1.1: What Is a Business?

1.1.1: The Goals of a Business

Learning Objective

Differentiate among potential goals of a business.

Key Points

• Economic value added suggests that a principal challenge for a business is balancing the interests of new parties affected by the business, interests that are sometimes in conflict with one another.
• Alternate definitions state that a business’ principal purpose is to serve the interests of a larger group of stakeholders, including employees, customers, and even society as a whole.
• Many observers hold that concepts such as economic value added are useful in balancing profit-making objectives with other ends.
• Social progress is an emerging theme for businesses. It is integral for businesses to maintain high levels of social responsibility.

Key Terms

corporation

A group of individuals, created by law or under authority of law, having a independent of the existences of its members, and powers and liabilities distinct from those of its members.

stakeholder

A person or organization with a legitimate interest in a given situation, action, or enterprise.

corporate social responsibility (CSR)

A company’s sense of responsibility towards the community and environment (both ecological and social) in which it operates. Companies express this citizenship (1) through their waste and pollution reduction processes, (2) by contributing educational and social programs and (3) by earning adequate returns on the employed resources.

Examples

• America has surpassed Europe in revenue growth over time. However, social responsibility may also have a critical role in business operations, so American revenue growth continuous existence should not be solely considered in corporate success.
• Stakeholder theorists believe that people who have legitimate interests in a business should influence its operation. Consumers, and even community members who could be affected by what the business does, ought to have some voice in the decision making.
• Advocates of business contract theory believe that a business is a community of participants organized around a common purpose. Contract theorists see the enterprise being run by employees and managers as a kind of representative democracy.

The Goals of a Business

Profit Maximization

According to economist Milton Friedman, the main purpose of a business is to maximize profits for its owners, and in the case of a publicly-traded company, the stockholders are its owners. Others contend that a business’s principal purpose is to serve the interests of a larger group of stakeholders, including employees, customers, and even society as a whole. Philosophers often assert that businesses should abide by some legal and social regulations. Anu Aga, ex-chairperson of Thermax Limited, once said, “We survive by breathing but we can’t say we live to breathe. Likewise, making money is very important for a business to survive, but money alone cannot be the reason for business to exist. “

Profit Maximization

This chart depicts profit maximization using the totals approach, where TR = Total Revenue and TC = Total Cost. The profit-maximizing output level is represented as the one at which total revenue is the height of C and total cost is the height of B; the maximal profit is measured as CB.

Social Benefit

Many observers would hold that concepts such as economic value added are useful in balancing profit-making objectives with other ends. They argue that sustainable financial returns are not possible without taking into account the aspirations and interests of other stakeholders such as customers, employees, society and the environment. This concept is called corporate social responsibility (CSR).

This conception suggests that a principal challenge for a business is to balance the interests of parties affected by the business, interests that are sometimes in conflict with one another. Former President Bill Clinton stated adamantly that major multinational companies must put their customers and employees’ interests before those of shareholders in order to promote economic development and growth, especially in emerging markets. For example, Alibaba, a Chinese Internet venture, strives to operate in the zone that Clinton calls “double-bottom line capitalism. ” The emerging new mantra is to create social progress as well as create profits. In a sense, corporate social responsibility highlights the fact that business, consumers and society are part of a shared ecosystem, and that the long-term health of this ecosystem must be maintained above all else.

Innovation as a Goal

Rohit Kishore persuades that business can also be viewed to exist for the purpose of creative expansion. Successful firms like Google manage to align their activities towards the purpose of creative expansion from the perspective of all stakeholders, especially employees. This also validates the growing importance of innovation as a core principle for corporation survival and success.

Contract Theory

Advocates of business contract theory believe that a business is a community of participants organized around a common purpose. These participants have legitimate interests in how the business is conducted and, therefore, they have legitimate rights over its affairs. Most contract theorists see the enterprise being run by employees and managers as a kind of representative democracy.

Stakeholder Theory

Stakeholder theorists believe that people who have legitimate interests in a business also ought to have voice in how the business is run. However, stakeholder theorists take contract theory a step further, maintaining that people outside of the business enterprise ought to have a say in how the business operates. Thus, for example, consumers, even community members who could be affected by what the business does (for example, by the pollutants of a factory) ought to have some control over the business.

Business as Property

Some people believe that a business is essentially someone’s property, and, as such, that its owners have the right to dispose of it as they see fit (within the confines of the law and morality). They do not believe that workers or consumers have special rights over the property, other than the right not to be harmed by its use without their consent. In this conception, workers voluntarily exchange their labor for wages from the business owner; they have no more right to tell the owner how he will dispose of his property than the owner has to tell them how to spend their wages. Similarly, assuming the business has purveyed its goods honestly and with full disclosure, consumers have no inherent rights to govern the business, which belongs to someone else.

People who subscribe to this view generally point out that a property owner’s rights are constrained by morality. Thus, a homeowner cannot burn down his home and thereby jeopardize the entire neighborhood. Similarly, a business does not have an unlimited right to pollute the air in the manufacturing process.

1.1.2: Benefits of Organization

Learning Objective

Explain the role of specialization, delegation, efficiency and departmentalization in effective organization.

Key Points

• Organization is the composition of individuals and groups directed towards coordinated goals.
• Division of labor is the assigning of responsibility for each organizational component to specific workers or group of workers.
• Specialization is division of labor with the added stipulation that the responsibility for a specific task lies with a designated expert in that field.
• Good organization structure is essential for expanding business activity. Organization structure determines the input resources needed for the expansion of a business activity.

Key Terms

resource

Something that one uses to achieve an objective. An examples of a resource could be a raw material or an employee.

efficiency

The extent to which time is well used for the intended task.

Example

• Functional authority is where managers have formal power over a specific subset of activities. For instance, the Production Manager may have the line authority to decide whether and when a new machine is needed but the Controller demands that a Capital Expenditure Proposal is submitted first, showing that the investment will have a yield of at least x%; or, a legal department may have functional authority to interfere in any activity that could have legal consequences. This authority would not be functional but it would rather be staff authority if such interference is “advice” rather than “order”.

Organization and Goal Orientation

Organizations have their own purposes and objectives. An organization employs the function of organizing to achieve its overall goals. It can serve to harmonize the individual goals of the employees with the overall objectives of the firm. Individuals form a group, and the groups form an organization. Organization, therefore, is the composition of individuals and groups. Individuals are grouped into departments, and their work is coordinated and directed towards organizational goals. Effective organization allows a firm to achieve continuity, effective management, and growth and diversification, and optimize the use of resources and provide proper treatment to employees.

Specialization and Division of Work

The philosophy of organization is centered on the concepts of specialization and division of work. Division of work refers to assigning responsibility for each organizational component to a specific individual or group. Specialization occurs when the responsibility for a specific task lies with a designated expert in that field. Certain operatives occupy positions of management at various points in the process to ensure coordination.

Efficiency

To make optimum use of resources such as labor, material, money, machine, and method, it is necessary to design an organization properly. Work should be divided and specific people should be given specific jobs to reduce the wastage of resources in an organization. In other words, effective organization promotes a high level of efficiency.

Delegation

Delegation is the process managers use to transfer authority and responsibility to positions below them. Today, organizations tend to encourage delegation from the highest to lowest possible levels. Delegation can improve an organizations flexibility to meet customers’ needs and help organizations adapt to competitive environments.

Departmentalization

Departmentalization is the basis on which individuals are grouped into departments, and departments into total organizations. Departmentalization allows organizations to simultaneously work on various projects and tasks. Approach options include:

• Functional – by common skills and work tasks
• Divisional – common product, program, or geographical location
• Matrix – combination of functional and divisional
• Team – to accomplish specific tasks
• Network – departments are independent, providing functions for a central core breaker

Organization

Any organization — in this case, a professional society — employs the function of organizing to achieve its overall goals.

1.1.3: Addressing Market Needs

Learning Objective

Recognize the needs for markets

Key Points

• A market is one of many varieties of systems, institutions, procedures, social relations, and infrastructures whereby parties engage in exchange.
• Many companies today have a customer focus (or market orientation). This implies that the company focuses its activities and products on consumer demands.
• Market research is for discovering what people want, need, and believe; and how they behave.
• Market segmentation is the division of the market or population into subgroups with similar motivations.

Key Terms

demand

The desire to purchase goods or services, coupled with the power to do so, at a particular price.

Market

Markets vary in form, scale, location, and types of participants, as well as the types of goods and services traded.

Example

• Markets vary in form, scale, location, and types of participants, as well as the types of goods and services traded. Examples of markets include: Physical retail markets, such as local farmers’ markets, shopping centers and shopping malls Non-physical internet markets Ad hoc auction markets Markets for intermediate goods used in production of other goods and servicesLabor markets and international currency and commodity markets Stock markets, for the exchange of shares in corporations Artificial markets created by regulation to exchange rights for derivatives that have been designed to ameliorate externalities, such as pollution permits. Illegal markets such as the market for illicit drugs, arms, or pirated products

What is a Market?

In mainstream economics, the concept of a market is any structure that allows buyers and sellers to exchange any type of goods, services, and information. The exchange of goods or services for money is called a transaction. Market participants consist of all the buyers and sellers of a certain good, thus influencing its price.

This influence is a major study of economics and has given rise to several theories and models concerning the basic market forces of supply and demand. There are two roles in markets, that of a buyer and that of a seller. The market facilitates trade and enables the distribution and allocation of resources in a society.

Supply and Demand

This graph depicts where a supply, such as a business, intersects with demand, such as the market need.

This graph shows quantity as the x-axis and price as the y-axis. Lines representing demand and supply cross each other in the graph.

Markets allow any tradeable item to be evaluated and priced. It emerges more or less spontaneously or is constructed deliberately by human interaction in order to enable the exchange of services and goods. Historically, markets originated in physical marketplaces which would often develop into—or from— small communities, towns and cities.

A firm in the market economy survives by producing goods that persons are willing and able to buy. Consequently, ascertaining market needs is vital for a firm’s future viability, and even existence, as a going concern.

Many companies today have a customer focus (or market orientation). This implies that the company focuses its activities and products on consumer demands. In the consumer-driven approach, consumer wants are the drivers of all strategic marketing decisions. No strategy is pursued until it passes the test of consumer research.

Every aspect of a market offering, including the nature of the product itself, is driven by the needs of potential consumers. The starting point is always the consumer.

Market Research

Market research is a key factor in obtaining an advantage over competitors and is necessary in order to determine market needs that can and should be met.

