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# Organic Chemistry ## Introduction All living things on earth are formed mostly of carbon compounds. The prevalence of carbon compounds in living things has led to the epithet “carbon-based” life. The truth is we know of no other kind of life. Early chemists regarded substances isolated from organisms (plants and animals) as a different type of matter that could not be synthesized artificially, and these substances were thus known as organic compounds. The widespread belief called vitalism held that organic compounds were formed by a vital force present only in living organisms. The German chemist Friedrich Wohler was one of the early chemists to refute this aspect of vitalism, when, in 1828, he reported the synthesis of urea, a component of many body fluids, from nonliving materials. Since then, it has been recognized that organic molecules obey the same natural laws as inorganic substances, and the category of organic compounds has evolved to include both natural and synthetic compounds that contain carbon. Some carbon-containing compounds are not classified as organic, for example, carbonates and cyanides, and simple oxides, such as CO and CO2. Although a single, precise definition has yet to be identified by the chemistry community, most agree that a defining trait of organic molecules is the presence of carbon as the principal element, bonded to hydrogen and other carbon atoms. Today, organic compounds are key components of plastics, soaps, perfumes, sweeteners, fabrics, pharmaceuticals, and many other substances that we use every day. The value to us of organic compounds ensures that organic chemistry is an important discipline within the general field of chemistry. In this chapter, we discuss why the element carbon gives rise to a vast number and variety of compounds, how those compounds are classified, and the role of organic compounds in representative biological and industrial settings.

# Organic Chemistry ## Hydrocarbons The largest databaseThis is the Beilstein database, now available through the Reaxys site (www.elsevier.com/online-tools/reaxys). of organic compounds lists about 10 million substances, which include compounds originating from living organisms and those synthesized by chemists. The number of potential organic compounds has been estimatedPeplow, Mark. “Organic Synthesis: The Robo-Chemist,” at 1060—an astronomically high number. The existence of so many organic molecules is a consequence of the ability of carbon atoms to form up to four strong bonds to other carbon atoms, resulting in chains and rings of many different sizes, shapes, and complexities. The simplest organic compounds contain only the elements carbon and hydrogen, and are called hydrocarbons. Even though they are composed of only two types of atoms, there is a wide variety of hydrocarbons because they may consist of varying lengths of chains, branched chains, and rings of carbon atoms, or combinations of these structures. In addition, hydrocarbons may differ in the types of carbon-carbon bonds present in their molecules. Many hydrocarbons are found in plants, animals, and their fossils; other hydrocarbons have been prepared in the laboratory. We use hydrocarbons every day, mainly as fuels, such as natural gas, acetylene, propane, butane, and the principal components of gasoline, diesel fuel, and heating oil. The familiar plastics polyethylene, polypropylene, and polystyrene are also hydrocarbons. We can distinguish several types of hydrocarbons by differences in the bonding between carbon atoms. This leads to differences in geometries and in the hybridization of the carbon orbitals. ### Alkanes Alkanes, or saturated hydrocarbons, contain only single covalent bonds between carbon atoms. Each of the carbon atoms in an alkane has sp3 hybrid orbitals and is bonded to four other atoms, each of which is either carbon or hydrogen. The Lewis structures and models of methane, ethane, and pentane are illustrated in . Carbon chains are usually drawn as straight lines in Lewis structures, but one has to remember that Lewis structures are not intended to indicate the geometry of molecules. Notice that the carbon atoms in the structural models (the ball-and-stick and space-filling models) of the pentane molecule do not lie in a straight line. Because of the sp3 hybridization, the bond angles in carbon chains are close to 109.5°, giving such chains in an alkane a zigzag shape. The structures of alkanes and other organic molecules may also be represented in a less detailed manner by condensed structural formulas (or simply, condensed formulas). Instead of the usual format for chemical formulas in which each element symbol appears just once, a condensed formula is written to suggest the bonding in the molecule. These formulas have the appearance of a Lewis structure from which most or all of the bond symbols have been removed. Condensed structural formulas for ethane and pentane are shown at the bottom of , and several additional examples are provided in the exercises at the end of this chapter. A common method used by organic chemists to simplify the drawings of larger molecules is to use a skeletal structure (also called a line-angle structure). In this type of structure, carbon atoms are not symbolized with a C, but represented by each end of a line or bend in a line. Hydrogen atoms are not drawn if they are attached to a carbon. Other atoms besides carbon and hydrogen are represented by their elemental symbols. shows three different ways to draw the same structure. All alkanes are composed of carbon and hydrogen atoms, and have similar bonds, structures, and formulas; noncyclic alkanes all have a formula of CnH2n+2. The number of carbon atoms present in an alkane has no limit. Greater numbers of atoms in the molecules will lead to stronger intermolecular attractions (dispersion forces) and correspondingly different physical properties of the molecules. Properties such as melting point and boiling point () usually change smoothly and predictably as the number of carbon and hydrogen atoms in the molecules change. Hydrocarbons with the same formula, including alkanes, can have different structures. For example, two alkanes have the formula C4H10: They are called n-butane and 2-methylpropane (or isobutane), and have the following Lewis structures: The compounds n-butane and 2-methylpropane are structural isomers (the term constitutional isomers is also commonly used). Constitutional isomers have the same molecular formula but different spatial arrangements of the atoms in their molecules. The n-butane molecule contains an unbranched chain, meaning that no carbon atom is bonded to more than two other carbon atoms. We use the term normal, or the prefix n, to refer to a chain of carbon atoms without branching. The compound 2–methylpropane has a branched chain (the carbon atom in the center of the Lewis structure is bonded to three other carbon atoms) Identifying isomers from Lewis structures is not as easy as it looks. Lewis structures that look different may actually represent the same isomers. For example, the three structures in all represent the same molecule, n-butane, and hence are not different isomers. They are identical because each contains an unbranched chain of four carbon atoms. ### The Basics of Organic Nomenclature: Naming Alkanes The International Union of Pure and Applied Chemistry (IUPAC) has devised a system of nomenclature that begins with the names of the alkanes and can be adjusted from there to account for more complicated structures. The nomenclature for alkanes is based on two rules: 1. To name an alkane, first identify the longest chain of carbon atoms in its structure. A two-carbon chain is called ethane; a three-carbon chain, propane; and a four-carbon chain, butane. Longer chains are named as follows: pentane (five-carbon chain), hexane (6), heptane (7), octane (8), nonane (9), and decane (10). These prefixes can be seen in the names of the alkanes described in . 2. Add prefixes to the name of the longest chain to indicate the positions and names of substituents. Substituents are branches or functional groups that replace hydrogen atoms on a chain. The position of a substituent or branch is identified by the number of the carbon atom it is bonded to in the chain. We number the carbon atoms in the chain by counting from the end of the chain nearest the substituents. Multiple substituents are named individually and placed in alphabetical order at the front of the name. When more than one substituent is present, either on the same carbon atom or on different carbon atoms, the substituents are listed alphabetically. Because the carbon atom numbering begins at the end closest to a substituent, the longest chain of carbon atoms is numbered in such a way as to produce the lowest number for the substituents. The ending -o replaces -ide at the end of the name of an electronegative substituent (in ionic compounds, the negatively charged ion ends with -ide like chloride; in organic compounds, such atoms are treated as substituents and the -o ending is used). The number of substituents of the same type is indicated by the prefixes di- (two), tri- (three), tetra- (four), and so on (for example, difluoro- indicates two fluoride substituents). We call a substituent that contains one less hydrogen than the corresponding alkane an alkyl group. The name of an alkyl group is obtained by dropping the suffix -ane of the alkane name and adding -yl: The open bonds in the methyl and ethyl groups indicate that these alkyl groups are bonded to another atom. Some hydrocarbons can form more than one type of alkyl group when the hydrogen atoms that would be removed have different “environments” in the molecule. This diversity of possible alkyl groups can be identified in the following way: The four hydrogen atoms in a methane molecule are equivalent; they all have the same environment. They are equivalent because each is bonded to a carbon atom (the same carbon atom) that is bonded to three hydrogen atoms. (It may be easier to see the equivalency in the ball and stick models in . Removal of any one of the four hydrogen atoms from methane forms a methyl group. Likewise, the six hydrogen atoms in ethane are equivalent () and removing any one of these hydrogen atoms produces an ethyl group. Each of the six hydrogen atoms is bonded to a carbon atom that is bonded to two other hydrogen atoms and a carbon atom. However, in both propane and 2–methylpropane, there are hydrogen atoms in two different environments, distinguished by the adjacent atoms or groups of atoms: Each of the six equivalent hydrogen atoms of the first type in propane and each of the nine equivalent hydrogen atoms of that type in 2-methylpropane (all shown in black) are bonded to a carbon atom that is bonded to only one other carbon atom. The two purple hydrogen atoms in propane are of a second type. They differ from the six hydrogen atoms of the first type in that they are bonded to a carbon atom bonded to two other carbon atoms. The green hydrogen atom in 2-methylpropane differs from the other nine hydrogen atoms in that molecule and from the purple hydrogen atoms in propane. The green hydrogen atom in 2-methylpropane is bonded to a carbon atom bonded to three other carbon atoms. Two different alkyl groups can be formed from each of these molecules, depending on which hydrogen atom is removed. The names and structures of these and several other alkyl groups are listed in . Note that alkyl groups do not exist as stable independent entities. They are always a part of some larger molecule. The location of an alkyl group on a hydrocarbon chain is indicated in the same way as any other substituent: Alkanes are relatively stable molecules, but heat or light will activate reactions that involve the breaking of C–H or C–C single bonds. Combustion is one such reaction: Alkanes burn in the presence of oxygen, a highly exothermic oxidation-reduction reaction that produces carbon dioxide and water. As a consequence, alkanes are excellent fuels. For example, methane, CH4, is the principal component of natural gas. Butane, C4H10, used in camping stoves and lighters is an alkane. Gasoline is a liquid mixture of continuous- and branched-chain alkanes, each containing from five to nine carbon atoms, plus various additives to improve its performance as a fuel. Kerosene, diesel oil, and fuel oil are primarily mixtures of alkanes with higher molecular masses. The main source of these liquid alkane fuels is crude oil, a complex mixture that is separated by fractional distillation. Fractional distillation takes advantage of differences in the boiling points of the components of the mixture (see ). You may recall that boiling point is a function of intermolecular interactions, which was discussed in the chapter on solutions and colloids. In a substitution reaction, another typical reaction of alkanes, one or more of the alkane’s hydrogen atoms is replaced with a different atom or group of atoms. No carbon-carbon bonds are broken in these reactions, and the hybridization of the carbon atoms does not change. For example, the reaction between ethane and molecular chlorine depicted here is a substitution reaction: The C–Cl portion of the chloroethane molecule is an example of a functional group, the part or moiety of a molecule that imparts a specific chemical reactivity. The types of functional groups present in an organic molecule are major determinants of its chemical properties and are used as a means of classifying organic compounds as detailed in the remaining sections of this chapter. ### Alkenes Organic compounds that contain one or more double or triple bonds between carbon atoms are described as unsaturated. You have likely heard of unsaturated fats. These are complex organic molecules with long chains of carbon atoms, which contain at least one double bond between carbon atoms. Unsaturated hydrocarbon molecules that contain one or more double bonds are called alkenes. Carbon atoms linked by a double bond are bound together by two bonds, one σ bond and one π bond. Double and triple bonds give rise to a different geometry around the carbon atom that participates in them, leading to important differences in molecular shape and properties. The differing geometries are responsible for the different properties of unsaturated versus saturated fats. Ethene, C2H4, is the simplest alkene. Each carbon atom in ethene, commonly called ethylene, has a trigonal planar structure. The second member of the series is propene (propylene) (); the butene isomers follow in the series. Four carbon atoms in the chain of butene allows for the formation of isomers based on the position of the double bond, as well as a new form of isomerism. Ethylene (the common industrial name for ethene) is a basic raw material in the production of polyethylene and other important compounds. Over 135 million tons of ethylene were produced worldwide in 2010 for use in the polymer, petrochemical, and plastic industries. Ethylene is produced industrially in a process called cracking, in which the long hydrocarbon chains in a petroleum mixture are broken into smaller molecules. The name of an alkene is derived from the name of the alkane with the same number of carbon atoms. The presence of the double bond is signified by replacing the suffix -ane with the suffix -ene. The location of the double bond is identified by naming the smaller of the numbers of the carbon atoms participating in the double bond: ### Isomers of Alkenes Molecules of 1-butene and 2-butene are structural isomers; the arrangement of the atoms in these two molecules differs. As an example of arrangement differences, the first carbon atom in 1-butene is bonded to two hydrogen atoms; the first carbon atom in 2-butene is bonded to three hydrogen atoms. The compound 2-butene and some other alkenes also form a second type of isomer called a geometric isomer. In a set of geometric isomers, the same types of atoms are attached to each other in the same order, but the geometries of the two molecules differ. Geometric isomers of alkenes differ in the orientation of the groups on either side of a bond. Carbon atoms are free to