were fewer competitors and products in a generally sheltered market environment. In the current global business environment, with more competitors and highly diverse markets in which new products and new product features are rapidly and continually introduced, the cost of inventory has increased due in part to quicker product obsolescence.

Inventory is a stock of items kept by a company to meet internal or external customer demand. An inventory system controls the levels of inventory by determining how much and when to order. Traditionally, there are two basic types of inventory systems: a continuous system and a periodic system. In the continuous inventory system, an order is placed for the same constant amount whenever the inventory on hand decreases to a certain level, whereas in a periodic system, an order is placed for a variable amount after specific regular intervals. Today, advanced inventory control systems such as materials requirement planning (MRP) and Just In-Time Production (JIT) systems that have been integrated by production systems are frequently used.

MRP is concerned with both production scheduling and inventory control. It is a material control system that attempts to keep adequate inventory levels to assure that required materials are available when needed. MRP is applicable in situations of multiple items with complex bills of materials. MRP is not useful for job shops or for continuous processes that are tightly linked.

The major objectives of an MRP system are to simultaneously:

1. Ensure the availability of materials, com-ponents, and products for planned pro-duction and for customer delivery,

2. Maintain the lowest possible level of in-ventory,

3. Plan manufacturing activities, delivery schedules, and purchasing activities.37

MRP is a time phased priority-planning techni-que that calculates material requirements and sche-dules supply to meet demand across all products and parts in one or more plants. The main theme of MRP is “getting the right materials to the right place at the right time”. MRP systems use four pieces of information to determine what material should be ordered and when:

•the master production schedule, which describes when each product is scheduled to be manufactured;

• billofmaterials,whichlistsexactlytheparts or materials required to make each product;

• productioncycletimesandmaterialneedsateach stage of the production cycle time; and,

• supplierleadtimes.The master schedule and bill of materials indi-

cate which materials should be ordered; the master schedule, production cycle times, and supplier lead times then jointly determine when orders should be placed. Bill of materials gives information about the product structure, i.e., parts and raw material units necessary to manufacture one unit of the pro-duct of interest.

MRP was pioneered in the 1970’s with the work of Orlicky. Later evolved or became part of integrated to Manufacturing Resource Planning systems (or MRPII). MRPII is a computer based planning and scheduling system designed to improve management’s control of manufacturing

An inventory system controls the levels of inventory by determining how much to order and when to order.

Materials requirement planning is a material control system that attempts to keep adequate inventory levels to assure that required materials are available when needed.

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and its support functions. In today’s corporate environment MRPII is often termed as ERP (Enterprise Resource Planning). MRPII represents a group of software programs designed to tie together disparate company functions to create more efficient operations in areas such as assembly or delivery of products and services. Thus MRP has evolved to become a component of an MRPII system. Technically, MRPII extends MRP and links it with the company’s information resources such as human resource information system, financial management, accounting, sales, and others.38 There are three primary functions of an MRP system. First, the system helps ensure that the appropriate materials are available for production and the necessary products are available for customers to avoid shortages. Second, MRP reduces waste by maintaining only the lowest possible materials and product levels in stock. Lastly, an MRP system helps plan manufacturing functions, delivery schedules and purchasing. When an MRP system is applied effectively, it reduces material waste while also avoiding product shortages.

Quality ManagementQuality management is a formalized system

that documents processes, procedures, and responsibilities for achieving quality policies and objectives. This system helps coordinate and direct a company’s activities to meet customer and regulatory requirements and improve its effectiveness and efficiency on a continuous basis. ISO 9001:2015, the international standard specifying requirements for quality management system, is the most prominent approach to quality management systems.

Quality management systems serve a variety of purposes, such as improving processes, reducing waste, lowering costs, facilitating and identifying training opportunities, engaging staff, and setting organization-wide direction. Implementing a quality management system affects every aspect of a company’s performance. Two overarching benefits to the design and implementation of documented quality management systems include:

1. Meeting the customers’ requirements, which helps to instill confidence in the company, in turn leading to more custom-ers, more sales, and more repeat business.

2. Second one is meeting the company’s requirements, which ensures compliance with regulations and provision of prod-ucts and services in the most cost- and resource-efficient manner, creating room for expansion, growth and profit.39

The degree to which a product or a service suc-cessfully satisfies its intended purpose has four pri-mary determinants: Design; how well it conforms to the design; ease of use; and after delivery servi-ce. Any serious attempt to deal with quality issues must take into account the costs associated with quality. Those costs can be classified into three ca-tegories:

• Appraisalcostsrelatetoinspection,testing,and other activities intended to uncover defective products or services, or to assure that there are none.

• Preventioncostsrelatetoattemptsforpreventing defects from occuring. They include costs such as planning and ad-ministration system, training, and quality control procedures.

• Failurecostsareincurredbydefectivepartsor products or by faulty services. Internal failures are those discovered during the production process; external failures are those discovered after delivery to the cus-tomer.

Quality management is a formalized system that documents processes, procedures, and responsibilities for achieving quality policies and objectives.

What are the main drawbacks of the Material Requirements Planning (MRP) system?

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The term total quality management (TQM) refers to a quest for quality in an organization. There are three key components of the TQM philosophy: One is a never-ending push to improve, which is referred to as continuous improvement; the second is the participation or involvement of relevant parties in organizational processes; and the third is the goal of customer satisfaction which means meeting or exceeding customer expectations. TQM expands the traditional view of quality- looking only at the quality of the final product – to looking at the quality of every aspect of the process that produces the product. TQM systems are intended to prevent poor quality from occuring.

Supply Chain ManagementSupply chain management (SCM) is the oversight

of materials, information, and finances as they move in a process from supplier to manufacturer, wholesaler, retailer, and consumer. Supply chain management coordinates and integrates these flows both within and among companies. One argument is that the ultimate goal of any effective supply chain management system is to reduce inventory (with the assumption that products are available when needed). SCM represents an effort by suppliers to develop and implement supply chains that are as efficient and economical as possible.

Supply chain management main flows are the product flow, information flow, and finances flow. The product flow is the movement of goods from a supplier to a customer, as well as any customer returns or service needs. The information flow involves transmitting orders and updating the status of delivery. The financial flow consists of credit terms, payment schedules, and consignment and title ownership arrangements.

Supply chain management is the active management of supply chain activities in order to maximize customer value and achieve a sustainable competitive advantage. It represents a conscious effort by the supply chain firms to develop and run supply chains in the most effective and efficient ways possible. SCM is created for the purpose of improving quality, reducing costs, and achieving competitive advantage in a world where lean manufacturing and specialization force companies to rely on one another for valuable productive activities. All supply chain activities, including product development, planning, sourcing, producing, delivering, and providing for returns are handled collaboratively within an integrated supply chain to ensure the maximum use of shared resources.

Key components of the TQM philosophy: continuous improvement; participation; customer satisfaction.

The concept of continuous improvement was not new, but it did not receive much interest in the World since 1980s except in Japan. Many Japanese companies used it for many years, and it became a cornerstone of the Japanese approach to production. The Japanese use the term kaizen to refer to continuous improvement.

Supply chain management (SCM) is the oversight of materials, information, and finances as they move in a process from supplier to manufacturer, wholesaler, retailer, and consumer.

Total quality management (TQM) refers to a quest for quality in an organization.

Supply chain management main flows are the product flow, information flow, and finances flow.

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A supply chain is the connected network of individuals, organizations, resources, activities, and technologies involved in the manufacture and sale of a product or service. A supply chain starts with the delivery of raw materials from a supplier to a manufacturer and ends with the delivery of the finished product or service to the end consumer. Supply chain management oversees each touch point of a company’s product or service, from initial creation to final sale. With so many places along the supply chain that can add value through efficiencies or lose value through increased expenses, proper supply chain management can increase revenues, decrease costs, and impact a company’s bottom line. Understanding the importance of SCM to its business, Walgreens Boots Alliance Inc. has placed focused effort on transforming its supply chain in 2016. The company operates the second largest pharmaceutical chain in the United States and needs to efficiently manage and revise its supply chain so it stays ahead of the changing trends and continues to add value to its bottom line.40

Supply chain strategies are the critical backbone to the companies today. Effective market coverage, availability of products at locations that hold the key to revenue recognition depends upon the effectiveness of supply chain strategy rolled out. Very simply stated, when a product is introduced in the market and advertised, the entire market in the country and all the sales counters need to have the product where the customer can make the purchase and take the delivery. Any glitch in the product not being available at the right time can result in drop in the customer interest and demand which can be disastrous. Transportation network design and management assume importance to support sales and marketing strategy.41

MANAGING INFORMATIONAutomated information processing has entered our lives at the end of the nineteenth century. In 1890, statis-

tician Herman Hollerith designed the Punch Card tabulating System to record that year’s U.S. census. The 1880 census was done by hand and took seven years to tabulate. However, Hollerith was able to complete the 1890 census in 12 weeks with a saving of 5 million USD for the US Census Bureau.42

By the 1960s, with the advent of affordable information technology, information systems had undergone material changes. Information systems have continued to evolve by developing technology. Moreover, management of information systems and technology have also evolved. Today’s information systems allow greater use of information throughout the company, but they generate new challenges in organizing, analyzing, and protecting information. Today information systems and information technology affect all companies. The need for managing information flows among businesses and their employees, businesses and their suppliers, businesses and their customers, and so on is very important. Since businesses are changing continuously, old fashioned companies that try to compete with the companies that have the latest technology will be unsuccessful. Time and place have always been at the center of business. Customers long had to go to the business during certain hours to satisfy their needs. Customers went to the store for shopping or went to the bank to arrange for a loan. Today, information technology allows businesses to deliver goods and services whenever and wherever it is convenient for the customer. Thus, customers can order clothes online, arrange a home mortgage loan by phone or computer, or buy a computer on the Internet at any time they choose.43

In the mid-1990s, the information technology concept started to move away and knowledge technology emerged. Knowledge is information charged with enough

Logistics typically refers to activities that occur within the boundaries of a single company and supply chains refer to networks of companies that work together and coordinate their actions to deliver a product in the market.

Knowledge is information charged with enough intelligence to make it relevant and useful.

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intelligence to make it relevant and useful. Knowledge technology (KT) adds a layer of intelligence to filter appropriate information and deliver it when it is needed. KT changes the traditional flow of information; instead of an individual going to the database, the database comes to the individual. This technology “thinks” about the facts

according to an individual’s needs, reducing the time that a person must spend finding and getting information. As KT became more sophisticated in the mid-2000s it became better known as business intelligence (BI). BI refers to a variety of software applications that analyze an organization’s raw data and take out useful insights from it. Companies using business intelligence can focus on the decisions as how to react to problems and opportunities. BI provides companies to have seamless information flow and therefore the right information goes to the right person at the right time.

The business that build flexible information infrastructure will have a significant competitive advantage. Constant changes in technology interact with each other to create more change. For business success, flexibility must be maintained to integrate these changes. There are many historical stories about mighty companies that couldn’t keep up with the challenges of change in the markets. Knowledge sharing is crucial for keeping pace with change.

Today, managers are exposed to information from inside and outside of the company. Too much and unnecessary information can confuse issues rather than clarify them. How can managers keep from getting buried in the infoglut? Stepping back to gain perspective is key to managing the flood of information. The most important step toward gaining perspective is to identify a few number of key goals one wishes to attain. Eliminating the information that is not relevant to the top priorities can reduce the amount of information flow. As the goals are refined, the huge stack of paper gradually dropped to a manageable size. Obviously, not all the information that is coming to the manager will be useful.

The effectiveness of management information depends on four characteristics:

1. Quality: The information must be accurate and reliable. If not, the solution of the problems will generate new problems.

2. Completeness: The information must be enough to allow the decision maker to make the right decision but not so much as to confuse the issue. Today, having excessive information rather than too little is a significant problem for business managers.

3. Timeliness: Managers can reach the information rapidly and on time. E-mail, instant messaging, and other social media tools make it possible for companies to hear about a problem immediately.

4. Relevance: Every decision maker needs a different variety of information. However, the problem is to have too much data by information systems. Decision makers must be careful about the questions they ask to get the answers they need.

Business intelligence (BI) activities include data mining, online analytical process, querying and reporting.

The effectiveness of management information depends on four characteristics: Quality, Completeness, Timeliness, and Relevance.

Knowledge technology (KT) adds a layer of intelligence to filter appropriate information and deliver it when it is needed.

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Data and InformationOften, the words information and data are used interchangeably. Yet they

are not the same thing. Data are fundamental to business intelligence. The simple way to understand the difference between data and information is to understand the primary function of the item that is looked at, then the distinction between the two can become clear. For example, while computers need data, humans need information and data are the building blocks. However, information gives meaning and context.

In essence, data refer to raw facts such as the number of items ordered or the number of machines used for the production. Data have not been shaped, processed, or interpreted. They are series of ones and zeros that humans would not be able to read. Data are disorganised and unfriendly. Once data have been processed and turned into information, they become palatable to human readers. They take on context and structure. Data become useful for businesses to make decisions and form the basis of progress.44

Data are the raw material that is to be processed for information or for collection of details. It is unorganized data or facts that are to be processed. Data are plain facts and have to be processed for further information, also have no meaning if not interpreted. Data alone are not enough to get details and find the meaning of something. On the other hand, the term information refers to data that have been gathered and converted into a meaningful context. Information is processed data. The data that can be made useful is known as information.

Data are raw and unorganized facts whereas information is the processed data that has a meaningful context.

The term information refers to data that have been gathered and converted into a meaningful context.

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Information is basically the data plus the meaning of what the data was collected for. Information cannot be generated without the help of data since information depends upon data. Information is something that is being conveyed and it is meaningful when data are gathered and meaning is generated. Information is processed and turns into a meaningful form.

Databases, Data Warehousing, and Data MiningDatabases are the heart of information systems. Databases are programs that assign multiple characteristics

to data and allow users to sort the data by characteristic. A database is a systematic collection of data that supports storage, update, and manipulation of data. Databases can be relatively small and specialized, such as those used for cost accounting and sales records. These databases are not shared among a company’s management. The database users typically create reports from the computers for management purposes. These reports are designed for customization to contain only the data that management needs for decision making. The information is confidential in this type of databases and the access to them is usually restricted. The database management system (DBMS) is a software for creating and managing databases. The DBMS provides users and programmers with a systematic way to create, retrieve, update, and manage data. A DBMS makes it possible for end users to create, read, update and delete data in a database. The DBMS essentially serves as an interface between the database and end users or application programs ensuring that data is consistently organized and remains easily accessible.

A data warehouse is constructed by integrating data from heterogeneous sources that support analytical reporting, structured and/or ad hoc queries, and decision making. It is a single, complete, and consistent store of data obtained from different sources made available to end users in what they can understand and use in a business context. Data warehousing involves different functions such as data cleaning, data integration, and data consolidations. Data warehouses are huge databases that contain almost all of the information about a company’s operations. Companies that have many facilities all over the world or country use these warehouses in order to keep all the operating information and use it according to their needs. Multiple users control access to both retrieving and entering data in data warehouses. Both customers and suppliers can access data warehouses with some restrictions.

The amount of data contained in data warehouses is overwhelming. The purpose of data mining is to find the useful data. Data mining is the process of determining the relevant factors in the accumulated data to extract the data that is important to the user. An automaker might use data-mining software to find patterns among car buyers, such as which buyers of which models, which incentive and then tailor its marketing and production decisions accordingly.45

A database is a systematic collection of data that supports storage, update and manipulation of data.

The database management system (DBMS) provides users and programmers with a systematic way to create, retrieve, update, and manage data.

A data warehouse is a single, complete and consistent store of data obtained from different sources made available to end users in what they can understand and use in a business context.

What are the functions of data warehouse tools?

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Data mining is searching for hidden patterns in a data warehouse. Data mining is the process of analyzing data from different perspectives and summarizing it into useful information. The software discovers previously unknown relationships among the data. Data mining software is one of the analytical tools for analyzing data and allows users to analyze data from many different dimensions, categorize it, and summarize the relationships identified. Technically, data mining is the process of finding correlations or patterns among dozens of fields in large relational databases. The success of data mining depends on a number of factors. The most important factor is access to data to mine in the first place. Most of the companies have a multitude of data storage systems that run on incompatible platforms. The divergent systems must be integrated in some way before the data can be connected. This integration helps companies to understand what is meant by all this data.

Data mining today is primarily used by companies with a strong consumer focus - retail, financial communication, and marketing organizations. It enables these companies to determine relationships among “internal” factors such as price, product positioning, or staff skills, and “external” factors such as economic indicators, competition, and customer demographics. And, it enables them to determine the impact on sales, customer satisfaction, and corporate profits. Finally, it enables them to “drill down” into summary information to view detailed transactional data. With data mining, a retailer could use point-of-sale records of customer purchases to send targeted promotions based on an individual’s purchase history. By mining demographic data from comment or warranty cards, the retailer could develop products and promotions to appeal to specific customer segments.46

INFORMATION TECHNOLOGYThere are as many ways to use information

technology (IT) in business as there are business activities to be performed, business problems to be solved, and business opportunities to be pursued. Technology has improved operations management such as productivity, efficiency, and customer responsiveness. A company’s information technology may incorporate its operations’ technology. Information technology includes hardware, computer networks, and software. A company’s information technology provides the foundation for serving customers, working with vendors, and managing internal company business processes.

The capability to reach and respond on-demand became technically possible thanks to the integration of broadband telecommunications, the Internet, digital communications, high performance mobile devices, and the digitization of all media content. Integration of information technology forms the critical infrastructure, and that infrastructure enables the next wave of IT developments and breakthroughs. New IT capabilities such as e-commerce and social networks, strongly influence competitive strategies and the efficiency of operations. New developments in information technology are important to all business disciplines because they trigger changes in marketing, operations, e-commerce, logistics, human resources, finance, accounting, and relationships with customers and business partners. Nothing about business or corporate strategy is untouched by IT.47

Data mining is the process of analyzing data from different perspectives and summarizing it into useful information.

Information technology includes hardware, computer networks, and software.

Developments in information technology trigger changes in marketing, operations, e-commerce, logistics, human resources, finance, accounting, and relationships with customers and business partners.

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HardwareComputer-based information technology began with the advent of mainframe computers in the 1950s.

These machines allowed industry to automate information storage and retrieval for the first time. By 1964 individual workstations were linked to a company’s mainframe so individuals could share information stored on the mainframe. The development of floppy disks in 1971 allowed users to share information easily with each other.48 Microcomputer technology was available as early as the 1970s, and the introduction of the first IBM Personal Computer (PC) in 1981 was the beginning of desktop computing. Soon these computers were being linked together within a company as a local-area network (LAN) so that users could share information among themselves without using mainframe.

Today, desktop and portable computers produced by manufacturers around the world have become commodity products with processing power that is more than a company’s entire computing center of the 1960s. As information became more easily shared, the computers became more powerful. The typical computer for individuals to use today has graphical icons, point-and-click and/or touch screen navigation, and preloaded software to access the Internet at a cheap price. Due to their portability, wireless capabilities, and light weight, laptop, and notebook computers are used instead of large desktop computers in the offices. They can be carried anywhere with you for business meetings or trip and used at home to remotely connect to office systems. Smaller handheld devices have also continued to improve in functionality and have become indispensable tools to access e-mail and other applications inside and outside of the office, or on the factory floor. Companies produce smartphones with touch screen navigation and scrolling, and simplified calling from an address book, e-mail and text messaging, visual voice mail, video playing, and Web browsing via Wi-Fi connectivity.49

Network technology converts data to on and off signals, in contrast to analog technology which sends signals in virtually infinite increments. Servers store information for users linked to them which allowed the development of data warehouses. Computers connect outside a LAN by Internet using telephone lines. Computers no longer need a physical connection to a network. Users can access and provide information by wireless networking as cellular and digital telephones do. A signal is sent to a satellite or central location and then bounced to its destination.

SoftwareComputer software provides the instructions that enable

users to tell the computer what to do. When people look for a computer to buy, they first think of the equipment. However finding the right software is more important than the right hardware. While some programs are easier to use, some are very complicated. Business persons first have to decide on the functions and performance of the computer then choose the right software. Although most software is sold commercially through suppliers like retail stores, some software, called shareware, are distributed to potential customers free of charge. If the program meets their needs and they decide to use it, they are asked to send a specified fee to the developer. Public domain software (freeware) is software that is free for the taking. But their quality is consistent. Operating system software tells the computer hardware how to run. Today, Microsoft Corporation’s Windows software becomes the standard operating system for the vast majority of microcomputers used as desktops and portable computers.

Business people generally use software for writing, manipulating numbers, filling and retrieving data, presenting information visually, communicating, and accounting. Today, many large and midsized companies have made capital investments in the enterprise systems. Enterprise resource planning (ERP) software, which is a form of integrated software, combines all of a company’s computerized functions into a single, integrated software program that runs off a single database, allowing various departments to easily share information and communicate with each other.

Computer software provides the instructions that enable users to tell the computer what to do.

Enterprise resource planning (ERP) software, which is a form of integrated software, combines all of a company’s computerized functions into a single, integrated software program that runs off a single database.

ERP combined with the Internet is the basis of companies’ e-business. Large manufacturing companies are the original target market for ERP. The main suppliers of ERP software and support are Baan, PeopleSoft, and SAP.

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Computer NetworksOne of the most important changes in business technology is to change mainframe computers by

network systems that allow many users to access information at the same time. Before the use of these systems, mainframe computers were serving as the center of information processing. The mainframe performed all the tasks and sent the results to a “dumb” terminal that could not perform those tasks itself. The network computing system (client/server computing) allows personal computers (clients) to obtain needed information from huge databases in a central computer (the server). Networks connect people to people and people to data.50

The main benefits of network computing systems are saving time and money, providing easy links across functional boundaries, and allowing employees to see complete information.

As mentioned earlier, a LAN is a type of computer network. Other types of networks used by firms include the Internet, intranets, and extranets. The Internet is a network of networks, connecting hundreds of thousands of corporate, educational, and research computer networks around the world.51 Open systems with unrestircted connectivity, using internet networking technologies as their technology platform, are today’s primary telecommunications technology drivers. Web browser suites, HTML Web page editors, Internet and intranet servers and network management software, TCP/IP Internet networking products, and network security firewalls are just a few examples. These technologies are being applied in Internet, intranet, and extranet applications, especially those for electronic commerce and collaboration.52

Information sharing is revolutionized by easily accessible Internet and the World Wide Web (WWW). Internet gives the opportunity of real time text, voice, graphics and video sharing among everybody with access to the Internet. Today, the Internet allows many-to-many communication through such things as file sharing, Web logs (blogs), and social networking services that connect many people to each other at once.

Internal network, referred to as intranets, is a companywide network, closed to public access, that uses the infrastructure and standards of the Internet and the Web. It may consist of many interlinked local area networks and also use leased lines in the wide area network. Typically, an intranet includes connections through one

or more gateway computers to the outside Internet. The main purpose of an intranet is to share company information and computing resources among employees. Employees in the company can communicate to each other and access company information by intranet. Access to intranets typically is limited to company’s employees and acccess to restricted data can further be limited to certain employees. Intranet gives the opportunity of working remotely by connecting to the company.