It is the systematic gathering and interpretation of information about individuals or organizations through the use of statistical and analytic methods in order to gain insight or support decision making, and includes both social and opinion research. Market research provides important information that identifies and analyzes the market’s need, size, and competition; thus making it possible to determine how to market a product.

Market segmentation is the division of the market or population into subgroups with similar motivations. It is widely used for segmenting the various differences within the market: geographic, personality, demographic, technographic, use of product, psychographic, and gender. This allows firms to further distinguish market needs by subdividing and focusing on various groups within markets.

Market Trends

Market trends are the upward or downward movement of a market during a period of time. Analyzing these trends is another method that allows firms to decipher the needs of markets and strive to meet them.

The market size is more difficult to estimate if one is starting with something completely new. In this case, one would have to derive the figures from the number of potential customers, or customer segments. Besides information about the target market, one also needs information about one’s competitors, customers, and products. Lastly, one needs to measure marketing effectiveness.

As an example of a process of addressing market needs, imagine the release of a new film. When performing marketing research on it, here are several practices that a studio may use:

• Concept testing, which evaluates reactions to a film idea and is fairly rare,
• Positioning studios, which analyze a script for marketing opportunities,
• Focus groups, which probe viewers’ opinions about a film in small groups prior to release,
• Test screenings, which involve the previewing of films prior to theatrical release,
• Tracking studies, which gauge (often by telephone polling) an audience’s awareness of a film on a weekly basis prior to and during theatrical release,
• Advertising testing, which measures responses to marketing materials such as trailers and television advertisements,
• Exit surveys, which measure audience reactions after seeing the film in the cinema.

1.1.4: Profit and Value

Learning Objective

Differentiate between profit and value

Key Points

• Normal profit represents the total opportunity costs (both explicit and implicit) of a venture to an investor, whereas economic profit is the difference between a firm’s total revenue and all costs (including normal profit).
• Given that profit is defined as the difference in total revenue and total cost, a firm achieves a maximum profit by operating at the point where the difference between the two is at its greatest.
• The value of a firm is linked to profit maximization. A firm looking to maximize its profits is actually concerned with maximizing its value.

Key Term

game theory

A branch of applied mathematics that studies strategic situations in which individuals or organisations choose various actions in an attempt to maximize their returns.

Examples

• Which of the following statements is true regarding a firm’s value? A) The value of a firm is the sum of its expected profits; B) The value of a firm is the sum of the PV of its current and future profits; or C) The value of a firm is its current profit. The answer is B. The present value of a firm is determined by considering both the current and expected profits of a firm.
• 1) If a firm’s current profits are $10,000 and the firm is expected to earn $10,500 in profits in each of the next 3 years, What is the value of the firm in present term. The interest rate is 8%. A) 41,500 B) 39,170 C) 37,060 D) 40,000 The answer is C. The following equation is used to determine the firm’s value: PV(firm)=p(0) + [p(1)/(1+i)]+ [p(2)/(1+i)^2]+ [p(3)/(1+i)^3], where p=10,00 p(1), p(2) and p(3)=10,500, and i=.08. PV(firm)=10,000+[10,500/(1+.08)]+ [10,500/(1+.08)^2]+ [10,500/(1+.08)^3] PV(firm)=10,000+9722+9002+8335 PV(firm)=37,060

Profit

In accounting, profit refers to the difference between the purchase and the component costs of delivered goods and/or services, and any operating or other expenses. In neoclassical microeconomic theory, the term profit has two related but distinct meanings. Normal profit represents the total opportunity costs (both explicit and implicit) of a venture to an investor, whereas economic profit is the difference between a firm’s total revenue and all costs (including normal profit). In both classical economics and Marxian economics, profit refers to the return of capital stock (means of production or land) to an owner in any productive pursuit involving labor, or a return on bonds and money invested in capital markets. By extension, in Marxian economic theory, the maximization of profit corresponds to the accumulation of capital, which is the driving force behind economic activity within capitalist economic systems. Some common-use definitions of profit include the following:

• Gross profit equals sales revenue minus cost of goods sold (COGS), thus removing only the part of expenses that can be traced directly to the production or purchase of the goods.
• Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) equals sales revenue minus cost of goods sold and all expenses, except for interest, amortization, depreciation and taxes.
• Earnings Before Interest and Taxes (EBIT), or operating profit, equals sales revenue minus cost of goods sold and all expenses except for interest and taxes. This is the surplus generated by operations.
• Earnings Before Tax (EBT), or net profit before tax, equals sales revenue minus cost of goods sold and all expenses except for taxes. It is also known as pre-tax book income (PTBI), net operating income before taxes, or simply pre-tax income.
• Earnings After Tax, or net profit after tax, equals sales revenue after deducting all expenses, including taxes (unless some distinction about the treatment of extraordinary expenses is made). In the U.S., the term net income is commonly used.

Profit Maximization

It is a standard economic assumption (though not necessarily a perfect one in the real world) that other things being equal, a firm will attempt to maximize its profits. Given that profit is defined as the difference in total revenue and total cost, a firm achieves a maximum by operating at the point where the difference between the two is at its greatest. In markets that do not show interdependence, this point can either be found by looking at graphical representations of revenue and cost directly, or by finding and selecting the best of the points where the gradients of the two curves (marginal revenue and marginal cost respectively) are equal. In interdependent markets, game theory must be used to derive a profit maximizing solution.

Value

Economic value is a measure of the benefit that an economic actor can gain from either a good or service. It is generally measured relative to units of currency. The interpretation, therefore, is “what is the maximum amount of money a specific actor is willing and able to pay for the good or service? ” Note that economic value is not the same as market price. If a consumer is willing to buy a good, this willingness implies that the customer places a higher value on the good than the market price. The difference between the value to the consumer and the market price is called “consumer surplus. ” It is easy to see situations where the actual value is considerably larger than the market price; the purchase of drinking water is one example. Value is linked to price through the mechanism of exchange. When an economist observes an exchange, two important value functions are revealed: those of the buyer and those of the seller. Just as the buyer reveals what he is willing to pay for a certain amount of a good, so, too, does the seller reveal what it costs him to give up the good. Said another way, value is how much a desired object or condition is worth relative to other objects or conditions.

In terms of a business, value is the present value of the firm’s current and future profits. The value of a firm is linked to profit maximization. A firm looking to maximize its profits is actually concerned with maximizing its value. As such, it is important for a firm to be able to accurately determine its present value.

Profit and Value

Profit is equal to a firm’s revenue minus its expenses, while value is the present value of the firm’s current and future profits.

1.1.5: Profit and Stakeholders

Learning Objective

Compare and contrast stakeholders and shareholders

Key Points

• The stockholders are the owners of the company, and the firm has a binding fiduciary duty to put their needs first to increase value for them.
• Stakeholder theory argues that there are other parties involved, including governmental bodies, political groups, trade associations, trade unions, communities, associated corporations, prospective employees, prospective customers, and the public at large.
• In some scenarios, even competitors are included as stakeholders.
• Stakeholders believe that an organization should strive to achieve satisfaction among all parties involved, as opposed to solely pursuing the highest profit.
• In some scenarios, even competitors are included as stakeholders.

Key Terms

stockholder

One who owns stock.

fiduciary duty

A legal or ethical relationship of confidence or trust between two or more parties. Typically, a fiduciary prudently takes care of money for another person.

stakeholder

A person or organization with a legitimate interest in a given situation, action, or enterprise.

Example

• In the case of a professional landlord undertaking the refurbishment of some rented housing that is occupied while the work is being carried out, key stakeholders would be the residents, neighbors (for whom the work is a nuisance), and the tenancy management team and housing maintenance team employed by the landlord. Other stakeholders would be funders and the design and construction teams.

What is a Stakeholder?

A stakeholder is an individual or group with an interest in an entity’s or organization’s ability to deliver intended results while maintaining viability of the product and/or service. The stakeholder concept was first used in a 1963 internal memorandum at the Stanford Research Institute. It defined stakeholders as “those groups without whose support the organization would cease to exist” .

Stakeholders

This diagram shows the typical stakeholders of a company.

In the traditional view of the firm, the stockholders are the owners of the company, and the firm has a binding fiduciary duty to put their needs first and to increase value. In older input-output models of the corporation, the firm converts the inputs of investors, employees, and suppliers into salable outputs which customers buy, thereby returning some capital benefit to the firm. By this model, firms only address the needs and wishes of those four parties: Investors, employees, suppliers, and customers. However, stakeholder theory argues that there are other parties involved, including governmental bodies, political groups, trade associations, trade unions, communities, associated corporations, prospective employees, prospective customers, and the public at large. Sometimes even competitors are counted as stakeholders.

Types of Stakeholders

Market stakeholders (sometimes called “primary stakeholders”) are those that engage in economic transactions with the business. Examples of primary stakeholders could be customers, suppliers, creditors or employees. Non-market stakeholders (sometimes called “secondary stakeholders”) are those who generally do not engage in direct economic exchange with the business, but are affected by or can affect its actions. Examples of non-market stakeholders include the general public, communities, activist groups, business support groups, or the media.

Stakeholders, Profit and Corporate Responsibility

Stakeholders, as opposed to shareholders, tend to focus on corporate responsibility over corporate profitability. Stakeholders believe that an organization should strive to achieve satisfaction among all parties involved, as opposed to solely pursuing the highest profit. An organization is a coalition between all stakeholders and exists to increase the common wealth of all parties.

In the field of corporate governance and corporate responsibility, a major debate is ongoing about whether the firm or company should be managed for stakeholders, stockholders (called “shareholders”), or customers. Proponents in favor of stakeholders may base their arguments on the following four key assertions:

1. Value can best be created by trying to maximize joint outcomes. For instance, by simultaneously addressing customer wishes in addition to employee and stockholder interests, both of the latter two groups also benefit from increased sales.
2. Supporters also take issue with the preeminent role given to stockholders by many business thinkers, especially in the past. The argument is that debt holders, employees, and suppliers also make contributions and take risks in creating a successful firm.
3. These normative arguments would matter little if stockholders had complete control in guiding the firm. However, many believe that due to certain kinds of board of directors’ structures, top managers like CEOs are mostly in control of the firm.
4. The greatest value of a company is its image and brand. By attempting to fulfill the needs and wants of many different people ranging from the local population and customers to their own employees and owners, companies can prevent damage to their image and brand, prevent losing large amounts of sales, avoid having disgruntled customers, and prevent costly legal expenses. While the stakeholder view has an increased cost, many firms have decided that the concept improves their image, increases sales, reduces the risks of liability for corporate negligence, and makes them less likely to be targeted by pressure groups, campaigning groups and NGOs (non-governmental organizations).