rotate around a single bond but not around a double bond; a double bond is rigid. This makes it possible to have two isomers of 2-butene, one with both methyl groups on the same side of the double bond and one with the methyl groups on opposite sides. When structures of butene are drawn with 120° bond angles around the sp2-hybridized carbon atoms participating in the double bond, the isomers are apparent. The 2-butene isomer in which the two methyl groups are on the same side is called a cis-isomer; the one in which the two methyl groups are on opposite sides is called a trans-isomer (). The different geometries produce different physical properties, such as boiling point, that may make separation of the isomers possible: Alkenes are much more reactive than alkanes because the moiety is a reactive functional group. A π bond, being a weaker bond, is disrupted much more easily than a σ bond. Thus, alkenes undergo a characteristic reaction in which the π bond is broken and replaced by two σ bonds. This reaction is called an addition reaction. The hybridization of the carbon atoms in the double bond in an alkene changes from sp2 to sp3 during an addition reaction. For example, halogens add to the double bond in an alkene instead of replacing hydrogen, as occurs in an alkane: ### Alkynes Hydrocarbon molecules with one or more triple bonds are called alkynes; they make up another series of unsaturated hydrocarbons. Two carbon atoms joined by a triple bond are bound together by one σ bond and two π bonds. The sp-hybridized carbons involved in the triple bond have bond angles of 180°, giving these types of bonds a linear, rod-like shape. The simplest member of the alkyne series is ethyne, C2H2, commonly called acetylene. The Lewis structure for ethyne, a linear molecule, is: The IUPAC nomenclature for alkynes is similar to that for alkenes except that the suffix -yne is used to indicate a triple bond in the chain. For example, is called 1-butyne. Chemically, the alkynes are similar to the alkenes. Since the functional group has two π bonds, alkynes typically react even more readily, and react with twice as much reagent in addition reactions. The reaction of acetylene with bromine is a typical example: Acetylene and the other alkynes also burn readily. An acetylene torch takes advantage of the high heat of combustion for acetylene. ### Aromatic Hydrocarbons Benzene, C6H6, is the simplest member of a large family of hydrocarbons, called aromatic hydrocarbons. These compounds contain ring structures and exhibit bonding that must be described using the resonance hybrid concept of valence bond theory or the delocalization concept of molecular orbital theory. (To review these concepts, refer to the earlier chapters on chemical bonding). The resonance structures for benzene, C6H6, are: Valence bond theory describes the benzene molecule and other planar aromatic hydrocarbon molecules as hexagonal rings of sp2-hybridized carbon atoms with the unhybridized p orbital of each carbon atom perpendicular to the plane of the ring. Three valence electrons in the sp2 hybrid orbitals of each carbon atom and the valence electron of each hydrogen atom form the framework of σ bonds in the benzene molecule. The fourth valence electron of each carbon atom is shared with an adjacent carbon atom in their unhybridized p orbitals to yield the π bonds. Benzene does not, however, exhibit the characteristics typical of an alkene. Each of the six bonds between its carbon atoms is equivalent and exhibits properties that are intermediate between those of a C–C single bond and a double bond. To represent this unique bonding, structural formulas for benzene and its derivatives are typically drawn with single bonds between the carbon atoms and a circle within the ring as shown in . There are many derivatives of benzene. The hydrogen atoms can be replaced by many different substituents. Aromatic compounds more readily undergo substitution reactions than addition reactions; replacement of one of the hydrogen atoms with another substituent will leave the delocalized double bonds intact. The following are typical examples of substituted benzene derivatives: Toluene and xylene are important solvents and raw materials in the chemical industry. Styrene is used to produce the polymer polystyrene. ### Key Concepts and Summary Strong, stable bonds between carbon atoms produce complex molecules containing chains, branches, and rings. The chemistry of these compounds is called organic chemistry. Hydrocarbons are organic compounds composed of only carbon and hydrogen. The alkanes are saturated hydrocarbons—that is, hydrocarbons that contain only single bonds. Alkenes contain one or more carbon-carbon double bonds. Alkynes contain one or more carbon-carbon triple bonds. Aromatic hydrocarbons contain ring structures with delocalized π electron systems. ### Chemistry End of Chapter Exercises

# Organic Chemistry ## Alcohols and Ethers In this section, we will learn about alcohols and ethers. ### Alcohols Incorporation of an oxygen atom into carbon- and hydrogen-containing molecules leads to new functional groups and new families of compounds. When the oxygen atom is attached by single bonds, the molecule is either an alcohol or ether. Alcohols are derivatives of hydrocarbons in which an –OH group has replaced a hydrogen atom. Although all alcohols have one or more hydroxyl (–OH) functional groups, they do not behave like bases such as NaOH and KOH. NaOH and KOH are ionic compounds that contain OH– ions. Alcohols are covalent molecules; the –OH group in an alcohol molecule is attached to a carbon atom by a covalent bond. Ethanol, CH3CH2OH, also called ethyl alcohol, is a particularly important alcohol for human use. Ethanol is the alcohol produced by some species of yeast that is found in wine, beer, and distilled drinks. It has long been prepared by humans harnessing the metabolic efforts of yeasts in fermenting various sugars: Large quantities of ethanol are synthesized from the addition reaction of water with ethylene using an acid as a catalyst: Alcohols containing two or more hydroxyl groups can be made. Examples include 1,2-ethanediol (ethylene glycol, used in antifreeze) and 1,2,3-propanetriol (glycerine, used as a solvent for cosmetics and medicines): ### Naming Alcohols The name of an alcohol comes from the hydrocarbon from which it was derived. The final -e in the name of the hydrocarbon is replaced by -ol, and the carbon atom to which the –OH group is bonded is indicated by a number placed before the name.The IUPAC adopted new nomenclature guidelines in 2013 that require this number to be placed as an “infix” rather than a prefix. For example, the new name for 2-propanol would be propan-2-ol. Widespread adoption of this new nomenclature will take some time, and students are encouraged to be familiar with both the old and new naming protocols. ### Ethers Ethers are compounds that contain the functional group –O–. Ethers do not have a designated suffix like the other types of molecules we have named so far. In the IUPAC system, the oxygen atom and the smaller carbon branch are named as an alkoxy substituent and the remainder of the molecule as the base chain, as in alkanes. As shown in the following compound, the red symbols represent the smaller alkyl group and the oxygen atom, which would be named “methoxy.” The larger carbon branch would be ethane, making the molecule methoxyethane. Many ethers are referred to with common names instead of the IUPAC system names. For common names, the two branches connected to the oxygen atom are named separately and followed by “ether.” The common name for the compound shown in is ethylmethyl ether: Ethers can be obtained from alcohols by the elimination of a molecule of water from two molecules of the alcohol. For example, when ethanol is treated with a limited amount of sulfuric acid and heated to 140 °C, diethyl ether and water are formed: In the general formula for ethers, R—O—R, the hydrocarbon groups (R) may be the same or different. Diethyl ether, the most widely used compound of this class, is a colorless, volatile liquid that is highly flammable. It was first used in 1846 as an anesthetic, but better anesthetics have now largely taken its place. Diethyl ether and other ethers are presently used primarily as solvents for gums, fats, waxes, and resins. Tertiary-butyl methyl ether, C4H9OCH3 (abbreviated MTBE—italicized portions of names are not counted when ranking the groups alphabetically—so butyl comes before methyl in the common name), is used as an additive for gasoline. MTBE belongs to a group of chemicals known as oxygenates due to their capacity to increase the oxygen content of gasoline. ### Key Concepts and Summary Many organic compounds that are not hydrocarbons can be thought of as derivatives of hydrocarbons. A hydrocarbon derivative can be formed by replacing one or more hydrogen atoms of a hydrocarbon by a functional group, which contains at least one atom of an element other than carbon or hydrogen. The properties of hydrocarbon derivatives are determined largely by the functional group. The –OH group is the functional group of an alcohol. The –R–O–R– group is the functional group of an ether. ### Chemistry End of Chapter Exercises

# Organic Chemistry ## Aldehydes, Ketones, Carboxylic Acids, and Esters Another class of organic molecules contains a carbon atom connected to an oxygen atom by a double bond, commonly called a carbonyl group. The trigonal planar carbon in the carbonyl group can attach to two other substituents leading to several subfamilies (aldehydes, ketones, carboxylic acids and esters) described in this section. ### Aldehydes and Ketones Both aldehydes and ketones contain a carbonyl group, a functional group with a carbon-oxygen double bond. The names for aldehyde and ketone compounds are derived using similar nomenclature rules as for alkanes and alcohols, and include the class-identifying suffixes -al and -one, respectively: In an aldehyde, the carbonyl group is bonded to at least one hydrogen atom. In a ketone, the carbonyl group is bonded to two carbon atoms: As text, an aldehyde group is represented as –CHO; a ketone is represented as –C(O)– or –CO–. In both aldehydes and ketones, the geometry around the carbon atom in the carbonyl group is trigonal planar; the carbon atom exhibits sp2 hybridization. Two of the sp2 orbitals on the carbon atom in the carbonyl group are used to form σ bonds to the other carbon or hydrogen atoms in a molecule. The remaining sp2 hybrid orbital forms a σ bond to the oxygen atom. The unhybridized p orbital on the carbon atom in the carbonyl group overlaps a p orbital on the oxygen atom to form the π bond in the double bond. Like the bond in carbon dioxide, the bond of a carbonyl group is polar (recall that oxygen is significantly more electronegative than carbon, and the shared electrons are pulled toward the oxygen atom and away from the carbon atom). Many of the reactions of aldehydes and ketones start with the reaction between a Lewis base and the carbon atom at the positive end of the polar bond to yield an unstable intermediate that subsequently undergoes one or more structural rearrangements to form the final product (). The importance of molecular structure in the reactivity of organic compounds is illustrated by the reactions that produce aldehydes and ketones. We can prepare a carbonyl group by oxidation of an alcohol—for organic molecules, oxidation of a carbon atom is said to occur when a carbon-hydrogen bond is replaced by a carbon-oxygen bond. The reverse reaction—replacing a carbon-oxygen bond by a carbon-hydrogen bond—is a reduction of that carbon atom. Recall that oxygen is generally assigned a –2 oxidation number unless it is elemental or attached to a fluorine. Hydrogen is generally assigned an oxidation number of +1 unless it is attached to a metal. Since carbon does not have a specific rule, its oxidation number is determined algebraically by factoring the atoms it is attached to and the overall charge of the molecule or ion. In general, a carbon atom attached to an oxygen atom will have a more positive oxidation number and a carbon atom attached to a hydrogen atom will have a more negative oxidation number. This should fit nicely with your understanding of the polarity of C–O and C–H bonds. The other reagents and possible products of these reactions are beyond the scope of this chapter, so we will focus only on the changes to the carbon atoms: Aldehydes are commonly prepared by the oxidation of alcohols whose –OH functional group is located on the carbon atom at the end of the chain of carbon atoms in the alcohol: Alcohols that have their –OH groups in the middle of the chain are necessary to synthesize a ketone, which requires the carbonyl group to be bonded to two other carbon atoms: An alcohol with its –OH group bonded to a carbon atom that is bonded to no or one other carbon atom will form an aldehyde. An alcohol with its –OH group attached to two other carbon atoms will form a ketone. If three carbons are attached to the carbon bonded to the –OH, the molecule will not have a C–H bond to be replaced, so it will not be susceptible to oxidation. Formaldehyde, an aldehyde with the formula HCHO, is a colorless gas with a pungent and irritating odor. It is sold in an aqueous solution called formalin, which contains about 37% formaldehyde by weight. Formaldehyde causes coagulation of proteins, so it kills bacteria (and any other living organism) and stops many of the biological processes that cause tissue to decay. Thus, formaldehyde is used for preserving tissue specimens and embalming bodies. It is also used to sterilize soil or other materials. Formaldehyde is used in the manufacture of Bakelite, a hard plastic having high chemical and electrical resistance. Dimethyl ketone, CH3COCH3, commonly called acetone, is the simplest ketone. It is made commercially by fermenting corn or molasses, or by oxidation of 2-propanol. Acetone is a colorless liquid. Among its many uses are as a solvent for lacquer (including fingernail polish), cellulose acetate, cellulose nitrate, acetylene, plastics, and varnishes; as a paint and varnish remover; and as a solvent in the manufacture of pharmaceuticals and chemicals. ### Carboxylic Acids and Esters The odor of vinegar is caused by the presence of acetic acid, a carboxylic acid, in the vinegar. The odor of ripe bananas and many other fruits is due to the presence of esters, compounds that can be prepared by the reaction of a carboxylic acid with an alcohol. Because esters do not have hydrogen bonds between molecules, they have lower vapor pressures than the alcohols and carboxylic acids from which they are derived (see ). Both carboxylic acids and esters contain a carbonyl group with a second oxygen atom bonded to the carbon atom in the carbonyl group by a single bond. In a carboxylic acid, the second oxygen atom also bonds to a hydrogen atom. In an ester, the second oxygen atom bonds to another carbon atom. The names for carboxylic acids and esters include prefixes that denote the lengths of the carbon chains in the molecules and are derived following nomenclature rules similar to those for inorganic acids and salts (see these examples): The functional groups for an acid and for an ester are shown in red in these formulas. The hydrogen atom in the functional group of a carboxylic acid will react with a base to form an ionic salt: Carboxylic acids are weak acids (see the chapter on acids and bases), meaning they are not 100% ionized in water. Generally only about 1% of the molecules of a carboxylic acid dissolved in water are ionized at any given time. The remaining molecules are undissociated in solution. We prepare carboxylic acids by the oxidation of aldehydes or alcohols whose –OH functional group is located on the carbon atom at the end of the chain of carbon atoms in the alcohol: Esters are produced by the reaction of acids with alcohols. For example, the ester ethyl acetate, CH3CO2CH2CH3, is formed when acetic acid reacts with ethanol: The simplest carboxylic acid is formic acid, HCO2H, known since 1670. Its name comes from the Latin word formicus, which means “ant”; it was first isolated by the distillation