An extranet is a private network that uses Internet technology and the public telecommunication system to securely share part of a business’s information or operations with suppliers, vendors, partners, customers, or other businesses. An extranet can be viewed as part of a company’s intranet that is extended to users outside the company. Some extranets can not be accessed by the general public. An extranet requires security and privacy. These can include firewall server management, the issuance and use of digital certificates or similar means of user authentication, encryption of messages, and the use of virtual private networks that tunnel through the public network. Companies can use an extranet to exchange large volumes of data using Electronic Data Interchange (EDI), collaborate with other companies on joint development efforts, jointly develop and use training programs with other companies, access services provided by one company to a group of other companies, and share news of common interest exclusively with partner companies.53

The network computing system (client/server computing) allows personal computers (clients) to obtain needed information from huge databases in a central computer (the server).

The Internet is a network of networks, connecting hundreds of thousands of corporate, educational, and research computer networks around the world.

Intranet is a companywide network, closed to public access, that uses the infrastructure and standards of the Internet and the Web.

An extranet is a private network that uses Internet technology and the public telecommunication system to securely share part of a business’s information or operations with suppliers, vendors, partners, customers, or other businesses.

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INFORMATION SYSTEMSInformation systems manipulate data into usable

information by combining computers, data mining tools, and human resources. Information system (IS) is any organized combination of people, hardware, software, communications networks, data resources, and policies and procedures that stores, retrieves, transforms, and disseminates information in an organization. People rely on modern information systems to communicate with one another using a variety of physical devices (hardware), information processing instructions and procedures (software), communications channels (networks), and stored data (data resources).54

Informations systems can be classified into two categories based on the general type of support they provide: Managerial support and operational support. Figure 6.5 represents this classification as management support systems and operations support systems.55 Information systems are categorized this way to spotlight the major roles each plays in the operations and management of a business.

Management Support Systems are divided into two as follows: Management Information Systems and Decision Support Systems. Similarly Operations Support Systems are classified as follows: Process Control Systems and Transaction Processing Systems.

Information systems designed to support business processes and operations may also be providing data to, or accepting data from, systems focused on business decision making or achieving competitive advantage. Today’s companies are constantly striving to achieve integration of their systems to allow information to flow freely through them, which adds even greater flexibility and business support than any of the individual system roles could provide.

Figure 6.5 Classification of Information Systems

Information system (IS) is any organized combination of people, hardware, software, communications networks, data resources, and policies and procedures that stores, retrieves, transforms, and disseminates information in an organization.

Management Support Systems are classified as Management Information Systems and Decision Support Systems.

Operations Support Systems are classified as Process Control Systems and Transaction Processing Systems.

Decision SupportSystems

Process ControlSystems

ManagementInformation Systems

Transaction ProcessingSystems

Management SupportSystems

Operations SupportSystems

Information Systems

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Operations Support Systems Companies use operations support systems to

maintain records and otherwise support operations and decisions at a nonstrategic level. Operations support systems produce a variety of information products for internal and external use; however, they do not emphasize the specific information products that can best be used by managers. Further processing by management information systems is usually required. The role of a company’s operations support systems is to process business transactions, control industrial processes, support enterprise communications and collaborations, and update corporate databases.56

Transaction processing systems are important examples of operations support systems that record and process the data resulting from business transactions. Sales and inventory processing and accounting systems are some examples for the application of these systems.

Process control systems are used to monitor and control physical processes. For example, a process control system, such as electronic sensors linked to computers, can warn an operator to make instant adjustments about the overheating of a machine.

Management Support SystemsWhen information system applications provide

information and support effective decision making for the decision makers, they are called management support systems. It is a very complex and difficult task for all decision makers and business professionals to provide information and support decision making. The information provided by these systems is based on both the internal and external data using various data analysis tools. Conceptually, a wide variety of information systems support many different decision making responsibilities: management information systems (MIS) and decision support systems (DSS).

Management information system is a specific category of information systems serving the middle level managers. MIS provide middle managers with reports on the company’s current performance. This information is used to monitor and control the business and predict future performance.

Decision support systems support nonroutine decision making for middle management. They focus on problems that are unique and rapidly changing, for which the procedure for arriving at a solution may not be fully predefined in advance. DSS use internal and external information together to answer the questions for decision making.57

In this part, a brief explanation about the operations support systems including transaction processing system, process control system, and management support systems including management information systems and decision support systems are given. However, management information systems and decision support systems are explained elaborately in the following heading through the purpose of this chapter.

Operations support systems process business transactions, control industrial processes, support enterprise communications and collaborations, and update corporate databases.

Most successful management support systems are one aspect of a distributed, enterprise information system that enables flexible and integrated information sharing and communication with both internal and external stakeholders.

http://study.com/academy/lesson/what-are-information-systems-definition-types-quiz.html

internet

What are the most important roles of an information system for a business enterprise?

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INFORMATION SYSTEMS FOR DECISION MAKING

Using information systems to support business decision making has been one of the primary thrusts of the business use of information technology. The fast pace of new information technologies made decision support available from lower levels of management to upper level of management. So much data clog the Internet and other sources that the challenge for businesses has shifted from acquiring data to sorting through it to find the most useful elements, which can then be turned into valuable information. New type of information systems are being developed for decision making ranging from general tools to specialized systems. Some of the most popular and common ones are described below.

Management Information SystemsThe functional areas such as accounting, finance,

marketing, production and human resources are supported by information systems designed for their particular reporting needs. General purpose reporting systems are referred to as management information systems. Their objective is to provide reports to managers for tracking operations, monitoring, and control. These systems provide reports about operational efficiency, effectiveness and productivity by extracting information from databases and processing it according to the needs of the user.58

Management information system (MIS) broadly refers to a computer-based system that provides managers with the tools to organize, evaluate, and efficiently manage departments within an organization. In order to provide past, present, and prediction information, a management information system includes software that helps in decision making; data resources such as databases; the hardware resources of a system; decision support systems; application of human resources and projects management; and any computerized processes that enable the department to run efficiently.59

The main purpose of the MIS is to give managers feedback about their own performance; top management can monitor the company as a whole. Information displayed by the MIS typically shows “actual” data over against “planned” results and results from a year before; thus it measures progress against goals. The MIS receives data from company units and functions. Some of the data are collected automatically from computer-linked check-out counters; others are keyed in at periodic intervals. Routine reports are preprogrammed and run at intervals or on demand while others are obtained using built-in query languages; display functions built into the system are used by managers to check on status at desk-side computers connected to the MIS by networks. Many sophisticated systems also monitor and display the performance of the company’s stock.60

Advances in the applications of MIS and technology continue to have deep effects on companies and managers. Modern computer-based information systems have become central components of many companies’ structures in order to gain competitive advantage. Since MIS provides high quality, timely, relevant, and relatively complete information to the managers, the need for tall management hierarchies has been reduced. Horizontal information flows are now have become more important. The direct flow of information from one department to another can be obtained by few layers of staff. Besides, advanced information systems can also lower the employee number needed to perform the companywide activities. Effective use of management information systems improve the decision-making and can cause the company to be more competitive in the market. Managers can find ways to improve customer service and companies can be more customer oriented by using management information systems. Therefore, managers can identify markets that previously had been perceived as unapproachable. The company’s information technology can also enable the company to enter into joint ventures, partnerships, and strategic alliances; use new distribution channels; and sell products globally.

Management information system (MIS) broadly refers to a computer-based system that provides managers with the tools to organize, evaluate, and efficiently manage departments within an organization.

Effective use of management information systems improve the decision-making and customer service processes which enebles the company to be more competitive in the market.

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Before the implementation of MIS, managers need to consider the company’s ultimate goals and what types of information managers need to measure to determine how well they are moving toward achieving those goals. They also investigate what sources of information might be available to measure and improve the company’s efficiency, quality, innovation, and responsiveness to customers expectations. The company’s current MIS needs to be evaluated to determine how accurate, reliable, timely, and relevant the information it provides is, as well as how the current system compares to the company’s competitors and others in the industry. During the implementation of MIS, consistent technological standards must be used that will allow the system to be used by different types of computer operating systems. In order to lessen resistance to the new MIS, user-friendly and accessible technology usage is very important.61

Decision Support SystemsA decision support system (DSS) is a highly

flexible and interactive information technology system that is designed to support decision making when the problem is not structured. DSS is an information system that quickly provides relevant data to help decision makers making decisions and choosing courses of action. Information technology brings speed, vast amount of information, and sophisticated processing capabilities to help create information useful in making a decision. The decision maker brings know-how in the form of his/her experience, intuition, judgement, and knowledge of the relevant factors. Information technology is an efficient instrument, but the decision maker must ask the proper questions to obtain the information for and must know how to process the information to get the questions answered. In fact, the primary objective of a DSS is to improve the effectiveness of a decision maker by providing assistance that will complement decision maker’s insights.62

Configuration of a DSS range from relatively simple applications that support a single user to complex enterprise-wide systems. A DSS can support the analysis and solution of a specific problem, evaluate a strategic opportunity, or support ongoing operations. These systems support unstructured and semistructured decisions, such as whether to make or buy products and what type of new products to develop and introduce into the existing markets.63

The characteristics of decision support systems are:1. An easy-to-use interactive interface,2. Models that enable sensitivity analysis,

what-if analysis, goal seeking, and risk analysis,

3. Data from both internal databases and external sources added to by the decision maker, who may have insights relevant to the decision situation.

DSS rely on both model bases and data bases as vital system resources. A DSS model base is a software component that consists of models used in computational and analytical routines that mathematically express relationships among variables. For example, a spreadsheet program might contain models that express simple accounting relationships among variables, such as Revenue 3 Expenses 6 Profit. Besides, DSS can combine model components to create integrated models that support specific types of decisions. The system typically contains built-in analytical modelling routines and also enables the decision maker to build his/her own models.

A decision support system (DSS) is an information system that quickly provides relevant data to help decision maker make decisions and choose courses of action.

Some of the most important benefits of the DSS are to improve the efficiency and speed of decision-making activities, increase the control, competitiveness and capability of futuristic decision-making of the organization, facilitate interpersonal communication, encourage learning or training, and help automate managerial processes.

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Executive Information SystemsAlthough the trend is increasingly toward employee

empowerment and decision making at all levels of a company, sometimes companies need to create specialized information systems to address the needs of executives. An executive information system (EIS) is a decision support system used to help senior executives in decision-making processes in the company. The decision-making process is done by providing easy access to important data needed to achieve strategic goals in an organization. An EIS normally features graphical displays on an easy-to-use interface. These systems can be used in various types of companies to monitor enterprise performance as well as to identify opportunities and problems.

Top managers can access the company’s primary databases by touching the computer screen, pointing with a mouse, or even speaking via voice recognition. The typical EIS lets users select among various data, such as the company’s income statement and sales figures as well as stock market trends for the company and for the industry as a whole. In an EIS, information is presented in forms tailored to the preferences of the executives using the system. For example, majority of the executive information systems emphasizes the use of a graphical user interface and graphic displays that can be customized to the information preferences of executives using the EIS. Other information presentation methods used by an EIS include exception reporting and trend analysis.

EIS depends on two factors: Internal factors such as need for timely information, improved communications, access to the operational data, rapid status updates on various business activities, and access to the corporate database. External factors such as increasing and intensifying global competition, rapidly changing business environment, accessing external databases, and various government regulations. Some of the important characteristics of EIS: Flexible and easily used; provides timely information with short response time and also with quick retrieval: produces correct and relevant information; contains user friendly interfaces consisting of the graphic user; accessed from different locations; customized to a large extent; and support over vision, mission and the strategy; and strategic management.

Expert SystemsAn expert system is a software that uses artificial

intelligence (AI) technologies to simulate the judgment and behavior of a human or an organization that has expert knowledge and experience in a particular field. AI’s scientific goal is to understand intelligence by building computer programs that exhibit intelligent behavior. It is concerned with the concepts and methods of symbolic inference, or reasoning, by a computer, and how the knowledge used to make those inferences will be represented inside the machine. Typically, an expert system incorporates a knowledge base containing accumulated experience and an inference or rules engine -- a set of rules for applying the knowledge base to each particular situation that is described to the program. The system’s capabilities can be enhanced by additions to the knowledge base or to the set of rules. Current systems may include machine learning capabilities that allow them to improve their performance based on experience, just as humans do.64

Expert systems imitate human thinking through complicated sets of “if…then” rules. The system applies human knowledge in a specific subject area to solve the problem. Expert systems are used for different types of business purposes. That is, credit limits for credit applicants can be determined, potential problems or breakdowns can be monitored and predicted in a manufacturing facility, and mortgage loans can be made. These systems are typically developed by capturing the knowledge of recognized experts in a field whether within a business itself or outside of it..

An executive information system (EIS) is a decision support system used to help senior executives in decision-making processes in the company.

An expert system is a software that uses artificial intelligence technologies to simulate the judgment and behavior of a human or an organization that has expert knowledge and experience in a particular field.

How does Management Information System (MIS) serve the managers for decision making?

9

217


The Great Decoupling: An Interview with Erik Brynjolfsson and Andrew McAfee

This HBR article covers an interview with Erik Brynjolfsson and Andrew McAfee, faculty members at the MIT Sloan School of Management, who have been working on digitization aspect of the modern business environment.

“Machines, it seems, can do almost anything human beings can. Now cars are even starting to drive themselves. What does that mean for business and employment? Will any jobs be left for people? Will machines take over not just low-skilled tasks but high-skilled ones too? If a man and a machine work side by side, which one will make the decisions? These are some of the questions facing companies, industries, and economies as digital technologies transform business...

In this interview with HBR editor Amy Bernstein and editor at large Anand Raman, Brynjolfsson and McAfee explain that while digital technologies will help economies grow faster, not everyone will benefit equally—as the latest data already shows. Compared with the Industrial Revolution, digital technologies are more likely to create winner-takeallmarkets. Brynjolfsson and McAfee also believe that despite the rapid pace of technological development, business dynamism has dipped, and they worry that the policy response has been inadequate. They conclude that though no one knows what the future holds, the time to start tackling the economic downside of new technologies is now”.

Source: Bernstein, A. & Raman, A. (June 2015). The great decoupling: An interview with Erik Brynjolfsson and Andrew McAfee. Harvard Business Review. Retrieved from https://hbr.org/2015/06/the-great-decoupling

Further Reading

Productivity Gains at Whirlpool Workers and management at Whirlpool

Appliance’s Benton Harbor plant in Michigan have set an example of how to achieve productivity gains, which has benefited not only the company and its stockholders, but Whirlpool customers, and the workers themselves.

Things weren’t always rosy at the plant. Productivity and quality weren’t good. Neither were lobor-management relations. Workers hid defective parts so management wouldn’t find them, and when a machine broke down, workers would simply sit down until sooner or later someone came to fix it. All that changed in the late 1980s. Faced with the possibility that the plant would be shut down, management and lobor worked together to find a way to keep the plant open. The way was to increase productivity-producing more without using more resources. Interestingly, the improvement in the productivity didn’t come by spending money on fancy machines. Rather, it was accomplished by placing more emphasis on quality. That was a shift from the old way, which emphasized volume, often at the expense of quality. To motivate workers, the company agreed to gain sharing, a plan that rewarded workers by increasing their pay for productivity increases.

The company overhauled the manufacturing process, and taught its workers how to improve quality. As quality improved, productivity went up because more of the output was good, and costs went down because of fewer defective parts that had to be scrapped or reworked. Costs of inventory also decreased, because fewer spare parts were needed to replace defective output, both at the factory and for warranty repairs. And workers were able to see the connection between their efforts to improve quality and productivity, and their pay.

Not only was Whirlpool able to use the productivity gains to increase workers’ pay, it was also able to hold the lid on price increases and to funnel some of the savings into research, which added to cost savings and quality improvement.Source: Stevenson, W. (2005). Operations Management (8th ed.). McGraw-Hill. Discuss:

1. What were the two key aspects that Whirlpool management did to achieve productivity gains?

2. Who has benefited from productivity gains?3. How are productivity and quality related?4. How can a company afford to pay its

workers for productivity gains?

In Practice


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LO 1 Defining the concept of production, production system, and production management

Briefly, production is defined as transformation of tangible and intangible inputs into goods or services. In other words, production is the transformasion or conversion of a set of inputs, such as raw materials, labor, knowledge, into one or more outputs such as tables, cars, banking services. Most organizations, including not-for-profit organizations, can be described as production systems. These organizations transform or convert a set of inputs into one or more outputs. The main purpose of production systems is to produce goods and/or services. Production management refers to the application of management principles to the production function in a factory. In other words, production management involves application of planning, organizing, directing and controlling the production process.

LO 2 Explaining the types of production processes

The processes are classified according to their physical configuration, material and product flow, flexibility and volume expectations. The four categories of processes are: Flow processes, Job-shop processes, Cellular processes and Project processes.

Flow process is when the product is built up through many separated stages; the product is built upon at each stage and then passed directly to the next stage where it is built upon again. Job-shop processes are characterized by manufacturing of one or few quantity of products produced according to the needs and requirements of customers. Cellular manufacturing is a manufacturing process that produces families of parts within a single line or cell of machines operated by operators who work only within the line or cell. Project processes are characterised by high degree of job customisation, the large scope for each project and need for substantial resources to complete the project.

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LO 3 Identifying historical evolution of production management

Contemporary production management has its roots in the Industrial Revolution that occurred during the late eighteenth and early nineteenth centuries in England. Until that time, goods had been produced in small shops by artisans and their apprentices without the aid of mechanical equipment. In the early 1900s Frederick W. Taylor approached the management of work as a science. Based on observation, measurement, and analysis, he identified the best method for performing each job. From the Industrial Revolution through the 1960s, the United States was the world’ greatest producer of goods and services, as well as the major source of managerial and technical expertise. However, in the 1970s and 1980s the U.S. manufacturing superiority was challenged by lower costs and higher quality from foreign manufacturers led by Japan. The Japanese manufacturers started to dominate many industries. In 1990s by the emergence of Internet, the way of making business and the production systems were affected deeply. Production management has changed dramatically over the years. More and more activities are taking place outside the enterprise in factories, distribution centers, offices and storesoverseas, therefore companies need to develop skills in coordinating operations across a global supply chain.


219

LO 6 Describing managing information

Today, a lot of information is coming to managers from inside and outside of the company. Too much information can confuse issues rather than clarify them. How can managers keep from getting buried in the infoglut? Stepping back to gain perspective is the key to managing the flood of information. The most important step toward gaining perspective is to identify a few number of key goals you wish to reach. Eliminating the information that is not related to those top priorities can reduce the amount of information flow. As the goals were refined, the huge stack of paper gradually dropped to a manageable size. Obviously, not all the information that is coming to the manager will be useful. The usefulness information managemant depends on four characteristics: Quality, completeness, timeliness and relevance.

LO 4 Describing the new trends in production processes

As a result of new global competition, companies have had to make a wide variety of high-quality custom-designed products at very low cost. Clearly something had to change on the production floor to make that possible. Several major developments have radically changed the production process and production management for the companies in order to compete in the global market. Some of the most important examples for new trends in production processes are flexible production system, just in time production system, lean production system, computer integrated manufacturing, mass customization and e-manufacturing.

LO 5 Explaining the scope of production management

The purpose of production management is to improve the most important production factors which are quantity, time, quality and cost. While production management tries to achieve these goals it simultaneously determines many other factors such as the product types, quantity of these products, quality of them and the production facility. The scope of production management ranges across the organization. People working in the production management are involved in product design, capacity planning and process design, selection and management of technology, design of work systems, facility location and layout, aggregate planning and master production schedule, inventory management and materials requirement planning, quality management, supply chain management.

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LO 7 Defining the information technology

There are as many ways to use information technology (IT) in business as there are business activities to be performed, business problems to be solved, and business opportunities to be pursued. Technology has improved operations management such as productivity, efficiency and customer responsiveness. A company’s information technology may incorporate its operations technology. Information technology includes hardware, computer networks and software. A company’s information technology provides the foundation for serving customers, working with vendors and managing internal company business processes.

LO 8 Identifying information systems

An information system (IS) can be any organized combination of people, hardware, software, communications networks, data resources, and policies and procedures that stores, retrieves, transforms, and disseminates information in an organization. Information systems can be classified into two categories based on the general type of support they provide: managerial support and operational support. Information systems are categorized this way to spotlight the major roles each plays in the operations and management of a business. Management Support Systems are divided as follows: Management Information Systems and Decision Support Systems. Similarly Operations Support Systems are classified as follows: Process Control Systems and Transaction Processing Systems.

LO 9 Describing the information systems for decision making

Using information systems to support business decision making has been one of the primary thrusts of the business use of information technology. The fast pace of new information technologies made decision support available from lower levels of management to upper levels of management. So much data clog the Internet and other sources that the challenge for businesses has shifted from acquiring data to sorting through it to find the most useful elements, which can then be turned into valuable information. New type of information systems are being developed for decision making such as management information systems, decision support systems, executive information systems and expert systems.

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1 Which one of the following is not a compe-titive advantage offered to a company by the pro-duction function?

a. Longer new product lead timeb. More inventory turnsc. Shorter manufacturing lead timed. Higher qualitye. Greater flexibility

2 Which one of the following is the characteris-tics of a service?

a. Not stockedb. Easily measurable qualityc. Transportabled. Resalablee. Easy to automate

3 Which one of the following process type produces a wide variety of products according to the needs and requirements of the customers?

a. Cellular processesb. Job shop processesc. Flow processesd. Continuous flow processese. Batch flow processes

4 Which one of the following person known as the father of scientific management?

a. Eli Whitneyb. Adam Smithc. Frederick W. Taylord. Henry Gannte. Henry Ford

5 Which one of the following production systems was introduced in response to a new demand for more product variety and for greater responsiveness to changes in products, production technology, and markets?

a. Mass customizationb. Lean production systemc. Just in time production systemd. Flexible manufacturing systeme. Computer integrated manufacturing system

6 Which one of the following is not one of the the phases of product design and development?

a. Idea generationb. Feasibility analysisc. Product specificationsd. Process specificationse. Preliminary screening

7 Which one of the following is constructed by integrating data from multiple heterogeneous so-urces that support analytical reporting, structured and/or ad hoc queries, and decision making?

a. Databaseb. Knowledgec. Informationd. Datae. Data warehouse

8 Which one of the following is a companywide network, closed to public access that uses the infrast-ructure and standards of the Internet and the Web?

a. Database warehouseb. Databasec. Internetd. Intranete. Extranet

9 Which one of the following system is a management support system?

a. Management information systemsb. Process control systemsc. Transaction processing systemsd. Electronic data interchange systemse. Database systems

10 Which one of the following systems is a software that uses artificial intelligence technologies to simulate the judgment and behavior of a human or an organization that has expert knowledge and experience in a particular field?

a. Process control systemsb. Transaction processing systemsc. Management information systemsd. Expert systeme. Executive information systems

Test yourself


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If your answer is incorrect, review “Production, Production Systems, and Production Management” section.

1. a If your answer is incorrect, review “The Scope of Production Management”.

6. e

If your answer is incorrect, review “Types of Production Processes”.

3. b If your answer is incorrect, review “Information Technology”.

8. d

If your answer is incorrect, review “Production, Production Systems, and Production Management” section.

2. a If your answer is incorrect, review “Managing Information”.

7. e

If your answer is incorrect, review “Historical Evolution of Production Management”.

4. c

If your answer is incorrect, review “New Trends in Production Process”.

5. d

If your answer is incorrect, review “Information Systems”.

9. a

If your answer is incorrect, review “Information systems for Decision Making”.