1.1.6: The Role of the Nonprofit

Learning Objective

Outline the characteristics of a nonprofit and their role in society

Key Points

• While NPOs are permitted to generate surplus revenues, these revenues must be retained by the organization for its self-preservation, expansion, or plans.
• Some NPOs may also be charity or service organizations. They may be organized as corporations, trusts, or cooperatives; or they may exist informally.
• Both NPOs and for-profit corporate entities must have board members, steering committee members, or trustees who owe the organization a fiduciary duty of loyalty and trust.
• NPOs have controlling members or boards. Many have paid staff including management, while others employ unpaid volunteers and even executives who work with or without compensation (occasionally nominal).

Key Terms

jurisdiction

The limits or territory within which authority may be exercised.

dividend

A pro rata payment of money by a company to its shareholders, usually made periodically (e.g., quarterly or annually).

fiduciary

Related to trusts and trustees.

Nonprofits Defined

A nonprofit organization (NPO) does not distribute profits or dividends. Instead it retains any earnings or surplus revenues to achieve its goals. An organization is deemed eligible for nonprofit status under US Internal Revenue Code Section 501(c).

While nonprofit organizations are permitted to generate surplus revenues, these revenues must be retained by the organization for its self-preservation, expansion, or plans. NPOs have controlling members or boards. Many have paid staff, including management, while others employ unpaid volunteers and even executives who work with or without compensation . Designation as a nonprofit and an intent to make money are not related in the United States. However, the extent to which an NPO can generate surplus revenues may be constrained, or the use of surplus revenues may be restricted.

Nonprofit Organizations

U.S. Navy Sailors, assigned to the aircraft carrier USS Ronald Reagan, position a frame of a wall while helping the nonprofit group Habitat for Humanity build homes.

Some NPOs may also be charitable or service organizations; they may be organized as a corporation, a trust, a cooperative, or they may exist informally. A very similar type of organization, called a supporting organization, operates like a foundation, but is more complicated to administer, holds more favorable tax status, and is restricted in the public charities it can support. For legal classification, elements of importance include:

• Economic activity
• Supervision and management provisions
• Representation
• Accountability and auditing provisions
• Provisions for the amendment of the statutes or articles of incorporation
• Provisions for the dissolution of the entity
• Tax status of corporate and private donors
• Tax status of the foundation

In the United States, nonprofit organizations are formed by filing bylaws and articles of incorporation in the state in which they expect to operate. In most jurisdictions, some of the above elements must be expressed in the charter of establishment. The act of incorporating creates a legal entity, which enables the organization to be treated as a corporation by law and to enter into business dealings, form contracts, and own property as any other individual or for-profit corporation may do. Most countries have laws that regulate the establishment and management of NPOs, and that require compliance with corporate governance regimes. Most larger organizations are required to publish financial reports detailing their income and expenditures publicly.

The two major types of nonprofit organization are membership and board-only. A membership organization elects the board, meets regularly, and has the power to amend the bylaws. A board-only organization typically has a self-selected board and a membership whose powers are limited to those delegated to it by the board. A board-only organization’s bylaws may even state that the organization does not have any membership, although the organization’s literature may refer to its donors as “members. “

In many countries, nonprofits may apply for tax exempt status, so the organization itself can be exempt from income tax and other taxes. In the United States, to be exempt from federal income taxes, the organization must meet the requirements set forth by the Internal Revenue Service. After reviewing the application to ensure the organization meets the conditions (such as the purpose, limitations on spending, and internal safeguards for a charity), the IRS may issue an authorization letter to the nonprofit granting it tax exempt status for income tax payment, filing, and deductibility purposes. The exemption does not apply to other federal taxes such as employment taxes. Federal tax-exempt status does not guarantee exemption from state and local taxes, and vice versa.

The Role of Nonprofits in Society

Nonprofit organizations play a vital role in society by focusing resources and providing services to community needs without regard to profit. Nonprofits aid in the development and upkeep of such sectors of society as the arts, economic development, cultural awareness, spirituality, veterans affairs, and health and wellness. In general, nonprofit organizations have strong ties to their local communities. Through these ties, nonprofits are able to accomplish local development and outreach.

1.2: The Business Environment

1.2.1: The State of the Economy

Despite recent economic woes, America’s economy remains the world’s largest and most diverse.

Learning Objective

Assess the connection between the increased presence of globalization and debt and the current state of the U.S. economy

Key Points

• Since 1980, the United States has championed globalization of trade and finance by opening its doors wider to foreign products and investment.
• However, consumers, businesses, home buyers, and the U.S. government itself borrowed heavily believing that the value of their investments would continue to grow.
• The financial crash of 2008 brought a sudden, traumatic halt to U.S. economic growth due, in large part, to the housing bubble.
• Large corporations and wealthy businesspeople were minimally affected by the recession, and were the first to recover.
• On the other hand, wages and incomes of typical Americans are lower today than in over a decade.

Key Terms

foreclosure

The proceeding, by a creditor, to regain property or other collateral following a default on mortgage payments.

free market

Any market in which trade is unregulated; an economic system free from government intervention.

Since the election of Ronald Reagan as president in 1980, the United States had championed globalization of trade and finance. It opened its doors wider to foreign products and investment than any other major economy. “” America’s entrepreneurial culture was the world’s model. The synergy of U.S. political freedoms and free markets appeared vindicated by the Soviet Union’s collapse in 1991. At home, a bipartisan consensus emerged in favor of further economic deregulation, which, in turn, spurred a freewheeling expansion of new types of investments that helped fuel a vast increase in international finance and commerce. But America’s growth came to rely increasingly on debt. Consumers, businesses, home buyers, and the U.S. government itself borrowed heavily in the belief that the value of their investments—including, fatefully for many, their homes—would continue to grow. The ready availability of credit on easy terms drove home prices, in particular, ever higher.

US Integration into the global economy

Imports and exports as a % of GDP, 1947-present

The financial crash of 2008 brought a sudden, traumatic halt to a quarter-century of U.S.-led global economic growth. When the housing boom finally collapsed in 2007, it exposed a fragile layer of high-risk home loans made over a decade to families that could not afford them, particularly if the economy weakened. Some borrowers had purchased homes they could not afford, trusting that in a rising market they could always sell their properties at a profit. As housing prices fell, homeowners who no longer could keep up with their mortgage payments were unable to pay their debt by selling their homes. These home loans thus were the unstable foundation for a massive but largely invisible speculation on mortgage securities and financial contracts sold around the world. Triggered by the housing collapse, this edifice toppled in 2008. Foreclosures grew, and panic followed. Giant Wall Street financial firms fell, reorganized, or were combined with larger competitors. Stock markets plunged, and the world’s economies headed into the worst crisis since the Great Depression of the 1930s.

However, large corporations and wealthy businesspeople were minimally affected by the recession, and were the first to recover. Shortly after the economic recovery began, many Fortune 500 corporations reported record profits and many billionaires saw their net worths hit new highs. The 2011 edition of the annual U.S. dollar billionaires ranking compiled by Forbes Magazine broke new records, both in terms of the number of billionaires (1,210) and their total wealth (US $4.5 trillion. )

On the other hand, wages and incomes of typical Americans are lower today than in over a decade. This “lost decade” of no wage and income growth began well before the Great Recession battered wages and incomes. In the historically weak expansion following the 2001 recession, hourly wages and compensation failed to grow for either high school or college-educated workers and, consequently, the median income of working-age families had not regained pre-2001 levels by the time the Great Recession hit in December 2007.

Incomes failed to grow over the 2000–2007 business cycle despite substantial productivity growth during that period. Although economic indicators are stronger today than they were two or three years ago, protracted high unemployment in the wake of the Great Recession has left millions of Americans with lower incomes and in economic distress.

Consensus forecasts predict that unemployment will remain high for many more years, suggesting that typical Americans are in for another lost decade of living standards growth as measured by key benchmarks such as median wages and incomes. For example, as a result of persistent high unemployment, some expect the incomes of families in the middle fifth of the income distribution in 2018 will still be below their 2007 and 2000 levels.

1.2.2: The State of Technology

The constant evolution of technology offers both considerable opportunity and risk to businesses across all industries.

Learning Objective

Recognize the critical business impacts of keeping pace with the current technological environment

Key Points

• Capturing opportunities in the current technological era is an enormous source of potential success for organizations.
• Disruptive innovations, such as Netflix, can upset entire industries in a very short period of time. This can result in big gains for the innovators and serious consequences for those who fall behind.
• In considering the current state of technology relative to businesses, it’s useful to consider how organizations commonly structure their IT department strategies.
• Most modern IT departments consider both what internal capabilities modern technology offers, as well as what external technological forces will impact the business and industry.

Key Terms

disruptive innovation

An innovation which redefines an existing market and value network, often through the creation or utilization of new technologies or processes.

IT strategies

The objectives, principles, and tactics involved in an organization’s approach to managing current and potential changes in technology.

Why Technology Matters

Technology is always changing, offering new opportunities and risks for business every single day. Netflix captured huge opportunity through utilizing online streaming services and redefining the TV and movie industry (many organizations went out of business as a result, encountering the risks of technology). This type of technological opportunity is often referred to as a disruptive innovation.

Disruptive Innovation

Disruptive innovations rapidly improve the overall performance (fulfillment of the user’s needs) in a fraction of the time normally required to improve organically through efficiency. Netflix disrupted the movie and TV market through rapidly improving the experience in a short amount of time.
This is a great opportunity for business, as well as a great threat.

Disruptive technology is illustrated in this image as a chart, with time being on the x-axis and performance on the y-axis. A line representing disruptive technology is shown increasing performance over a very short period of time, crossing over other lines representing use.

As a result, business are constantly monitoring current and emerging technologies to capture opportunities and avoid enormous risk to keep pace with the demands of the modern economy. 

How Technology Impacts Business

By looking at how business IT strategies are structured, we can identify why technology matters through considering the state of technology from various perspectives. Without diving into too much detail, here are some key building blocks to integrating the state of technology into an organization’s strategy:

Internal Capabilities

Technology is the great enabler. Nowadays, integrating technological tools to execute complex tasks is the norm. These integrations impact every facet of the organization. On the manufacturing floor, smarter machines can reduce production time, increase efficiency, and lower costs. In marketing, online tools can enable rapid iterative testing of creative assets and utilization of social networks. Keeping pace with the latest technology for organizational efficiency is key to competitive success.