of red ants. It is partially responsible for the pain and irritation of ant and wasp stings, and is responsible for a characteristic odor of ants that can be sometimes detected in their nests. Acetic acid, CH3CO2H, constitutes 3–6% vinegar. Cider vinegar is produced by allowing apple juice to ferment without oxygen present. Yeast cells present in the juice carry out the fermentation reactions. The fermentation reactions change the sugar present in the juice to ethanol, then to acetic acid. Pure acetic acid has a penetrating odor and produces painful burns. It is an excellent solvent for many organic and some inorganic compounds, and it is essential in the production of cellulose acetate, a component of many synthetic fibers such as rayon. The distinctive and attractive odors and flavors of many flowers, perfumes, and ripe fruits are due to the presence of one or more esters (). Among the most important of the natural esters are fats (such as lard, tallow, and butter) and oils (such as linseed, cottonseed, and olive oils), which are esters of the trihydroxyl alcohol glycerine, C3H5(OH)3, with large carboxylic acids, such as palmitic acid, CH3(CH2)14CO2H, stearic acid, CH3(CH2)16CO2H, and oleic acid, Oleic acid is an unsaturated acid; it contains a double bond. Palmitic and stearic acids are saturated acids that contain no double or triple bonds. ### Key Concepts and Summary Functional groups related to the carbonyl group include the –CHO group of an aldehyde, the –CO– group of a ketone, the –CO2H group of a carboxylic acid, and the –CO2R group of an ester. The carbonyl group, a carbon-oxygen double bond, is the key structure in these classes of organic molecules: Aldehydes contain at least one hydrogen atom attached to the carbonyl carbon atom, ketones contain two carbon groups attached to the carbonyl carbon atom, carboxylic acids contain a hydroxyl group attached to the carbonyl carbon atom, and esters contain an oxygen atom attached to another carbon group connected to the carbonyl carbon atom. All of these compounds contain oxidized carbon atoms relative to the carbon atom of an alcohol group. ### Chemistry End of Chapter Exercises

# Organic Chemistry ## Amines and Amides Amines are molecules that contain carbon-nitrogen bonds. The nitrogen atom in an amine has a lone pair of electrons and three bonds to other atoms, either carbon or hydrogen. Various nomenclatures are used to derive names for amines, but all involve the class-identifying suffix –ine as illustrated here for a few simple examples: In some amines, the nitrogen atom replaces a carbon atom in an aromatic hydrocarbon. Pyridine () is one such heterocyclic amine. A heterocyclic compound contains atoms of two or more different elements in its ring structure. Like ammonia, amines are weak bases due to the lone pair of electrons on their nitrogen atoms: The basicity of an amine’s nitrogen atom plays an important role in much of the compound’s chemistry. Amine functional groups are found in a wide variety of compounds, including natural and synthetic dyes, polymers, vitamins, and medications such as penicillin and codeine. They are also found in many molecules essential to life, such as amino acids, hormones, neurotransmitters, and DNA. Amides are molecules that contain nitrogen atoms connected to the carbon atom of a carbonyl group. Like amines, various nomenclature rules may be used to name amides, but all include use of the class-specific suffix -amide: Amides can be produced when carboxylic acids react with amines or ammonia in a process called amidation. A water molecule is eliminated from the reaction, and the amide is formed from the remaining pieces of the carboxylic acid and the amine (note the similarity to formation of an ester from a carboxylic acid and an alcohol discussed in the previous section): The reaction between amines and carboxylic acids to form amides is biologically important. It is through this reaction that amino acids (molecules containing both amine and carboxylic acid substituents) link together in a polymer to form proteins. The table here summarizes the structures discussed in this chapter: ### Key Concepts and Summary The addition of nitrogen into an organic framework leads to two families of molecules. Compounds containing a nitrogen atom bonded in a hydrocarbon framework are classified as amines. Compounds that have a nitrogen atom bonded to one side of a carbonyl group are classified as amides. Amines are a basic functional group. Amines and carboxylic acids can combine in a condensation reaction to form amides. ### Chemistry End of Chapter Exercises

# Understanding Economic Systems and Business ## Introduction ### Learning Outcomes After reading this chapter, you should be able to answer these questions: 1. How do businesses and not-for-profit organizations help create our standard of living? 2. What are the sectors of the business environment, and how do changes in them influence business decisions? 3. What are the primary features of the world’s economic systems, and how are the three sectors of the U.S. economy linked? 4. How do economic growth, full employment, price stability, and inflation indicate a nation’s economic health? 5. How does the government use monetary policy and fiscal policy to achieve its macroeconomic goals? 6. What are the basic microeconomic concepts of demand and supply, and how do they establish prices? 7. What are the four types of market structure? 8. Which trends are reshaping the business, microeconomic, and macroeconomic environments and competitive arena? This module provides the basic structures upon which the business world is built: how it is organized, what outside forces influence it, and where it is heading. It also explores how the world’s economies and governments shape economic activity. Each day in the United States, thousands of new businesses are born. Only a rare few will become the next Apple, Google, or Amazon. Unfortunately, many others will never see their first anniversary. The survivors are those that understand that change is the one constant in the business environment. Those organizations pay attention to the business environment in which they operate and the trends that affect all businesses and then successfully adapt to those trends. In this module, we will meet many businesses, both large and small, profit and not-for-profit, that prosper because they track trends and use them to identify potential opportunities. This ability to manage change is a critical factor in separating the success stories from the tales of business failure. We begin our study of business by introducing you to the primary functions of a business, the relationship between risk and profits, and the importance of not-for-profit organizations. We’ll also examine the major components of the business environment and how changing demographic, social, political and legal, and competitive factors affect all business organizations. Next, we’ll explore how economies provide jobs for workers and also compete with other businesses to create and deliver products to consumers. You will also learn how governments attempt to influence economic activity through policies such as lowering or raising taxes. Next, we discuss how supply and demand determine prices for goods and services. Finally, we conclude by examining key trends in the business environment, economic systems, and the competitive environment.

# Understanding Economic Systems and Business ## The Nature of Business 1. How do businesses and not-for-profit organizations help create our standard of living? Take a moment to think about the many different types of businesses you come into contact with on a typical day. As you drive to class, you may stop at a gas station that is part of a major national oil company and grab lunch from a fast food chain such as Taco Bell or McDonald’s or the neighborhood pizza place. Need more cash? You can do your banking on a smartphone or other device via mobile apps. You don’t even have to visit the store anymore: online shopping brings the stores to you, offering everything from clothes to food, furniture, and concert tickets. A business is an organization that strives for a profit by providing goods and services desired by its customers. Businesses meet the needs of consumers by providing medical care, autos, and countless other goods and services. Goods are tangible items manufactured by businesses, such as laptops. Services are intangible offerings of businesses that can’t be held, touched, or stored. Physicians, lawyers, hairstylists, car washes, and airlines all provide services. Businesses also serve other organizations, such as hospitals, retailers, and governments, by providing machinery, goods for resale, computers, and thousands of other items. Thus, businesses create the goods and services that are the basis of our standard of living. The standard of living of any country is measured by the output of goods and services people can buy with the money they have. The United States has one of the highest standards of living in the world. Although several countries, such as Switzerland and Germany, have higher average wages than the United States, their standards of living aren’t higher, because prices are so much higher. As a result, the same amount of money buys less in those countries. For example, in the United States, we can buy an Extra Value Meal at McDonald’s for less than $5, while in another country, a similar meal might cost as much as $10. Businesses play a key role in determining our quality of life by providing jobs and goods and services to society. Quality of life refers to the general level of human happiness based on such things as life expectancy, educational standards, health, sanitation, and leisure time. Building a high quality of life is a combined effort of businesses, government, and not-for-profit organizations. In 2017, Vienna, Austria, ranked highest in quality of life, followed by Zurich, Switzerland; Auckland, New Zealand; and Munich, Germany. It may come as a surprise that not one of the world’s top cities is in the United States: seven of the top 10 locations are in western Europe, two are in Australia/New Zealand, and one is in Canada. At the other end of the scale, Baghdad, Iraq, is the city scoring the lowest on the annual survey. Creating a quality of life is not without risks, however. Risk is the potential to lose time and money or otherwise not be able to accomplish an organization’s goals. Without enough blood donors, for example, the American Red Cross faces the risk of not meeting the demand for blood by victims of disaster. Businesses such as Microsoft face the risk of falling short of their revenue and profit goals. Revenue is the money a company receives by providing services or selling goods to customers. Costs are expenses for rent, salaries, supplies, transportation, and many other items that a company incurs from creating and selling goods and services. For example, some of the costs incurred by Microsoft in developing its software include expenses for salaries, facilities, and advertising. If Microsoft has money left over after it pays all costs, it has a profit. A company whose costs are greater than revenues shows a loss. When a company such as Microsoft uses its resources intelligently, it can often increase sales, hold costs down, and earn a profit. Not all companies earn profits, but that is the risk of being in business. In U.S. business today, there is generally a direct relationship between risks and profit: the greater the risks, the greater the potential for profit (or loss). Companies that take too conservative a stance may lose out to more nimble competitors who react quickly to the changing business environment. Take Sony, for example. The Japanese electronics giant, once a leader with its Walkman music player and Trinitron televisions, steadily lost ground—and profits—over the past two decades to other companies by not embracing new technologies such as the digital music format and flat-panel TV screens. Sony misjudged what the market wanted and stayed with proprietary technologies rather than create cross-platform options for consumers. Apple, at the time an upstart in personal music devices, quickly grabbed the lion’s share of the digital music market with its iPods and iTunes music streaming service. By 2016, Sony restructured its business portfolio and has experienced substantial success with its PlayStation 4 gaming console and original gaming content. ### Not-for-Profit Organizations Not all organizations strive to make a profit. A not-for-profit organization is an organization that exists to achieve some goal other than the usual business goal of profit. Charities such as Habitat for Humanity, the United Way, the American Cancer Society, and the World Wildlife Fund are not-for-profit organizations, as are most hospitals, zoos, arts organizations, civic groups, and religious organizations. Over the last 20 years, the number of nonprofit organizations—and the employees and volunteers who work for them—has increased considerably. Government is our largest and most pervasive not-for-profit group. In addition, more than 1.5 million nongovernmental not-for-profit entities operate in the United States today and contribute more than $900 billion annually to the U.S. economy. Like their for-profit counterparts, these groups set goals and require resources to meet those goals. However, their goals are not focused on profits. For example, a not-for-profit organization’s goal might be feeding the poor, preserving the environment, increasing attendance at the ballet, or preventing drunk driving. Not-for-profit organizations do not compete directly with one another in the same manner as, for example, Ford and Honda, but they do compete for talented employees, people’s limited volunteer time, and donations. The boundaries that formerly separated not-for-profit and for-profit organizations have blurred, leading to a greater exchange of ideas between the sectors. As discussed in detail in the ethics chapter, for-profit businesses are now addressing social issues. Successful not-for-profits apply business principles to operate more effectively. Not-for-profit managers are concerned with the same concepts as their colleagues in for-profit companies: developing strategy, budgeting carefully, measuring performance, encouraging innovation, improving productivity, demonstrating accountability, and fostering an ethical workplace environment. In addition to pursuing a museum’s artistic goals, for example, top executives manage the administrative and business side of the organization: human resources, finance, and legal concerns. Ticket revenues cover a fraction of the museum’s operating costs, so the director spends a great deal of time seeking major donations and memberships. Today’s museum boards of directors include both art patrons and business executives who want to see sound fiscal decision-making in a not-for-profit setting. Therefore, a museum director must walk a fine line between the institution’s artistic mission and financial policies. According to a survey by , over the next several years, major art museums will be looking for new directors, as more than a third of the current ones are approaching retirement. ### Factors of Production: The Building Blocks of Business To provide goods and services, regardless of whether they operate in the for-profit or not-for-profit sector, organizations require inputs in the form of resources called factors of production. Four traditional factors of production are common to all productive activity: natural resources, labor (human resources), capital, and entrepreneurship. Many experts now include knowledge as a fifth factor, acknowledging its key role in business success. By using the factors of production efficiently, a company can produce more goods and services with the same resources. Commodities that are useful inputs in their natural state are known as natural resources. They include farmland, forests, mineral and oil deposits, and water. Sometimes natural resources are simply called land, although, as you can see, the term means more than just land. Companies use natural resources in different