10. d

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your turn 1

The main activities of production management are as below:• Specificationandprocurementofinputresourcesnamelymanage-

ment, material, land, labor, equipment, and capital.• Productdesignanddevelopmenttodeterminetheproductionpro-

cess for transforming the input into output of goods and services.• Supervisionandcontroloftransformationprocessforefficientpro-

duction of goods and services.

your turn 2

When the product features are set by the company and the product is produced in advance of orders(depending on the forecasts), it is “made to stock”. It is a strategy of a company in order to meet the anticipated demand and if the forecasting is true it is very cost effective. When there are few product lines and long preparation times between products, the company can apply “made to stock”.

When the product features are set by the customer and the production is performed after receiving the order, it is “made to order”. Therefore, the product is customized and the customers’ special requests are accepted.

What are the main activities of production management?

What is the difference between made to stock and made to

order?

your turn 3The main advantage of a project approach is its flexibility to customise the product. The main disadvantage is the cost of this production. These processes usually cannot exploit economies of scale, productivity gains from learning, and the general efficiencies of repetitiveness to the same extent that other can.

What are the main advantages and disadvantages of

project processes?

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your turn 4

your turn 5

The Japanese production system is based on three principles: (1) Quality comes first, (2) Improve the product and process continuously, and (3) Eliminate all forms of waste. In the implementation of these principles, there is total organizational commitment and involvement. Everyone is responsible for product quality, process improvement, and reduction of waste. Training of the workers are very important because they have gerater responsibility. Japanese companies utilize the principles of experimentation and measurement to see whether or not alternative methods are better.

Much more is expected from the workers in a lean production system. They must work together in a team and play active roles in operating and improving systems. Individual creativity is much less important than team success. Due to high responsibility, workers feel more pressure and anxiety. Moreover, a flatter organizational structure means, career paths are not as steep in lean production structure. Workers become generalists rather than specialists in this system.

What are the main principles of Japanese production

system?

What are the responsibilities of workers in a lean production

system compared to traditional workers?

your turn 6

MRP systems also have several potential drawbacks. First, MRP relies upon accurate input information. If a small business has not maintained good inventory records or has not updated its bills of materials with all relevant changes, it may encounter serious problems with the outputs of its MRP system. The problems could range from missing parts and excessive order quantities to schedule delays and missed delivery dates. Another potential drawback associated with MRP is that the systems can be difficult, time consuming, and costly to implement. Many businesses encounter resistance from employees when they try to implement MRP.

What are the main drawbacks of the Material Requirements

Planning (MRP)system?


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your turn 7

The following are the functions of data warehouse tools:• DataExtraction:Involvesgatheringdatafrommultipleheterogene-

ous sources.• DataCleaning:Involvesfindingandcorrectingtheerrorsindata.• DataTransformation:Involvesconvertingthedatafromlegacy

format to warehouse format.• DataLoading:Involvessorting,summarizing,consolidating,check-

ing integrity, and building indices and partitions.• Refreshing:Involvesupdatingfromdatasourcestowarehouse.

What are the functions of data warehouse tools?

your turn 8

your turn 9

There are three vital roles that information systems can perform for a business enterprise:

• Supportofbusinessprocessandoperations.• Supportofdecisionmakingbyemployeesandmanagers.• Supportofstrategiesforcompetitiveadvantage.

MIS managers are primarily interested in weekly, monthly, and yearly results, although some systems enable managers to drill down to see daily or hourly data if required. MIS generally provides answers to routine questions that have been specified in advance and have a predefined procedure for answering them. For instance, MIS reports might list the total kilograms of lettuce used this quarter by a restaurant chain or compare total annual sales for specific products to planned targets.

What are the most important roles of an information system

for a business enterprise?

How does Management Information System serve serve the

managers for decision making?


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1Bedeian, A. G. (1993). Management. The Dyden Press, p. 52.

2Martinich, J. S. (1997). Production and Operations Management. John Wiley &Sons Inc., pp. 7-8.

3Kumar, S. A. & Suresh, N. (2009). Operations Management. New Age International Ltd., Publishers, p. 3.

4Donelly, J. H., Gibson, J. L., & Ivancevich, J.M. (1990). Fundamentals of Management (7 th ed.). Von Hoffman Press, Inc., pp. 506-507.

5Rastogi, M. K. (2010). Production and Operations Management. University Science Press, p.7.

6Martinich, op. cit., pp. 8-9.7Ashwathappa, K. & Bhat, K. S. (2009). Production

and Operations Management. Himalaya Publishing House, p. 51.

8Chand, S. (2016). Production Management: it’s Meaning, Definition, Function, and Scope. Your Article Library: The Next Generation Library. Retrieved from http://www.yourarticlelibrary.com/production-management/production-management-its-meaning-definition-function-and-scope/27925/

9Rastogi, op. cit., p. 2.10Martinich, op. cit., pp. 329-330.11What is Six Sigma. Net, Job Shop Manufacturing.

Retrieved from http://www.whatissixsigma.net/job-shop-manufacturing/.

12Encylopedia of Management. Cellular Manufacturing. Retrieved from http://www.referenceforbusiness.com/management/Bun-Comp/Cellular-Manufacturing.html

13Martinich, op. cit., p. 340.14Stevenson, W. J. (2005). Operations Management

(8th ed.). McGraw-Hill Irwin, p.18.15Evans, J. R., Collier, D. A. (2007). Operations

Management: An Integrated Goods and Services Approach. Thomson Higher Education, p. 23.

16Russell, R. S. & Taylor III, B.W. (2009). Operations Management: Along the Supply Chain (6th ed.). John Wiley & Sons Inc., p.7.

17Davis, M. M. & Heineke, J. (2005). Operations Management: Integrating Manufacturing and Services (5th ed.). McGraw-Hill Irwin, pp.19-20.

18Russell, op. cit., p.7.19Nickels, W. G., McHugh, J. M., & McHugh, S.

M. (2008). Understanding Business (8th ed.). McGraw-Hill Irwin, pp. 239-240.

20Toni DE, T. S. (1998). Manufacturing flexibility: A literature review. International Journal of Production Research, 36 (6), pp.1587–1617.

21 ElMaraghy, H. A. (2006). Flexible and reconfigurable manufacturing systems paradigms. International Journal of Flexible Manufacturing System (IJFMS), 17(4), 261–276, Special issue on reconfigurable manufacturing systems.

22ElMaraghy H.A. (2007). Reconfigurable Process Plans For Responsive Manufacturing Systems. In: Cunha P.F., Maropoulos P.G. (Eds). Digital Enterprise Technology, Springer. .

23ElMaraghy, H. & Caggiano, A. (2016). Flexible Manufacturing System. Retrieved from http://link.springer.com/referenceworkentry/10.1007%2F978-3-642-20617-7_6554

24Elmaraghy, op. cit., pp. 261-276.25Reid, R.D. & Sanders, N.R. (2005). Operations

Management: An Integrated Approach (2nd ed.). John Wiley &Sons Inc., p.18.

26Kootanaee1, A. J., Babu, K. N., & Talari, H. F. (March 2013). Just-in-Time Manufacturing System: From Introduction to Implement. International Journal of Economics, Business and Finance, 1 (2), p. 8.

27Davis & Heineke, op. cit., p. 353.28Boone, E. & Kurtz, D. L. (2005). Contemporary

Business (11th ed.). Thomson South-Western Corp., p. 361.

29Abdulghafour, A. B. Computer Integrated Manufacturing. Retrieved from http://www.uotechnology.edu.iq/dep-production/branch3_files/cim.pdf.

30Nickels et al., op. cit., p.241.31 Stevenson, op. cit., p.127.32 Cheng, K. & Bateman, R. J. (2008). E-Manufacturing:

Characteristics, applications and potentials. Progress in Natural Science,18, p. 1323.

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33Lee, J. (2003). E-manufacturing-fundamental, tools, and transformation. Robotics and Computer Integrated Manufacturing, 19, p. 502.

34Stevenson, op. cit., pp.122-123.35Gallego, G. (2001). Aggregate production

planning. IEOR 4000: Production Management, Lecture 5. retrieved from http://www.columbia.edu/~gmg2/4000/pdf/lect_05.pdf.

36Stevenson, op. cit., pp. 544-545.37Gallego, G. (2001). Production management,

materials requirement planning. IEOR 4000. Retrieved from http://www.columbia.edu/~gmg2/4000/pdf/lect_06.pdf

38Moustakis, V. (2000). Materials requirement planning. Report Produced For the EC Funded Project. Retrieved from http://www.adi.pt/docs/innoregio_MRP-en.pdf.

39American Society for Quality, (ASQ). Learn About Quality, Quality Management System. Retrieved from http://asq.org/learn-about-quality/quality-management-system/

40Investopedia. Supply Chain Management – SCM. Retrieved from http://www.investopedia.com/terms/s/scm.asp#ixzz4eQiQbbkF

41Management Study Guide. Supply Chain Management. Retrieved from http://www.managementstudyguide.com/supply-chain-management-definition.htm

42Mejia-Gomez, L. R. & Balkin, D. B. (2002). Management. McGraw-Hill, p. 386.

43Nickels et al., op. cit., p. 596.44DQ Global Blog. What is the difference between

data and information? Retrieved from https://www.dqglobal.com/2014/05/27/what-is-the-difference-between-data-and-information/

45Mejia-Gomez & Balkin, op. cit., p. 388.46Data Mining: What is data mining? Retrieved from

http://www.anderson.ucla.edu/faculty/jason.frand/teacher/technologies/palace/datamining.htm.

47Turban, E. & Volonino, L. (2013). Information Technology for Management (8th ed.). John Wiley & Sons, Inc., p. 2.

48Meija-Gomez & Balkin, op. cit., p. 389.49Brown, C. V., De Hayes, D. W., Hoffer, J. A.,

Martin, E. W., & Perkins, W. C. (2012). Managing Information Technology (Int. ed.). Pearson, p. 2.

50Nickels et al., op. cit, p. 605.51Meija-Gomez & Balkin, op. cit., p. 390.52O’Brien, J. A. & Marakas, G.M. (2011). Management

Information Systems (10th ed.). McGraw-Hill Irwin, p. 256.

53Rouse, M. Techtarget Network, Search Enterprise Wan, Definition, Extranet. Retrieved from http://searchenterprisewan.techtarget.com/definition/extranet.

54O’Brien & Marakas, op. cit., p. 38.55Turban & Volonino, op. cit., p. 35.56O’Brien & Marakas, op. cit., p. 48.57Laudon, K. C. & Laudon, J. P. (2007). Management

Information Systems: Managing the Digital Firm (10th ed.). Pearson Prentice Hall, p. 54.

58Turban & Volonino, op. cit., p. 37.59Beal, V. MIS-Management Information System.

Webopedia. Retrieved from http://www.webopedia.com/TERM/M/MIS.html

60Inc., Management Information Systems. Retrieved from https://www.inc.com/encyclopedia/management-information-systems-mis.html.

61Meija-Gomez & Balkin, op. cit., pp. 397-398.62Haag, S., Cummings, M., & Phillips, A. (2007).

Management Information System: For the Information Age (6th ed.). McGraw-Hill/Irwin, p.184.

63Turban & Volonino, op. cit., p. 40.64Rouse, M. Searchhealthit. Techtarget. Retrieved from

http://searchhealthit.techtarget.com/definition/expert-system


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Describe and distinguish the areas of accounting.

Understand the recording process.

Explain and understand the financial statement analysis.

Define accounting and relevant terms. Identify the users of accounting information.

Describe the profession of accounting.

Identify the content and purpose of the basic financial statements.

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Chapter OutlineAccounting - Terms and DefinitionsUsers of Accounting Information Areas of Accounting Accountants and Accounting ProfessionRecording Business TransactionsBasic Financial StatementsAnalyzing Financial Statements

Key TermsAccountingAccountants

Accounting (Financial) informationBookkeeping

Financial statementsFinancial statement analysis

Recording processLiquidity


Accounting and Financial Analysis

229


“Managers and investors alike must understand that accounting numbers are the beginning, not the end, of business valuation.”

Warren BuffettThroughout this chapter you will study how financial accounting functions within business entities.

However, before beginning on the study of accounting, you need to know and understand some basic terms of accounting.

What is the role of accounting in business? The simplest answer to this question is that accounting provides information for managers to use in operating a business. In addition, accounting provides information to other stakeholders to use in assessing economic performance and condition of the business.

Each type of organizations has managers. Managers are responsible to manage the organizations in effective and efficient manner. Some of the managers will be responsible at the top level such as to formulate strategies or to make long term plans; some of the managers are in the middle level to make short term plans, to organize resources, to direct personnel, and to control operations. Accounting will provide benefit to the managers to report a business entity’s financial condition, support decisions, and control business operations. Managers in organizations or in all the business entities will need information in their decision making process. Some of the needed information will be financial some non-financial. Who will provide the necessary information to them? Where will they get the information? The answer is “accounting”. Accounting will provide useful “financial information” about the business entity to all decision makers.

Anyone who focus on a business entity must learn how to read, understand, and analyze the accounting statements and financial statements even the accounting process itself is performed by accountants. The purpose of this chapter is to introduce basic accounting principles, terms, and rules. Consequently, the readers will have an idea of what accounting is, how it works, and why it is important.

ACCOUNTING – TERMS AND DEFINITIONSEconomic events and transactions, such as purchase of materials and sales of inventory to the customers

will occur in business entities and all of them will affect their success. All the economic events and transactions must be identified, recorded, and results must be reported. Accounting organizes and summarizes financial information in the financial statements for decision makers’ use. All the data related to economic events and transactions must be collected, categorized, summarized, and analyzed in order to be converted to financial information.Financial information can be seen as an input for an efficient decision making process.

Definition of AccountingIn a general sense, accounting is an information system

that measures business transactions or economic events, processes the data into reports, and communicates the results to decision makers.1 Accounting consists of three basic activities—it identifies, records, and communicates the economic events of an organization to interested users. The purpose is to provide financial information about the business entity to the decision makers that they will be more informed in their decision making process.

Economic events of a company must be identified and specified. If any event or transaction affects the financial position of a company and can be measured reliably in monetary terms, it means that economic event is a financial transaction.

Accounting is an information systemthat provides reports to decision makers about the economic activities and condition of a business.

Accounting provides information

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7 Accounting and Financial Analysis

Once a company identifies the financial transactions, it records those events in the accounting books (like journal and ledgers) in order to provide a history of its financial transactions. Recording consists of keeping a systematic and chronological diary of events that are measured reliably in monetary amounts.

Finally, the company communicates the collected information to interested users by means of financial statements.

The method used to record and summarize the accounting data into reports is called an accounting system (see Figure 7.1). Source documents such as a sales invoice, will be used to identify the economic event whether is financial or not and serve as input of the accounting system.

The method used to record and summarize the accounting data into reports is called an accounting system.

A major purpose of accounting is to help decision makers evaluate the financial position and performance of the company in order to make well informed decisions. To be able to understand what is happening in the world of business, it is necessary to understand the language of business. Accounting is famously known as the “the language of business”. This is because accounting is the means by which business information is communicated to all information users. The better our understanding of the language, the better we can understand what is happening with our finances, our businesses, or our investments!2

A vital element in communicating economic events is the accountant’s ability to analyze and interpret the reported information. Analysis involves the use of ratios, percentages, graphs, and charts to highlight significant financial trends and relationships. Interpretation involves explaining the uses, meaning, and limitations of reported data.3

Financial statement analysis and interpretation are the main parts of accounting. So we will explain basic financial analysis techniques and some ratios in this chapter.

How can we provide financial information to the decision makers, how can we communicate with them? Financial statements are the communication tools between accounting and information users.

An accounting system provides information about the business entity in financial statements such as the balance sheet, the income statement, and the statement of cash flows.

• Sales documents• Purchasing documents• Payroll records• Bank records• Others

• Journalizing• Posting• All accounts aresummarized

• Balance sheet• Income statement• Cash flows statement• Other reports

InputsAccountingDocuments

Processing Outputs

Figure 7.1 Accounting System Process

Accounting is “the language of business”.

Financial statements are the tools to communicate the financial information to users.

Where can you find financial information about a company?

1

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Definition of BookkeepingMany people confuse bookkeeping and

accounting. They think that bookkeeping is accounting. Actually it is not. Bookkeeping is the act of recording and organizing financial transactions in the accounting system in accordance with the generally accepted accounting principles (GAAP). It ensures that records of the individual financial transactions are correct, up-to-date, and comprehensive. In modern accounting systems, bookkeeping is processed by computer software.

Accounting process on the other hand includes bookkeeping function and also includes reporting and analyzing the financial data to be used in the decision-making process. Thus, accounting involves the entire process of identifying, recording, and communicating economic events.4

USERS OF ACCOUNTING INFORMATION

In modern economies, different information users make different economic decisions, based on their relationsip with the entity.5

The users of accounting information either directly or indirectly connected to the business entity can be classified as internal and external users.

Internal UsersInternal users of accounting information are

managers who plan, organize, and run a business. They include marketing managers, production supervisors, finance directors, and company officers.6

Managers in different fields use accounting information to administer the activities, businesses, or functional areas they oversee as well as coordinating those activities, businesses, or functions within the framework of the organization.7

Business entities present summarized financial information in the form of financial statements to both internal and external information users. In addition to financial statements, for internal users, accounting provides internal reports, such as financial comparisons of operating alternatives, projections of income from new sales campaigns, and forecasts of cash needs for the next year.8

Individual managers often require detailed information for different purposes in an accounting system. Consider, for example, the sales order information of a company. This information will be used for different purposes in decisions of different managers. The sales manager may be interested in the total amount of sales in order to determine the commissions to be paid. The marketing manager of the company uses sales information to evaluate the impact of a particular promotion strategy. The distribution manager is more likely to be interested in the sales order quantities by geographic region and by customer-requested delivery dates to ensure timely deliveries. Whereas the manufacturing manager’s focus would be the quantities of various products and their expected delivery dates, so that s/he can develop an effective production schedule.9

ERP integrates company resources for higher efficiency

Bookkeeping and accounting are not the same processes.

Bookkeeping is the recording of a firm’s financial transactions which usually involves only the recording of budgetary events.

Internal users of accounting information are managers who plan, organize, and run a business.

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To simultaneously serve the needs of the managers of different departments, companies create a database consisting of small and detailed information that can be used for multiple purposes. For instance, the sales order database will contain detailed information about the product, quantity of the order, selling price, and delivery details (place and date) for each sales order. The database stores information in a way that allows different managers to access the information they need. Many companies are building their own Enterprise Resource Planning (ERP) systems, which are single databases that collect data and feed it into applications that support the company’s business activities, such as purchasing, production, distribution, and sales.10

External UsersExternal users are individuals and organizations

outside a company who needs financial information about the company. There are several types of external users of accounting information. The two most common types are investors and creditors. The information needs and questions of external users are quite different. Current and prospective investors (owners) use accounting information to make decisions to buy, hold, or sell stock. Creditors such as suppliers and banks use accounting information to evaluate the risks of selling on credit or lending money.11 Taxing authorities want to know whether the company complies with the tax laws. Customers or clients are interested in whether a company will continue to honor product warranties. Labor unions want to know whether the owners have the ability to pay increased wages and benefits. Regulatory agencies, such as the Securities and Exchange Commission or the Federal Trade Commission, want to know whether the company is operating within prescribed rules.12

AREAS OF ACCOUNTINGThere are several specialized fields of accounting

practice. The two most common fields are financial accounting and managerial accounting. Other fields include cost accounting, environmental accounting, tax accounting, international accounting, not-for-profit accounting, and social accounting.

Financial AccountingFinancial accounting focuses on reporting to

external parties such as stockholders, investors, governmental agencies, creditors, banks, and suppliers. Financial accounting measures and records business transactions and provides financial statements that are based on generally accepted accounting principles (GAAP).

Financial accounting is primarily concerned with the recording and reporting of economic data and activities for a business especially for external users. These accounting disclosures of business operations help determine investment and lending decisions. A variety of government regulations and laws require to collect, process, and report the financial information. Financial accounting deals with past events. Financial accounting is the face a business shows the outside world.13

Managers of all levels need to know accounting because their decisions will often be determined by “the numbers”.

External users are individuals and organizations outside a company who seek for financial information about the company.

Give an example for a type of information that will be important if you want to invest in a company as a shareholder (owner).

2

Financial accounting measures and records business transactions and provides financial statements that are based on generally accepted accounting principles (GAAP).

Financial accounting and managerial accounting have different goals.

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Managerial AccountingManagerial accounting is concerned with

providing information to internal decision makers, such as company managers. Managerial accounting uses both financial accounting and estimated data to aid management in running day-to-day operations and in planning future operations.

Managerial accounting measures, analyzes, and reports financial and nonfinancial information that helps managers make decisions to fulfill the goals of an organization. Managers use managerial accounting information to develop, communicate, and implement strategies. They also use managerial accounting information to coordinate product design, production, and marketing decisions as well as evaluating performance.

We can summarize the main purposes of managerial accounting information that is used within a business as follows:14

• Planning: An example of planning is budgeting. Budgeting is the process of forecasting future financial needs. This process is based on the funds that the com-pany expects to collect as a result of sales and how much will be paid to purchase materials, for salaries, and wages etc.

• Decision Making: Managerial account-ing information will be helpful to evaluate various alternatives available. For example, management may be considering whether to purchase or lease an equipment.

• Control: Management also uses account-ing information to determine whether the business is operating according to its plans and identifies the differences.

The key questions are: (1) How will this information help managers do their jobs better, and (2) Do the benefits of producing this information exceed the costs?15

Table 7.1. shows the major differences between financial and managerial accounting, even though they often rely on the same underlying financial data.

Managerial accounting uses both financial accounting and estimated data to aid management in running day-to-day operations and in planning future operations.

Table 7.1 Comparison of Financial and Managerial Accounting

Financial Accounting Managerial Accounting

Purpose of information

• Communicateorganization’sfinancialpositiontothoseoutsidetheorganization:• Owners,stockholders• Creditors,banks• Taxauthorities• Regulators• Suppliers

• Helpmanagersmakedecisionstofulfillanorganization’sgoals.Reportstothoseinsidetheorganizationfor:• Planning• Directingandmotivating• Controlling• Performanceevaluation

Primary users• External users such as owners,

investors, banks, regulators, andsuppliers

• Managersoftheorganization

Focusandemphasis• Past-oriented.• Emphasizesfinancial

consequencesofpastactivities

• Future-oriented.• Emphasizesdecisions

affectingthefuture(budgetfor 2018 prepared in 2017)

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Timespanandtypeofreports

• Emphasizesprecision.• Annualandquarterlyfinancial

reports,primarilyonthecompanyasawhole.

• Emphasizessummarydataconcerningtheentireorganization.

• Emphasizestimeliness.• Variesfromhourly

information to 15 to 20 years,withfinancialandnonfinancialreportsonproducts,departments,territoriesandstrategies.

• Emphasizesdetailedsegmentreportsaboutdepartments,products,andcustomers

Rulesofmeasurementandreporting

• MustfollowGAAPandbecertifiedbyexternal,independentauditors.

• Emphasizesobjectivityandverifiability.

• Mandatoryforexternalreports

• Need not follow GAAP butare based on cost-benefitanalysis.

• Emphasizesrelevance.• Notmandatory

Sources:Noreen,E.W.,Brewer,P.,&Garrison,R.H.(2011).Managerial Accounting for Managers(2nded.).McGraw-Hill/Irwin,p.34;Horngren,C.T.,Datar,S.M.,Madhav,V.,&Rajan,M.V.(2012).Cost Accounting: A Managerial Emphasis(14thed.).PearsonEducation,p.4.