External Forces

Technology changes the expectations of consumers and as a result businesses must keep up to remain relevant. Having a presence on Facebook, for example, is an external technological force that companies have had to integrate into their process. Another example is the auto industry, where both consumers and governments expect (and sometime requires) businesses to adopt new, expensive technology to reduce carbon footprints.

Opportunities

Identifying technologies that could cut costs, improve productivity, capture new markets, or fulfill new needs for consumers is a constant focal point for technology specialists. Identifying opportunities before they become competitive risks is a key to survival in the modern business world.  

Threats

Closely related to the opportunities above, there is always the threat of falling behind the current state of technology (such was the case with streaming media). Another threat in the modern digital age is security. Target was recently hacked, incurring a massive leak of customer data. This can be costly both from a legal perspective and from a branding perspective. 

Conclusion

All and all, the current state of technology is always evolving. What’s most important to keep in mind is the general perspective a business owner or manager must take when considering technology. Technology can be an enormous source of competitive advantage, both for your organization and your competitors.

1.2.3: The State of Competition

Current competition can be examined through market dominance, mergers and acquisitions, public sector regulation, and intellectual property.

Learning Objective

Describe how market dominance, mergers and acquisitions, public sector regulation, and intellectual property contribute to the current state of competition

Key Points

• Competition occurs when different firms attempt to attract the same group of buyers by offering products with greater perceived benefit.
• A firm is considered dominant if acts to an appreciable extent independently of its competitors; customers; and, ultimately, of its consumer.
• Often, firms take advantage of their increase in market power, their increased market share, and decreased number of competitors after a merger or acquisition–which can adversely affect the deal that consumers get.
• Public sector industries, or industries which are by their nature providing a public service, are involved in competition in many ways similar to private companies.
• Competition has become increasingly present in intellectual property, such as copyright; trademarks; patents; industrial design rights; and, in some jurisdictions, trade secrets.

Key Terms

product

Any tangible or intangible good or service that is a result of a process and that is intended for delivery to a customer or end user.

intellectual property

Any product of someone’s intellect that has commercial value: copyrights, patents, trademarks, and trade secrets.

Example

• Take Coke and Pepsi, two interdependent companies. An attempt by Pepsi to attract buyers (increase sales) through an advertising campaign will decrease the sales of Coke. How Coke chooses to react to Pepsi will be based on an analysis of how the firms have acted in past situations. The industry’s competitive dynamics are composed of the ongoing series of competitive actions and competitive responses that take place as Coke and Pepsi compete for customers.

Competition occurs when competing firms attempt to attract buyers by offering products with greater perceived benefit. Common benefits include price, service, reputation, and image, but may include virtually anything else associated with a product that the buyer values. A buyer’s perceptions of what constitutes a benefit may vary widely based on the nature of the product. Since the actions taken by one competitor to attract buyers are likely to affect the performance of other competitors, competing firms are said to be interdependent. The current state of competition can be examined based on the following categories.

Dominance and Monopoly

When firms hold large market shares, consumers risk paying higher prices and getting lower quality products than when compared to competitive markets. However, the existence of a very high market share does not always mean consumers are paying excessive prices since the threat of new entrants to the market can restrain a high market share firm’s price increases. A firm is considered dominant if acts to an appreciable extent independently of its competitors; customers; and, ultimately, of its consumer.

This lack of competition can lead to abuses in today’s business environment. Forms of abuse relating directly to pricing include price exploitation. It is difficult to prove at what point a dominant firm’s prices become “exploitative” and this category of abuse is rarely found.

Mergers and Acquisitions

A merger or acquisition involves, from a competition perspective, the concentration of economic power in the hands of fewer than before. This usually means that one firm buys out the shares of another. Often, firms take advantage of their increase in market power, their increased market share, and decreased number of competitors–which can adversely affect the deal that consumers get. Since mergers and acquisitions can lead to market dominance, competition law attempts to deal with this problem before it arises.

Public Sector Regulation

Public sector industries, or industries which are by their nature providing a public service, are involved in competition in many ways similar to private companies. Many industries, such as railways, electricity, gas, water, and media have their own independent competitive concerns and sector regulators. These government agencies are charged with ensuring that private providers carry out certain public service duties in line with social welfare goals.

Intellectual Property and Innovation

Competition has become increasingly present in intellectual property, such as copyright; trademarks; patents; industrial design rights; and, in some jurisdictions, trade secrets. On the one hand, it is believed that promotion of innovation through enforcement of intellectual property rights promotes competitiveness, while on the other the contrary may be the consequence. The question rests on whether it is legal to acquire a monopoly through accumulation of intellectual property rights. In which case, the law must either give preference to intellectual property rights or towards promoting competitiveness. Concerns also arise over anti-competitive effects and consequences due to:

Intellectual Property

Competition in regard to intellectual property is a growing concern in today’s business environment.

A message is written in red and blue on a black background. It says: WARNING! INTELLECTUAL PROPERTY ZONE. Have pennies for thoughts ready!

• Intellectual properties that are collaboratively designed with consequence of violating antitrust laws (intentionally or otherwise).
• The further effects on competition when such properties are accepted into industry standards.
• Cross-licensing of intellectual property.
• Bundling of intellectual property rights to long term business transactions or agreements to extend the market exclusiveness of intellectual property rights beyond their statutory duration.
• Trade secrets, if they remain a secret, having an eternal length of life.

1.2.4: The Social Environment

Businesses must consider their social environment, since their actions have repercussions that echo throughout society.

Learning Objective

Express how materiality and sociality are accelerating the transformation of the global socio-business environment

Key Points

• CSR policy functions as a built-in, self-regulating mechanism whereby a business monitors and ensures its active compliance with the spirit of the law, ethical standards, and international norms.
• The goal of CSR is to embrace responsibility for the company’s actions and encourage a positive impact through its activities on the environment, consumers, employees, communities, and all other stakeholders.
• A new global business environment is emerging from two accelerating shifts that are now transforming how we use natural systems and material resources (materiality), and how we coordinate human action (sociality).
• Corporate social responsibility (CSR) is a form of corporate self-regulation integrated into a business model. CSR policy functions as a built-in, self-regulating mechanism whereby a business monitors and ensures its active compliance with the spirit of the law, ethical standards, and international norms.
• The goal of CSR is to embrace responsibility for the company’s actions and encourage a positive impact through its activities on the environment, consumers, employees, communities, stakeholders and all other members of the public sphere who may also be considered as stakeholders.

Key Terms

Scarcity

The condition of something being scarce or deficient.

stakeholder

A person or organization with a legitimate interest in a given situation, action, or enterprise.

Example

• Heightened awareness of CSR and sustainable development has been endorsed by an increased responsiveness to ethical, social, environmental and other global issues. In recent years, companies have been the center of scandals regarding accounting practices, damages to the environment, inadequate treatment of employees and workers and the effect of its products on the society.

The Social Environment of Business

Businesses do not operate in a vacuum. A firm’s actions have repercussions that echo throughout society. Corporate social responsibility (CSR) is a form of corporate self-regulation integrated into a business model. CSR policy functions as a built-in, self-regulating mechanism whereby a business monitors and ensures its active compliance with the spirit of the law, ethical standards, and international norms. The goal of CSR is to embrace responsibility for the company’s actions and encourage a positive impact through its activities on the environment, consumers, employees, communities, and all other members of the public sphere who may be considered stakeholders.

CSR diagram 

This diagram shows the different components of CSR.

In the center of the circle is quality of management. The next layer is divided into marketplace, workplace, environment, and community. And further outside of that is consumers, shareholders, unions, employees, local communities, NGOs, and government.

The topics surrounding CSR have become more complex due to globalization and the issues that arise from companies competing in international markets. Companies are manufacturing goods, hiring local labor, and utilizing raw materials and resources extracted from the environment in international locations. This heightened awareness of CSR and sustainable development has been endorsed by an increased responsiveness to ethical, social, environmental, and other global issues. In recent years, companies have been the center of scandals regarding accounting practices, damages to the environment, inadequate treatment of employees and workers, and the effect of products on society. This new global business environment is emerging from two accelerating shifts that are transforming how we use natural systems and material resources (materiality), and how we coordinate human action (sociality).

Materiality

Continuing industrial development has brought us into contact with the one planet limit on material supply. Thus, material resource scarcity is increasing, raising supply costs and shifting us away from the old economic growth strategy based in continually increasing resource consumption (more with more), to a new growth strategy based in increasing resource performance (more with less).

Sociality

Global adoption of digital communications and information technology (CIT) has converged media, communications, and information processing onto the Internet. Thus, CIT resource abundance is increasing, lowering communication costs and shifting us from the old coordination strategy based in hierarchical messaging (chain of command) to a new coordination strategy based in networked conversation (peer teaming). Hundreds of millions have embraced new social media tools such as Facebook and Twitter. As a result, a new social business environment has emerged around our organizations in a rising crescendo of change–transforming our whole conduct of life, bringing new risks, new rules, and vast new opportunities for economic growth.

Financial Case for CSR

The business case for CSR within a company will likely rest on one or more of these arguments:

1. Human resources: A CSR program can aid recruitment and retention. Potential recruits often ask about a firm’s CSR policy during an interview, and having a comprehensive policy can provide an advantage. CSR can also help improve the perception of a company among its staff, particularly when staff can become involved through payroll giving, fundraising activities, or community volunteering. CSR has been found to encourage customer orientation among frontline employees.
2. Risk management: Managing risk is a central part of many corporate strategies. Reputations that take decades to build up can be ruined in hours through incidents such as corruption scandals or environmental accidents. These can also draw unwanted attention from regulators, courts, governments, and media. Building a genuine culture of “doing the right thing” within a corporation can offset these risks.
3. Brand differentiation: In crowded marketplaces, companies strive for a unique selling proposition that can separate them from the competition in the minds of consumers. CSR can play a role in building customer loyalty based on distinctive ethical values.
4. License to operate: Corporations are keen to avoid interference in their business through taxation or regulations. By taking substantive voluntary steps, they can persuade governments and the wider public that they are taking issues such as health and safety, diversity, or the environment seriously as good corporate citizens with respect to labor standards and impacts on the environment.

1.2.5: The State of Global Business

Global business is changing and evolving quickly due to demographic and technological trends.

Learning Objective

Identify how the Internet, a swelling global middle class, and the tottering global finance system has generated a new global business environment

Key Points

• In the last five years over 50% people in the developed world have used the internet as their preferred source for news and entertainment, banking, shopping, and communications. They also use the internet to conduct basic business processes. This has created a new social business environment.
• Some two billion people have joined the ranks of the rising global middle class. This has placed material resources under increasing supply pressure. Furthermore, the global finance system has tottered to the brink of chaos with debt and employment issues, and rising global food and energy prices.
• All of the recent economic and technological changes generated an entirely new global business environment, and an emerging new global economy, with new rules, new patterns of costs, new methods of work, new risks, new opportunities, and new horizons for growth, evolution and change.