ways. International Paper Company uses wood pulp to make paper, and Pacific Gas & Electric Company may use water, oil, or coal to produce electricity. Today urban sprawl, pollution, and limited resources have raised questions about resource use. Conservationists, environmentalists, and government bodies are proposing laws to require land-use planning and resource conservation. Labor, or human resources, refers to the economic contributions of people working with their minds and muscles. This input includes the talents of everyone—from a restaurant cook to a nuclear physicist—who performs the many tasks of manufacturing and selling goods and services. The tools, machinery, equipment, and buildings used to produce goods and services and get them to the consumer are known as capital. Sometimes the term capital is also used to mean the money that buys machinery, factories, and other production and distribution facilities. However, because money itself produces nothing, it is not one of the basic inputs. Instead, it is a means of acquiring the inputs. Therefore, in this context, capital does not include money. Entrepreneurs are the people who combine the inputs of natural resources, labor, and capital to produce goods or services with the intention of making a profit or accomplishing a not-for-profit goal. These people make the decisions that set the course for their businesses; they create products and production processes or develop services. Because they are not guaranteed a profit in return for their time and effort, they must be risk-takers. Of course, if their companies succeed, the rewards may be great. Today, many individuals want to start their own businesses. They are attracted by the opportunity to be their own boss and reap the financial rewards of a successful firm. Many start their first business from their dorm rooms, such as Mark Zuckerberg of Facebook, or while living at home, so their cost is almost zero. Entrepreneurs include people such as Microsoft cofounder Bill Gates, who was named the richest person in the world in 2017, as well as Google founders Sergey Brin and Larry Page. Many thousands of individuals have started companies that, while remaining small, make a major contribution to the U.S. economy. A number of outstanding managers and noted academics are beginning to emphasize a fifth factor of production—knowledge. Knowledge refers to the combined talents and skills of the workforce and has become a primary driver of economic growth. Today’s competitive environment places a premium on knowledge and learning over physical resources. Recent statistics suggest that the number of U.S. knowledge workers has doubled over the last 30 years, with an estimated 2 million knowledge job openings annually. Despite the fact that many “routine” jobs have been replaced by automation over the last decade or outsourced to other countries, technology has actually created more jobs that require knowledge and cognitive skills. ### Summary of Learning Outcomes 1. How do businesses and not-for-profit organizations help create our standard of living? Businesses attempt to earn a profit by providing goods and services desired by their customers. Not-for-profit organizations, though not striving for a profit, still deliver many needed services for our society. Our standard of living is measured by the output of goods and services. Thus, businesses and not-for-profit organizations help create our standard of living. Our quality of life is not simply the amount of goods and services available for consumers but rather the society’s general level of happiness. Economists refer to the building blocks of a business as the factors of production. To produce anything, one must have natural resources, labor (human resources), capital, and entrepreneurship to assemble the resources and manage the business. Today’s competitive business environment is based upon knowledge and learning. The companies that succeed will be those that learn fast, use knowledge efficiently, and develop new insights.

# Understanding Economic Systems and Business ## Understanding the Business Environment 1. What are the sectors of the business environment, and how do changes in them influence business decisions? Businesses do not operate in a vacuum but rather in a dynamic environment that has a direct influence on how they operate and whether they will achieve their objectives. This external business environment is composed of numerous outside organizations and forces that we can group into seven key subenvironments, as illustrates: economic, political and legal, demographic, social, competitive, global, and technological. Each of these sectors creates a unique set of challenges and opportunities for businesses. Business owners and managers have a great deal of control over the internal environment of business, which covers day-to-day decisions. They choose the supplies they purchase, which employees they hire, the products they sell, and where they sell those products. They use their skills and resources to create goods and services that will satisfy existing and prospective customers. However, the external environmental conditions that affect a business are generally beyond the control of management and change constantly. To compete successfully, business owners and managers must continuously study the environment and adapt their businesses accordingly. Other forces, such as natural disasters, can also have a major impact on businesses. While still in the rebuilding stage after Hurricane Katrina hit in 2005, the U.S. Gulf Coast suffered another disaster in April 2010 as a result of an explosion on the Deepwater Horizon oil-rig, which killed 11 workers and sent more than 3 million barrels of oil into the Gulf of Mexico. This event, which played out for more than 87 days, severely affected the environment, businesses, tourism, and people’s livelihoods. Global oil conglomerate BP, which was responsible for the oil spill, has spent more than $60 billion in response to the disaster and cleanup. Seven years after the explosion, tourism and other businesses are slowly recovering, although scientists are not certain about the long-term environmental consequences of the oil spill. No one business is large or powerful enough to create major changes in the external environment. Thus, managers are primarily adapters to, rather than agents of, change. Global competition is basically an uncontrollable element in the external environment. In some situations, however, a firm can influence external events through its strategies. For example, major U.S. pharmaceutical companies have been successful in getting the Food and Drug Administration (FDA) to speed up the approval process for new drugs. In recent years, the five largest companies in the S&P Index—Google, Facebook, Amazon, Microsoft, and Apple—have spent close to $50 million on lobbying activities in the nation’s capital in an effort to help policy makers understand the tech industry and the importance of innovation and an “open” internet. Let’s now take a brief look at these varied environmental influences. ### Economic Influences This category is one of the most important external influences on businesses. Fluctuations in the level of economic activity create business cycles that affect businesses and individuals in many ways. When the economy is growing, for example, unemployment rates are low, and income levels rise. Inflation and interest rates are other areas that change according to economic activity. Through the policies it sets, such as taxes and interest rate levels, a government attempts to stimulate or curtail the level of economic activity. In addition, the forces of supply and demand determine how prices and quantities of goods and services behave in a free market. ### Political and Legal Influences The political climate of a country is another critical factor for managers to consider in day-to-day business operations. The amount of government activity, the types of laws it passes, and the general political stability of a government are three components of political climate. For example, a multinational company such as General Electric will evaluate the political climate of a country before deciding to locate a plant there. Is the government stable, or might a coup disrupt the country? How restrictive are the regulations for foreign businesses, including foreign ownership of business property and taxation? Import tariffs, quotas, and export restrictions also must be taken into account. In the United States, laws passed by Congress and the many regulatory agencies cover such areas as competition, minimum wages, environmental protection, worker safety, and copyrights and patents. For example, Congress passed the Telecommunications Act of 1996 to deregulate the telecommunications industry. As a result, competition increased and new opportunities arose as traditional boundaries between service providers blurred. Today the dramatic growth in mobile technology has changed the focus of telecommunications, which now faces challenges related to broadband access and speed, content streaming, and much-needed improvements in network infrastructure to address ever-increasing data transmissions. Federal agencies play a significant role in business operations. When Pfizer wants to bring a new medication for heart disease to market, it must follow the procedures set by the Food and Drug Administration for testing and clinical trials and secure FDA approval. Before issuing stock, Pfizer must register the securities with the Securities and Exchange Commission. The Federal Trade Commission will penalize Pfizer if its advertisements promoting the drug’s benefits are misleading. These are just a few ways the political and legal environment affect business decisions. States and local governments also exert control over businesses—imposing taxes, issuing corporate charters and business licenses, setting zoning ordinances, and similar regulations. We discuss the legal environment in greater detail in a separate appendix. ### Demographic Factors Demographic factors are an uncontrollable factor in the business environment and extremely important to managers. Demography is the study of people’s vital statistics, such as their age, gender, race and ethnicity, and location. Demographics help companies define the markets for their products and also determine the size and composition of the workforce. You’ll encounter demographics as you continue your study of business. Demographics are at the heart of many business decisions. Businesses today must deal with the unique shopping preferences of different generations, which each require marketing approaches and goods and services targeted to their needs. For example, the more than 75 million members of the millennial generation were born between 1981 and 1997. In 2017 they surpassed baby boomers as America’s largest generation. The marketing impact of millennials continues to be immense. These are technologically savvy and prosperous young people, with hundreds of billions of dollars to spend. And spend they do—freely, even though they haven’t yet reached their peak income and spending years. Other age groups, such as Generation X—people born between 1965 and 1980—and the baby boomers—born between 1946 and 1964—have their own spending patterns. Many boomers nearing retirement have money and are willing to spend it on their health, their comforts, leisure pursuits, and cars. As the population ages, businesses are offering more products that appeal to middle-aged and senior markets. In addition, minorities represent more than 38 percent of the total population, with immigration bringing millions of new residents to the country over the past several decades. By 2060 the U.S. Census Bureau projects the minority population to increase to 56 percent of the total U.S. population. Companies recognize the value of hiring a diverse workforce that reflects our society. Minorities’ buying power has increased significantly as well, and companies are developing products and marketing campaigns that target different ethnic groups. ### Social Factors Social factors—our attitudes, values, ethics, and lifestyles—influence what, how, where, and when people purchase products or services. They are difficult to predict, define, and measure because they can be very subjective. They also change as people move through different life stages. People of all ages have a broader range of interests, defying traditional consumer profiles. They also experience a “poverty of time” and seek ways to gain more control over their time. Changing roles have brought more women into the workforce. This development is increasing family incomes, heightening demand for time-saving goods and services, changing family shopping patterns, and impacting individuals’ ability to achieve a work-life balance. In addition, a renewed emphasis on ethical behavior within organizations at all levels of the company has managers and employees alike searching for the right approach when it comes to gender inequality, sexual harassment, and other social behaviors that impact the potential for a business’s continued success. ### Technology The application of technology can stimulate growth under capitalism or any other economic system. Technology is the application of science and engineering skills and knowledge to solve production and organizational problems. New equipment and software that improve productivity and reduce costs can be among a company’s most valuable assets. Productivity is the amount of goods and services one worker can produce. Our ability as a nation to maintain and build wealth depends in large part on the speed and effectiveness with which we use technology—to invent and adapt more efficient equipment to improve manufacturing productivity, to develop new products, and to process information and make it instantly available across the organization and to suppliers and customers. Many U.S. businesses, large and small, use technology to create change, improve efficiencies, and streamline operations. For example, advances in cloud computing provide businesses with the ability to access and store data without running applications or programs housed on a physical computer or server in their offices. Such applications and programs can now be accessed through the internet. Mobile technology allows businesses to communicate with employees, customers, suppliers, and others at the swipe of a tablet or smartphone screen. Robots help businesses automate repetitive tasks that free up workers to focus on more knowledge-based tasks critical to business operations. ### Summary of Learning Outcomes 1. What are the sectors of the business environment, and how do changes in them influence business decisions? The external business environment consists of economic, political and legal, demographic, social, competitive, global, and technological sectors. Managers must understand how the environment is changing and the impact of those changes on the business. When economic activity is strong, unemployment rates are low, and income levels rise. The political environment is shaped by the amount of government intervention in business affairs, the types of laws it passes to regulate both domestic and foreign businesses, and the general political stability of a government. Demographics, or the study of people’s vital statistics, are at the heart of many business decisions. Businesses today must deal with the unique preferences of different generations, each of which requires different marketing approaches and different goods and services. The population is becoming increasingly diverse: currently minorities represent more than 38 percent of the total U.S. population, and that number will continue to increase over the next several decades. Minorities’ buying power has increased significantly as well, and companies are developing products and marketing campaigns that target different ethnic groups. Social factors—our attitudes, values, and lifestyles—influence what, how, where, and when people purchase products. They are difficult to predict, define, and measure because they can be very subjective. They also change as people move through different life stages.