As illustrated in Table 7.1, financial and managerial accounting differ not only in their user orientation but

also in their emphasis on the past and the future, in the type of data provided to users, and in several other ways.

ACCOUNTANTS AND ACCOUNTING PROFESSIONAccountants work throughout private industry and government. A private accountant works for a

business firm in any position not included in public accounting. In private (or managerial) accounting, the accountant is involved in activities such as cost accounting (finding the cost of producing specific products), budgeting, accounting information system design and support, or tax planning and preparation. Accountants might also be a member of a company’s internal audit team.16 A certified management accountant (CMA) is a certified professional who works for a single company.

Accountants get to the top of organizations as often as anyone else. Why? Because accountants must deal with every aspect of a company’s business in order to record all of its activities. Accountants often have the broadest view of what is going on in the company.17

Public accountants and their staff provide services to the general public on a fee basis.18 In public accounting, an accountant may practice as an individual or as a member of a public accounting firm. Individuals in public accounting offer expert service to the general public, in much the same way that doctors serve patients and lawyers serve clients.19 Public accounting firms provide areas of service such as auditing, tax consulting, and management consulting. A major portion of public accounting involves auditing.

Another option is to pursue one of the many accounting opportunities in governmental agencies. Public accountants who meet education, experience,

and examination requirements may become a Certified Public Accountant (CPA). CPAs generally perform general accounting, audit, or tax services.20 CPAs are licensed professional accountants who serve the general public.

A private accountant works for a business firm in any position not included in public accounting.

Certified Public Accountants (CPAs) are licensed professional accountants who serve the general public.

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All professions have regulations. Accountancy profession in Turkey is regulated through the law No. 3568, “The Law of Independent Accountancy, Certified Public Accountancy, and Sworn-in Certified Public Accountancy”. It was enacted in 1989. The law establishes accounting and auditing as a profession and defines those who are rendering services in these fields as professionals. The Law defines accounting and auditing as a profession and recognizes two qualifications of accounting and auditing professionals granted by the Union of Chambers of Certified Public Accountants (TÜRMOB): Certified Public Accountant (CPA, Serbest Muhasebeci Mali Müşavirler-SMMM) and Sworn-in Certified Public Accountant (Sworn-in CPAs, Yeminli Mali Müşavirler-YMM). Only accountants who have been awarded a license by TÜRMOB are entitled to render professional services.21

In distinguishing between the two titles, SMMMs may keep books, prepare financial statements, and conduct general audits, but cannot perform tax audits nor provide consulting services. With the exception of bookkeeping, YMMs are allowed to perform all the services provided by SMMMs in addition to tax audits and certifying financial statements.

Governing OrganizationsThe Republic of Turkey adopted a new Turkish

Commercial Code in 2012 (Law No. 6102). The law contains provisions on the formation and operation of entities in its jurisdiction and stipulates the accounting, auditing, and ethical standards to be applied by companies and professionals. The Code requires application of Turkish Accounting Standards (TAS) in the preparation of the financial statements of public interest entities (PIEs).22

The Public Oversight, Accounting and Auditing Standards Board of Turkey (POA), known in Turkish as Kamu Gözetimi, Muhasebe ve Denetim Standartları Kurumu (KGK) was established in 2011 with the legal authority to establish and issue accounting and financial reporting standards.23

Turkey has already adopted IFRS Standards for the financial statements of all public interest entities. Turkish Accounting Standards (TAS) are issued by

the Public Oversight, Accounting and Auditing Standards Board of Turkey.

The Union of Chambers of Certified Public Accountants of Turkey (TÜRMOB) is the national umbrella organization for the 81 local chambers of CPAs (SMMMs) and Chambers of Sworn-in CPAs (YMMs). The Union is empowered to award professional licenses that Turkey’s accountants must have to render professional services.

The Turkish Capital Markets Board, under the Capital Markets Law, establishes financial reporting requirements with respect to listed entities, financial intermediaries, and portfolio management companies, along with their subsidiaries, associates, and joint ventures.

Similarly, the Banking Regulation and Supervision Agency sets financial reporting requirements for entities under its purview, while the Under Secretariat of Treasury supervises insurance, reinsurance companies as well as pension funds. As mentioned above, as PIEs all regulated entities are required to apply TAS.

Ethics in AccountingEthical considerations are important to acco-

unting. Because users of accounting information must depend on the good faith of people involved in accounting activities. State laws around the world require companies to report relevant and reliable information to outsiders. Relevant means “able to affect a decision”. Reliable means “verifiable and free of error and bias”. Occasionally, a company might report biased information. It may overstate profits or understate the company’s debts. In recent years, several well-known companies such as Enron, repor-ted misleading information.

Public Oversight Accounting and Auditing Standards Authority (KGK) http://www.kgk.gov.trUnion Of Chambers Of Certified Public Accountants Turkey (TÜRMOB) http://www.turmob.org.tr

internet

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What are the criteria for ethical judgments in accounting? The responsibility for setting ethical standards for the profession is shared between the professional accountancy organizations and the public oversight authority.

For example, the American Institute of Certified Public Accountants (AICPA), other professional organizations, and most companies have codes of conduct that require ethical conduct.24 Similarly, the Union of Chambers of Certified Public Accountants and Sworn-in Certified Public Accountants of Turkey (TÜRMOB) has the responsibility for establishing professional ethics standards for its members. In collaboration with the Experts Accountants Association of Turkey (EAAT), TÜRMOB has adopted, translated (in accordance with the IFAC Translation Policy), and published the 2014 version of the IESBA Code of Ethics. Members of EAAT must also comply with the Code as issued by TÜRMOB.25

The Role of Auditors in Ensuring Proper Reporting

A company’s actual performance may differ from what is reported to the public. How does a society deal with this conflict of interest? In Turkey, law requires all companies that sell their stock to the public to have an annual audit by independent auditors.

Companies want to be profitable and financially strong to attract investors, so there is a conflict of interest here. To provide reliable information, financial statements of companies must be audited by independent accountants. An audit is an examination of a company’s financial records. The independent accountants then issue an opinion that states whether or not the financial statements give a fair picture of the company’s financial situation. The vast majority of accountants do their jobs professionally and ethically, but these examples are not much heard. Unfortunately, only those who cheat make the headlines. In recent years we have seen many accounting scandals.

Audits are intended to protect the public by ensuring that accounting data are relevant and reliable.26 The auditor’s role is to certify that the financial reports are accurate and within the generally accepted reporting guidelines. An auditor’s stamp of approval does not imply anything about a firm’s performance; the auditor is certifying only that the information contained within the financial statements is accurate.27

RECORDING BUSINESS TRANSACTIONS

An accounting system is the composition of methods and procedures for collecting, classifying, summarizing, and reporting the financial and operating information of a business. Understanding both the recording of transactions and the combining of these transaction records to form financial statements is critical for developing two skills: (1) Ability to communicate the results of transactions to others, and (2) Understanding of how transactions affect the financial statements and how the financial statements reflect the transactions.28

Accounting systems may be either manual or computerized. Understanding a manual accounting system assists in recognizing the relationships among accounting data and accounting reports. In addition, most computerized systems use principles used in a manual system.

Investors seek for relevant and reliable information to outsiders.

An audit is an examination of a company’s financial records.

The financial statements of company must be audited, why?

3

An accounting system is the composition of methods and procedures for collecting, classifying, summarizing, and reporting the financial and operating information of a business.

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The Accounting CycleThe accounting cycle is a set of steps that are repeated in the

same order every period to keep track of what happened in the business and to report the financial effect of those transactions. The accounting cycle is the financial process starting with obtaining data from business transactions and leading up to preparation of financial statements. This cycle starts when a business transaction occurs. It will end when the transaction has been included in the financial statements or reports of the company. The steps of the accounting cycle are illustrated in Figure 7.2.

The accounting process starts with identifying and analyzing business transactions and events. Transactions can include the sale of a product or the purchase of supplies, equipment, land, etc for business activities that impact the financial position of company. The transaction is recorded chronologically in the journal. All the transactions are recorded through journal entries. The third step is to post each journal entry to the appropriate ledger accounts. The journalized transactions are posted to the account that it impacts. The accounting cycle requires summarizing of the entries pertaining to a particular period in a trial balance. A trial balance is essentially a list of all accounts and provides an overview of the various types of financial transactions entered into by any organization during a period. After preparation of trial balance, the next step is recording the adjustments like adjusting prepaid/outstanding expenses, recording advance/accrued income, etc. The purpose of adjusting entries is to match incomes with expense during the accounting period. One of the most important steps of the accounting process involve preparing the financial statements. Final step of the accounting process involves closing the books for the revenue and expense accounts which leads to begin again the entire cycle with zero balances.

In manual accounting systems, these steps are followed manually and sequentially by an accountant. In the computerized accounting systems, many software programs like SAP, ERP, etc complete all the steps involved in the accounting process simultaneously and the user is just required to initiate the process by providing the relevant financial data.

The Accounting EquationThe accounting equation is the formula used to capture the company’s financial position at any point

in time. The accounting equation shows how assets, liabilities, and owners’ equity are related to each other:

assets = liabilities + owners’ equity

The accounting cycle is a set of steps that are repeated in the same order every period to keep track of what happened in the business and to report the financial effect of those transactions.

Transactions

Journal EntriesClosing theBooks

Posting

Trial Balance

RecordingAdjusting

Entries

Adjusted TrialBalance

FinancialStatements

Figure 7.2 Accounting Cycle

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This relationship is the basic accounting equation. Assets must equal the sum of liabilities and owner’s equity. Liabilities appear before owners’ equity in the basic accounting equation because they are paid first if a business is liquidated.

The accounting equation applies to all economic entities regardless of size, nature of business, or form of business organization. It applies to a small proprietorship such as a corner grocery store as well as to a giant corporation such as Arçelik. The equation provides the underlying framework for recording and summarizing economic events.

AssetsAssets are economic resources a business owns. The

business uses its assets in carrying out such activities as production and sales. The common characteristic possessed by all assets is the capacity to provide future services or benefits. Cash, merchandise inventory, equipment furniture, and land are examples of assets.

LiabilitiesLiabilities are claims of creditors against assets.

Liabilities are existing debts and obligations of the company. Liabilities are something the business owes. Businesses of all sizes usually borrow money and purchase merchandise on credit. Examples are debt, taxes, accounts payable, and warranty claims.

Owners’ equityThe owners’ claims to the assets of the business

are called equity. Also known as owner’s equity or stockholder’s equity, depending on how the business is organized. Owners’ equity equals what is owned (assets) minus what is owed (liabilities). It is the company’s net worth.

To find out what belongs to owners, we subtract the creditors’ claims (the liabilities) from assets.

assets – liabilities = owners’ equity

Transaction AnalysisAccounting is based on actual business

transactions; not opinions, expectations, or desires. Businesses engage in transactions with customers, suppliers, employees, governmental entities, and others. A transaction is any event that affects the financial position of the business and can be measured reliably on monetary terms.

Source documents like invoices, receipts, checks, or contracts usually support the details of a transaction. We will give examples of transactions of a small company named Sun-Shine.

Transaction 1: Starting the BusinessDeniz Güneş decides to open a management

consulting company as a proprietorship named Sun-Shine. On April 1, 2017, Deniz Güneş invested $30.000 cash in the business. This transaction results in an equal increase in assets and owner’s equity. The effect of this transaction on the accounting equation of the business is as follows:

The accounting equation is the formula used to capture the company’s financial position at any point in time. Left side of the equation always equals the right side of the equation.

The accounting equation:assets = liabilities + owners’ equity

Assets are economic resources a business owns.

Liabilities are existing debts and obligations of the company.

Owners’ equity equals what is owned (assets) minus what is owed (liabilities). It is the company’s net worth.

A transaction is an event that affects the financial position of the enterprise and requires recording.

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Transaction ASSETS = LIABILITIES + OWNER’S EQUITY

Cash Capital

(1) +30.000 +30.000

Balance 30.000 30.000

For each transaction, the amount on the left side of the equation must equal the amount on the right side. The first transaction increases both the assets (in this case, cash) and the owner’s equity (capital) of the business.

Transaction 2: Purchase of supplies for cashOn April 5, 2017, Sun-Shine Company purchases supplies, paying cash of $20.000. This transaction

results in an equal increase and decrease in total assets, though the composition of assets changes: Cash decreases $20.000, and the asset Supplies increases $20.000.

Transaction ASSETS = LIABILITIES + OWNER’S EQUITYCash+Supplies Capital

(1) +30.000 +30.000

(2) -20.000+20.000

Balance 10.00020.000 30.000

Total 30.000 30.000

Transaction 3: Purchase of equipment on creditOn April 10, 2017, The company buys equipment on account (credit), agreeing to pay $25.000 within

60 days. This transaction is a purchase on account (a credit purchase). The asset Equipment increases $25.000, and the liability Accounts Payable increases by the same amount. The effect on the equation is:

Transaction ASSETS = LIABILITIES + OE

Cash+Supplies+Equipment AccountsPayable Capital

(1) +30.000 +30.000

(2) -20.000+20.000

(3) --------+25.000 +25.000

Balance 10.00020.00025.000 25.000 30.000

Total 55.000 55.000

Using Accounts to Record TransactionsAccounting relies on a system of accounts, with a name

or a title of each account intended to capture the nature of the items in the account. An account is a detailed record of increases and decreases in a specific asset, liability, or owner’s equity item.

A shortened form of the general ledger account is called the T-account because it takes the form of the capital letter T. An account, in its simplest form, has three parts: First, each account has a title, which is the name of the item recorded in the account. Second, each

An account is a detailed record of increases and decreases in a specific asset, liability, or owner’s equity item.

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account has a space for recording increases in the amount of the item. Third, each account has a space for recording decreases in the amount of the item. See the cash account appears as follows:

Cash AccountDebit side Credit side

The left side of the account is called the debit side, and the right side is called the credit side. Debits and credits are sometimes abbreviated as Dr. and Cr.

Debit-Credit Rules and Double Entry AccountingAmounts entered on the left side of an account, regardless of the account title, are called debits to

the account. Entering an amount on the left side of an account is called debiting the account. Amounts entered on the right side of an account are called credits, and the account is said to be credited.

These are the rules of debit and credit. Whether an account is increased or decreased by a debit or a credit depends on the type of account. Debits are not “good” or “bad.” Neither are credits. When the totals of the two sides of an account are compared, an account will have a debit balance if the total of the debit amounts exceeds the credits. An account will have a credit balance if the credit amounts exceed the debits.

Accounting uses the double-entry system, which means that we record the dual effects of each transaction. As a result, every transaction affects at least two accounts. It would be incomplete to record only the giving side, or only the receiving side, of a transaction.

Sun-Shine company entered increases in cash—an asset—on the left side, and decreases in cash on the right side. Therefore, we must enter increases in liabilities on the right or credit side, and decreases in liabilities on the left or debit side.

Look again at the accounting equation:Assets = Liabilities + Owners’ EquityIf a debit increases assets, then a credit must be used to increase liabilities or owners’ equity because they

are on opposite sides of the equal sign. Likewise, if a credit decreases assets, then a debit must be used to decrease liabilities or owners’ equity. These rules can be shown as follows:

ASSETS = LIABILITIES + OWNERS’ EQUITYDebit for increases

Credit for decreases

Debit for decreases

Credit for increases

Debit for decreases

Credit forincreases

Maintaining the equality of the balance sheet equation requires the amounts debited to various accounts for each transaction equal the amounts credited to various accounts. As a result, the sum of balances in accounts with debit balances at the end of each period must equal the sum of balances in accounts with credit balances. Debits equal credits: this applies to each individual transaction and to the balance sheet as a whole.29

A company borrowed money from the bank for 3 months. Show the effects of this transaction on the accounting equation.

4

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Steps in the Recording ProcessIn practically every business, there are three

basic steps in the recording process:1. Analyze each transaction for its effects on

the accounts,2. Enter the transaction information in a

journal,3. Transfer the journal information to the

appropriate accounts in the ledger.Accountants record transactions first in a journal,

which is the chronological record of transactions. The journal entry presents the full story for each transaction. The journal is referred to as the book of original entry. For each transaction the journal shows the debit and credit effects on specific accounts.

Entering transaction data in the journal is known as journalizing. Companies make separate journal entries for each transaction. A complete entry consists of: the date of the transaction; the accounts and amounts to be debited and credited; and a brief explanation of the transaction.

Accountants then post (copy) the data to the book of accounts called the ledger. The process of copying from the journal to the ledger is called posting. We post from the journal to the ledger. The ledger provides the balance in each of the accounts. For example, the cash account shows the amount of cash available to meet current obligations. The accounts receivable show amounts due from customers; the accounts payable show amounts owed to creditors.

The Recording Process IllustratedIllustrations show the basic steps in the recording

process, using the April transactions of Sun-Shine Company.

Transaction 1: On April 1, 2017, Deniz Güneş invested $30.000 cash in the business. The business increased cash, which is an asset, so we debit cash. The business also increased owner’s equity, so we credit capital.

Journal Entry

Date Account Titles Debit Credit

April1,2017 CASH 30.000

CAPITAL 30.000

Ledger Accounts

CASH CAPITAL

30.000 30.000

Transaction 2: On April 5, 2017, Sun-Shine Company purchases supplies, paying cash of $20.000.

The purchase decreased cash. Therefore, we credit cash. The asset supplies, increased, so we debit the supplies account.

Journal Entry


April5,2017 SUPPLIES 20.000

CASH 20.000

Ledger Accounts

CASH SUPPLIES

30.000 20.000 20.000

Transaction 3: On April 10, 2017, The company buys equipment on account (credit), agreeing to pay $25.000 within 60 days.

Journal Entry


April5,2017

EQUIPMENT 25.000

ACCOUNTSPAYABLE 25.000

A journal is the chronological record of transactions

A ledger is the book holding all the accounts with their balances.

Posting is the process of copying from the journal to the ledger.

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Ledger Accounts

EQUIPMENT ACCOUNTSPAYABLE

25.000 25.000

The Ledger Accounts After PostingWe next show the accounts of Sun-Shine

Company after posting.

CASH SUPPLIES

30.000 20.000 20.000

EQUIPMENT ACCOUNTSPAYABLE

25.000 25.000

CAPITAL

30.000

Each account has a balance. An account balance is the difference between the account’s total debits and its total credits. For example, the $10.000 balance in the cash account is the difference between total debited amount and credited amount and it means how much money on hand.

Chart of AccountsA list of the accounts in the ledger is called a

chart of accounts. The accounts are normally listed in the order in which they appear in the financial statements. The balance sheet accounts are usually listed first in the order of assets, liabilities, and owner’s equity. The income statement accounts are then listed in the order of revenues and expenses.

Companies use a chart of accounts to list all their accounts along with the account numbers. Account numbers usually have two or more digits. In Turkey, we have Uniform Chart of Accounts that companies must use the account titles according to the Uniform Chart of Accounts.

BASIC FINANCIAL STATEMENTSWe already know that the financial statements

summarize the transaction data into a form that is useful for decision making. The most important financial statements are the balance sheet, the income statement, and the cash flows statement. The amounts and accounts appearing in the financial statements are drawn from the ledger.

The Balance SheetA balance sheet or statement of financial

position is a financial statement that reports a business’s assets, liabilities, and equity on a specific date. Balance sheets are static. They are like snapshots, that they reflect conditions on the date of their preparation. In this respect it’s a position statement rather than a flow statement.

Explain what an account is and how it helps in the recording process.

5

The financial statements summarize the transaction data into a form that is useful for decision making.

The most important financial statements are the balance sheet, the income statement, and the cash flows statement.

A balance sheet or statement of financial position is a financial statement that reports a business’s assets, liabilities, and equity on a specific date.

Balance sheet also called the statement of financial condition or statement of financial position, must always balance.

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A balance sheet has two sides: assets are listed and totaled on the left; liabilities and equity are listed and totaled on the right. The total of all assets must equal the total of all liabilities plus equity.

Anything owned by a firm is an asset; anything owed by a firm is a liability. Firms normally support a portion of their assets with funds of the owners, called “owner’s equity” (also called “stockholder’s equity”).

Each balance sheet has a heading that includes the name of the business, the title “Balance Sheet or Statement of Financial Position” and the date. The information in the balance sheet presents a picture of the business’s financial position on the date in the heading. Balance sheets are prepared at least once a year.

Balance sheet classificationA classified balance sheet groups together similar assets and similar liabilities, using a number of

standard classifications and sections.

Assets Liabilities and Owners’ (Stockholders’) Equity

Currentassets

Non-Currentassets

Currentliabilities

Non-Current(Long-term)liabilities

Owners’(Stockholders’)equity

Classification of assets. Assets that management expects to convert to cash, or to sell, or to consume during the normal operating cycle of the business are current assets. All other assets are noncur-rent assets.

Current assets are the assets that a company expects to convert to cash or use up within one year or within its operating cycle, whichever is longer. Common types of current assets are cash, short-term investments, receivables (notes receivable, accounts receivable, and interest receivable), inventories, and prepaid expenses (insurance and supplies).

Companies list current assets in the order in which they expect to convert them into cash. The operations of a merchandising business involve the purchase of merchandise for sale (purchasing activity), the sale and distribution of the products to customers (sales activity), and the receipt of cash from customers (collection activity). This overall process is referred to as the operating cycle. Thus, the operating cycle begins with spending cash, and it ends with receiving cash from customers, as illustrated in Figure 7.3.

The operating cycle of a business is the time between buying and/or creating a product or service and receiving the cash on its sale. For most businesses, this will be less than a year.

Current assets are the assets that a company expects to convert to cash or use up within one year or within its operating cycle, whichever is longer.

Cash

InventoryAccountsReceivable

Figure 7.3 Operating Cycle

The operating cycle of a business is the time between buying and/or creating a product or service and receiving the cash on its sale.

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Non-current assets include long-term investments, property, plant and equipment (fixed assets), and intangible assets.

Classification of liabilities. Similarly, obligations that management expects to discharge with a cash payment or otherwise settle during the operating cycle are current liabilities, whereas all other obligations are noncurrent liabilities.

Current liabilities are all those debts of the company that are expected to be paid within the next 12 months, the same period in which the current assets are expected to become cash. Common examples are accounts payable, wages payable, bank loans payable, interest payable, and taxes payable.

Non-current (long-term) liabilities are obligations that a company expects to pay after one year. Liabilities in this category include bonds payable, mortgages

payable, long term notes payable, lease liabilities, and pension liabilities.

Owners’ (stockholders’ or share-holders’) equity. Business owners have several options for obtaining the capital they need to start and operate their business. One way is to contri-bute their own money to the business. The owners’ claims to the assets of the business is called owners’ equity. Owners’ equity consists of contributed ca-pital, retained earnings and, other reserves.

Contributed capital is the amount that the owners have invested in the company. Business owners’ personal contributions to the business are called equity capital or owner capital or paid in capital. This type of capital may come from personal funds, such as from accumulated savings, or from funds the owners borrow using their homes or other personal property as security for the loan.

A second component of owners’ equity is retained earnings. Retained earnings are the profits that the owners do not take out of the business but instead save for use by the business. Normally, a good policy for a company is not to distribute all of its profits. It is better to hold some of its profits in reserve for use in the business through retained earnings. Reserves are created for different purposes. For example, the board may aside a portion of retained earnings as a reserve for an amount that the business expects to pay managers and employees as bonuses.30

Non-current assets include long-term investments, property, plant and equipment (fixed assets), and intangible assets.

Explain the necessity of classifying the assets as current and non-current.

6

Non-current (long-term) liabilities are obligations that a company expects to pay after one year.