Key Terms

business environment

the system within which companies exist

debt

Money that one person or entity owes or is required to pay to another, generally as a result of a loan or other financial transaction.

employment

The work or occupation for which one is used, and often paid.

internet

The Internet, the largest global internet.

In the last five years, over 50% of the general public throughout the developed world have begun to use the internet as their preferred source for news and entertainment, as well as their preferred support for the conduct of banking, shopping, and personal and business communications.

They are also increasingly coming to use the internet to conduct many more basic business processes such as filing taxes and regulatory compliance forms, locating and initiating key business connections, coordinating work teams, and telecommuting. This has, almost overnight, created a new social business environment.

At the same time, in the material domain of life almost two billion people have joined the ranks of the rising global middle class as the developing economies of India and China have come fully on-line. This has placed every key material resource – energy, food, water, shelter, and the regenerative ecosystem itself – under rapidly increasing supply pressure.

These make inflation rates in developing countries stay at high levels. And amplifying all these social and material pressures, the global finance system has tottered to the brink of chaos with both Europe and North America facing unprecedented and unresolved debt and employment issues, with global food and energy prices doubling since just 2008.

All this has generated an entirely new global business environment, and an emerging new global economy, with new rules, new patterns of costs, new methods of work, new risks, new opportunities, and new horizons for growth, evolution and change.

And the trends that have created this new environment are all accelerating.

The Circular Flow of Business and the Economy

Refers to a simple economic model which describes the reciprocal circulation of business and the global economy.

1.3: Trends in American Business

1.3.1: Productivity Gains in Agriculture

During the second agricultural revolution, U.S. agricultural productivity rose fast, especially due to the development of new technologies.

Learning Objective

Outline agricultural advances that have resulted in productivity gains

Key Points

• Between 1950 and 2000, during the so called “second agricultural revolution of modern times,” U.S. agricultural productivity rose fast, especially due to the development of new technologies.
• Avoiding losses of agricultural products to spoilage, insects, and rats contribute greatly to productivity.
• Additional innovations include the pasteurization of milk, which allow it to be shipped long distances without spoiling.

Key Terms

revolution

A sudden, vast change in a situation, a discipline, or the way of thinking and behaving.

pasteurize

To heat food for the purpose of killing harmful organisms, such as bacteria, viruses, protozoa, molds, and yeasts.

agriculture

The art or science of cultivating the ground, including the harvesting of crops, and the rearing and management of livestock; tillage; husbandry; farming.

Examples

• During the second agricultural revolution, the average amount of milk produced per cow increased from 5,314 pounds to 18,201 pounds per year (+242%), the average yield of corn rose from 39 bushels to 153 bushels per acre (+292%), and each farmer in 2000 produced on average 12 times as much farm output per hour worked as a farmer did in 1950.
• The amount of feed required to produce a kilogram of live weight chicken fell from 5 in 1930 to 2 by the late 1990s and the time required fell from three months to six weeks. 
•  

Huge productivity gains in agriculture were recorded in the twentieth century. Avoiding losses of agricultural products to spoilage, insects, and rats contributes significantly to productivity. Large amounts of hay stored outdoors were traditionally lost to spoilage before indoor storage or other means of coverage became more common. Pasteurization of milk allowed it to be shipped by railroad. (It was noted that calves fed pasteurized milk were less likely to develop tuberculosis, and soon it was found that pasteurization reduced the incidences of several other diseases in humans. ) Keeping livestock indoors in winter reduces the amount of feed needed. Also, feeding chopped hay and ground grains, particularly corn (maize), was found to improve digestibility. The amount of feed required to produce a kilogram of live weight chicken fell from 5 in 1930 to 2 by the late 1990s and the time required fell from 3 months to 6 weeks.

Between 1950 and 2000, during the so called “second agricultural revolution of modern times,” U.S. agricultural productivity rose fast, especially due to the development of new technologies (the greatest period of agricultural productivity growth in the U.S. occurred from World War 2 until the 1970s). For example, the average amount of milk produced per cow increased from 5,314 pounds to 18,201 pounds per year (+242%), the average yield of corn rose from 39 bushels to 153 bushels per acre (+292%), and each farmer in 2000 produced on average of 12 times as much farm output per hour worked as a farmer did in 1950.

1.3.2: Productivity Gains in Manufacturing

Manufacturing is a critical sector in the U.S. economy, creating millions of jobs and contributing substantially to overall GDP.

Learning Objective

Discuss the various factors that impact productivity in manufacturing, alongside trends in jobs and production

Key Points

• Manufacturing plays a vital role in the overall health of the U.S. economy.
• As of 2016, manufacturing accounts for over 12 million US jobs. This number is down from the 1980’s, but is still a significant aspect of the workforce.
• Globalization has a somewhat mixed impact on manufacturing, as it offers access to more markets (growth) while also offering access to cheaper production elsewhere (outsourcing).
• Technology has a great impact on manufacturing as well, with machines drastically lowering costs and increasing efficiency. However, this too may ultimately cost jobs while increasing production.

Key Term

GDP

Or gross domestic product, this economic indicator measures the total amount of products and services produced over a specific time frame.

Manufacturing in the United States is important both economically and politically. As a potential source of gross domestic product (GDP) and jobs across various skill levels, manufacturing plays a vital role in the overall health of the U.S. economy.

Trends in Manufacturing

Jobs and overall contributions to GDP from manufacturing are impacted by a number of factors, most importantly trends in outsourcing, changes in skilled labor (domestically), and advances in technology. 

Over the past few decades, there have been drastic changes in the overall number of manufacturing jobs in the United States. As of October 2016, the United States employed over 12 million people in the manufacturing industries. At its highest in the 1980s, the United States had nearly 20 million manufacturing employees in the country. 

Total US Manufacturing Employment

This chart illustrates the changes in overall manufacturing employment from the 1940s onward. The peak of manufacturing employment was in the 1980s, though it’s worth noting that this is not normalized as a percentage of population (i.e., population growth would impact this assessment).

Population is shown on the y-axis and years are shown on the x-axis. A blue line moves up and down, showing the changes in employment over the years.

Globalization

With globalization and the availability of affordable labor and real estate overseas, there has been a trend towards outsourcing manufacturing over the past few decades. This trend has had some clear effects on the overall number of manufacturing jobs domestically and the GDP.

2014 U.S. Exports

This is a graphic diagram depicting the most common U.S. exports, including a number of manufactured goods.

This diagram is split into differently colored and shaped boxes, each showing a different export and percentage per export.

On the other side of things, globalization has opened more markets than ever before. U.S. manufactured goods are sold across the world, which offers great potential for expanding upon production levels of manufacturing. The United States manufacturers more goods than any other country excepting China and the EU as of 2014, indicating that trends in decreasing manufacturing employment may be a result of complex factors such as technological evolution.

Technology Advances

Similarly, technology has increased the efficiency of manufacturing significantly over time. This increase in efficiency often results in less labor required for a higher volume of output. As this trend continues, and robotics (and even AI) continues to evolve, some jobs may be lost to technology while gross output should increase (or, at least maintain).

Conclusion

Manufacturing is a significant aspect of the U.S. economy, and will maintain its importance in the near future. Outsourcing of jobs and technological advances are a threat to the availability of jobs in this sector, while access to global markets and a political focus on creating jobs offers growth opportunities.

1.3.3: Productivity Gains from Technology

Productivity improving technologies date back to antiquity, and have accelerated greatly of late.

Learning Objective

Identify the fundamental factors that have led to technological evolution over the centuries

Key Points

• Technologies that improve productivity date back to antiquity, with rather slow progress until the late Middle Ages.
• Technological progress was aided by literacy and the diffusion of knowledge that accelerated after the spinning wheel spread to Western Europe in the 13th century.
• However, technological and economic progress did not proceed at a significant rate until the English Industrial Revolution in the late 18th century.
• Even then productivity only grew about 0.5% annually, with high productivity growth only beginning during the late 19th century in the Second Industrial Revolution.
• Productivity gains were not just the result of inventions, but also of continuous improvements to those inventions which greatly increased output in relation both capital and labor compared to the original inventions.

Key Terms

internal combustion

The process where fuel is burned within an engine such as a diesel engine, producing power directly as opposed to externally such as in a steam engine.

electromagnetism

A unified fundamental force that combines the aspects of electricity and magnetism and is one of the four fundamental forces. (technically it can be unified with weak nuclear to form electroweak) Its gauge boson is the photon.

automation

The act or process of converting the controlling of a machine or device to a more automatic system, such as computer or electronic controls.

Examples

• The Spinning Jenny and Spinning Mule greatly increased the productivity of thread manufacturing compared to the spinning wheel.
• Mining and metal refining technologies played a key role in technological progress. Much of our understanding of fundamental chemistry evolved from ore smelting and refining, with De Re Metallica being the leading chemistry text for 180 years. Railroads evolved from mine carts and the first steam engines were designed specifically for pumping water from mines.
• Mining and metal refining technologies played a key role in technological progress. Much of our understanding of fundamental chemistry evolved from ore smelting and refining, with De Re Metallica being the leading chemistry text for 180 years. Railroads evolved from mine carts and the first steam engines were designed specifically for pumping water from mines.

Productivity Gains from Technology

In 1889, David Ames Wells described the economic events and technologies that created the great productivity growth during 1870-1890:

“The economic changes that have occurred during the last quarter of a century -or during the present generation of living men- have unquestionably been more important and more varied than during any period of the world’s history.”

Technologies that improve productivity date back to antiquity, with rather slow progress until the late Middle Ages. Technological progress was aided by literacy and the diffusion of knowledge that accelerated after the spinning wheel spread to Western Europe in the 13^th century. The spinning wheel increased the supply of rags used for pulp in manufacturing paper, and the technology reached Sicily sometime in the 12^th century. Cheap paper was a factor in the development of the moveable type printing press, ca. 1440, which lead to a large increase in the number of books and titles published.

Books on science and technology eventually began to appear, such as the mining technical manual, De Re Metallica. Mining and metal refining technologies played a key role in technological progress. Much of our understanding of fundamental chemistry evolved from ore smelting and refining, with De Re Metallica being the leading chemistry text for 180 years. Railroads evolved from mine carts and the first steam engines were designed specifically for pumping water from mines.