# Understanding Economic Systems and Business ## How Business and Economics Work 1. What are the primary features of the world’s economic systems, and how are the three sectors of the U.S. economy linked? A business’s success depends in part on the economic systems of the countries where it is located and where it sells its products. A nation’s economic system is the combination of policies, laws, and choices made by its government to establish the systems that determine what goods and services are produced and how they are allocated. Economics is the study of how a society uses scarce resources to produce and distribute goods and services. The resources of a person, a firm, or a nation are limited. Hence, economics is the study of choices—what people, firms, or nations choose from among the available resources. Every economy is concerned with what types and amounts of goods and services should be produced, how they should be produced, and for whom. These decisions are made by the marketplace, the government, or both. In the United States, the government and the free-market system together guide the economy. You probably know more about economics than you realize. Every day, many news stories deal with economic matters: a union wins wage increases at General Motors, the Federal Reserve Board lowers interest rates, Wall Street has a record day, the president proposes a cut in income taxes, consumer spending rises as the economy grows, or retail prices are on the rise, to mention just a few examples. ### Global Economic Systems Businesses and other organizations operate according to the economic systems of their home countries. Today the world’s major economic systems fall into two broad categories: free market, or capitalism; and planned economies, which include communism and socialism. However, in reality many countries use a mixed market system that incorporates elements from more than one economic system. The major differentiator among economic systems is whether the government or individuals decide: 1. How to allocate limited resources—the factors of production—to individuals and organizations to best satisfy unlimited societal needs 2. What goods and services to produce and in what quantities 3. How and by whom these goods and services are produced 4. How to distribute goods and services to consumers Managers must understand and adapt to the economic system or systems in which they operate. Companies that do business internationally may discover that they must make changes in production and selling methods to accommodate the economic system of other countries. summarizes key factors of the world’s economic systems. ### Capitalism In recent years, more countries have shifted toward free-market economic systems and away from planned economies. Sometimes, as was the case of the former East Germany, the transition to capitalism was painful but fairly quick. In other countries, such as Russia, the movement has been characterized by false starts and backsliding. Capitalism, also known as the private enterprise system, is based on competition in the marketplace and private ownership of the factors of production (resources). In a competitive economic system, a large number of people and businesses buy and sell products freely in the marketplace. In pure capitalism, all the factors of production are owned privately, and the government does not try to set prices or coordinate economic activity. A capitalist system guarantees certain economic rights: the right to own property, the right to make a profit, the right to make free choices, and the right to compete. The right to own property is central to capitalism. The main incentive in this system is profit, which encourages entrepreneurship. Profit is also necessary for producing goods and services, building manufacturing plants, paying dividends and taxes, and creating jobs. The freedom to choose whether to become an entrepreneur or to work for someone else means that people have the right to decide what they want to do on the basis of their own drive, interest, and training. The government does not create job quotas for each industry or give people tests to determine what they will do. Competition is good for both businesses and consumers in a capitalist system. It leads to better and more diverse products, keeps prices stable, and increases the efficiency of producers. Companies try to produce their goods and services at the lowest possible cost and sell them at the highest possible price. But when profits are high, more businesses enter the market to seek a share of those profits. The resulting competition among companies tends to lower prices. Companies must then find new ways of operating more efficiently if they are to keep making a profit—and stay in business. ### Communism The complete opposite of capitalism is communism. In a communist economic system, the government owns virtually all resources and controls all markets. Economic decision-making is centralized: the government, rather than the competitive forces in the marketplace, decides what will be produced, where it will be produced, how much will be produced, where the raw materials and supplies will come from, who will get the output, and what the prices will be. This form of centralized economic system offers little if any choice to a country’s citizens. Early in the 20th century, countries that chose communism, such as the former Soviet Union and China, believed that it would raise their standard of living. In practice, however, the tight controls over most aspects of people’s lives, such as what careers they can choose, where they can work, and what they can buy, led to lower productivity. Workers had no reasons to work harder or produce quality goods, because there were no rewards for excellence. Errors in planning and resource allocation led to shortages of even basic items. These factors were among the reasons for the 1991 collapse of the Soviet Union into multiple independent nations. Recent reforms in Russia, China, and most of the eastern European nations have moved these economies toward more capitalistic, market-oriented systems. North Korea and Cuba are the best remaining examples of communist economic systems. Time will tell whether Cuba takes small steps toward a market economy now that the United States reestablished diplomatic relations with the island country a few years ago. ### Socialism Socialism is an economic system in which the basic industries are owned by the government or by the private sector under strong government control. A socialist state controls critical, large-scale industries such as transportation, communications, and utilities. Smaller businesses and those considered less critical, such as retail, may be privately owned. To varying degrees, the state also determines the goals of businesses, the prices and selection of goods, and the rights of workers. Socialist countries typically provide their citizens with a higher level of services, such as health care and unemployment benefits, than do most capitalist countries. As a result, taxes and unemployment may also be higher in socialist countries. For example, in 2017, the top individual tax rate in France was 45 percent, compared to 39.6 percent in the United States. With both countries electing new presidents in 2017, tax cuts were a campaign promise that both President Macron and President Trump took on as part of their overall economic agendas. Many countries, including the United Kingdom, Denmark, India, and Israel, have socialist systems, but the systems vary from country to country. In Denmark, for example, most businesses are privately owned and operated, but two-thirds of the population is sustained by the state through government welfare programs. ### Mixed Economic Systems Pure capitalism and communism are extremes; real-world economies fall somewhere between the two. The U.S. economy leans toward pure capitalism, but it uses government policies to promote economic stability and growth. Also, through policies and laws, the government transfers money to the poor, the unemployed, and the elderly or disabled. American capitalism has produced some very powerful organizations in the form of large corporations, such as General Motors and Microsoft. To protect smaller firms and entrepreneurs, the government has passed legislation that requires that the giants compete fairly against weaker competitors. Canada, Sweden, and the UK, among others, are also called mixed economies; that is, they use more than one economic system. Sometimes, the government is basically socialist and owns basic industries. In Canada, for example, the government owns the communications, transportation, and utilities industries, as well as some of the natural-resource industries. It also provides health care to its citizens. But most other activity is carried on by private enterprise, as in a capitalist system. In 2016, UK citizens voted for Britain to leave the European Union, a move that will take two or more years to finalize. It is too early to tell what impact the Brexit decision will have on the UK economy and other economies around the world. The few factors of production owned by the government in a mixed economy include some public lands, the postal service, and some water resources. But the government is extensively involved in the economic system through taxing, spending, and welfare activities. The economy is also mixed in the sense that the country tries to achieve many social goals—income redistribution and retirement pensions, for example—that may not be attempted in purely capitalist systems. ### Macroeconomics and Microeconomics The state of the economy affects both people and businesses. How you spend your money (or save it) is a personal economic decision. Whether you continue in school and whether you work part-time are also economic decisions. Every business also operates within the economy. Based on their economic expectations, businesses decide what products to produce, how to price them, how many people to employ, how much to pay these employees, how much to expand the business, and so on. Economics has two main subareas. Macroeconomics is the study of the economy as a whole. It looks at aggregate data for large groups of people, companies, or products considered as a whole. In contrast, microeconomics focuses on individual parts of the economy, such as households or firms. Both macroeconomics and microeconomics offer a valuable outlook on the economy. For example, Ford might use both to decide whether to introduce a new line of vehicles. The company would consider such macroeconomic factors as the national level of personal income, the unemployment rate, interest rates, fuel costs, and the national level of sales of new vehicles. From a microeconomic viewpoint, Ford would judge consumer demand for new vehicles versus the existing supply, competing models, labor and material costs and availability, and current prices and sales incentives. ### Economics as a Circular Flow Another way to see how the sectors of the economy interact is to examine the circular flow of inputs and outputs among households, businesses, and governments as shown in . Let’s review the exchanges by following the red circle around the inside of the diagram. Households provide inputs (natural resources, labor, capital, entrepreneurship, knowledge) to businesses, which convert these inputs into outputs (goods and services) for consumers. In return, households receive income from rent, wages, interest, and ownership profits (blue circle). Businesses receive revenue from consumer purchases of goods and services. The other important exchange in takes place between governments (federal, state, and local) and both households and businesses. Governments supply many types of publicly provided goods and services (highways, schools, police, courts, health services, unemployment insurance, social security) that benefit consumers and businesses. Government purchases from businesses also contribute to business revenues. When a construction firm repairs a local stretch of state highway, for example, government pays for the work. As the diagram shows, government receives taxes from households and businesses to complete the flow. Changes in one flow affect the others. If government raises taxes, households have less to spend on goods and services. Lower consumer spending causes businesses to reduce production, and economic activity declines; unemployment may rise. In contrast, cutting taxes can stimulate economic activity. Keep the circular flow in mind as we continue our study of economics. The way economic sectors interact will become more evident as we explore macroeconomics and microeconomics. ### Summary of Learning Outcomes 1. What are the primary features of the world’s economic systems, and how are the three sectors of the U.S. economy linked? Economics is the study of how individuals, businesses, and governments use scarce resources to produce and distribute goods and services. Today there is a global trend toward capitalism. Capitalism, also known as the private enterprise system, is based upon marketplace competition and private ownership of the factors of production. Competition leads to more diverse goods and services, keeps prices stable, and pushes businesses to become more efficient. In a communist economy, the government owns virtually all resources, and economic decision-making is done by central government planning. Governments have generally moved away from communism because it is inefficient and delivers a low standard of living. Socialism is another centralized economic system in which the basic industries are owned by the government or by the private sector under strong government control. Other industries may be privately owned. The state is also somewhat influential in determining the goals of business, the prices and selection of products, and the rights of workers. Most national economies today are a mix of socialism and capitalism. The two major areas in economics are macroeconomics, the study of the economy as a whole, and microeconomics, the study of households and firms. The individual, business, and government sectors of the economy are linked by a series of two-way flows. The government provides public goods and services to the other two sectors and receives income in the form of taxes. Changes in one flow affect the other sectors.