Contributed capital is the amount that the owners have invested in the company.

Retained earnings are the profits that the owners do not take out of the business but instead save for use by the business.

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Exhibit 7.1 Balance Sheet of Arçelik Company

CONSOLIDATEDSTATEMENTOFFINANCIALPOSITION(BalanceSheet)fortheyearendedDecember31,2015and2014.

(AmountsexpressedinthousandsofTurkishLira(TRY)unlessotherwiseindicated.)

ASSETS 31.12.2015 31.12.2014

Current assets:

Cashandcashequivalents 2.167.627 1.621.221

Tradereceivables 4.790.525 4.433.898

-Due from related parties 8.950 22.371

-Trade receivables, third parties 4.781.575 4.411.527

Derivativeinstruments 16.293 7.783

Inventories 2.140.057 2.124.946

Prepaidexpenses 74.944 68.741

Currentincometaxassets 27.014 57.988

Othercurrentassets 179.678 145.365

Assetsheldforsale 10.114 11.815

Total current assets 9.406.252 8.471.757

Non-current assets:

Financialinvestments 539.176 698.488

Tradereceivables 13.205 24.423

Derivateinstruments 144.742 17.803

Associates 209.881 195.311

Investmentproperties - 5.929

Property,plantandequipment 2.055.675 1.812.746

Intangibleassets 1.170.930 1.091.195

-Goodwill 163.450 169.195

-Other intangible assets 1.007.480 922.000

Deferredtaxassets 198.647 77.353

Total non-current assets 4.332.256 3.923.248

TOTAL ASSETS 13.738.508 12.395.005

LIABILITIES

Current liabilities:

Financialliabilities 1.035.741 719.862

Shorttermportionoflongtermfinancialliabilities 1.149.001 1.082.761

Tradepayables 2.090.394 1.781.442

-Due to related parties 413.983 203.022

-Trade payables, third parties 1.676.411 1.578.420

Derivativeinstruments 3.263 3.811

Employeebenefitobligations 156.910 163.623

Otherpayables 168.519 124.918

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-Due to related parties 12.982 10.003

-Other payables, third parties 155.537 114.915

Currentincometaxliabilities 13.062 18.154

Provisions 334.536 263.992

Othercurrentliabilities 284.871 272.240

Total current liabilities 5.236.297 4.430.803

Non-current liabilities

Financialliabilities 3.268.907 2.964.986

Otherpayables 60.674 57.823

Derivateinstruments —

Provisions 318.522 268.671

-Provision for employee benefits 192.470 174.896

-Other provisions 126.052 93.775

Deferredtaxliabilities 149.635 245.422

Othernon-currentliabilities 28.636 28.602

Total non-current liabilities 3.826.374 3.565.504

TOTAL LIABILITIES 9.062.671 7.996.307

EQUITY

Paid-incapital 675.728 675.728

Adjustmenttosharecapital 468.811 468.811

Sharepremium 889 889

Othercomprehensiveincome/expensenottobereclassifiedtoprofitorloss

-Actuarial gain/loss arising from defined benefit plans -57.615 -44.552

-Non-current assets revaluation fund 75.747 67.241

Othercomprehensiveincome/losstobereclassifiedtoprofitorloss

-Financial assets revaluation fund 374.201 525.549

-Foreign cur. hedge of net invest. in foreign operations -259.170 -216.342

-Cash flow hedges 1.413 412

Currencytranslationdifferences 324.618 178.569

Contributiontoshareholders’equityrelatedtomerger 14.507 14.507

Restrictedreserves 307.051 275.430

Retainedearnings 1.839.690 1.792.299

Netincomefortheperiod 891.141 617.084

Atributableto:

Equity holders of the parent 4.657.011 4.355.625

Non-controlling interest 18.826 43.073

Total equity 4.675.837 4.398.698

TOTAL LIABILITIES AND EQUITY 13.738.508 12.395.005

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Income StatementAs you know, profitability is one of the major

goals of a business. Business entities must be profitable in order to be successful and to survive. Profit, however, means different things to different people. Accountants prefer to use the term net income because it can be precisely defined from an accounting point of view as the net increase in owners’ equity that results from a company’s operations.31

The income statement (also called the statement of profit and loss or statement of operations) shows the amount of sales, all the costs incurred in making those sales and all the overhead costs incurred in running the operations of the company so it would be able to deliver on its promises to customers. It reports the success or failure of the company’s operations for a period of time. The income statement presents a summary of a business entity’s revenues and expenses for a period of time.

Net income is reported on the income statement, and management, owners, and others use it to measure a company’s progress in meeting the goal of profitability. Net income, in its simplest form, is measured as the difference between revenues and expenses when revenues exceed expenses:

net income = revenues - expenses

Revenues are increases in owners’ equity resulting from selling goods, rendering services, or performing other business activities.

Expenses are decreases in owners’ equity resulting from the cost of selling goods or rendering services and the cost of the activities necessary to carry on a business, such as attracting and serving customers. In other words, expenses

are the cost of the goods and services used to earn revenues. Examples include salaries expense, rent expense, advertising expense, utilities expense, and depreciation (allocation of cost) of a building or office equipment. These expenses are often called the cost of doing business or expired costs.

SalesCompanies must sell products or services to

their customers or clients to earn revenue. Nothing happens until you sell something to your customers. Sales revenue will be earned by selling the products and services that the company regularly offers for sale in the normal course of business. This means sales revenue doesn’t include the sale of excess equipment or land, because that’s not our normal and regular business. We also don’t include the sale of a building that we’re not using anymore. Gain or loss on the sales of building will be reported as an unusal and extraordinary income but not as a sales revenue.

Managers, investors, and others often use the amount of sales and trends in sales as indicators of a firm’s progress. Increasing sales suggest growth; decreasing sales indicate the possibility of decreased future earnings and other financial problems.

The income statement shows the amount of sales, all the costs incurred in making those sales and all the overhead costs incurred in running the operations of the company so it would be able to deliver on its promises to customers.

Revenues are increases in owners’ equity resulting from selling goods, rendering services, or performing other business activities.

Expenses are the cost of the goods and services used to earn revenues.

Income statement goes by various names, including the statement of earnings, profit and loss (P&L) statement, statement of income and expenses, or statement of operations.

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Cost of salesThe cost of sales or cost of goods sold (COGS)

is the cost of creating the products that a company sells; therefore, the only costs included in the measure are those that are directly tied to the production of the products.

For a manufacturer, it is the cost of producing the products sold during an accounting period. In a manufacturing company, COGS always includes the cost of the supplies and materials used in creating the product along with the direct labor costs used to produce the good. It excludes indirect expenses such as distribution costs and sales force costs.

Gross profitThis is a key measure of profitability. For a

merchandiser or manufacturer gross profit is the difference between net sales and the cost of goods sold. Gross profit represents the merchandising profit of a company. Earning a gross profit is very important, because it must be enough to cover all of the operating expenses of a business.

Operating expensesOperating expenses include all the operating

costs of the business, what it takes to keep the doors open and to support the sales of the company’s products. Operating expenses are often grouped into the categories of research and development expenses, sales and marketing expenses, and general and administrative expenses.

Let’s look briefly at what each of these categories of expenses typically includes:

Research and development expenses. Research and development (R&D) is money spent to create new products or to significantly improve existing products. A company which can afford to spend more for

R&D has a better chance of staying ahead of its competitors. Having better products sooner than others should provide an edge, at least for a while.

Sales and marketing expenses. Selling expenses include the costs of storing goods and preparing them for sale: preparing displays, advertising and otherwise promoting sales, and delivering goods to a buyer if the seller has agreed to pay the cost of delivery.

General and administrative expen-ses (G&A). General and administrative expen-ses include expenses for accounting, personnel, credit checking, collections, and any other ex-penses that apply to overall operations. Examples include the costs of executive salaries, accounting and human resources personnel, many corporate and emp-loyee welfare costs, and all the costs of supporting the company’s administrative organization. As you see, another cost of doing business.

Operating incomeOperating income, is the difference between

gross profit and operating expenses. Operating income is an important measure of overall profitability, because it represents the income of a company’s main business. It’s usually the final result of the company’s normal business activities, before unusual, nonrecurring, or financially related items that are often considered incidental to what the company is in business to do.

Other income and expensesOther income and expenses also called

nonoperating revenues and expenses, are not related to a company’s operating activities. The nonoperating items, such as interest expense on borrowed money and profits or losses on selling nonbusiness assets that are likely to happen in the normal course of doing business, but are not part of main activities of the business.

While typically small in relation to the operations of the business, they are not necessarily minor. In fact, some of them can become very large in relation to net income, especially if the company’s profit margins are modest. An example might be the sale of unused land the company has held for many years, often at a price many times greater than the value at which it was carried on the company’s books. When such items get very large, they will most likely be labeled extraordinary items and shown separately.

The cost of sales or cost of goods sold (COGS) is the cost of creating the products that a company sells.

Gross profit is the difference between net sales and the cost of goods sold

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Income before taxes, income taxes, and net incomeIncome before taxes is the amount a company has earned from all activities—operating and

nonoperating—before taking into account the amount of income taxes it incurred.Income taxes also called provision for income taxes, represent the expense for state taxes on corporate

income. Income taxes are shown as a separate item on the income statement. Corporations must report and pay income taxes on their earnings.

Net income is the final figure, or “bottom line,” of an income statement. It is what remains of gross margin after operating expenses have been deducted, other revenues and expenses have been added or deducted, and income taxes have been deducted.

The income statement is a useful tool for understanding a company’s performance in a very high-level way. See the Arçelik example in Exhibit 7.2.

Exhibit 7.2 Income Statement of Arçelik Company

CONSOLIDATEDSTATEMENTOFPROFITORLOSSfortheyearendedDecember31,2015and2014.(AmountsexpressedinthousandsofTurkishLira(TRY)unlessotherwiseindicated)

2015 2014

NetSales 14.166.100 12.514.033

Costofsales -9.630.207 -8.535.201

Gross Profit 4.535.893 3.978.832

Generaladministrativeexpenses -602.068 -532.789

Marketing,sellinganddistributionexpenses -2.722.014 -2.356.247

Researchanddevelopmentexpenses -125.173 -102.055

Otherincomefromoperatingactivities 471.267 216.137

Otherexpensesfromoperatingactivities -275.148 -235.089

Operating profit 1.282.757 968.789

incomefrominvestmentsactivities 17.857 16.264

expensesfrominvestmentsactivities -2.781 -1.377

incomefromassociation(net) 24.403 18.156

Operating income before financial income 1.322.236 1.001.832

financalincome 782.555 476.126

financalexpenses -1.319.670 -746.336

Profit before tax 785.121 731.622

Tax income/expense

-taxesonincome -97.286 -80.892

-deferredtaxincome/expense 205.158 -12.752

Net income for the period 892.993 637.978

Attributableto:

Non-controllinginterest 1.852 20.894

Equity holders of the parent 891.141 617.084

Net income is the final figure, or “bottom line,” of an income statement.

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Statement of Cash FlowsHow can a profitable firm run out of cash?

Two explanations of the relation between cash and income suggest answers:32 (1) Net income for a particular period does not equal cash flow from operations. (2) Firms receive cash inflows and disburse cash outflows because of investment and financing activities, which the income statement does not report directly.

The statement of cash flows reports the cash coming in (positive amounts) and the cash going out (negative amounts) during a period. Money comes in immediately as a result of the sale of goods and services for cash and later from customers who buy on credit. Money goes out to pay for various costs and operating expenses. Business activities result in a net cash inflow or a net cash outflow.

The statement of cash flows reports the net increase or decrease in cash during a period and the ending cash balance. It provides useful information about a firm’s ability to generate cash from operations, maintain and expand its operating capacity, meet its financial obligations, and pay dividends. As a result, it is used by managers in evaluating past operations and in planning future investing and financing activities. It is also used by investors, creditors, and others in assessing a firm’s profit potential. In addition, it is a basis for assessing the firm’s ability to pay its maturing debt.33 The statement of cash flows reports cash flows by three types of activities: Cash flows from operating, investing, and financing activities.

ANALYZING FINANCIAL STATEMENTS

Accounting is designed to provide information that business owners, managers, and lenders use for decision making. The basic financial statements provide much of the information users need to make economic decisions about businesses. A firm’s financial managers can use the financial statements to assess the financial condition of the firm. Readers cannot easily answer questions about a firm’s profitability and risks based only on the raw information in financial statements. For example, one cannot assess the profitability of a firm by noting the amount of net income—large net income could result from a large firm earning small profits on its transactions or from a small firm earning large profits. Comparing net income with the assets used to generate those earnings will provide more useful information.34

Financial ratios provide a quick and relatively simple means of assessing the financial health of a business. Ratio analysis expresses the relationship among selected items of financial statement data. A ratio expresses the mathematical relationship between one quantity and another. The relationship is expressed in terms of either a percentage, a rate, or a simple proportion.

Firms can assess their financial characteristics by comparing their financial ratios with those of other firms in the same industry. Ratios also allow quick comparisons between your business and other businesses in your industry. Banks and investors use them to help decide whether a business is a good credit or investment risk. Managers look at ratios to monitor operations and spot weak areas and inefficiency. For example, ratios can indicate whether a business is carrying a dangerous amount of debt, holding too much inventory, or not collecting accounts receivable quickly enough. Managers could also look at their customers’ and vendors’ ratios to assess any risk involved.

The statement of cash flows helps a reader understand how a firm obtains and uses cash.

The income statement shows revenue and expenses that were recorded according to the accrual basis accounting.

The statement of cash flows reports cash flows by three types of activities: Cash flows from operating, investing, and financing activities.

Financial ratios provide a quick and relatively simple means of assessing the financial health of a business.

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Financial ratios are commonly classified according to the characteristics they measure as: liquidity ratios; efficiency (activity) ratios; debt ratios; and profitability ratios.

Measures and Evaluation of Liquidity

Liquidity refers to a firm’s ability to meet short-term obligations. Liquidity ratios give a picture of a company’s short-term financial solvency.

Since short-term assets are commonly used to pay short-term obligations (which are current liabilities), most liquidity measures compare current assets with current liabilities. The greater the level of current assets available relative to current liabilities, the greater the firm’s liquidity.

A high degree of liquidity can enhance the firm’s safety, but an excessive degree of liquidity can reduce the firm’s return. For example, holding an excessive amount of cash is a waste and can reduce a firm’s returns.

Net working capital (NWC)The excess of the current assets of a business over

its current liabilities is called net working capital (NWC). The net working capital is often used in evaluating a company’s ability to meet currently maturing debts.

Net working capital is the difference between current assets and current liabilities:

net working capital = current assets – current liabilities

When current assets exceed current liabilities, net working capital is positive. When current assets are much larger than current liabilities, businesses are better able to pay current liabilities. Businesses with large amounts of net working capital usually find it easier to borrow money, because lenders feel assured that these businesses will have the means to repay their loans.

When net working capital is negative, a company might not be able to pay short term creditors, and the company might ultimately be forced into bankruptcy. Many businesses set up NWC credit lines to make sure they don’t run out of cash at a critical point. Calculate the NWC of Arçelik Company for the year 2015:

9.406.252 - 5.236.297 = 4.169.955 Turkish LiraAs you realize we got the numbers from the

balance sheet illustrated above. NWC of Arçelik is positive. It means Arçelik has the ability to pay its short term debts by using its current assets.

As we mentioned above liquidity ratios will be used to evaluate the company’s short term debt paying ability. Most commonly used liquidity ratios are current ratio and quick ratio (acid test ratio).

Current ratioThe current ratio is closely related to working

capital; it is another way of expressing the relationship between current assets and current liabilities. The current ratio (CR) is used to assess a company’s ability to pay current liabilities as they become due. The current ratio helps investors and creditors understand the liquidity of a company and how easily that company will be able to pay off its current liabilities. It is computed as current assets divided by current liabilities:

current ratio = current assets / current liabilities

If current ratio is more than 1, it indicates a positive status for the creditors. A higher current ratio less risk for those who lend money. If the current ratio is less than 1, it indicates that the company has a negative net working capital.

Liquidity is a firm’s ability to meet short-term obligations. The greater the level of current assets available relative to current liabilities, the greater the firm’s liquidity.

Net working capital (NWC) is the excess of the current assets of a business over its current liabilities.

The current ratio (CR) measures the ability of the firm to pay its current liabilities.

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Generally, the higher the current ratio, the greater the safety margin between current obligations and the ability to pay them. A very low current ratio, of course, can be unfavorable, indicating that a company will not be able to pay its debts on time. Generally, we don’t want to current ratio too low or too high, because if CR is too low, company may not pay own current liabilities. Also, if the CR is too high, company may not be investing short term resources in longer term investments that earn higher returns.

Now, we can calculate the current ratio of Arçelik Company for the year 2015.

9.406.252 / 5.236.297 = 1,8 times You can estimate that Arçelik’s current ratio

will be higher than 1, because NWC is positive. 1,8 means the company’s current assets can pay its short term liabilities 1,8 times. After payment of the short term liabilities, company has some current assets to continue its daily operations. According to current ratio, we can say company has good position because they can pay their short term liabilities easily in 2015.

Quick ratio (Acid test ratio)The quick ratio (acid test ratio) is a liquidity

ratio that measures the ability of a company to pay its current liabilities with most liquid assets. The quick ratio is similar to the current ratio, but it’s a tougher measure of liquidity than the current ratio, because it excludes inventories.

Inventory may not be easily converted into cash and therefore may be excluded when assessing liquidity. Inventory is excluded because some companies have difficulty turning their inventory into cash. Quick ratio is used to see the dependency of the company on its inventories to pay its short term debts. The quick ratio is more conservative than the current ratio, a more well-known liquidity measure, because it excludes inventory from current assets.

quick ratio = (current assets – inventory) / current liabilities

or quick ratio is calculated by adding cash, cash equivalents, short-term investments, and current receivables together that can easily be converted into cash. The formula:

quick ratio = (cash + marketable securities +accounts receivable) / current liabilities

Generally, the quick ratio should be lower than the current ratio, because the inventory figure drops from the calculation. A higher ratio correlates to a higher level of liquidity. This usually corresponds to better financial health. In the event that short-term obligations need to be paid off immediately, there are situations in which the current ratio would overestimate a company’s short-term financial strength.

Let’s calculate the quick ratio of Arçelik for the year 2015:

quick ratio (acid test ratio) = (9.406.252 - 2.140.057) / 5.236.297 = 1,4 times

The result of quick ratio shows that even the company faces problems to sell its inventory, it has still ability to pay its short term liabilities as 1,4 times. As we can understand from the results, the quick ratio is very close to the current ratio because amount of inventory is not a very high portion in total current assets. In other words, the company is not depending on the inventory to be able to pay its short term debts. So the result of quick ratio is satisfactory in terms of short term debt paying ability. The company can pay its short term debts quickly.

Calculate and explain the meaning of current ratio of Arçelik Company for the year 2014.

7

The quick ratio measures a company’s ability to meet its short-term obligations with its most liquid assets.

The quick ratio excludes inventory from current assets.

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Measures of Efficiency Efficiency ratios (Activity ratios) measure

how efficiently a firm manages its assets. Efficiency ratios use turnover measures to show how efficiently a company operates and uses its assets.

Efficiency ratios are meaningful only when comparing with other firms in the industry or a company’s prior turnover ratios.

Accounts receivable turnover and average collection period (ACP)

The accounts receivable turnover ratio measures how many times a business can collect its average accounts receivable during the year. It measures the ability of a company to efficiently issue credit to its customers and collect funds from them in a timely manner. Since the receivables turnover ratio measures a business’ ability to efficiently collect its receivables, if only makes sense that a higher ratio would be more favorable.

Higher ratios mean that companies are collecting their receivables more frequently throught the year and it indicates a combination of a conservative credit policy and an aggressive collections department, as well as a number of high-quality customers. Increasing turnover in accounts payable over a period of time, generally indicates improvement in the process of cash collection on credit sales. However, a normal level of receivables turnover differs depending on the industy. Also, very high values of this ratio may not be favorable, if achieved by extremely strict credit terms since such policies may repel potential buyers.

Accounts receivable turnover is calculated by dividing net sales by the average accounts receivable for that period.

accounts receivable turnover = net sales / average accounts receivable

The accounts receivable turnover ratio as a 3,07 for Arçelik, the company can collect its receivables 3,07 times in a year.

accounts receivable turnover = 14.166.100 /(( 4.790.525 + 4.433.898)/2)

= 3,07 timesIf the company can collect 3,07 times in a year

it means they have to wait 117 days to collect their receivables. So, in order to decide about the company’s collection ability, you can use whether the accounts receivable turnover ratio or the Average Collection Period ratio. Actually they are different ratios but both of them will provide same information about company’s credit policy and efficiency of receivebles. Let’s calculate the average collection period ratio.

The average collection period measures the average number of days it takes for a company to collect revenue from its credit sales. The average daily sales are the 360 divided by trade receivable turnover ratio in the year

The average collection period = 360 / 3,07 = 117 days

Lower average collection period ratio is favorable because it shows company can collect cash earlier from customers. This shows that the company is not giving out interest free loans to customers for long periods of time. A low ACP also reduces the risk of default. Comparing this measure with the credit terms provides information on the efficiency in collecting receivables. When management takes too long to collect cash from customers, they will have difficulty paying own suppliers.

Efficiency (activity) ratios measure how efficiently a company operates and uses its assets.

The accounts receivable turnover ratio shows how quickly a company converts accounts receivable into cash.

The average collection period (ACP) measures the average number of days it takes for the company to collect revenue from its credit sales.

The result of accounts receivable turnover ratio is number of times; the result of the average collection period ratio is number of days.

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Asset turnoverFirms prefer to support a high level of sales

with a relatively small amount of assets so that they efficiently utilize the assets they invest in. Firms that maintain excess assets indicate that they are not investing their funds wisely.

The asset turnover ratio is calculated by dividing net sales by average total assets. It shows how efficiently a company can use its asset to generate sales. The asset turnover ratio can be calculated:

asset turnover = net sales / total assetsThe total assets turnover ratio measures a

firm’s ability to generate sales from a particular level of investment in assets, or alternatively, to control the amount of assets it uses to generate a particular level of sales. Low asset turnover means that the company does not use its assets efficiently. It can have idle capacity.

Inventory turnover (IT) and days of inventory outstanding

A business should keep enough inventory on hand to meet the needs of its customers and its operations. At the same time, however, an excessive amount of inventory reduces solvency by tying up funds. Excess inventories also increase insurance expense, property taxes, storage costs, and other related expenses. These expenses further reduce funds that could be used elsewhere to improve operations. Finally, excess inventory also increases the risk of losses because of price declines or obsolescence of the inventory.35

The inventory turnover is a ratio showing how many times a company’s inventory is sold and replaced over a period of time. It shows how often a company replaces its inventory. The more times the inventory is sold and replaced during the year, the more likely the company is to be successful. But don’t forget, the turnover ratio is meaningful only when comparing with other firms in the industry or a company’s prior turnover ratios.

It is computed by dividing the cost of goods sold by the average inventory.

inventory turnover = cost of goods sold / average inventory

This calculation uses the cost of goods sold figure as the numerator, since inventories are usually carried at cost.

In general, high inventory turnover ratio indicates better performance and shows that a company can sustain sales volume. Because inventories are the least liquid form of current asset, a high inventory turnover ratio is generally positive. On the other hand, if the ratio is unusually high compared with the average for your industry could mean you are losing sales because inventory shortage. A lower value means inefficiency in controlling inventory levels. A lower turnover implies weak sales and, therefore, may be an indication of over-stocking which may pose risk of obsolescence and increased inventory holding costs.