Later, near the beginning of the Industrial Revolution, came publication of the Encyclopédie, written by numerous contributors and edited by Denis Diderot and Jean le Rond d’Alembert (1751–72). It contained many articles on science and was the first general encyclopedia to provide in depth coverage on the mechanical arts, but far more celebrated for its presentation of thoughts of the Enlightenment.

Important mechanisms for the transfer of technical knowledge were scientific societies. The Royal Society of London for Improving Natural Knowledge is one example, though they were better known as the Royal Society and technical colleges. The École Polytechnique is one example. Probably the first period in history in which an economic progress was observable during one generation was the British Agricultural Revolution in the 18^th century.

However, technological and economic progress did not proceed at a significant rate until the English Industrial Revolution in the late 18^th century, and even then productivity grew about 0.5% annually. High productivity growth began during the late 19^th century in what is sometimes called the Second Industrial Revolution. Most major innovations of the Second Industrial Revolution were based on the modern scientific understanding of chemistry, electromagnetism theory, and thermodynamics.

Productivity gains were not just the result of inventions, but also of continuous improvements to those inventions which greatly increased output in relation to both capital and labor compared to the original inventions.

Technology and productivity

Technology has had a profound effect on productivity.

A picture of a cable engine.

Since the beginning of the Industrial Revolution, some of the major contributors to productivity have been as follows:

• Replacing human and animal power with water and wind power, steam, electricity and internal combustion, and greatly increasing the use of energy;
• Energy efficiency in the conversion of energy to process heat or chemical energy in the manufacture of materials;
• Infrastructures: canals, railroads, highways, and pipelines;
• Mechanization, both production machinery and agricultural machines;
• Work practices and processes: the American system of manufacturing, Taylorism (scientific management), mass production, assembly line, and modern business enterprise;
• Materials handling of bulk materials, palletization, and containerization;
• Scientific agriculture: fertilizers and the green revolution, and livestock and poultry management;
• New materials for new processes of production and dematerialization;
• Communications: telegraph, telephone, radio, satellites, fiber optic networks, and the Internet;
• Home economics: public water supply, household gas, and appliances;
• Automation and process control;
• Computers and software for data processing.

Example: The Spinning Jenny and Spinning Mule greatly increased the productivity of thread manufacturing compared to the spinning wheel

1.3.4: Service Economy Growth

Most of the U.S. economy is classified as services as of 2011 (agriculture 1.2%, industry 22.1%, services 76.7%).

Learning Objective

Identify the characteristics of the service sector that have led to its growing prevalence

Key Points

• The growth of the service sector is a response to the change of traditional manufacturing industries into services.
• Many modern services combine both products and services, and the distinction between the two has blurred.
• Service producing sectors include a clear focus on knowledge and ICT, ever-changing business processes, and unique financial, regulatory, and investment structures.
• Service industries also cover a large variety of business types.

Key Terms

services

That which is produced, then traded, bought or sold, then finally consumed and consists of an action or work.

manufacture

The action or process of making goods systematically or on a large scale.

productivity

Productivity is a measure of the efficiency of production and is defined as total output per one unit of a total input.

Example

• Many products are being transformed into services. For example, IBM treats its business as a service business. Although it still manufactures computers, it sees the physical goods as a small part of the “business solutions” industry.

As shown below, most of the U.S. economy is classified as services. Agriculture accounts for 1.2%, industry makes up 22.1%, and services contribute 76.7% (2011 est.).

Hospital equipment

Health care is part of the service economy

In fact, the current list of Fortune 500 companies contains more service companies and fewer manufacturers than in previous decades.

A “service” can be described as all intangible effects that result from a client interaction that creates and captures value. Services are everywhere in today’s world. The sector ranges from common “intangible” goods, such as health and education, to newer goods, such as modern communications and IT. Services are said to be essential to increase productivity and growth and are considered salient to the development of knowledge-based economies.

Many products are being transformed into services. For example, IBM treats its business as a service business. Although it still manufactures computers, it sees the physical goods as a small part of the “business solutions” industry.

The growth of the service sector is, in part, a response to the change of traditional manufacturing industries into services. Many modern services combine both products and services, and the distinction between the two has blurred. However, still a number of typically shared characteristics distinguish services from goods-producing sectors. These include a clear focus on knowledge and ICT, ever-changing business processes, and unique financial, regulatory, and investment structures. Service industries also cover a large variety of business types, from travel to highly knowledge-intensive services, such as global communication networks and specialized financial services. In general, knowledge-intensive services encompass both professional services (e.g., financial, legal), and science and technology-linked services (e.g., environmental, mining, health).

1.4: Introduction to Entrepreneurship

1.4.1: The Goals of Entrepreneurs

The goals of entrepreneurs are varied and individualized but can include the achievement of independence, financial success, or social change.

Learning Objective

Discover the factors that lead individuals to entrepreneurship

Key Points

• Entrepreneurship is the act of being an entrepreneur or “one who undertakes innovations, finance and business acumen in an effort to transform innovations into economic goods.”
• An individual may start a new organizations or may be part of revitalizing mature organizations in response to a perceived opportunity.
• The most obvious form of entrepreneurship is that of starting new businesses (referred as Startup Company).
• In recent years, startup has been extended to include social and political forms of entrepreneurial activity.
• When entrepreneurship is describing activities within a firm or large organization it is referred to as intra-preneurship.

Key Terms

entrepreneur

A person who organizes and operates a business venture and assumes much of the associated risk.

seniority

A measure of the amount of time a person has been a member of an organization, as compared to other members, and with an eye towards awarding privileges to those who have been members longer.

intra-preneurship

When entrepreneurship is describing activities within a firm or large organization it is referred to as intra-preneurship.

Examples

• Most new entrepreneurs help the local economy. A few—through their innovations—contribute to society as a whole. One example is entrepreneur Steve Jobs, who co-founded Apple in 1976, and ignited the subsequent revolution in desktop computers.
• Entrepreneurship offers a greater possibility of achieving significant financial rewards than working for someone else.
• Entrepreneurs are their own bosses. They make the decisions. They choose whom to do business with and what work they will do. They decide what hours to work, as well as what to pay and whether to take vacations.

Entrepreneurship is the act of being an entrepreneur or “one who undertakes innovations, finance and business acumen in an effort to transform innovations into economic goods”. This may result in new organizations or may be part of revitalizing mature organizations in response to a perceived opportunity. The most obvious form of entrepreneurship is that of starting new businesses (referred as a startup company); however, in recent years, the term has been extended to include social and political forms of entrepreneurial activity. When entrepreneurship is describing activities within a firm or large organization it is referred to as intra-preneurship and may include corporate venturing, when large entities spin-off organizations.

What leads a person to strike out on his own and start a business? Sometimes it is a proactive response to a negative situation. Perhaps a person has been laid off once or more. Sometimes a person is frustrated with his or her current job and doesn’t see any better career prospects on the horizon. Sometimes a person realizes that his or her job is in jeopardy. A firm may be contemplating cutbacks that could end a job or limit career or salary prospects. Perhaps a person already has been passed over for promotion. Perhaps a person sees no opportunities in existing businesses for someone with his or her interests and skills. Some people are actually repulsed by the idea of working for someone else. They object to a system where reward is often based on seniority rather than accomplishment, or where they have to conform to a corporate culture. Other people decide to become entrepreneurs because they are disillusioned by the bureaucracy or politics involved in getting ahead in an established business or profession. Some are tired of trying to promote a product, service, or way of doing business that is outside the mainstream operations of a large company.

In contrast, some people are attracted to entrepreneurship simply for the sake of the advantages of starting a business. These include:

• Entrepreneurs are their own bosses. They make the decisions. They choose whom to do business with and what work they will do. They decide what hours to work, as well as what to pay and whether to take vacations.
• Entrepreneurship offers a greater possibility of achieving significant financial rewards than working for someone else.
• It provides the ability to be involved in the total operation of the business, from concept to design and creation, from sales to business operations and customer response.
• It offers the prestige of being the person in charge.
• It gives an individual the opportunity to build equity, which can be kept, sold, or passed on to the next generation.
• Entrepreneurship creates an opportunity for a person to make a contribution. Most new entrepreneurs help the local economy. A few—through their innovations—contribute to society as a whole. One example is entrepreneur Steve Jobs, who co-founded Apple in 1976, and ignited the subsequent revolution in desktop computers.

Some people evaluate the possibilities for jobs and careers where they live and make a conscious decision to pursue entrepreneurship.

No one reason is more valid than another; none guarantee success. However, a strong desire to start a business, combined with a good idea, careful planning, and hard work, can lead to a very engaging and profitable endeavor.

Entrepreneurship history

Notable persons and their works in entrepreneurship history. Figure created by Mikko Ohtamaa.

1.4.2: Benefits of a Small Organization

In general, small firms have greater flexibility than larger firms and capacity to respond promptly to industry or community developments.

Learning Objective

Discuss how flexibility, adaptation, independence, and the involvement of high skilled personnel in small organizations bring about benefits

Key Points

• A small firm has the ability to modify its products or services in response to unique customer needs.
• The average entrepreneur or manager of a small business knows his customer base far better than one in a large company.
• The participants in small firms, such as the entrepreneur, partners, advisers, and employees, have a passionate, almost compulsive, desire to succeed. This entrepreneurial spirit makes them work harder and better.
• Small business is also well suited to Internet marketing because it can easily serve specialized niches, something that would have been more difficult prior to the Internet revolution which began in the late 1990s.

Key Terms

startup

a new organization or business venture

entrepreneur

A person who organizes and operates a business venture and assumes much of the associated risk.

bureaucracy

Structure and regulations in place to control activity. Usually in large organizations and government operations.

Example

• When entrepreneur William J. Stolze helped start RF Communications in 1961 in Rochester, New York, three of the founders came from the huge corporation General Dynamics, where they held senior marketing and engineering positions. In the new venture, the marketing expert had the title “president” but actually worked to get orders. The senior engineers were no longer supervisors; instead, they were designing products. As Stolze said in his book, Start Up, “In most start-ups that I know of, the key managers have stepped back from much more responsible positions in larger companies, and this gives the new company an immense competitive advantage. “

Benefits of Small Business

Greater Flexibility

In general, small start-up firms have greater flexibility than larger firms and the capacity to respond promptly to industry or community developments. They are able to innovate and create new products and services more rapidly and creatively than larger companies that are mired in bureaucracy. Whether reacting to changes in fashion, demographics, or a competitor’s advertising, a small firm usually can make decisions in days, not months or years.