# Understanding Economic Systems and Business ## Macroeconomics: The Big Picture 1. How do economic growth, full employment, price stability, and inflation indicate a nation’s economic health? Have you ever looked at CNN’s Headline News on a mobile device or turned on the radio and heard something like, “Today the Labor Department reported that for the second straight month unemployment declined”? Statements like this are macroeconomic news. Understanding the national economy and how changes in government policies affect households and businesses is a good place to begin our study of economics. Let’s look first at macroeconomic goals and how they can be met. The United States and most other countries have three main macroeconomic goals: economic growth, full employment, and price stability. A nation’s economic well-being depends on carefully defining these goals and choosing the best economic policies for achieving them. ### Striving for Economic Growth Perhaps the most important way to judge a nation’s economic health is to look at its production of goods and services. The more the nation produces, the higher its standard of living. An increase in a nation’s output of goods and services is economic growth. The most basic measure of economic growth is the gross domestic product (GDP). GDP is the total market value of all final goods and services produced within a nation’s borders each year. The Bureau of Labor Statistics publishes quarterly GDP figures that can be used to compare trends in national output. When GDP rises, the economy is growing. The rate of growth in real GDP (GDP adjusted for inflation) is also important. Recently, the U.S. economy has been growing at a slow but steady rate of between 3 and 4 percent annually. This growth rate has meant a steady increase in the output of goods and services and relatively low unemployment. When the growth rate slides toward zero, the economy begins to stagnate and decline. One country that continues to grow more rapidly than most is China, whose GDP has been growing at 6 to 7 percent per year. Today few things in the global marketplace are not or cannot be made in China. The primary contributor to China’s rapid growth has been technology. For example, most tablets and laptops are manufactured in China. The level of economic activity is constantly changing. These upward and downward changes are called business cycles. Business cycles vary in length, in how high or low the economy moves, and in how much the economy is affected. Changes in GDP trace the patterns as economic activity expands and contracts. An increase in business activity results in rising output, income, employment, and prices. Eventually, these all peak, and output, income, and employment decline. A decline in GDP that lasts for two consecutive quarters (each a three-month period) is called a recession. It is followed by a recovery period when economic activity once again increases. The most recent recession began in December 2007 and ended in June 2009. Businesses must monitor and react to the changing phases of business cycles. When the economy is growing, companies often have a difficult time hiring good employees and finding scarce supplies and raw materials. When a recession hits, many firms find they have more capacity than the demand for their goods and services requires. During the most recent recession, many businesses operated at substantially lower than capacity. When plants use only part of their capacity, they operate inefficiently and have higher costs per unit produced. Let’s say that Mars Corp. has a huge plant that can produce one million Milky Way candy bars a day, but because of a recession Mars can sell only half a million candy bars a day. The plant uses large, expensive machines. Producing Milky Ways at 50 percent capacity does not efficiently utilize Mars’s investment in its plant and equipment. ### Keeping People on the Job Another macroeconomic goal is full employment, or having jobs for all who want to and can work. Full employment doesn’t actually mean 100 percent employment. Some people choose not to work for personal reasons (attending school, raising children) or are temporarily unemployed while they wait to start a new job. Thus, the government defines full employment as the situation when about 94 to 96 percent of those available to work actually have jobs. During the 2007–2009 recession in the United States, the unemployment rate peaked at 10 percent in October 2009. Today, that rate hovers at about 4 percent. Maintaining low unemployment levels is of concern not just to the United States but also to countries around the world. For example, high youth unemployment rates (for workers 25 years of age and younger) in Spain, Italy, and Greece continue to cause protests in these European countries as elected officials struggle with how to turn around their respective economies and put more people, particularly young people, back to work. The UK’s impending exit from the European Union may also have an effect on unemployment rates, as global companies move jobs out of Britain to central European countries such as Poland. ### Measuring Unemployment To determine how close we are to full employment, the government measures the unemployment rate. This rate indicates the percentage of the total labor force that is not working but is actively looking for work. It excludes “discouraged workers,” those not seeking jobs because they think no one will hire them. Each month the U.S. Department of Labor releases statistics on employment. These figures help us understand how well the economy is doing. ### Types of Unemployment Economists classify unemployment into four types: frictional, structural, cyclical, and seasonal. The categories are of small consolation to someone who is unemployed, but they help economists understand the problem of unemployment in our economy. Frictional unemployment is short-term unemployment that is not related to the business cycle. It includes people who are unemployed while waiting to start a better job, those who are reentering the job market, and those entering for the first time, such as new college graduates. This type of unemployment is always present and has little impact on the economy. Structural unemployment is also unrelated to the business cycle but is involuntary. It is caused by a mismatch between available jobs and the skills of available workers in an industry or a region. For example, if the birthrate declines, fewer teachers will be needed. Or the available workers in an area may lack the skills that employers want. Retraining and skill-building programs are often required to reduce structural unemployment. Cyclical unemployment, as the name implies, occurs when a downturn in the business cycle reduces the demand for labor throughout the economy. In a long recession, cyclical unemployment is widespread, and even people with good job skills can’t find jobs. The government can partly counteract cyclical unemployment with programs that boost the economy. In the past, cyclical unemployment affected mainly less-skilled workers and those in heavy manufacturing. Typically, they would be rehired when economic growth increased. Since the 1990s, however, competition has forced many American companies to downsize so they can survive in the global marketplace. These job reductions affected workers in all categories, including middle management and other salaried positions. Firms continue to reevaluate workforce requirements and downsize to stay competitive to compete with Asian, European, and other U.S. firms. After a strong rebound from the global recession of 2007–2009, when the auto industry slashed more than 200,000 hourly and salaried workers from their payrolls, the automakers are now taking another close look at the size of their global workforces. For example, as sales steadily rose after the recession, Ford Motor Company’s workforce in North America increased by 25 percent over the past five years. As car sales plateaued in 2017, the company recently announced it would cut approximately 10 percent of its global workforce in an effort to reduce costs, boost profits, and increase its stock value for shareholders. The last type is seasonal unemployment, which occurs during specific times of the year in certain industries. Employees subject to seasonal unemployment include retail workers hired for the holiday shopping season, lettuce pickers in California, and restaurant employees in ski country during the summer. ### Keeping Prices Steady The third macroeconomic goal is to keep overall prices for goods and services fairly steady. The situation in which the average of all prices of goods and services is rising is called inflation. Inflation’s higher prices reduce purchasing power, the value of what money can buy. Purchasing power is a function of two things: inflation and income. If incomes rise at the same rate as inflation, there is no change in purchasing power. If prices go up but income doesn’t rise or rises at a slower rate, a given amount of income buys less, and purchasing power falls. For example, if the price of a basket of groceries rises from $30 to $40 but your salary remains the same, you can buy only 75 percent as many groceries ($30 ÷ $40) for $30. Your purchasing power declines by 25 percent ($10 ÷ $40). If incomes rise at a rate faster than inflation, then purchasing power increases. So you can, in fact, have rising purchasing power even if inflation is increasing. Typically, however, inflation rises faster than incomes, leading to a decrease in purchasing power. Inflation affects both personal and business decisions. When prices are rising, people tend to spend more—before their purchasing power declines further. Businesses that expect inflation often increase their supplies, and people often speed up planned purchases of cars and major appliances. From the early 2000s to April 2017, inflation in the United States was very low, in the 0.1 to 3.8 percent range; for 2016 it was 1.3 percent. For comparison, in the 1980s, the United States had periods of inflation in the 12 to 13 percent range. Some nations have had high double- and even triple-digit inflation in recent years. As of early 2017, the monthly inflation rate in Venezuela was an astounding 741 percent, followed by the African country of South Sudan at 273 percent. ### Types of Inflation There are two types of inflation. Demand-pull inflation occurs when the demand for goods and services is greater than the supply. Would-be buyers have more money to spend than the amount needed to buy available goods and services. Their demand, which exceeds the supply, tends to pull prices up. This situation is sometimes described as “too much money chasing too few goods.” The higher prices lead to greater supply, eventually creating a balance between demand and supply. Cost-push inflation is triggered by increases in production costs, such as expenses for materials and wages. These increases push up the prices of final goods and services. Wage increases are a major cause of cost-push inflation, creating a “wage-price spiral.” For example, assume the United Auto Workers union negotiates a three-year labor agreement that raises wages 3 percent per year and increases overtime pay. Carmakers will then raise car prices to cover their higher labor costs. Also, the higher wages will give autoworkers more money to buy goods and services, and this increased demand may pull up other prices. Workers in other industries will demand higher wages to keep up with the increased prices, and the cycle will push prices even higher. ### How Inflation Is Measured The rate of inflation is most commonly measured by looking at changes in the consumer price index (CPI), an index of the prices of a “market basket” of goods and services purchased by typical urban consumers. It is published monthly by the Department of Labor. Major components of the CPI, which are weighted by importance, are food and beverages, clothing, transportation, housing, medical care, recreation, and education. There are special indexes for food and energy. The Department of Labor collects about 80,000 retail price quotes and 5,000 housing rent figures to calculate the CPI. The CPI sets prices in a base period at 100. The base period, which now is 1982–1984, is chosen for its price stability. Current prices are then expressed as a percentage of prices in the base period. A rise in the CPI means prices are increasing. For example, the CPI was 244.5 in April 2017, meaning that prices more than doubled since the 1982–1984 base period. Changes in wholesale prices are another important indicator of inflation. The producer price index (PPI) measures the prices paid by producers and wholesalers for various commodities, such as raw materials, partially finished goods, and finished products. The PPI, which uses 1982 as its base year, is actually a family of indexes for many different product categories, including crude goods (raw materials), intermediate goods (which become part of finished goods), and finished goods. For example, the PPI for finished goods was 197.7 in April 2017, a 3.9-point increase, and for chemicals was 106.5, up 3.8 points since April 2016. Examples of other PPI indexes include processed foods, lumber, containers, fuels and lubricants, metals, and construction. Because the PPI measures prices paid by producers for raw materials, energy, and other commodities, it may foreshadow subsequent price changes for businesses and consumers. ### The Impact of Inflation Inflation has several negative effects on people and businesses. For one thing, inflation penalizes people who live on fixed incomes. Let’s say that a couple receives $2,000 a month retirement income beginning in 2018. If inflation is 10 percent in 2019, then the couple can buy only about 91 percent (100 ÷ 110) of what they could purchase in 2018. Similarly, inflation hurts savers. As prices rise, the real value, or purchasing power, of a nest egg of savings deteriorates. ### Summary of Learning Outcomes 1. How do economic growth, full employment, price stability, and inflation indicate a nation’s economic health? A nation’s economy is growing when the level of business activity, as measured by gross domestic product (GDP) is rising. GDP is the total value of all goods and services produced in a year. The goal of full employment is to have a job for all who can and want to work. How well a nation is meeting its employment goals is measured by the unemployment rate. There are four types of unemployment: frictional, structural, cyclical, and seasonal. With price stability, the overall prices of goods and services are not moving very much either up or down. Inflation is the general upward movement of prices. When prices rise, purchasing power falls. The rate of inflation is measured by changes in the consumer price index (CPI) and the producer price index (PPI). There are two main causes of inflation. If the demand for goods and services exceeds the supply, prices will rise. This is called demand-pull inflation. With cost-push inflation, higher production costs, such as expenses for materials and wages, increase the final prices of goods and services.

# Understanding Economic Systems and Business ## Achieving Macroeconomic Goals 1. How does the government use monetary policy and fiscal policy to achieve its macroeconomic goals? To reach macroeconomic goals, countries must often choose among conflicting alternatives. Sometimes political needs override economic needs. For example, bringing inflation under control may call for a politically difficult period of high unemployment and low growth. Or, in an election year, politicians may resist raising taxes to curb inflation. Still, the government must try to guide the economy to a sound balance of growth, employment, and price stability. The two main tools it uses are monetary policy and fiscal policy. ### Monetary Policy Monetary policy refers to a government’s programs for controlling the amount of money circulating in the economy and interest rates. Changes in the money supply affect both the level of economic activity and the rate of inflation. The Federal Reserve System (the Fed), the central banking system of the United States, prints money and controls how much of it will be in circulation. The money supply is also controlled by the Fed’s regulation of certain bank activities. When the Fed increases or decreases the amount of money in circulation, it affects interest rates (the cost of borrowing money and the reward for lending it). The Fed can change the interest rate on money it lends to banks to signal the banking system and financial markets that it has changed its monetary policy. These changes have a ripple effect. Banks, in turn, may pass along this change to consumers and businesses that receive loans from the banks. If the cost of borrowing increases, the economy slows because interest rates affect consumer and business decisions to spend or invest. The housing industry, business, and investments react most to changes in interest rates. As a result of the 2007–2009 recession and the global financial crisis that ensued, the Fed dropped the federal funds rate—the interest rate charged on overnight loans between banks—to 0 percent in December 2008 and kept the rate at zero until December 2015, when it raised the rate to 0.25 percent. This decision marked the first increase in the federal-funds rate since June 2006, when the federal funds rate was 5.25 percent. As the U.S. economy continues to show a slow but steady expansion, the Fed subsequently increased the federal funds rate to a range of 0.75 to 1 percent in March 2017. As expected, this change has a ripple effect: the regional Federal Reserve Banks increase the discount rate they charge commercial banks for short-term loans, many commercial banks raise the interest rates they charge their customers, and credit card companies increase the annual percentage rate (APR) they charge consumers on their credit card balances. As you can see, the Fed can use monetary policy to contract or expand the economy. With contractionary policy, the Fed restricts, or tightens, the money supply by selling government securities or raising interest rates. The result is slower economic growth and higher unemployment. Thus, contractionary policy reduces spending and, ultimately, lowers inflation. With expansionary policy, the Fed increases, or loosens, growth in the money supply. An expansionary policy stimulates the economy. Interest rates decline, so business and consumer spending go up. Unemployment rates drop as businesses expand. But increasing the money supply also has a negative side: more spending pushes prices up, increasing the inflation rate. ### Fiscal Policy The other economic tool used by the government is fiscal policy, its program of taxation and spending. By cutting taxes or by increasing spending, the government can stimulate the economy. Look again at . The more government buys from businesses, the greater the business revenues and output. Likewise, if consumers or businesses have to pay less in taxes, they will have more income to spend for goods and services. Tax policies in the United States therefore affect business decisions. High corporate taxes can make it harder for U.S. firms to compete with companies in countries with lower taxes. As a result, companies may choose to locate facilities overseas to reduce their tax burden. Nobody likes to pay taxes, although we grudgingly accept that we have to. Although most U.S. citizens complain that they are overtaxed, we pay lower taxes per capita (per person) than citizens in many countries similar to ours. In addition, our taxes represent a lower percentage of gross income and GDP compared to most countries. Taxes are, of course, the major source of revenue for our government. Every year, the president prepares a budget for the coming year based upon estimated revenues and expenditures. Congress receives the president’s report and recommendations and then, typically, debates and analyzes the proposed budget for several months. The president’s original proposal is always modified in numerous ways. shows the sources of revenue and expenses for the U.S. budget. Whereas fiscal policy has a major impact on business and consumers, continual increases in government spending raises another important issue. When government takes more money from business and consumers (the private sector), a phenomenon known as crowding out occurs. Here are three examples of crowding out: 1. The government spends more on public libraries, and individuals buy fewer books at bookstores. 2. The government spends more on public education, and individuals spend less on private education. 3. The government spends more on public transportation, and individuals spend less on private transportation. In other words, government spending is crowding out private spending. If the government spends more for programs (social services, education, defense) than it collects in taxes, the result is a federal budget deficit. To balance the budget, the government can cut its spending, increase taxes, or do some combination of the two. When it cannot balance the budget, the government must make up any shortfalls by borrowing (just like any business or household). In 1998, for the first time in a generation, there was a federal budget surplus (revenue exceeding spending) of about $71 billion. That budget surplus was short lived, however. By 2005, the deficit was more than $318 billion. In the fiscal year of 2009, the federal deficit was at an all-time high of more than $1.413 trillion. Six years later, at the end of the 2015 fiscal year, the deficit decreased to $438 billion. The U.S. government has run budget deficits for many years. The accumulated total of these past deficits is the national debt, which now amounts to about $19.8 trillion, or about $61,072 for every man, woman, and child in the United States. Total interest on the debt is more than $2.5 trillion a year. To cover the deficit, the U.S. government borrows money from people and businesses in the form of Treasury bills, Treasury notes, and Treasury bonds. These are federal IOUs that pay interest to their owners. The national debt is an emotional issue debated not only in the halls of Congress, but by the public as well. Some believe that deficits contribute to economic growth, high employment, and price stability. Others have the following reservations about such a high national debt: 1. Not Everyone Holds the Debt: The government is very conscious of who actually bears the burden of the national debt and keeps track of who holds what bonds. If only the rich were bondholders, then they alone would receive the interest payments and could end up receiving more in interest than they paid in taxes. In the meantime, poorer people, who held no bonds, would end up paying taxes that would be transferred to the rich as interest, making the debt an unfair burden to them. At times, therefore, the government has instructed commercial banks to reduce their total debt by divesting some of their bond holdings. That’s also why the Treasury created savings bonds. Because these bonds are issued in relatively small denominations, they allow more people to buy and hold government debt. 2. It Crowds Out Private Investment: The national debt also affects private investment. If the government raises the interest rate on bonds to be able to sell them, it forces private businesses, whose corporate bonds (long-term debt obligations issued by a company) compete with government bonds for investor dollars, to raise rates on their bonds to stay competitive. In other words, selling government debt to finance government spending makes it more costly for private industry to finance its own investment. As a result, government debt may end up crowding out private investment and slowing economic growth in the private sector. ### Summary of Learning Outcomes 1. How does the government use monetary policy and fiscal policy to achieve its macroeconomic goals? Monetary policy refers to actions by the Federal Reserve System (the Fed) to control the money supply. When the Fed restricts the money supply, interest rates rise, the inflation rate drops, and economic growth slows. By expanding the money supply, the Fed stimulates economic growth. The government also uses fiscal policy— changes in levels of taxation and spending—to control the economy. Reducing taxes or increasing spending stimulates the economy; raising taxes or decreasing spending does the opposite. When the government spends more than it receives in tax revenues, it must borrow to finance the deficit. Some economists favor deficit spending as a way to stimulate the economy; others worry about our high level of national debt.