Days of inventory outstanding measures the number of days it will take a company to sell all of its inventory.

Let’s calculate the the inventory turnover ratio and days of inventory outstanding for Arçelik.

inventory turnover = 9.630.207 / ((2.140.057 + 2.124.946)/2)

= 4,5 timesdays of inventory outstanding = 360 / 4,5 =

80 daysThe inventory turnover ratio measures how

many times, on average, inventory is sold during the year. Inventory turned over 4,5 times in 2015; it means that Arçelik sells its entire inventory within 80 days’ period.

The asset turnover ratio is an efficiency ratio that measures a company’s ability to generate sales from its assets by comparing net sales with average total assets.

Inventory turnover ratio shows how many times a company’s inventory is sold and replaced over a period of time.

Firms must consider the optimum level of inventory.

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Measures and Evaluation of Long-Term Solvency

Long-term solvency is about a company’s ability to survive for many years in financial terms. Solvency analysis evaluates the ability of a company to pay its long-term debt and the interest on that debt.

Firms that borrow a large proportion of their funds, have a high degree of financial leverage. Increasing amounts of debt in a company’s capital structure means that the company is becoming more heavily leveraged. Financial leverage represents the degree to which a firm uses borrowed funds to finance its assets. This can favorably affect the firm’s owners when the firm performs well, because the earnings generated by the firm can be spread among a relatively small group of owners. When the firm experiences poor performance, however, a high degree of financial leverage is dangerous. Firms with a high degree of financial leverage incur higher fixed financial costs (interest expenses) that must be paid regardless of their levels of sales. These firms are more likely to experience debt repayment problems and therefore are perceived as

having more risk. Conversely, firms that obtain a larger proportion of funds from equity financing incur smaller debt payments and therefore have less risk.36

Solvency ratios, also called leverage ratios, measure a company’s ability to sustain operations indefinitely by comparing debt levels with equity, assets, and earnings. Solvency ratios show a company’s ability to make payments and pay off its long-term obligations to creditors, bondholders, and banks. Better solvency ratios indicate a more creditworthy and financially sound company in the long-term.

Debt-to-total assets ratioThe debt-to-total–assets ratio measures the

percentage of total financing provided by creditors. It measures a company’s total liabilities as a percentage of its total assets. Debt financing is riskier than equity financing because debt must be repaid at specific points in time, whether the company is performing well or not. Thus, companies with higher levels of liabilities compared with assets are considered highly leveraged and riskier for lenders.

The debt to total assets ratio is computed by dividing total debt (both current and long-term) by total assets.

debt-to-total assets ratio = total liabilities / total assets

The higher the percentage of debt to total assets, the greater the risk that the company may be unable to meet its maturing obligations. The lower the ratio, the more equity “buffer” is available to creditors if the company becomes insolvent. Thus,

Calculate and explain the meaning of Inventory turnover ratio of Arçelik Company for the year 2014.

8

Financial leverage represents the degree to which a firm uses borrowed funds to finance its assets.

The debt-to-total-assets ratio measures the percentage of total financing provided by creditors.

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from the creditors’ points of view, a low ratio of debt to total assets is desirable.

debt-to-assets ratio = 5.236.297 + 3.826.374 / 13.738.508

= 66%To start with, debt to asset ratio indicates the

proportion of a company’s assets that are being financed with debt, rather than equity. Arçelik’s debt to asset ratio is 66% in 2015. The meaning of this percentage, Arçelik financed about 66% of assets with its liabilities. In other words, Arçelik financed about 34% of assets with its equity. Therefore, Arçelik’s total liability amount is more than total equity amount. It means that there can be financial risk for Arçelik, so it can be signal for a weakness in solvency.

Debt-to-equity ratioA measure of the amount of long-term financing

provided by debt relative to equity is called the debt-to-equity ratio. This ratio measures the percentage of debt tied up in the owner’s equity. Generally, this calculation uses only long-term debt

debt-to-equity ratio = long-term debt / total equityA higher debt to equity ratio indicates that more

creditor financing (bank loans) is used than investor financing (shareholders). Highly leveraged companies are usually more vulnerable to business downturns than those with lower debt-to equity ratios.

If debt is risky, why have any? By using the other’s money, we can increase the company’s profitability. We call it as a financial leverage effect.

Despite its riskiness, debt is a flexible tool of financing business operations. The interest paid on debt is tax-deductible, whereas dividends on stock are not. Because debt usually carries a fixed interest charge, the cost of financing can be limited, and leverage can be used to advantage. If a company can earn a return on assets greater than the cost of interest, it makes an overall profit. However, the company runs the risk of not earning a return on assets equal to the cost of financing the assets, thereby incurring a loss.37

Times interest earnedTimes interest earned, sometimes called the

interest coverage ratio, measures a firm’s ability to cover its interest payments. This ratio shows how many times the interest expenses are covered by the net operating income, income before interest and tax, of the company. It is computed by dividing income before interest expense and income taxes by interest expense.

times interest earned = earnings before interest and taxes (EBIT) / annual interest expense

The higher the times interest earned, the more likely the firm can meet its obligations.

Measures and Evaluation of Profitability

Investors and creditors are interested in evaluating not only a company’s liquidity and solvency, but also its profitability. Profitability is company’s ability to earn a satisfactory income.

Profitability ratios measure the income or operating success of an enterprise for a given period of time. A company’s income, or the lack of it, affects its ability to obtain debt and equity financing, its liquidity position, and its ability to grow. As a consequence, creditors and investors are interested in evaluating profitability. For analyzing profitability, we mainly focus on the income statement. Remember, we classify the income statement according to the sales, operating profit, income after tax amount or net income, and if there are any unusual gains or losses.

Gross profit margin (GPM)To start with, the most important part of the

income statement is the first section which consists of sales and cost of the sales. The difference between sales revenue and cost of goods sold (COGS) is the gross profit of the company.

gross profit margin = (sales – cost of goods sold) / sales

A measure of the amount of long-term financing provided by debt relative to equity is called the debt-to-equity ratio.

Profitability ratios measure the income or operating success of an enterprise for a given period of time

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Gross profit margin indicates the percentage of revenue available to cover operating and other expenditures. A high GPM suggests that the firm has good cost management controls of its operations. A high GPM also indicates that a business can make a reasonable profit on sales, as long as it keeps overhead costs in control. If business is slow and profits are weak, a high margin could indicate overpricing. A low GPM, especially relative to industry norms, could indicate underpricing. As an industry becomes more competitive, this ratio declines. In general, the GPM should be stable, not fluctuating much from period to period, unless the industry has been undergoing changes that affect the costs of goods sold or pricing policies.

Operating profit margin (OPM)Operating profit also known as earnings before

interest and tax (EBIT) is a part of a company’s income statement. The operating profit margin is an important indicator of the company’s earning power from its current operations. Operating profit is any income directly related to the operations of the business. The operating profit margin (OPM) is a measure of overall operating efficiency and incorporates all of the expenses associated with ordinary business activities.

operating profit margin = operating income / sales

Like GPM, the higher the OPM, the more pricing flexibility a company has in its operations. This pricing flexibility provides greater safety during tough economic times. A higher OPM could also be a sign of the degree of cost control management.

Net profit margin (NPM)Net profit margin shows how much of each

sales amount shows up as net income after all expenses are paid. Net profit margin is calculated by net income dividing by sales revenue.

net profit margin = net income / sales

Net profit margin measures profitability after consideration of all revenues and expenses, including interest, taxes, and non-operating items. It also indicates how well the company converts sales into profits after all expenses are subtracted. A higher net profit margin means that a company is more efficient at converting sales into actual profit. The higher the profit margin, the more pricing flexibility a firm may have in its operations or the greater cost control initiated by management.

Return on assets (ROA)The return on assets ratio measures the overall

profitability of assets in terms of the income earned on each dollar invested in assets. It is computed by dividing net income by average total assets.

return on assets =net income / total assetsThe ROA provides a broad measure of a firm’s

performance. ROA gives an idea as to how efficient management is at using its assets to generate earnings. The higher ROA means that assets are used efficiently.

The difference between sales revenue and cost of goods sold (COGS) is the gross profit of the company.

Gross profit and gross profit margin have different meanings.

The operating profit margin (OPM) is a measure of overall operating efficiency and incorporates all of the expenses associated with ordinary business activities.

Net profit margin measures profitability after consideration of all revenues and expenses, including interest, taxes, and non-operating items.

The return on assets ratio measures the overall profitability of assets.

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Return on equity (ROE)Return on equity (ROE) is about the

profitability of the owners’ equity. Of course, owners are interested in how much they have earned on their investment in the business. This ratio shows how much net income the company earned for each dollar or Turkish lira invested by the owners. It measures how much profit each dollar or lira of owners’ equity generates.

return on equity = Net Income / Owners’ equityThe higher ROE will increase the wealth of its

owners. The benefit comes from earnings reinvested in the company at a high return on equity rate that in turn gives the company a high growth rate. This ratio has to be used carefully because ROE can be high if a company is heavily leveraged. Using high levels of financial leverage can increase ROE,

because less equity will be used and the net profit will be distributed among fewer shareholders.

In this chapter, we briefly introduced accounting and financial analysis, as main business activities. The details will be explained through a variety of accounting and finance courses in the following semesters. Remember, the importance and scope of accounting and financing functions change according to the size and the resources of the business entity.

The financing function of a business will be explained also briefly in the next chapter.

Return on equity (ROE) shows how much net income the company earned for each dollar invested by the owners.

Turkish SMEs’ Use of Financial Statements for Decision Making

“With a sample of 91 small Turkish firms, this study examines the factors that affect the use of financial statements, and the important information they contain, to make decisions. A principal components analysis identifies three key variables that determine the use of financial statements: experience, confidence, and knowledge. .….

The analysis provides three main findings: Owners of Turkish SMEs who use financial statements to make decisions (1) are more experienced than those who do not use financial

statements to make decisions, (2) have more confidence in their financial statements than those who do not use financial statements to make decisions, and (3) have greater knowledge about financial statements than owners who do not use financial decisions to make decisions.” ….Source: Vanauken, H. E., Ascigil, S., & Carraher, S. (2016). Turkish SMEs’ use of financial statements for decision making. The Journal of Entrepreneurial Finance 19 (1).Retrieved at http://digitalcommons.pepperdine.edu/jef/vol19/iss1/6

Further Reading

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Uniform Chart of AccountsThe introduction of the Uniform Chart

of Accounts as of 1 January 1994 marks the beginning of a new era for Turkish accounting practice. The Communiqués introduced by the Ministry of Finance on the Uniform Chart of Accounts regulate the basic concepts and principles of accounting in addition to providing a guideline for the preparation and presentation of financial statements.

This regulation primarily aims at ensuring a true and fair reflection of the operations and results of companies by imposing common criteria for the accounting of each and every transaction as well as their conclusive presentation. Basic concepts of accounting are as follows:

1. Social responsibility concept2. Entity concept3. Going concern concept4. Cut-off concept5. Monetary unit concept6. Costing concept7. Objectivity concept8. Consistency concept9. Full disclosure concept10. Prudence concept11. Materiality concept12. Substance over form concept

Purposes of financial statements • Toprovideusefulinformationinthe

decision making process of investors, creditors and other related parties.

• Toprovideusefulinformationtoevaluatefuture cash flows.

• Toprovideinformationonassets,liabilities,change in such items and operating results.

Characteristics of information in the financial statements

In order to help the decision maker, understand financial statements easily and quickly, they should be comprehensive, appropriate to needs, reliable, comparable, and be timely prepared and presented.The framework of the Uniform Chart of Accounts

Companies are required to establish their accounting systems according to the framework of the uniform chart of accounts. Discuss:

1) Explain the basic accounting concepts. Why accounting concepts are important in financial reporting?

2) How can you record the transactions in this chapter according to the Turkish Uniform Chart of Accounts? (Search for the full list of chart of accounts and journalize the transactions by using code numbers)

In Practice


260

LO 1 Defining accounting and relevant terms

Accounting organizes and summarize financial information so decision makers can use it. All the data related to economic events and transactions must be collected, categorized, summa-rized and analyzed in order to convert to financial information helpful to decision makers. Accounting consists of three basic activities—it identifies, records, and communicates the eco-nomic events of an organization to interested users.

Bookkeeping is the recording of a firm’s financial transac-tions. Bookkeeping is the act of recording and organizing of financial transactions in the accounting system in accordance with the generally accepted accounting principles (GAAP). It ensures that records of the individual financial transactions are correct, up-to-date and comprehensive. Today bookkeeping is done with the use of computer software.

LO 2 Identify the users of accounting information

Users of accounting information can be divided broadly into two groups: internal users and external users. Internal users of acco-unting information are managers who plan, organize, and run a business. These include marketing managers, production super-visors, finance directors, and company officers. There are several types of external users of accounting information. The informati-on needs and questions of external users are very different.

LO 3 Describing and distinguishing the areas of accounting

The two most common accounting areas are financial accoun-ting and managerial accounting. Other fields include cost acco-unting, environmental accounting, tax accounting, accounting systems, international accounting, not-for-profit accounting, and social accounting.

Financial accounting focuses on reporting to external par-ties such as stockholders, investors, governmental agencies, cre-ditors, banks, and suppliers.

Managerial accounting is concerned with providing infor-mation to internal decision makers, such as the company’s ma-nagers. Managerial accounting uses both financial accounting and estimated data to aid management in running day-to-day operations and in planning future operations.

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LO 4 Describing the profession of accounting

Accountants can be classified as private and public accoun-tants. Private accountant works for a business firm in any posi-tion not included in public accounting. Accountants and their staff who provide services on a fee basis are said to be employed in public accounting.

In Turkey, the profession was largely self-regulated under the Law on Certified Public Accountancy (CPA) and Sworn-in Certified Public Accountancy (Law No. 3568). The Law defines accounting and auditing as a profession. Accordingly, accountants who have been awarded a license by Union of Chambers of Certified Public Accountants (TÜRMOB) are entitled to render professional services.

LO 5 Understanding the recording process

An accounting system is a composition of methods and pro-cedures for collecting, classifying, summarizing, and reporting a business’s financial and operating information. Accounting systems must effectively collect, accumulate, and report the companies’ transactions.

The accounting cycle is a set of steps that are repeated in the same order every period to keep track of what happened in the business and to report the financial effect of those transac-tions.

Accounting relies on a system of accounts, with the name or title of each account intended to capture the nature of the items in the account. An account is a detailed record of increases and decreases in a specific asset, liability, or owner’s equity item. Companies will prepare financial statements at the end of each period by using the balance of accounts.

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LO 6 Identifying the content and purpose of the basic financial statements

The most important financial statements are the balance sheet, the income statement, and the cash flows statement.A balance sheet, or statement of financial position, is a financial statement that reports a business’s assets, liabilities, and equity on a specific date. This relationship is described by the follo-wing basic accounting equation:Assets = Liabilities + Owner’s Equity

An income statement presents the revenues and expenses of a company for a specific period of time. Net income is measu-red as the difference between revenues and expenses:Net Income = Revenues - Expenses

The statement of cash flows reports the net increase or dec-rease in cash during the period and the ending cash balance.

LO 7 Explaining and understanding the financial statement analysis

The basic financial statements provide much of the informa-tion users need to make economic decisions about businesses. Financial ratios provide a quick and relatively simple means of assessing the financial health of a business.

Liquidity refers to a firm’s ability to meet short-term ob-ligations. Liquidity ratios give a picture of a company’s short-term financial solvency. Efficiency (activity) ratios show how efficiently a company operates and uses its assets. Debt ratios show to what extent and how well a company uses borrowed funds to finance its operations. Profitability ratios use various profit margin analyses to show return on sales and capital, as a measure of how well a company is using its resources to gene-rate profits

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Test yourself

1 What are the three basic activities of accounting?

a. Identifying, recording, and communicatingb. Evaluating, recording, and identificationc. Evaluating, managing, and financingd. Social responsibility reporting, identifying, and

comparinge. Operating efficiency, recording efficiency, and

ethical issues

2 “Accounting is the means by which business information is communicated to the all information users.” Based on this signification, which of the follo-wing describes the accounting in the proper content?

a. Accounting is “the hidden face of business.” b. Accounting is “the books of business.”c. Accounting is “the language of business.” d. Accounting is “the heart of business.”e. Accounting is “the hidden figures of business.”

3 Which one is the act of recording and organizing of financial transactions in the accounting system in accordance with the generally accepted accounting principles (GAAP)?

a. Controlling b. Bookkeepingc. Analyzing d. Closing e. Decision making

4 Which of the following users is an internal information user?

a. Creditors b. Taxing authorities c. Middle level managersd. Customers or clients e. Current and prospective investors

5 Which area of accounting is concerned with providing information to internal decision makers?

a. Financial accounting b. Corporate governancec. Auditingd. Managerial accountinge. Bookkeping

6 Which was established with the authority to set and to issue Turkish Accounting and Financial Reporting Standards (TASs and TFRSs) that are in full compliance with IFRS Standards and to deter-mine the application scope of those standards?

a. Chambers of Sworn-in CPAs b. Union of Chambers of Certified Public Acco-

untants of Turkey c. Public Oversight, Accounting and Auditing

Standards Board of Turkeyd. The Capital Markets Board of Turkeye. Banking Regulation and Supervision Agency

7 Which transactions below will be recorded chronologically?

a. The income statement b. The balance sheetc. Trial balance d. The ledger e. The journal

8 Which transaction is recorded in the following journal entry?


May1,2017 CASHEQUIPMENT

30.00050.000

CAPITAL 80.000

a. In May 1, 2017, the owner invested $30.000 cash and an equipment its value is $50.000 in order to establish the business.

b. In May 1, 2017, the owner invested $30.000 cash and purchased an equipment its value is $50.000.

c. In May 1, 2017, the company purchases equip-ment, paying cash of $30.000.

d. In May 1, 2017, the company buys equipment on account (credit), agreeing to pay $50.000 within 60 days.

e. In May 1, 2017, the company buys equipment $50.000 on cash but the remainder is paid by using capital.


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Test

you

rsel

f

If your answer is incorrect, review “Definition of accounting”.

1. a If your answer is incorrect, review “Governing organizations”.

6. c

If your answer is incorrect, review “Definition of bookkeeping”.

3. b If your answer is incorrect, review “The recording process illustrated”.

8. a

If your answer is incorrect, review “Definition of accounting”.

2. c If your answer is incorrect, review “The accounting cycle”.

7. e

If your answer is incorrect, review “Internal users”.

4. c

If your answer is incorrect, review “Managerial accounting”.

5. d

If your answer is incorrect, review “Measures and evaluation of liquidity”.

9. b

If your answer is incorrect, review “The balance sheet”.

10. e

9 Which ratio measures the ability of the firm to pay its current liabilities?

a. Average payment period (APP) b. Current ratio c. Asset turnover d. Debt-to-equity ratio e. Gross profit margin (GPM)

10 Which one below will report a business’s assets, liabilities, and equity on a specific date?

a. The profit or loss statement b. The income statement c. The statement of cash flows d. Non-current assets e. The balance sheet

Ans

wer

s fo

r “T

est y

ours

elf”


265

Where can you find financial information about a

company?

Your turn 1

Financial information of companies can be obtained through a variey of sources. Companies will prepare and publish their financial statements in order to communicate with decision makers. Financial statements are reliable sources for evaluating companies’ financial condition. So you can use their financial statements to get information about their financial conditons.

Your turn 2

If you want to be one of the owner or shareholders of company, you will invest your own money or other assets in the company for an unlimited time to earn profit. But especially in fluctuated circumstances the company’s ability to earn profit will be uncertain. Therefore, profitability of the company will be one of the most critical issues for the success of an investment. Consequently, the profitability and earning power of the company will be one set of information to seek for.

Give an example for a type of information that will be important

if you want to invest in a company as a shareholder (owner).

Your turn 3

The financial statements are communication tools between a company and external users. External information users are not inside the company even its owners (unless owners are managers) and they can not directly access the information. They have to use published financial statements. Financial statements must report the true picture of a company. If independent third parties approve the correctness of financial statements, then these statements are assessed as realiable sources which can be used in decision making processes.

The financial statements of company must be audited, why?

Your turn 4

Accounting equation: Assets = Liabilities + Owners’ Equity If a company borrows money from a bank, company’s cash will increase. Cash is an asset meaning that the asset side of the equality will increase. In this case, the company borrowed money for a limited time, only for 3 months, so at the due date company must pay back the loan. It means company’s debt is increasing and debts are parts of liabilities so right side of equality will also increase the same amount.

A company borrowed money from the bank for 3 months. Show

the effects of this transaction on the accounting equation.

Suggested answ



266

Sug

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ed a

nsw

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for

“You

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rn”

Explain what an account is and how it helps in

the recording process.

Your turn 5An account is a record of increases and decreases in specific asset, liability, and owner’s equity items. Each one of the items that will be reported in the financial statements must be followed in a separate journal, because financial statements will be prepared by using tha balance of each account.

Your turn 6

A classified balance sheet groups together similar assets and similar liabilities, using a number of standard classifications and sections. This is useful because items within a group have similar economic characteristics.

Assets that management expects to convert to cash, or to sell, or to consume during the normal operating cycle of the business are current assets. To understand the company’s ability to continue to the daily activities and operations we must see the asset items that are related to operating activities like cash, inventories. They will be consumed or used in short term and we have to report them as current assets. All other assets are noncurrent assets. Non current assets’ usefelness will continue for the longer time, at least longer than one year and they are not vary as liquid items, therefore we must report as different section on the balance sheet.

Explain the necessity of classifying the assets as current and

non-current.

Your turn 7

To calculate the current ratio of Arçelik Company for the year 2014 we have to look at the Balance Sheet (Statement of Financial Position) of 2014. In the Balance Sheet you will see the current asset and current liabilities. Calculation is:8.471.757 / 4.430.803 = 1,9 times

Current ratio for 2014 is 1,9 times. Arçelik can pay its short term debts 1,9 times by using its current assets. There is no risk for short term creditors. Also Arçelik has Net Working Capital, because current ratio is higher than 1; it means the company can continue its daily operations after payment of current liabilities.

Calculate and explain the meaning of current ratio of Arçelik

Company for the year 2014.

Your turn 8

Actually to calculate the inventory turnover ratio we should use average inventory amount. If you paid attention in previous sections, for calculating the inventory turnover for 2015, we used the average inventory amount. Therefore, for calculating the mentioned ratio we need to obtain data from 2013 balance sheet of the company.

Calculate and explain the meaning of inventory turnover

ratio of Arçelik Company for the year 2014.


267

1 Horngren, C. T., Harrison, W. T., & Oliver, M. S. (2012). Accounting (9th ed.). Prentice Hall, p. 3.

2 Harrison, W. T., Horngren, C. T., Thomas, W., & Suwardy, T. (2014). Financial Accounting: International Financial Reporting Standards (9th ed.), Global Edition. Pearson Educated Limited, p. 4.

3 Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2009). Accounting Principles (9th ed.). John Wiley & Sons, p. 5.

4 Ibid.5 Harrison, et. al., op.cit., p.10.6 Kimmel, P. D., Weygandt, J. J., & Kieso, D. E.

(2009). Financial Accounting: Tools for Business Decision Making (5th ed.). John Wiley & Sons, Inc., p. 6.