Small business is also well suited to Internet marketing because it can easily serve specialized niches, something that would have been more difficult prior to the Internet revolution, which began in the late 1990s. Adapting to change is crucial in business and particularly small business; not being tied to any bureaucratic inertia, it is typically easier to respond to the marketplace quickly. Small business proprietors tend to be intimate with their customers and clients which results in greater accountability and maturity.

A small firm has the ability to modify its products or services in response to unique customer needs. The average entrepreneur or manager of a small business knows his customer base far better than one in a large company. If a modification in the products or services offered, or even the business’s hours of operation, would better serve the customers, it is possible for a small firm to make changes. Customers can even have a role in product development.

Entrepreneurial Spirit

Another strength comes from the involvement of highly skilled personnel in all aspects of a startup business. In particular, startups benefit from having senior partners or managers working on tasks below their highest skill level. For example, when entrepreneur William J. Stolze helped start RF Communications in 1961 in Rochester, New York, three of the founders came from the huge corporation General Dynamics, where they held senior marketing and engineering positions. In the new venture, the marketing expert had the title “president” but actually worked to get orders. The senior engineers were no longer supervisors; instead, they were designing products. As Stolze said in his book, Start Up, “In most start-ups that I know of, the key managers have stepped back from much more responsible positions in larger companies, and this gives the new company an immense competitive advantage. ” Another strength of a startup is that the people involved–the entrepreneur, any partners, advisers, employees, or even family members–have a passionate, almost compulsive, desire to succeed. This makes them work harder and better. Finally, many small businesses and startup ventures have an intangible quality that comes from people who are fully engaged and doing what they want to do. This is “the entrepreneurial spirit,” the atmosphere of fun and excitement that is generated when people work together to create an opportunity for greater success than is otherwise available. This can attract workers and inspire them to do their best.

Independence

Independence is another advantage of owning a small business. One survey of small business owners showed that 38% of those who left their jobs at other companies said their main reason for leaving was that they wanted to be their own bosses. Freedom to operate independently is a reward for small business owners. In addition, many people desire to make their own decisions, take their own risks, and reap the rewards of their efforts. Small business owners have the satisfaction of making their own decisions within the constraints imposed by economic and other environmental factors. However, entrepreneurs have to work very long hours and understand that ultimately their customers are their bosses. Additionally, the startup cycle of initial financing can be daunting, and entrepreneurs have to act responsibly and intelligently so as not to end up in the “Valley of Death. ” Several organizations in the United States provide help for the small business sector, such as the Internal Revenue Service’s Small Business and Self-Employed One-Stop Resource.

Start-up financing cycle

Diagram of the typical financing cycle for a start-up company.

1.4.3: Entrepreneurship and the Economy

Creativity and entrepreneurship are needed to combine inputs in profitable ways, resulting in large scale economic growth/development.

Learning Objective

Identify the characteristics of an entrepreneurial economy and the factors that lead to it

Key Points

• Entrepreneurship drives economic resources to work efficiently, which positively impacts long-term economic development and growth.
• The entrepreneur is a factor in microeconomics, and the study of entrepreneurship reaches back to the work of Richard Cantillon and Adam Smith in the late 17th and early 18th centuries.
• In the 20th century, the understanding of entrepreneurship owes much to the work of economist Joseph Schumpeter in the 1930s and other Austrian economists such as Carl Menger, Ludwig von Mises and Friedrich von Hayek.
• An entrepreneur is a person willing and able to convert a new idea or invention into a successful innovation.
• They employ what is called “the gale of creative destruction” to replace in whole or in part inferior innovations, creating new products including new business models.

Key Terms

entrepreneur

A person who organizes and operates a business venture and assumes much of the associated risk.

business model

The particular way in which a business organization ensures that it generates income, one that includes the choice of offerings, strategies, infrastructure, organizational structures, trading practices, and operational processes and policies.

microeconomics

the study small-scale financial activities such as that of the individual or company

creative destruction

Refers to the linked processes of the accumulation and annihilation of wealth under capitalism.

Example

• Schumpeter’s initial example of entrepreneurship and long-term economic growth was the combination of a steam engine and then current wagon making technologies to produce the horseless carriage. In this case the innovation, the car, was transformational but did not require the development of a new technology, merely the application of existing technologies in a novel manner.

Entrepreneurial Economics

Entrepreneurial economics is the study of the entrepreneur and entrepreneurship within the economy. The accumulation of factors of production per se does not explain economic development. They are necessary inputs in production, but they are not sufficient for economic growth. Human creativity and productive entrepreneurship are needed to combine these inputs in profitable ways, and hence an institutional environment that encourages free entrepreneurship becomes the ultimate determinant of economic growth. Thus, the entrepreneur and entrepreneurship should take center stage in any effort to explain long-term economic development. Early economic theory, however did not pay proper attention to the entrepreneur. As William J. Baumol observed in the American Economic Review, “The theoretical firm is entrepreneurless—the Prince of Denmark has been expunged from the discussion of Hamlet.” The article was a prod to the economics profession to attend to this neglected factor. If entrepreneurship remains as important to the economy as ever, then the continuing failure of mainstream economics to adequately account for entrepreneurship indicates that fundamental principles require re-evaluation. The characteristics of an entrepreneurial economy are high levels of innovation combined with high level of entrepreneurship which result in the creation of new ventures as well as new sectors and industries. Entrepreneurship is difficult to analyze using the traditional tools of economics e.g. calculus and general equilibrium models.

Startup financing cycle

Diagram of the typical financing cycle for a startup company

Equilibrium models are central to mainstream economics, and exclude entrepreneurship. Joseph Schumpeter and Israel Kirzner argued that entrepreneurs do not tolerate equilibrium.

Studies about entrepreneurs in Economics, Psychology and Sociology largely relate to four major currents of thought. Early thinkers such as Max Weber emphasized its occurrence in the context of a religious belief system, thereby suggesting that some belief systems do not encourage entrepreneurship. This contention has, however, been challenged by many sociologists. Some thinkers such as K Samuelson believe that there is no relationship between religion, economic development and entrepreneurship. Karl Marx considered the economic system and mode of production as its sole determinants. Weber suggested a direct relation between the ethics and economic system as both intensively interacted. Another current of thought underscores the motivational aspects of personal achievement. This overemphasized the individual and his values, attitudes and personality. This thought, however, has been severely criticized by many scholars such as Kilby (1971) and Kunkel (1971).

Economists of the 1930s and the Acknowledgement of Entrepreneurship

Entrepreneurship is a factor in microeconomics, and its study reaches back to the work of Richard Cantillon and Adam Smith in the late 17th and early 18th centuries. It was ignored theoretically until the late 19th and early 20th centuries and empirically until a profound resurgence in business and economics in the last 40 years. In the 20th century, the understanding of entrepreneurship owes much to the work of Joseph Schumpeter in the 1930s and other Austrian economists such as Carl Menger, Ludwig von Mises and Friedrich von Hayek. To Schumpeter, an entrepreneur is a person willing and able to convert a new idea or invention into a successful innovation. Entrepreneurship employs what Schumpeter called “the gale of creative destruction” to replace in whole or in part inferior innovations across markets and industries, simultaneously creating new products and business models. In this way, creative destruction is largely responsible for the dynamism of industries and long-run economic growth. The supposition that entrepreneurship leads to economic growth is an interpretation of the residual in endogenous growth theory and as such is hotly debated in academic economics. An alternate description posited by Israel Kirzner suggests that the majority of innovations may be much more incremental improvements such as the replacement of paper with plastic in the construction of a drinking straw.

For Schumpeter, entrepreneurship resulted in new industries but also in new combinations of currently existing inputs. Schumpeter’s initial example of this was the combination of a steam engine and then current wagon-making technologies to produce the horseless carriage. In this case the innovation, the car, was transformational but did not require the development of a new technology, merely the application of existing technologies in a novel manner. It did not immediately replace the horsedrawn carriage, but in time, incremental improvements which reduced the cost and improved the technology led to the complete practical replacement of beast drawn vehicles in modern transportation. Despite Schumpeter’s early 20th-century contributions, traditional microeconomic theory did not formally consider the entrepreneur in its theoretical frameworks (instead assuming that resources would find each other through a price system). In this treatment the entrepreneur was an implied but unspecified actor, but it is consistent with the concept of the entrepreneur being the agent of x-efficiency. Different scholars have described entrepreneurs as, among other things, bearing risk. For Schumpeter, the entrepreneur did not bear risk: the capitalist did.

1.5: Learning Business Topics

1.5.1: Context and Current Events

There are two main ways to learn business topics: problem-based and team-based learning.

Learning Objective

Discover how problem-based learning leads to a more effective and fulfilling experience for students learning business topics

Key Points

• Problem-based learning is a student-centered pedagogy in which students learn about a subject in the context of complex, multifaceted, and realistic problems.
• PBL is a learning method that can promote the development of critical thinking skills –students learn how to analyze a problem, identify relevant facts and generate hypotheses, identify necessary information/knowledge for solving the problem and make reasonable judgments about solving the problem.
• The goals of PBL are to help the students develop flexible knowledge, effective problem solving skills, self-directed learning, effective collaboration skills and intrinsic motivation.
• In the workplace, employers use team-based learning to teach and develop their employees.

Key Terms

critical thinking

The application of logical principles, rigorous standards of evidence, and careful reasoning to the analysis and discussion of claims, beliefs, and issues.

self-directed

Directed independently by oneself without external control or constraint.

workshop

A brief intensive course of education for a small group; emphasizes interaction and practical problem solving

Problem-based learning (PBL) is a student-centered pedagogy in which students learn about a subject in the context of complex, multifaceted, and realistic problems. The goals of PBL are to help the students develop flexible knowledge, effective problem solving skills, self-directed learning, effective collaboration skills, and intrinsic motivation. Working in groups, students identify what they already know, what they need to know, and how and where to access new information that can lead to resolution of the problem. In PBL, students are encouraged to take responsibility for their group and organize and direct the learning process with support from a tutor or instructor. The role of the instructor is to provide appropriate scaffolding and support for the process, modelling of the process, and monitoring the learning. The tutor must build the students’ confidence to take on the problem and encourage them, while also stretching their understanding.

The six core characteristics of PBL are as follows:

• PBL consists of student-centered learning.
• Learning occurs in small groups.
• Teachers act as facilitators or tutors.
• A problem forms the basis for organized focus and stimulus for learning.
• Problems stimulate the development and use of problem solving skills.
• New knowledge is obtained through means of self-directed learning.