# Understanding Economic Systems and Business ## Microeconomics: Zeroing in on Businesses and Consumers 1. What are the basic microeconomic concepts of demand and supply, and how do they establish prices? Now let’s shift our focus from the whole economy to microeconomics, the study of households, businesses, and industries. This field of economics is concerned with how prices and quantities of goods and services behave in a free market. It stands to reason that people, firms, and governments try to get the most from their limited resources. Consumers want to buy the best quality at the lowest price. Businesses want to keep costs down and revenues high to earn larger profits. Governments also want to use their revenues to provide the most effective public goods and services possible. These groups choose among alternatives by focusing on the prices of goods and services. As consumers in a free market, we influence what is produced. If Mexican food is popular, the high demand attracts entrepreneurs who open more Mexican restaurants. They want to compete for our dollars by supplying Mexican food at a lower price, of better quality, or with different features, such as Santa Fe Mexican food rather than Tex-Mex. This section explains how business and consumer choices influence the price and availability of goods and services. ### The Nature of Demand Demand is the quantity of a good or service that people are willing to buy at various prices. The higher the price, the lower the quantity demanded, and vice versa. A graph of this relationship is called a demand curve. Let’s assume you own a store that sells jackets for snowboarders. From past experience, you know how many jackets you can sell at different prices. The demand curve in depicts this information. The x-axis (horizontal axis) shows the quantity of jackets, and the y-axis (vertical axis) shows the related price of those jackets. For example, at a price of $100, customers will buy (demand) 600 snowboard jackets. In the graph, the demand curve slopes downward and to the right because as the price falls, people will want to buy more jackets. Some people who were not going to buy a jacket will purchase one at the lower price. Also, some snowboarders who already have a jacket will buy a second one. The graph also shows that if you put a large number of jackets on the market, you will have to reduce the price to sell all of them. Understanding demand is critical to businesses. Demand tells you how much you can sell and at what price—in other words, how much money the firm will take in that can be used to cover costs and hopefully earn a profit. Gauging demand is difficult even for the very largest corporations, but particularly for small firms. ### The Nature of Supply Demand alone is not enough to explain how the market sets prices. We must also look at supply, the quantity of a good or service that businesses will make available at various prices. The higher the price, the greater the number of jackets a supplier will supply, and vice versa. A graph of the relationship between various prices and the quantities a business will supply is a supply curve. We can again plot the quantity of jackets on the x-axis and the price on the y-axis. As shows, 800 jackets will be available at a price of $100. Note that the supply curve slopes upward and to the right, the opposite of the demand curve. If snowboarders are willing to pay higher prices, suppliers of jackets will buy more inputs (for example, Gore-Tex® fabric, dye, machinery, labor) and produce more jackets. The quantity supplied will be higher at higher prices, because manufacturers can earn higher profits. ### How Demand and Supply Interact to Determine Prices In a stable economy, the number of jackets that snowboarders demand depends on the jackets’ price. Likewise, the number of jackets that suppliers provide depends on price. But at what price will consumer demand for jackets match the quantity suppliers will produce? To answer this question, we need to look at what happens when demand and supply interact. By plotting both the demand curve and the supply curve on the same graph in , we see that they cross at a certain quantity and price. At that point, labeled E, the quantity demanded equals the quantity supplied. This is the point of equilibrium. The equilibrium price is $80; the equilibrium quantity is 700 jackets. At that point, there is a balance between the quantity consumers will buy and the quantity suppliers will make available. Market equilibrium is achieved through a series of quantity and price adjustments that occur automatically. If the price increases to $160, suppliers produce more jackets than consumers are willing to buy, and a surplus results. To sell more jackets, prices will have to fall. Thus, a surplus pushes prices downward until equilibrium is reached. When the price falls to $60, the quantity of jackets demanded rises above the available supply. The resulting shortage forces prices upward until equilibrium is reached at $80. The number of snowboard jackets supplied and bought at $80 will tend to rest at equilibrium unless there is a shift in either demand or supply. If demand increases, more jackets will be purchased at every price, and the demand curve shifts to the right (as illustrated by line D2 in ). If demand decreases, less will be bought at every price, and the demand curve shifts to the left (D1). When demand decreased, snowboarders bought 500 jackets at $80 instead of 700 jackets. When demand increased, they purchased 800. ### Changes in Demand A number of things can increase or decrease demand. For example, if snowboarders’ incomes go up, they may decide to buy a second jacket. If incomes fall, a snowboarder who was planning to purchase a jacket may wear an old one instead. Changes in fashion or tastes can also influence demand. If snowboarding were suddenly to go out of fashion, demand for jackets would decrease quickly. A change in the price of related products can also influence demand. For example, if the average price of a snowboard rises to $1,000, people will quit snowboarding, and jacket demand will fall. Another factor that can shift demand is expectations about future prices. If you expect jacket prices to increase significantly in the future, you may decide to go ahead and get one today. If you think prices will fall, you will postpone your purchase. Finally, changes in the number of buyers will affect demand. Snowboarding is a young person’s sport, and the number of teenagers will increase in the next few years. Therefore, the demand for snowboard jackets should increase. ### Changes in Supply Other factors influence the supply side of the picture. New technology typically lowers the cost of production. For example, North Face, a supplier of ski and snowboard jackets, purchased laser-guided pattern-cutting equipment and computer-aided pattern-making equipment. Each jacket was cheaper to produce, resulting in a higher profit per jacket. This provided an incentive to supply more jackets at every price. If the price of resources such as labor or fabric goes up, North Face will earn a smaller profit on each jacket, and the amount supplied will decrease at every price. The reverse is also true. Changes in the prices of other goods can also affect supply. Let’s say that snow skiing becomes a really hot sport again. The number of skiers jumps dramatically, and the price of ski jackets soars. North Face can use its machines and fabrics to produce either ski or snowboard jackets. If the company can make more profit from ski jackets, it will produce fewer snowboard jackets at every price. Also, a change in the number of producers will shift the supply curve. If the number of jacket suppliers increases, they will place more jackets on the market at every price. If any suppliers stop making jackets available, the supply will naturally decrease. Taxes can also affect supply. If the government decides, for some reason, to tax the supplier for every snowboard jacket produced, then profits will fall, and fewer jackets will be offered at every price. summarizes the factors that can shift demand and supply curves. To better understand the relationship between supply and demand across the economy, consider the impact of 2005’s Hurricane Katrina on U.S. energy prices. Oil and gas prices were already at high levels before Hurricane Katrina disrupted production in the Gulf Coast. Most U.S. offshore drilling sites are located in the Gulf of Mexico, and almost 30 percent of U.S. refining capacity is in Gulf States that were hit hard by the storm. Prices rose almost immediately as supplies fell while demand remained at the same levels. The storm drove home the vulnerability of the U.S. energy supply to not only natural disasters, but also terrorist attacks and price increases from foreign oil producers. Many energy policy experts questioned the wisdom of having such a high concentration of oil facilities—about 25 percent of the oil and natural gas infrastructure—in hurricane-prone states. Refiners were already almost at capacity before Katrina’s devastation. High energy prices affect the economy in many ways. With oil at the time costing $50 to $60 a barrel—more than double the 2003 price—both businesses and consumers across the United States felt the pinch in their wallets. Midwestern agricultural businesses export about 70 percent of their grain production through Gulf of Mexico port facilities. With fewer usable docking spaces, barges couldn’t unload and return for more crops. The supply of both transportation services and grain products was inadequate to meet demand, pushing up transportation and grain costs. Higher gas prices also contributed to rising prices, as 80 percent of shipping costs are related to fuel. More than a decade after Katrina, U.S. gas prices have fluctuated dramatically, with the cost of a gallon of regular gas peaking in 2014 at $3.71, dropping as low as $1.69 in early 2015, and moderating to $2.36 in mid-2017. Recent research by JP Morgan Chase revealed that consumers spend roughly 80 percent of their savings from lower gas prices, which helps the overall economy. ### Summary of Learning Outcomes 1. What are the basic microeconomic concepts of demand and supply, and how do they establish prices? Demand is the quantity of a good or service that people will buy at a given price. Supply is the quantity of a good or service that firms will make available at a given price. When the price increases, the quantity demanded falls, but the quantity supplied rises. A price decrease leads to increased demand but a lower supply. At the point where the quantity demanded equals the quantity supplied, demand and supply are in balance. This equilibrium point is achieved by market adjustments of quantity and price.