7 Horngren, C. T., Srikant, M. D., & Rajan, M. V. (2012). Cost Accounting: A Managerial Emphasis (14th ed). Pearson Education, Inc., p. 3.

8 Kimmel, et. al., op. cit.9 Horngren, et. al., op. cit.10 Ibid.11 Kimmel, et. al., op. cit.12 Ibid., p. 7.13 Webster, W. H. (2004). Accounting for Managers.

McGraw-Hill, p. 6.14 Monger, R. (2010). Financial Accounting: A Global

Approach. John Wiley & Sons, Inc., p. 7.15 Horngren, et. al., op. cit.16 Weygandt Jerry J., Kimmel, P. D., & Kieso, D. E.

(2009). Accounting Principles (9th ed.). John Wiley & Sons, Inc.,p. 29.

17 Horngren, et. al., op.cit., p. 4.18 Warren, Carl S., James M. Reeve, & Duchac,J. E.

(2007). Accounting (22th ed.). South-Western, Cengage Learning, p. 9.

19 Weygandt, et. al., op. cit., p. 29. 20 Warren, et. al., op. cit., p. 9.21 https://www.ifac.org/about-ifac/membership/country/

turkey22 https://www.ifac.org/about-ifac/membership/country/

turkey.23 https://www.ifac.org/about-ifac/membership/country/

turkey.24 Harrison, W. & Horngren, C. T. (2008). Financial

Accounting (7th ed.). Pearson, p. 6.25 https://www.ifac.org/about-ifac/membership/country/

turkey26 Harrison & Horngren, op. cit.27 Madura, J. (2007). Introduction to Business (4th

ed.). South-Western, Cengage Learning, p. 572.28 Stickney, C. P., Weil, R. L. & Schipper, K. (2010).

Financial Accounting: An Introduction to Concepts, Methods, and Uses (13th ed.). South-Western, Cengage Learning, p. 43.

29 Ibid., p. 52.30 Monger, op. cit.31 Needles, B. E. & Powers, M. (2007). Financial

Accounting (9th ed.). Houghton Mifflin, p. 158.32 Stickney, et. al., op. cit., p. 184.33 Warren, et. al., op. cit., p. 692.34 Stickney, et. al., op. cit., p. 244.35 Warren, et. al., op. cit., p. 752.36 Madura, op. cit., p. 582.37 Needles, op. cit., p. 726.

endnotes

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Chapter 8 Managing Financial Resources

Lear

ning

Out

com

es

Explain the significance of short-term-financial planning.

Distinguish most widely used techniques in the capital budgeting process.

Discuss how financial decisions influence shareholder value.

Identify main decision fields of business finance. Describe main functions of financial markets.

Understand the roles of basic tools used in long-term financing.

Describe risk and distinguish various types of financial risks.

Explain why ethics is important in finance.

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1 2468

Chapter OutlineOverview of Business FinanceFinancial Markets Short-Term Financial ManagementLong-Term FinancingCapital Investment DecisionsFinancial Risk ManagementShareholder Value ManagementEthics in Financial Management

Key TermsCapital structure

Capital budgetingEconomic profit

BudgetCorporate governance

Enterprise risk managementWorking capital


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In the new millenium, we have been experiencing enormous advances in technology and communication systems which generate new opportunities and challenges for businesses all over the world. In today’s business world, companies have to struggle in highly competitive markets to achieve their goals and be successful. These goals include surviving, growing, making profits, and increasing market share in the industry they are operating. Above all, the ultimate goal of businesses is to maximize the wealth of the owners or investors of the business. In other words, business managers concentrate their efforts on increasing the wealth of shareholders through value creation. As the performance of a business is expected to be reflected in the stock price, the shares of successful companies tend to appreciate and provide capital gains for investors. Moreover, profitable companies can also provide dividend gains for their shareholders, if they distribute some of their profits to the shareholders in the form of dividends. Thus, managerial decisions influence the performance of companies and creation of value or wealth for the shareholders.

In fact, managers can be thought of as agents of owners of a company. The shareholders in a way act as the principal owners who delegate the management of the business to professional executives. As a result, managers undertake major strategic and daily operational decisions on behalf of the owners of a company, and they must work to serve the best interest of the shareholders. Hence, they must manage the resources of the company efficiently and effectively to enhance the goal of shareholder value maximization. During the value creation process, business managers must undertake a wide variety of business decisions. All decisions involve trade-offs meaning some benefits can be achieved only at the expense of some costs. Business decisions must be carefully evaluated to consider the benefits and costs associated both in the short and long-terms. Effective decisions should support the long-run performance of a business rather than the short-term achievements.

OVERVIEW OF BUSINESS FINANCE

Business finance is one of the main fields of decision making for business managers. Business finance focuses on decisions such as whether to invest in a new factory building; to borrow from a bank; to finance the purchase of a machine; and what percentage of the profit should the company distribute as dividends.

Business finance decisions are related to the resources of a business and they can be grouped as investment decisions, financing decisions and operating decisions as shown in Figure 8.1:1

• InvestmentdecisionsMaking sound investment choices in line with

business strategies and economic analysis.• FinancingdecisionsSelecting the optimum mix of internal and

external funds to finance the investments of the business.

• OperatingdecisionsEmploying the resources of the business to

efficiently generate profits.

Business finance comprises decisions of businesses which are basically related to investment and financing of assets of a business.

InvestmentDecisons

FinancingDecisons

OperatingDecisons

Figure 8.1 Business Finance Decisions

When businesses manage financial decisions effectively, they can improve the overall results of their activities and the value creation process.

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8 Managing Financial Resources

Investment DecisionsIn order to carry out their activities and accomplish their goals in line with their strategies, businesses

must own some resources, as also explained in Chapter 7. To invest in these resources, managers must make careful analyses as they allocate funds for these resources. Investment decisions mainly include decisions related to current assets, which can be converted into cash in a relatively short period, namely within one year; fixed assets, which can be converted into cash in a longer time of period, that is to say, in more than a year. In fact, current assets are more liquid assets. They are referred to as working capital which consists of investments such as cash, marketablesecurities,accountsreceivables,andinventory.Fixedassets,ontheotherhand,compriselessliquid investments such as land, building, machinery, equipment etc.

Since investment decisions influence how the funds of the business are engaged, they require cautious planning and implementation. Businesses usually establish capital budgets to plan for long-term investments.

Financing DecisionsFinancing decisions involve decisions about how much

profit to distribute as well as how to finance the resources of the company. As businesses invest in assets to carry on their operations, they must make decisions regarding how to finance these resources. The main sources of finance for companies can be grouped as:

• InternalFundsInternal funds are generated by retaining those profits

which are not distributed as dividends to the shareholders. These types of funds provide financing sources for the company to be reinvested in the business for growth. The retained earnings of the company become a part of equity and they provide equity financing.

• ExternalfundsExternal funds are provided from creditors; by

borrowing from financial institutions, by issuing bonds, or byissuingsharesofstock.Fundsprovidedbycreditorsintheformofbankloansorbondsissuedbythecompany convey debt financing, whereas funds provided through stock issues convey equity financing.

The combination of internal funds and external funds creates the financing structure, in other words the capital structure of the company. Companies strive to find the optimum capital structure that would maximize the profit of the company with an acceptable level of risk.

The best mix of debt financing and equity financing depends on the type of the industry in which the company operates and general economic conditions as well. Moreover, it depends on the following factors:

• Levelofriskthatmanagementcanbeassumedincaseofunpredictedevents.• Levelofearningstocovertheinterestpaymentsassociatedwithdebtfinancinganddividendpay-

mentsassociatedwithequityfinancing.

Current assets can be converted into cash in a relatively short period.

Fixed assets can be converted into cash in a longer time of period.

The combination of internal funds and external funds creates the financing structure, in other words the capital structure of the company.

Internal funds are generated by the profits which are not distributed as dividends to the shareholders.

External funds are generated by borrowing from financial institutions, by issuing bonds, or by issuing shares of stock.

Financing decisions involve decisions about how much profit to distribute as well as how to finance the resources of the company.

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• Levelofcontrolthatmanagementseekstomaintainasissuingnewsharesofstockbringsnewshareholderstothecompanywhohavevotingrightsasownersofthecompany.

• Costsofdebtfinancingandequityfinanc-ingatthetimeofcapitalstructuredecisions.

• Conditionsinthefinancialmarkets.Firmsattempttopursuethebestmixofdebtand

equity financing in theory. However, in practice, there is no magical formula to attain the optimum financing mix. Firmsusually make capital structure decisions on the basis of market timing, managers’ risk appetite, flexibility of management, and other factors.2

Operating DecisionsOperatingdecisions focuson the efficientuse

of resources to create competitive advantage in the market by developing effective and cost efficient systems and processes such as production, service, information, and technology. Businesses need to manage the cash flows and financing needs which arise from daily operations. Operating decisionsmainly affect the revenues, costs, and profits of the company. Business managers utilize budgets and economic analysis tools to evaluate operating decisions. Indeed, operational results provide information to assess the performance of the company, and they also provide information for future strategic decisions.

FINANCIAL MARKETSSince businesses operate within the financial

system of the economy, they interact with financial markets and institutions. Businesses cooperate with financial markets and financial institutions to implement appropriate financial decisions within the dynamics of business environment.

Some economic units (households, business firms, governments, and foreigners) spend more than they earn during a certain period. Revenues of these so-called saving-deficit units are not sufficient to cover their expenditures. On the other hand,some economic units earn more than they spend. Hence, revenues of these so-called saving-surplus units exceed their expenditures. Some mechanisms are needed to ease the flow of funds from surplus units to deficit units. Suppliers of funds and demanders of funds come together in financial markets to exchange savings or funds in return for financial claims or securities (Mishkin & Eakins, 2012).3

Capital structure decisions are made on the basis of market timing, managers’ risk appetite, flexibility of management, and other factors.

The financial manager of a company is considering how much of the net profit can be distributed to the stockholders as dividends and how much of the net profit can be retained in the company to be a part of equity. What type of finance decision is in considered by the financial manager?

1

http://www.borsaistanbul.com/en/home-pageinternet

Financial markets are institutions and procedures which facilitate the transfer of funds through financial transactions involving financial claims.

Stocks and bonds are most widely used financial securities in the financial markets.

The Borsa İstanbul is the sole exchange entity of Turkey.

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Functions of Financial MarketsFinancialmarketsservemanyrolesamongwhichare:4

• EfficientallocationofcapitalFinancialmarketshelpchannelfundsintoprofitableinvestmentsandboosteconomicgrowth• PricediscoveryPricesoffinancialassetsareformedinthemarketbytheinteractionofdemandandsupplyforthesesecurities. • LiquidityInvestors can sell their investments and turn them into cash in financial markets. • RiskSharingFinancial institutions such as commercial banks,

mutual funds, and pension funds create and sell assets with different risk characteristics for different type of investors.

Structure of Financial MarketsFinancialmarketscanbeclassifiedas:5

• Money markets:Marketswhereshort-termsecuri-tieslikecommercialpaperandtreasurybillsaretraded.

• Capital markets:Marketswherelong-termsecuritieslikebondsandstocksaretraded.

They can also be classified as:• Primary markets:Marketsinwhichsecuritiesare

offeredforthefirsttime.• Secondary markets:Marketsinwhichcurrently

outstandingsecuritiesaretraded.

Companies go public in primary markets through initial public offerings(IPOs).The annual ‘Best Initial Public Offering’ prize sponsored by Swedish East Capital, Europe’s leading investment company, was awarded to Halkbank in Turkey in 2007. Shares equivalent to 24.98% of the bank were sold for $1.849 billion. For the initial public offering of shares, the number of total requests both inside and outside Turkey amounted to 17.4 billion TL ($12.9 billion), a figure 8 times more than the volume of the initial public offering itself. Recently, Turkish fashion retailer Mavi Jeans announced its plans for the listing on Istanbul’s stock Exchange. Mavi Giyim’s initial public offering (IPO) bids were collected in June 2017 and trading is seen priced at 43-51 lira per share. (http://www.reuters.com/article/turkey-mavi-ipo-idUSI7N1II01F)

Financial institutions such as commercial banks, mutual funds, and pension funds create and sell assets with different risk characteristics for different type of investors.

Money markets include short-term securities like commercial paper and treasury bills.

Capital markets include long-term securities like bonds and stocks.

Stocks are traded in the capital markets since they have no maturity.

Identify the type of markets involved when you buy or sell shares of stock of a company listed at Borsa İstanbul.

2

Initial public offerings of shares of stock takes place in primary markets.

Currently outstanding securities are traded in secondary markets.

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SHORT-TERM FINANCIAL MANAGEMENTCompanies can generate more cash flows and value by managing their working capital efficiently.

Working Capital ManagementWorking capital includes current asset investments of the firm, which comprises assets that can be

converted into cash within one year. Current assets include cash, marketable securities, accounts receivables, inventory, and other short-term investments of the firm. Companies need to sustain a sufficient level of working capital to ensure that short-term obligations are met on time. Net Working Capital on the other hand refers to the current assets of the firm less the current liabilities.

Companies usually utilizes the self-liquidating principle to maintain a proper level of working capital. According to this principle, temporary investments are financed with temporary sources while permanent asset investments are financed with permanent sources.6

Working capital can be financed by:• Accruedwagesandsalaries,• Accruedtaxes,• Short-termloansprovidedfromcommercialbanks,financecompa-

niesorfactors,• Issuingcommercialpapers(short-termpromissory

notes).With respect to how much cash should be held, special

attention is needed. Financial managers must establish aproper balance between holding too little cash and too much cash. Too much cash means forgoing profitable investment opportunities whereas too little cash means increased risk insolvency.7

Short-Term Financial PlanningCompanies need to plan for the future to predict future

financing requirements andprepare for future needs. Proforma financial statements (mainly balance sheet and income statement) are prepared for this purpose. Through these pro forma statements financial managers forecast revenues and expenses of the planning period together with the level of funds which will be invested in current assets

and fixed assets.Pro forma income

statement exhibits forecasted revenues and expenses for a future period. Pro forma balance sheet displays forecasted assets and total financing provided by debt and equity financing at a future date.

In cases when it is estimated that the total financing forecasted will not cover the future asset investments, the shortage shouldbe financed.Financialmanagersmustprepareplans to finance thefinancing requirements that will arise. Otherwise, companies may faceinsolvency risks.

Companies may invest heavily in working capital which consists of more liquid assets to enhance liquidity. However, these investments usually yield a lower return compared to fixed investments.

Net Working Capital refers to the current assets of the firm less the current liabilities.

Pro forma income statement exhibits forecasted revenues and expenses for a future period.

Pro forma balance sheet displays forecasted assets and total financing provided by debt and equity financing at a future date.

Being unable to meet maturing liabilities leads to insolvency. To plan for future cash

flows, financial managers utilize cash budgets which present cash balances of the company at future dates.

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In addition to pro forma financial statements, financial managers employ budgets for short-term planning. A budget is a plan to show how much money a person or organization will earn and how much they will need or be able to spend.

LONG -TERM FINANCING Companies usually prefer to finance their long-

term assets with long-term resources such as long-term trade credit extended by their suppliers, long-term leasing, long-term bank loans, issuing bonds or issuing stock. The financial manager’s goal is to provide the appropriate level of long-term financing at the minimum cost with an acceptable level of risk. The business must be able to generate cash flows to pay back the debt and refrain from going bankrupt.

Basic Tools of Long-Term Financing

Trade creditSuppliers may extend trade credit to their

customers for a long time especially when they sell fixed assets. The terms of the credit are negotiated between the supplier and the business.

LeasingCompanies may choose to lease machinery,

equipment, and other fixed assets to finance the purchase of them for a long-term, which is called capital lease. It is a lease agreement by which the lessee rents the property and makes regular payments to the lessor for a specified number of months or years. The lessor agrees to transfer the ownership rights to the lessee after the completion of the lease period. Capital or finance leases are long-term and non-cancellable in nature.

Bank loansBanks may grant a business a line of credit by

which the business can borrow funds to fulfill its long-term financing needs. Banks usually prefer to extend long-term credit to large companies with a sound credit history and may ask for a collateral since long-term financing is riskier than short-term financing.

A budget is a plan to show how much money a person or organization will earn and how much they will need or be able to spend.

What are the main functions of budgets?

3

Companies usually finance their long-term assets with long-term resources such as long-term trade credit extended by their suppliers, long-term leasing, long-term bank loans, or by issuing bonds or stocks.

Capital lease is a lease agreement by which the lessee rents the property and makes regular payments to the lessor for a specified number of months or years.

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Banks usually assess the credit worthiness of companies to establish a credit relationship with companies by in view of 5 C’s of credit as shown in Figure 8.2.

• Character.Banksevaluatetheexperienceandtrackrecordofthebusinessownersandmanagersintheindustry.

• Capacity. Capacityreferstoconsideringyourotherdebtswhendeterminingtheabilitytorepaythe loan.

• Capital.Capitalreferstothevalueofyourassetslessyourliabilities.Insimpleterms,capitalreflectstohowmuchyouown(forexample,car,realestate,cash,andinvestments)minushowmuch you owe.

• Collateral.Collateralreferstoanyassetofaborroweralendercanusetopaythedebtifthebor-rowerisunablepaybacktheloan.

• Conditions. Banksmayevaluatetheindustryandcompetitionaswellasgeneraleconomiccon-ditions.

Issuing bondsFirms may issue bonds as a form of debt financing.

A bond is a promissory note with a fixed interest rate, contractual payments, and principal.

As the party issuing the bonds, the company sells the bonds to bond investors and provides financing. In return, the company promises to pay back principal (face value / par value) of the bond at maturity (e.g. 3 years, 5 years) together with interest payments at certain intervals called coupon payments, which are rewards for the bond holders who in a way lend their money to the company.

Bonds may be sold for a value equal to the par value or maturity value. Iftheyaresoldbelowtheparvalue,theyarecalleddiscountbonds.Ontheother hand, if the price or market value is above the par value, they are called premium bonds.

For example, in May 2017, Vakifbank issued international bonds for USD 500,000,000 maturing in 2022 with a 5.625% coupon. Bonds were sold at a price of 99.892. USD. Therefore, these bonds are discount bonds.(See more: http://cbonds.com/news/item/911585)

Issuing stocksFirmsmayissuesharesofstocktoraisecapitalasaformofequityfinancing.Stocksrepresentownership

interestinthebusinessanditsassets.Companiesraisecapitalbyissuingsharesofstock.Financingdecisionsinvolve debt or equity financing. Bond issuances provide debt financing whereas issuing shares of stock provideequityfinancing.Stockscanbeissuedintheformofpreferredstockorcommonstock.Preferredstock is a hybrid security that resembles bonds as it pays a fixed amount of dividend and resembles common stock as it provides equity financing and has no maturity.

Financingdecisionsinvolvedebtfinancingorequityfinancing.Bondissuancesprovidedebtfinancingwhereas issuing shares of stock provide equity financing for companies.

Character Capacity Capital Collateral Conditions

Figure 8.2 Five C’s of Credit

A bond is a promissory note with a fixed interest rate, contractual payments, and a principal.

Interest payments for borrowings from banks or bondholders are tax deductible. Therefore, after-tax cost of borrowing is the interest cost less the tax benefit.

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If a company goes bankrupt, creditors who provide debt financing for the business have the highest priority, meaning they receive their claims first. Then comes the preferred stockholders in terms of priority of claims. What remains can be used to cover the claims of the common stockholders. Thus, common stockholders are sometimes named as the residual owners of the company.8

Stocks grant the holders:• Limitedliabilityincaseofbankruptcy

(limitedwiththeamountofinvestment).• Claimonincomeintheformofdividends.• Claimonassetsifthebusinessgoesbank-

rupt.• VotingrightsintheelectionoftheBoard

ofDirectors.• Preemptiverights.Preemptive rights gives the preferred stockholders

the right to purchase new shares of stock proportionate with their existing share of ownership.

CAPITAL INVESTMENT DECISIONS

Capital investment decisions are related to long-term investments of businesses. Therefore, they involve a higher level of risk compared to short-term investments, namely working capital. Financialmanagershelpmanagersofthecompanyto assess the profitability of investments and select the best investment alternatives.

Activities of planning and evaluating investment projects is called capital budgeting. The capital budgeting process involves economic analysis and selection of projects according to some criteria determined by the management of the company.9

Investment decisions can be grouped as: 1. Assessingtheprofitabilityofasinglein-

vestment project.2. Assessingtherelativeprofitabilityofcom-

petinginvestmentprojects.3. Selectingthebestinvestmentprojectsina

portfolioofprojectswithalimitedbudget. Companies need to invest in fixed assets to

carry out their operations, to differentiate their products; to improve product quality; or create cost advantages. It is almost impossible for a firm to survive and grow without making capital investments. However, it is difficult to find remarkably profitable projects in efficient markets.

Financing decisions involve debt or equity financing. Bond issuances provide debt financing whereas issuing shares of stock provide equity financing.

Preferredstockisahybridsecurity.

Preemptive rights gives the preferred stockholders the right to purchase new shares of stock proportionate with their existing share of ownership.

An example of a share of stock.

Do stockholders receive dividends out of the net profit of the company each and every year?

4

Activities of planning and evaluating investment projects is called capital budgeting.

The capital budgeting process involves economic analysis and selection of projects according to some criteria determined by the management of the company.

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Efficient markets are markets where all valid information is available to all participants at the same time, and where prices respond immediately to available information.

Since fixed assets are assets which can be turned into cash in more than a year and are larger in amount compared to investments in current assets, they are considered to be more risky. Therefore, companies must make careful analysis in order to take proper capital investment decisions to generate new products or new ways of improving existing products. New ideas for profitable projects are usually generated within the firm especially in the research and development department.

In evaluating investment projects, managers focus on the changes in the cash flows of the firm when the project is undertaken. Hence, incremental (marginal) cash flows expected to be generated by the investment project should be considered.10

Typically, investment projects start with an initial cash outflow which is called the initial investment outlay and continue with usually cash inflows during the life of the project. The amount of the cash flows and the timing of the cash flows should be projected and should be assessed against the investment outlay. Most of the time, it is hard to project the cash flows which will be generated in

the future. Managers decide to accept the project if the project adds value to the firm, otherwise they reject the project.11

Firms utilize various techniques to assessprofitability of investment projects. Some techniques incorporate time value of money. In these techniques, expected cash flows are discounted back to present to come up with the present value of futurecashflows.Futurecashflowsarediscountedwith the cost of capital of the firm. The present value of all future cash flows is compared with the initial investment outlay. If the present value of future cash flows is greater than the initial outlay, it means that the marginal cash flows generated by the project not only cover the investment outlay, but it generates some net worth, which is called the Net Present Value (NPV) of the project.

NPV is one of thewidely used techniques toevaluate profitability of investment projects. If theNPVofaprojectisfoundtobepositive,thisimplies that the project is profitable and can be accepted. Another widely used technique closely related to NPV is the Internal Rate of Return (IRR). IRR is the discount rate that equates the present value of future cash flows with the initial outlay of the project. If the IRR is above the shareholders’ required rate of return, then the project should be accepted. However, if the IRR of the project is below the required rate of return, it should be rejected.

Another way to assess whether the present value of future cash flows cover the initial outlay and create additional value is to divide the present value of future cash flows by the initial outlay, which is calledProfitabilityIndex(PI).PIbeinggreaterthan1 indicates that the project’s present value of future

Efficient markets are markets where all valid information is available to all participants at the same time, and where prices respond immediately to available information.

Managers focus on changes in the cash flows of the firm to evaluate the profitability of an investment project.