Advocates of PBL claim it can be used to enhance content knowledge while simultaneously fostering the development of communication, problem-solving, critical thinking, collaboration, and self-directed learning skills.

PBL may position students in a simulated real-world working and professional context that involves policy, process, and ethical problems that will need to be understood and resolved to some outcome. By working through a combination of learning strategies to discover the nature of a problem, understanding the constraints and options to its resolution, defining the input variables, and understanding the viewpoints involved, students learn to negotiate the complex sociological nature of the problem and how competing resolutions may inform decision making.

Current Issues

Accountants must stay up to date with current issues in reporting and disclosure.

PBL can also promote the development of critical thinking skills. In PBL learning, students learn how to analyze a problem, identify relevant facts, generate hypotheses, identify necessary information/knowledge for solving the problem, and make reasonable judgments about solving the problem.

Principles

• Problem-based learning: Use problems encountered in the course of work as the context for learning.
• Point of the Wedge: Push responsibility combined with support to the most junior person possible
• Teach, Don’t Tell: Use inquiry (i.e., Socratic Method) to teach rather than just giving the answer or solving the issue
• Owning the Client or Project: Individuals have a heightened sense of accountability and motivation because they have their own client or project with support from more experienced team members

Routines

• Rounds: Meetings where a less-experienced team member presents an issue or challenge and recommends a course of action.
• Team Workshops: A team member leads a developmental event for other members focusing on a specific technical or service topic.
• Shadowing: Less-experienced team members accompany a more experienced member to a meeting that he or she would not normally attend.
• Observation and Feedback: A specific activity is observed, and coaching is given using the Socratic Method.
• Lessons Learned Forum: A thorough review and discussion using mistakes and successes as a situation to learn from. This is similar to an After Action Review.

Making It Work

The mission of a teaching hospital is to develop doctors. While businesses earnestly espouse a desire to develop their people, such activities are too often seen as separate from work and something that interferes with getting work done. Businesses are not as motivated as teaching hospitals to develop people on the job. For that reason, the transfer of approaches used in teaching hospitals to a business context might have failed if not for the fact that the new processes create side benefits that motivate the business team members.

1.5.2: Business Cases and Examples

The teaching approach of presenting students with a case and putting them in the role of a decision maker is known as the case method.

Learning Objective

Identify how case studies can lead students to a deeper understanding of business topics

Key Points

• The case method is similar to the case study method, but the two teaching approaches are not identical.
• The length of a business case study may range from two or three pages to thirty pages or more.
• Typically, information is presented about a business firm’s products, markets, competition, financial structure, sales volumes, management, employees, and other factors affecting the firm’s success.
• Students are expected to scrutinize the case study and prepare to discuss strategies and tactics that the firm should employ in the future.

Key Terms

dilemma

A circumstance in which a choice must be made between two or more alternatives that seem equally undesirable.

case method

A teaching approach that consists of presenting the students with a case, and putting them in the role of a decision-maker facing a problem.

case study

An intensive analysis of an individual unit (e.g., a person, group, or event) stressing developmental factors in relation to context; also called a case report.

Case Method

The case method is a teaching approach that presents the students with a case and puts them in the role of a decision maker facing a problem (Hammond 1976). The case method overlaps with the case study method, but the two are not identical. “Case studies recount real life business or management situations that present business executives with a dilemma or uncertain outcome. The case describes the scenario in the context of the events, people and factors that influence it and enables students to identify closely with those involved. ” — European Case Clearing House, Case studies. “

Business Case Discussion

A lot can be learned from the contents of a business case.

Typically, information is presented about a business firm’s products, markets, competition, financial structure, sales volumes, management, employees, and other factors affecting the firm’s success. The length of a business case study can range from two or three pages to 30 pages or more.

Business schools often obtain case studies published by the Harvard Business School, INSEAD, the Ross School of Business at the University of Michigan, the Richard Ivey School of Business at the University of Western Ontario, the Darden School at the University of Virginia, IESE, other academic institutions, or case clearing houses (such as European Case Clearing House). Harvard’s most popular case studies include Lincoln Electric Co. and Google, Inc.

Students are expected to scrutinize the case study and prepare to discuss strategies and tactics that the firm should employ in the future. Three different methods have been used in business case teaching:

• Prepared case-specific questions to be answered by the student. This is used with short cases intended for undergraduate students. The underlying concept is that such students need specific guidance to be able to analyze case studies.
• Problem-solving analysis. This method, initiated by the Harvard Business School is by far the most widely used method in MBA and executive development programs. The underlying concept is that with enough practice (that is, hundreds of case analyses) students develop intuitive skills for analyzing and resolving complex business situations. Successful implementation of this method depends heavily on the skills of the discussion leader.
• A generally applicable strategic planning approach. This third method does not require students to analyze hundreds of cases. A strategic planning model is provided, and students are instructed to apply the steps of the model to between six and twelve cases during a semester. This is sufficient to develop their ability to analyze a complex situation, generate a variety of possible strategies, and select the best ones. In effect, students learn a generally applicable approach to analyzing cases studies and real situations. This approach does not make any extraordinary demands on the artistic and dramatic talents of the teacher. Consequently, most professors are capable of supervising application of this method.

History of Business Cases

When Harvard Business School was founded, the faculty realized that there were no textbooks suitable to a graduate program in business. Their first solution to this problem was to interview leading practitioners of business and to write detailed accounts of what these managers were doing. Of course, the professors could not present these cases as practices to be emulated because there were no criteria available for determining what would succeed and what would not succeed. So the professors instructed their students to read the cases and to come to class prepared to discuss the cases and to offer recommendations for appropriate courses of action. The basic outlines of this method are still present in business school curricula today.

1.5.3: Application of Knowledge

A business game (also called business simulation game) refers to a simulation game that is used as an educational tool for teaching business.

Learning Objective

Justify the use of business simulation games in the process of applying business knowledge

Key Points

• Business games may be carried out for various business training such as general management, finance, organizational behavior, and human resources.
• In business simulation games, players receive a description of an imaginary business and an imaginary environment and make decisions (on price, advertising, production targets, and so on) about how their company should be run.
• There are several important steps to a business game, including: the theoretical instruction; the introduction to the game, where the participants are told how to operate the computer; and debriefing, which is the most important part of the simulation and gaming experience.

Key Terms

debriefing

The report of a mission or project, or the information so obtained.

distribution

The process by which goods get to final consumers over a geographical market, including storing, selling, shipping, and advertising.

simulation

Something which simulates a system or environment in order to predict actual behavior.

Examples

• The Beer Distribution Game is a simulation game created by a group of professors at MIT Sloan School of Management in early 1960s to demonstrate a number of key principles of supply chain management. The game is played by teams of at least four players, often in heated competition, and takes from one to one and a half hours to complete. A debriefing session of roughly equivalent length typically follows to review the results of each team and discuss the lessons involved.
• The purpose of the game is to understand the distribution side dynamics of a multi-echelon supply chain used to distribute a single item, in this case, cases of beer. The aim is to meet customer demand for cases of beer through the distribution side of a multi-stage supply chain with minimal expenditure on back orders and inventory. Players can see each other’s inventory but only one player sees actual customer demand. Verbal communication between players is against the rules so feelings of confusion and disappointment are common. Players look to one another within their supply chain frantically trying to figure out where things are going wrong. Most of the players feel frustrated because they are not getting the results they want. Players wonder whether someone in their team did not understand the game or assume customer demand is following a very erratic pattern as backlogs mount and/or massive inventories accumulate. During the debriefing, it is explained that these feelings are common and that reactions based on these feelings within supply chains create the bullwhip effect.
• For a complete understanding, the game is played not only within a supply chain, but two or three supply chains are set up (when there are enough players and volunteers to help). In real life, more than the understanding one gets by playing as different entities in a single supply chain, it is the learning when supply chains compete with each other that the real strategic intent is made clear. The team or supply chain which turns up with the least total costs when played over 12-15 cycles is the winner.

Applying Knowledge Through Games

Business games (also called business simulation games) refer to simulation games that are used as an educational tool for teaching business. Business games may be carried out for various business trainings such as general management, finance, organizational behavior, and human resources. Often the term business simulation is used with the same meaning.

Business Game

Business game (also called business simulation game) refers to simulation games that are used as an educational tool for teaching business.

An exterior view of a street business called GAME.

Business strategy games are intended to enhance the decision-making skills of students, especially under conditions defined by limited time and information. They vary in focus from how to undertake a corporate takeover to how to expand a company’s share of the market. Typically, the player feeds information into a computer program and receives back a series of optional or additional data that are conditional upon the player’s initial choices. The game proceeds through several series of these interactive, iterative steps. As can be noted, this definition does not consider continuous (real-time) processing an alternative.

In business simulation games, players receive a description of an imaginary business and an imaginary environment and make decisions – on price, advertising, production targets, and so on – about how their company should be run. A business game may have an industrial, commercial or financial background (Elgood, 1996). Ju and Wagner mention that the nature of business games can include decision-making tasks, which pit the player against a hostile environment or hostile opponents. These simulations have a nature of strategy or war games, but usually are very terse in their user interface. Other types of managerial simulations are resource allocation games, in which the player or players have to allocate resources to areas such as plant, production, marketing, and human resources, in order to produce and sell goods.

The Simulation Gaming Process

Business simulation game developers regard their artefacts to be learning environments. When arguing for this, they most often refer to David A. Kolb’s influential work in the field of experiential learning. During the last decades, ideas from constructivism have influenced the learning discussion within the simulation gaming field. The activities carried out during a simulation game training session are:

• Theoretical instruction: The teacher goes through certain relevant aspects of a theory and participants can intervene with questions and comments.
• Introduction to the game: The participants are told how to operate the computer and how to play the game.
• Playing the game: Participants get the opportunity to practice their knowledge and skills by changing different parameters of the game and reflecting on the possible consequences of these changes. Permanent contact with the participants is advisable, as well as keeping the training going to maintain a positive atmosphere and to secure that the participants feel engaged.
• Group discussions: Each of the participants is given a possibility to present and compare their results from the game with the results of others. The participants are encouraged to present their results to others. The teacher should continually look for new ways of enriching the discussions and to help the participants find the connection between the game results and the problems in the real world. The quality of this group discussion plays a relevant role in the training as it will affect the participants’ transfer of knowledge and skills into the real world.

The last phase in the list above is usually called debriefing. Debriefing is the most important part of the simulation and gaming experience. We all learn from experience, but without reflecting on this experience the learning potential may be lost. Simulation gaming needs to be seen as contrived experiences in the learning cycle, which require special attention at the stages of reflection and generalization.