Net Present Value (NPV) shows the amount of wealth that is expected to be created if the project is undertaken.

Internal Rate of Return (IRR) is the discountratethatmakestheNPVoftheproject equal to zero.

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cash flows exceeds the initial outlay and therefore it isprofitable.APIvaluelessthan1impliesthattheproject should not be accepted.

Some other techniques ignore time value of money, such as the payback period. The payback period is the number of years needed to recover the initial investment outlay. Managers can make the decision to accept or reject the project by comparing the calculated payback period with the target payback period they set. If the project’s payback period is less than the firm’s maximum desired payback period, the project should be accepted. If the project’s payback period is more than the firm’s maximum desired payback period, it should be rejected. In case they are comparing two competing projects, the one with a shorter payback period is more preferential. In fact, the longer the payback period, the riskier the project. Although this tool is easy to use, it is not very desirable since it does not take into account the timing of cash flows and how much they are worth as of today.

FINANCIAL RISK MANAGEMENT

Risk and return concepts are important for investors and business managers in the process of managing financial resources.

Risk and ReturnReturn of an investment is the expected

benefits of the investment in the form of cash flows. In a world of uncertainties, financial assets or securities may generate returns different from what is expected. Risk can be defined as the potential variability in future cash flows. Observed returnmay deviate from the expected return and the deviations could be either positive (upside risk) or negative (downside risk). Risk is usually measured by standard deviation or variance, which is the square of standard deviation: The greater the variance or the standard deviation, the greater the risk.12

Although there are many types of risk classes, basic types of risk for a business can be classified as:

• Creditrisk(Defaultrisk)The risk that a company or individual will not

be able to pay the contractual interest or principal on its debt obligations.

• MarketriskThe risk that the value of an investment to

fluctuate due to general market conditions.

The payback period is the number of years needed to recover the initial investment outlay.

When comparing two mutually exclusive projects how can managers decide on the relative profitability?

5

If a firm decides to place a budget limit on investment projects, then the proper decision is to select the projects which adds more value to the firm, hence projects with thehighestNPV.

Return of an investment is the expected benefits of the investment in the form of cash flows.

There is a positive relationship between risk and return. Investors will not be willing to assume additional risk unless they expect to be compensated with additional return.

Risk is usually measured by standard deviation or variance, which is the square of standard deviation: The greater the variance or the standard deviation, the greater the risk.

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• PoliticalriskThe risk that a country’s government will

suddenly change its policies.• OperationalriskVarious risks that can arise from a company’s

ordinary businessInvesting in a portfolio of stocks, investors

can get rid of some of the risk by investing across different securities which do not tend to move precisely together. An investment portfolio is like a pie that is divided into pieces of a variety of asset classes and/or types of investments in different sizes as shown in Figure 8.3. Diversification is a risk management technique that mixes a wide variety of investments within a portfolio.

Thus, we can also classify risk as:13

• DiversifiableriskWe can reduce the risk of a portfolio through

diversification if different types of investments in the investment portfolio do not perfectly move in the same direction.

• Non-diversifi-ablerisk

Market risk cannot be eliminated through random

diversification. It is also called systematic risk, since it affects all the securities in the market. For example, the collapse of Lehman Brothers in 2008 initiated major shocks with a domino effect in the financial system of USA.

Enterprise Risk ManagementFinancial risks have been controlled through

hedge funds and other tools over the years, often by investment banks. In time, it was realized that many risks could be prevented or their impact reduced, through loss prevention and control systems. These findings led firms to a broader view of risk management. Enterprise Risk Management (ERM) approach has emerged to provide the means to recognize and mitigate risks with a holistic approach.14

Enterprise Risk Management (ERM) is an integrated risk management approach, which considers risks in the context of business strategy and manages them with a portfolio perspective through well-defined risk responsibilities and strong risk monitoring processes. In ERM, there is a senior level position usually called Chief Risk Officer (CRO) who has the highest responsibility for overseeing the centralized risk management function.

Governmentbonds

Stocks

Corporate bonds

Figure 8.3 Investment Portfolio

An investment portfolio is like a pie that is divided into pieces of a variety of asset classes and/or types of investments in different sizes.

A portfolio constructed of different kinds of investments will, on average, yield higher returns and pose a lower risk than any individual investment within the portfolio.

http://www.investopedia.com/terms/d/diversification.asp#ixzz4iP2PMZDD

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Chief Risk Officer (CRO) has the highest responsibility for overseeing the centralized risk management function.

Shareholder value can be improved with the help ofChiefRiskOfficer(CRO).

What is the main difference between Traditional Risk Management (TRM) systems and Enterprise Risk Management (ERM) systems?

6

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SHAREHOLDER VALUE MANAGEMENT There is a growing emphasis on shareholder value creation and shareholder value management in the

businessliterature.Valuebasedprocesses,measuresandincentiveshaveemergedtosupportshareholdervalue management. As financial decisions play a vital role in the value creation of businesses, it would be useful to emphasize how financial decisions influence shareholder value.15

Financial Decisions in Value Creation We can analyze the role of financial decisions in creating shareholder value by grouping them under

different aspects.16

Investing aspect of value creationCompanies can create value if they can achieve economic returns above the cost of capital on their

existing and new investments. Hence, they must devise necessary processes and tools to implement efficient economic analysis and managerial evaluation regarding investment choices.

Financing aspect of value creationFinancialdecisionswithrespecttoprovisionoflong-termfunds,distributionofprofitsasdividends,

and capital structure generate costs and benefits for the businesses. When companies make effective choices related to financing decisions, they can enhance the goal of maximizing shareholder wealth.

Operating aspect of value creationBy offering the right products and services in a cost effective manner by

efficient economic analysis, companies can gain competitive advantage and generate long-term cash flows to enhance value creation.

Today, big companies and consulting firms employ a number of value based methodologies to track if companies are creating value. These methodologies link performance of businesses to the market value or the stock price of the company in order to monitor and improve business decisions, processes and policies.

Value-Based MethodologiesVariousvalue-basedmethodologieshaveevolvedespeciallyafterthe80’stoassesshowmanagement

actions reflect on the shareholder value results. Before the new millennium, the emphasis was on profit margins, whereas nowadays new value measures are in place such as Economic Profit or Economic Value Added (EVA) and Cash Flow Return on Investment (CFROI).17

Economic profit or economic value added (EVA)Economicvalueadded is a formof economicprofit.EVA is a contemporarymeasureof corporate

success. Big companies like Coca Cola and Eli Lilly have used EVA as a metric to monitor shareholder value creation.AsEVAtakesintoaccountthecostofdebtandequitycapital,itenablesmanagerstothinklikeshareholders when they are making investment decisions.18

When businesses develop mechanisms and tools to maintain proper investing, financing and operating decisions in line with business strategies, they can reinforce the value creation process.

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ThefollowingformulaisusedtocalculateEVA:

EVA= NOPAT / (Capital Base, net of depreciation * WACC)

NOPAT: Net Operating Profit After TaxWACC : Weighted Average Cost of CapitalIfEVAispositive,thenitmeansthecompanyisaddingvalue.

Cash flow return on investment (CFROI)Cash flow return on investment (CFROI) is the

indicator that helps a company to evaluate the performance of an investment or product. It can also be termed as the calculationthathelpsthestockmarkettosetpricesonthebasisofcashflow.CFROIcanbeassumedastherealrateofreturnthecompanyearnsonitsportfolioofprojects.CFROImetricisrootedonthediscounted cash flow valuation (Madden, 1999).19 Thus:

1. Morecashispreferredtoless.2. Cashhasatimevalue.3. Soonerispreferredtolate.4. Lessuncertaintyisbetter.ThefollowingformulaisusedtocalculateCFROI:

CFROI = Cash Flow / Market Value of Capital Employed

ETHICS IN FINANCIAL MANAGEMENTEthics have become a significant topic in the business world especially after the ethical scandals

brought to public attention by the media in1980s. Many companies collapsed because of accounting frauds and other ethical crimes. Today, ethical issues influencing businesses include environmental issues such as pollution and animal rights, bribery, insider trading in the financial markets, layoff of employees due to corporate restructuring, and sexual harassment.20

Dealing with ethical problems is an important challenge especially in the fieldoffinancialmanagement.Financialdecisionscompriseissuesconnecteddirectly with money which tends to highlight the vulnerability of financial managers to ethical dilemmas.

One of the most important scandals in the financial industry of Turkey is the collapse of İmar Bankası in 2003. As stated in European Investment Bank’s Economic and Financial Report 2004/02 about The Turkish Banking Sector: “The most recent reports of Imar Bank to the BRSA, as late as late June 2003, indicated a total deposit amount of TL 750 trillion (around $0.5 billion). The investigation of depositors’ documents, however, revealed that this amount was actually TL 8.1 quadrillion (more than $5 billion). The bank had also converted some offshore deposits (not covered by government guarantee) and sold Treasury bills to the public even though it did not have a license to do so. The bank maintained a double-accounting system throughout, where true information would exist at the branch level but the headquarters would falsify it and then report to the Banking Regulation and Supervision Agency”(https://www.econstor.eu/bitstream/10419/45294/1/656504056.pdf )

Economic Profit or Economic Value Added (EVA) is a form of economic profit.

Companies must comply with legal regulations and corporate governance principles to curb ethical problems.

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Corporate GovernanceCorporate governance is the framework of rules and

practices by which a board of directors ensures accountability, fairness, and transparency in a company’s relationship with its all stakeholders. Corporate Governance provides the business procedures for proper supervision, control, and information-flows to serve as a system of checks-and-balances

Capital Markets Board of Turkey’s Corporate Governance Principles consist of four main sections, namely shareholders, disclosure and transparency, stakeholders and board of directors:

• ShareholdersShareholders have many rights such as to obtain and

evaluate information, right to participate in the general shareholders’ meeting and right to vote.

• Disclosure and transparencyCompanies should establish information policies with respect to shareholders and adhere to these policies• Stakeholders When a conflict of interest arises among the stakeholders, the

company should seek to adopt a well-balanced policy aimed at protecting the rights of stakeholders.

• Board of directorsThe board of directors should perform its functions in a rational

manner and act in accordance with the rules of good faith through maintaining the balance between interests of the company and the shareholders and stakeholders.

Ethics and Corporate Social ResponsibilityIt is claimed by academic and business authorities that companies have the obligation to assume social

responsibilities. Companies should consider the effects of their activities on their stakeholders. The main stakeholders of the business are customers, suppliers, employees, environment, government, competitors, investors and the society. Companies should consider the affected parties’ rights and responsibilities (See Chapter 1). Hence, when making a judgement, the situation is analyzed to consider the harms and benefits of the situation to the stakeholders affected together with the consequences of alternative decisions.21

Internal ControlsTo fight against fraud and corruption, companies can establish internal control systems. Typically,

implementation of internal controls involve the following steps:22

• Identificationofpossibleinternalandexternalthreats,• Identificationofinternalprocesses,• Identificationofprocessgapsusingcontrolassessmenttools,• Implementinginternalcontrolstofillgapswithstrongcontrolprocesses,• Testingthecontrolswithanearlywarningsystem.

Corporate governance is the system of rules, practices, and processes by which a company is directed and controlled.

http://www.businessdictionary.com/definition/corporate-governance.html

internet

Market manipulation should be prohibited to protect shareholders according to G20 / OECDCorporateGovernancePrinciples.Whatismarketmanipulation?

7

The main stakeholders of the business are customers, suppliers, employees, environment, government, competitors, investors and the society.

283


SupposeyouareanemployeeofabigCorporationthesharesofwhicharetradedinBorsaİstanbul.OneofyourfriendsintheOfficetellyouthatheaccidentallyheardthecompanyisplanningtomakeabiginvestmentwhich is expected to be very profitable and is likely to cause a dramatic increase in the share price. However, this information has not been disclosed to public yet. You plan to use all your savings to invest in the shares of the company hoping to make a huge fortune. You tell your spouse about your plans and she warns you that it may be illegal. Which terminology is used for such cases? Is it legal? What are the likely consequences you will face in case you implement your plan?

8

What is Value-Based Management?An Excerpt From Valuation: Measuring and Managing the Value of Companies

Recent years have seen a plethora of new management approaches for improving organizational performance: total quality management, flat organizations, empowerment, continuous improvement, reengineering, kaizen, team building, and so on. Many have succeeded-but quitea fewhave failed.Often thecauseof failurewas performance targets that were unclear or not properly aligned with the ultimate goal of creating value. Value-based management (VBM) tacklesthis problem head on. It provides a precise and unambiguous metric-value-upon which an entire organization can be built.

The thinking behind VBM is simple.The value of a company is determined by its discounted future cash flows. Value is createdonly when companies invest capital at returns thatexceedthecostofthatcapital.VBMextendsthese concepts by focusing on how companies use them to make both major strategic and everyday operating decisions. Properly executed, it is anapproach to management that aligns a company’s overall aspirations, analytical techniques, and management processes to focus management decision making on the key drivers of value.Source: http://www.mckinsey.com/business-functions/strategy-and-corporate-finance/our-insights/what-is-value-based-management

Further Reading

There is an agency relationship between the owners and the managers of the company. The stockholders or owners act as (principles or principals-senior officials?) and hire the managers to act in the best interest of the company. Sometimes, conflicts of interest may arise between the principle and the agent as they may pursue different goals, which will lead to agency problems and accordingly agency costs.

Sometimes, the owners of a firm may wish the firm to implement a risky investment project hoping that it will increase the value of the company. However, managers may refrain from undertaking the risk as they may fear losing their jobs in case the project fails. Discuss: Which mechanisms can be put into practice in order to align managers’ interests with those of stockholders?

In Practice


284

LO 1 Identifying main decision fields of business finance

Business finance comprises decisions of businesses which are basically related to investment and financing of assets of a business. Business finance decisions are related to the resources of a business and they can be grouped as:

• InvestmentdecisionsMaking sound investment choices in line with the business strategies and economic analysis

• FinancingdecisionsSelecting the optimum mix of internal and external funds to finance the investments of the business

• OperatingdecisionsEmploying the resources of the business efficiently to generate profits

LO 2 Describing main functions of financial markets

Financial markets serve many roles among which are:• Efficientallocationofcapital

Financialmarketshelpchannelfundsintoprofitableinvestmentsandboosteconomicgrowth• Pricediscovery

Pricesoffinancialassetsareformedinthemarketbytheinteractionofdemandandsupplyforthesesecurities.

• LiquidityInvestors can sell their investments and turn them into cash in financial markets.

• RiskSharing

LO 3 Explaining the significance of short-term financial planning

Companies need to plan for the future to predict future financing requirements. Through pro forma statements financial managers forecast revenues and expenses of the planning period together with the level of funds that will be invested in current assets and fixed assets. If the forecasted total financing is not sufficient to cover the future asset investments, the shortage should be financed. Financial managers must prepare plans to finance the financing requirements that will arise.Otherwisecompaniesmayfaceinsolvencyrisks.

Sum

mar

y


285

LO 4 Understanding the roles of basic tools used in long-term financing

Companies usually prefer to finance their long-term assets with long-term resources such as long-term trade credit extended by their suppliers, long-term leasing, long-term bank loans, issuing bonds or issuing stock. Basic tools used in long-term financing are:

• Tradecredit• Leasing• Bankloans• Issuingbonds• Issuingstocks

LO 5 Distinguishing most widely used techniques in the capital budgeting process

Firms utilize various techniques to assess profitability of investment projects. Some techniquesincorporate time value of money whereas some techniques ignore time value of money. Most widely used techniques in the capital budgeting processareNPV,PIandIRR.IftheNPVofaprojectisfound to be positive, this implies that the project is profitable and can be accepted. If the IRR is above the shareholders’ required rate of return, then the project should be accepted. If the project’s payback period is less than the firm’s maximum desired payback period, the project should be accepted.

LO 6 Describing risk and distinguishing various types of financial risks

Risk can be defined as the potential variability in future cash flows. Basic types of risk for a business can be classified as:

• Creditrisk(Defaultrisk)The risk that a company or individual will not be able to pay the contractual interest or principal on its debt obligations.

• MarketriskThe risk that the value of an investment to fluctuate due to general market conditions.

• PoliticalriskThe risk that a country’s government will suddenly change its policies.

• OperationalriskVariousrisksthatcanarisefromacompany’sordinarybusiness

Sum

mary


286

LO 7 Discussing how financial decisions influence shareholder value

Companies can create value if they can achieve economic returns above the cost of capital on their existing and new investments. When companies make effective choices related to financing decisions, they can enhance the goal of maximizing shareholder wealth. By offering the right products and services in a cost effective manner by efficient economic analysis, companies can gain competitive advantage and generate long-term cash flows to enhance value creation.

LO 8 Explaining why ethics is important in finance

Dealing with ethical problems are an important challenge especially in the field of financial management. Financial decisions comprise issues connected directly with money, which tends to highlight the vulnerability of financial managers to ethical dilemmas. To fight against frauds and corruption, companies can establish internal control systems.

Sum

mar

y


287

Test yourself

1 Bonds that sell above the face value are …………. bonds.

a. Discountb.Premiumc. Junk d. Convertible e. Perpetuity

2 The following features belong to stocks except for…..

a.Votingrightsb.Limitedliabilityc. Residual claim on assetsd.Preemptiverightse. Claim on interest

3 What type of a business finance decision is the decision to purchase a new equipment concerned with?

a. Investmentb. Short-term financingc. Long-termfinancingd. Working capital e.Operating

4 Which of the following securities are traded in money markets?

a. Government bondsb. Corporate bondsc. Preferredstockd. Common stocke. Commercial paper

5 Projected fixed asset investments of a company for next year can be seen in the ……..

a. Cash budgetb. Income statementc. Balance sheetd.Proformaincomestatemente. Proformabalancesheet

6 What is the type of risk which leads the value of an investment to fluctuate due to general mar-ket conditions?

a. Liquidityriskb. Credit riskc. Default riskd. Market risk e. Politicalrisk

7 An investment project is deemed acceptable if the IRR of the project is ………….

a. Smaller than the required rate of return of the project.

b.Larger than the required rate of return of theproject.

c. Smaller than the profitability index of the project.

d.Largerthantheprofitabilityindexoftheproject.e. Is equal to the profitability index of the project.

8 Any asset of a borrower a lender can use to pay the debt if the borrower is unable pay back the loan is a………………

a. Capitalb. Capacityc. Collaterald.Lessore. Exchange

9 Which of the following entitles common stockholders to maintain a proportionate share of ownership in the firm?

a. Preemptiverightsb. Covenantsc. Votingrightsd.Limitedliabilitye. Claim on income

10 Which of the following capital budgeting techniques ignores time value of money?

a.NetPresentValueb. Internal Rate of Returnc. Modified Internal Rate of Returnd.PaybackPeriode. CompoundValue


288

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“You

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A

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“Tes

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f”

If your answer is incorrect, review “Finan-cial Markets”.

1. b If your answer is incorrect, review “Finan-cial Risk Management”.

6. d

If your answer is incorrect, review “Over-view of Business Finance”.

3. a If your answer is incorrect, review “Long-term Financing”.

8. c


2. e If your answer is incorrect, review “Capital Investment Decisions”.

7. b


4. e

If your answer is incorrect, review “Short-Term Financial Management”.

5. e

If your answer is incorrect, review “Long-term Financing”.

9. a

If your answer is incorrect, review “Capital Investment Decisions”.

10. d

The financial manager of a company is considering how much of

the net profit can be distributed to the stockholders as dividends

and how much of the net profit can be retained in the company to

be a part of equity. What type of finance decision is in considered

by the financial manager?

your turn 1Thefinancialmanager,isconsideringafinancingdecisioninthiscase.Finan-cing decisions involve decisions about how much profit to distribute as well as how to finance the resources of the company.

When people buy or sell securities that are already being traded in the market, they are making transactions in the secondary markets.

The main functions of budgets include planning, coordination and commu-nication. Budgets provide targets and gives direction to achieve goals of the business. Budgets help coordinate efforts of different functional areas of the bu-siness. Targets and results are communicated to functional managers to ensure commitment and corrective action.

your turn 2

your turn 3

Identify the type of markets involved when you buy or sell

shares of stock of a company listed at Borsa İstanbul.

What are the main functions of budgets?


289

Suggested answ


Stockholders do not necessarily receive dividends each and every year. It is up to the management to decide whether to distribute or how much to distribute dividends out of the net profit. Net profit not distributed but retained in the company becomes an addition to the retained earnings and thus becomes part of shareholders’ equity providing equity financing for the business.

Mutually exclusive projects refer to a sect of projects out of which only one project can be selected for investment. In case of mutually exclusive projects, the project with highest net present value or the highest IRR or the lowest payback period is preferred.

your turn 4

your turn 5

Do stockholders receive dividends out of the net profit of the

company each and every year?

When comparing two mutually exclusive projects how can

managers decide on the relative profitability?

The main difference between ERM and TRM is that ERM takes a top-down, enterprise-wide view of all risk exposures whereas TRM attempts to manage risk in distinct silos. ERM systems integrate all risk-management functions, such as collecting data, risk analysis and risk prevention.

your turn 6

What is the main difference between Traditional Risk

Management (TRM) systems and Enterprise Risk Management

(ERM) systems?

Manipulation is the act of artificially inflating or deflating the price of a security. Inmostcases,manipulationisillegal.Forexample,completingtransactionstogive a false impression about supply or demand may drive the stock price to an artificial level.

your turn 7

Market manipulation should be prohibited to protect

shareholders according to G20 / OECD Corporate Governance

Principles. What is market manipulation?


290

Sug

gest

ed a

nsw

ers

for

“You

r tu

rn”

Suppose you are an employee of a big corporation the shares

of which are traded in the Borsa İstanbul. One of your friends

in the Office tells you that he accidentally heard the company is

planning to make a big investment which is expected to be very

profitable and is likely to cause a dramatic increase in the share

price. However, this information has not been disclosed to public

yet. You plan to use all your savings to invest in the shares of the

company hoping to make a huge fortune. You tell your spouse

about your plans and she warns you that it may be illegal. Which

terminology is used for such cases? Is it legal? What are the likely

consequences you will face in case you implement your plan?

your turn 8This case is considered as insider trading. Insider trading is buying or selling a stock based on material information that is not available to the general public. It is unfair and harms capital markets by destroying investor confidence. Insider traders can face criminal penalties as well as financial penalties.

1Helfert, E. A. (2001). Financial Analysis Tools and Techniques. McGraw-Hill.

2Keown, M. P. (2014). Foundations of Finance. Pearson.

3Mishkin, F. S.,& Eakins, S.G. (2012). Financial Markets and Institutions.Pearson.

4Ibid.5Keown, op. cit.6Ibid.7Ibid.8Ibid.9Ross, W. J. (2007). Fundamentals of Corporate

Finance. McGraw Hill.10Keown, op. cit.11Goetze, N. (2015). Investment Appraisal. Springer.12Keown, op. cit.

13Ibid.14Sayılır, F. (2016). Enterprise Risk Management

anditsEffectonFirmValueinTurkey.Journal of Management Research, 9(1), 86-99.

15Helfert, op.cit.16Ibid.17Ibid.18Grant,J.L.(2003).Foundations of Economic Value

Added. Wiley.19Madden, B. J. (1999). Cash Flow Return on

Investment Valuation. Butterworth-Heineman.20Boone, L. E. (2005). Contemporary Business.

Thomson-South Western.21Ibid.22Reading, S. A. (2013). Internal Auditing.

The Institute of Internal Auditors Research Foundation.

endnotes