# Understanding Economic Systems and Business ## Competing in a Free Market 1. What are the four types of market structure? One of the characteristics of a free-market system is that suppliers have the right to compete with one another. The number of suppliers in a market defines the market structure. Economists identify four types of market structures: (1) perfect competition, (2) pure monopoly, (3) monopolistic competition, and (4) oligopoly. summarizes the characteristics of each of these market structures. ### Perfect Competition Characteristics of perfect (pure) competition include: 1. A large number of small firms are in the market. 2. The firms sell similar products; that is, each firm’s product is very much like the products sold by other firms in the market. 3. Buyers and sellers in the market have good information about prices, sources of supply, and so on. 4. It is easy to open a new business or close an existing one. In a perfectly competitive market, firms sell their products at prices determined solely by forces beyond their control. Because the products are very similar and each firm contributes only a small amount to the total quantity supplied by the industry, price is determined by supply and demand. A firm that raised its price even a little above the going rate would lose customers. In the wheat market, for example, the product is essentially the same from one wheat producer to the next. Thus, none of the producers has control over the price of wheat. Perfect competition is an ideal. No industry shows all its characteristics, but the stock market and some agricultural markets, such as those for wheat and corn, come closest. Farmers, for example, can sell all of their crops through national commodity exchanges at the current market price. ### Pure Monopoly At the other end of the spectrum is pure monopoly, the market structure in which a single firm accounts for all industry sales of a particular good or service. The firm is the industry. This market structure is characterized by barriers to entry—factors that prevent new firms from competing equally with the existing firm. Often the barriers are technological or legal conditions. Polaroid, for example, held major patents on instant photography for years. When Kodak tried to market its own instant camera, Polaroid sued, claiming patent violations. Polaroid collected millions of dollars from Kodak. Another barrier may be one firm’s control of a natural resource. DeBeers Consolidated Mines Ltd., for example, controls most of the world’s supply of uncut diamonds. Public utilities, such as gas and water companies, are pure monopolies. Some monopolies are created by a government order that outlaws competition. The U.S. Postal Service is currently one such monopoly. ### Monopolistic Competition Three characteristics define the market structure known as monopolistic competition: 1. Many firms are in the market. 2. The firms offer products that are close substitutes but still differ from one another. 3. It is relatively easy to enter the market. Under monopolistic competition, firms take advantage of product differentiation. Industries where monopolistic competition occurs include clothing, food, and similar consumer products. Firms under monopolistic competition have more control over pricing than do firms under perfect competition because consumers do not view the products as perfect substitutes. Nevertheless, firms must demonstrate product differences to justify their prices to customers. Consequently, companies use advertising to distinguish their products from others. Such distinctions may be significant or superficial. For example, Nike says “Just Do It,” and Tylenol is advertised as being easier on the stomach than aspirin. ### Oligopoly An oligopoly has two characteristics: 1. A few firms produce most or all of the output. 2. Large capital requirements or other factors limit the number of firms. Boeing and Airbus Industries (aircraft manufacturers) and Apple and Google (operating systems for smartphones) are major players in different oligopolistic industries. With so few firms in an oligopoly, what one firm does has an impact on the other firms. Thus, the firms in an oligopoly watch one another closely for new technologies, product changes and innovations, promotional campaigns, pricing, production, and other developments. Sometimes they go so far as to coordinate their pricing and output decisions, which is illegal. Many antitrust cases—legal challenges arising out of laws designed to control anticompetitive behavior—occur in oligopolies. The market structure of an industry can change over time. Take, for example, telecommunications. At one time, AT&T had a monopoly on long-distance telephone service nationwide. Then the U.S. government divided the company into seven regional phone companies in 1984, opening the door to greater competition. Other companies such as MCI and Sprint entered the fray and built state-of-the-art fiber-optic networks to win customers from the traditional providers of phone service. The 1996 Telecommunications Act changed the competitive environment yet again by allowing local phone companies to offer long-distance service in exchange for letting competition into their local markets. Today, the broadcasting, computer, telephone, and video industries are converging as companies consolidate through merger and acquisition. ### Summary of Learning Outcomes 1. What are the four types of market structure? Market structure is the number of suppliers in a market. Perfect competition is characterized by a large number of buyers and sellers, very similar products, good market information for both buyers and sellers, and ease of entry into and exit from the market. In a pure monopoly, there is a single seller in a market. In monopolistic competition, many firms sell close substitutes in a market that is fairly easy to enter. In an oligopoly, a few firms produce most or all of the industry’s output. An oligopoly is also difficult to enter, and what one firm does will influence others.

# Understanding Economic Systems and Business ## Trends in the Business Environment and Competition 1. Which trends are reshaping the business, microeconomic, and macroeconomic environments and competitive arena? Trends in the business and economic environment occur in many areas. As noted earlier, today’s workforce is more diverse than ever, with increasing numbers of minorities and older workers. Competition has intensified. Technology has accelerated the pace of work and the ease with which we communicate. Let’s look at how companies are meeting the challenges of a changing workforce, the growing demand for energy, and how companies are meeting competitive challenges. ### Changing Workforce Demographics As the baby boomer generation ages, so does the U.S. workforce. In 2010, more than 25 percent of all employees were retirement age. Fast forward to the U.S. labor force in 2017, however, and millennials have taken over the top spot in the labor market, with more than 40 percent of the total workforce. Although older workers are now retiring closer to the traditional retirement age of 65, many plan to keep working beyond 65, often into their 70s. No longer is retirement an all-or-nothing proposition, and older workers in the baby boomer generation are taking a more positive attitude toward their later years. A surprising number of Americans expect to work full- or part-time after “retirement,” and most would probably work longer if phased retirement programs were available at their companies. Financial reasons motivate most of these older workers, who worry that their longer life expectancies will mean outliving the money they saved for retirement, especially after retirement savings took a hit during the global recession of 2007–2009. For others, however, the satisfaction of working and feeling productive is more important than money alone. These converging dynamics continue to create several major challenges for companies today. And by 2020, additional generational shifts are projected to occur in the U.S. labor force, which will have an even bigger effect on how companies do business and retain their employees. Today’s workforce spans five generations: recent college graduates (Generation Z); people in their 30s and 40s (millennials and Generation X); baby boomers; and traditionalists (people in their 70s). It is not unusual to find a worker who is 50, 60, or even 70 working for a manager who is not yet 30. People in their 50s and 60s offer their vast experience of “what’s worked in the past,” whereas those in their 20s and 30s tend to be experimental, open to options, and unafraid to take risks. The most effective managers will be the ones who recognize generational differences and use them to the company’s advantage. Many companies have developed programs such as flexible hours and telecommuting to retain older workers and benefit from their practical knowledge and problem-solving skills. In addition, companies should continually track where employees are in their career life cycles, know when they are approaching retirement age or thinking about retirement, and determine how to replace them and their knowledge and job experiences. Another factor in the changing workforce is the importance of recognizing diversity among workers of all ages and fostering an inclusive organizational culture. According to a recent report by the U.S. Census Bureau, millennials are the largest generation in U.S. history, and more than 44 percent classify themselves as something other than “White.” In addition, women continue to make progress on being promoted to management, although their path to CEO seems to be filled with obstacles. Recent statistics suggest that fewer than 5 percent of Fortune 500 companies have female CEOs. The most successful organizations will be the ones that recognize the importance of diversity and inclusion as part of their ongoing corporate strategies. ### Global Energy Demands As standards of living improve worldwide, the demand for energy continues to rise. Emerging economies such as China and India need energy to grow. Their demands are placing pressure on the world’s supplies and affecting prices, as the laws of supply and demand would predict. For example, in recent years, China and India were responsible for more than half of the growth in oil products consumption worldwide. State-supported energy companies in China, India, Russia, Saudi Arabia, and other countries will place additional competitive pressure on privately owned oil companies such as BP, Chevron, ExxonMobil, and Shell. Countries worldwide worry about relying too heavily on one source of supply for energy. The United States imports a large percentage of its oil from Canada and Saudi Arabia. Europeans get 39 percent of their natural gas from Russia’s state-controlled gas utility OAO Gazprom. This gives foreign governments the power to use energy as a political tool. For example, continuing tensions between Russia and Ukraine in November 2015 caused Russia to stop sending natural gas to Ukraine, which also causes gas disruptions in Europe because Russia uses Ukraine’s pipelines to transport some of its gas deliveries to European countries. In 2017, Russia announced plans to build its own pipeline alongside Ukraine’s gas line in the Baltic Sea, which would allow Russia to bypass Ukraine’s pipelines altogether and deliver gas directly to European countries. Countries and companies worldwide are seeking additional sources of supply to prevent being held captive to one supplier. For example, the relatively new technology of extracting oil from shale rock formations in the United States (known as fracking) has help create an important resource for the country’s oil industry. This innovative approach to finding new sources of energy now accounts for more than half of the country’s oil output, which can help reduce U.S. dependence on foreign oil and create new jobs. ### Meeting Competitive Challenges Companies are turning to many different strategies to remain competitive in the global marketplace. One of the most important is relationship management, which involves building, maintaining, and enhancing interactions with customers and other parties to develop long-term satisfaction through mutually beneficial partnerships. Relationship management includes both supply chain management, which builds strong bonds with suppliers, and relationship marketing, which focuses on customers. In general, the longer a customer stays with a company, the more that customer is worth. Long-term customers buy more, take less of a company’s time, are less sensitive to price, and bring in new customers. Best of all, they require no acquisition or start-up costs. Good long-standing customers are worth so much that in some industries, reducing customer defections by as little as five points—from, say, 15 percent to 10 percent per year—can double profits. Another important way companies stay competitive is through strategic alliances (also called strategic partnerships). The trend toward forming these cooperative agreements between business firms is accelerating rapidly, particularly among high-tech firms. These companies have realized that strategic partnerships are more than just important—they are critical. Strategic alliances can take many forms. Some companies enter into strategic alliances with their suppliers, who take over much of their actual production and manufacturing. For example, Nike, the largest producer of athletic footwear in the world, does not manufacture a single shoe. Other companies with complementary strengths team up. For example, Harry’s Shave Club, an online men’s grooming subscription service, recently teamed up with retail giant Target to improve sales and boost its brand presence among Target shoppers. Harry’s products are now available in Target’s brick-and-mortar stores and on Target’s website as part of an exclusive deal that makes Target the only mass retailer to carry Harry’s grooming products. The men’s shaving industry accounts for more than $2.6 billion in annual sales. ### Summary of Learning Outcomes 1. Which trends are reshaping the business, microeconomic, and macroeconomic environments and competitive arena? To remain competitive, businesses must identify and respond to trends in the various sectors of the business environment. As the population ages, large numbers of baby boomers are approaching retirement age. Companies must plan for this exodus of employees and find ways to retain the vast amounts of knowledge they represent. Many older workers are choosing to continue working after traditional retirement age, creating a five-generation workforce. Worldwide demand for energy, especially from China and India, is challenging oil companies to increase supplies or to find alternative technologies to produce more oil, such as fracking. U.S. vulnerability to disruptions in energy supply became painfully apparent when Hurricane Katrina put Gulf Coast refineries and offshore drilling rigs out of commission. Companies are using relationship management and strategic alliances to compete effectively in the global economy. ### Preparing for Tomorrow’s Workplace Skills 1. Select a not-for-profit organization whose mission interests you. What are the organization’s objectives? What resources does it need to achieve those goals? Select a for-profit business that provides a similar service, and compare the two organizations. How does each use the factors of production? (Resources, Information, Systems) 2. Team Activity Form seven teams. Each team is responsible for one of the sectors of the external business environment discussed in the chapter (economic, political/legal, demographic, social, competitive, global, and technological). Your boss, the company president, has asked each team to report on the changes in that area of the external environment and how they will affect the firm over the next five years. The firm is the Boeing Company. Each team should use the library, the internet, and other data sources to make its projections. Each team member should examine at least one data source. The team should then pool the data and prepare its response. A spokesperson for each team should present the findings to the class. (Interpersonal, Resources, Information) 3. If a friend claimed, “Economics is all theory and not very practical,” how might you counter this claim? Share your rationale with the class. (Interpersonal, Information) 4. Team Activity Create two teams of four people each. Have one side choose a communist economy and the other capitalism. Debate the proposition that “capitalism/a command economy is good for developing nations.” (Interpersonal, Information) 5. What are the latest actions the federal government has taken to manage the economy? Has it used monetary policy or fiscal policy to achieve its macroeconomic goals? Summarize your findings. Choose one of the following industries, and discuss how the government’s actions will affect that industry: airlines, automobile manufacturers, banking, biotechnology, chemical manufacturing, home building, oil and gas, retail stores, and telecommunication services. (Information, Systems) 6. As a manufacturer of wireless headphones, you are questioning your pricing policies. You note that over the past five years, the CPI increased an average of 3 percent per year but that the price of a pair of wireless headphones increased an average of 8 percent per year for the first three years and 2 percent per year for the next two years. What does this information tell you about demand, supply, and other factors influencing the market for these headphones? (Resources, Information) ### Ethics Activity Historically, diesel cars have not been big sellers in the U.S. auto market, mainly because their engines couldn’t pass the strict emissions standards set up by the Environmental Protection Agency and the California Air Resources Board. But that all changed in 2005, when German automaker Volkswagen made a decided push to develop “clean diesel” engines, specifically manufactured to meet strict U.S. emissions standards. By 2010, VW had introduced several models of diesel cars in the United States, and their sales helped propel Volkswagen to the number-two slot in global auto sales, after Toyota and ahead of GM. While VW was receiving major media attention for its clean diesel models, researchers from West Virginia University discovered that these so-called clean engines had been constructed with a “defeat device”—software that could actually tell when the car was being tested off road for emissions and lower the level of emissions that harm the environment. By December 2014, Volkswagen agreed to voluntarily recall more than a half-million clean diesel cars in the United States to address the emissions issues. But the scandal continued to escalate, with accusations that senior management knew about the rigged engines, and VW’s CEO resigned and several other executives were fired. Class-action lawsuits and other litigation followed, and in April 2017, VW agreed to a $4.3 billion settlement, which included a criminal fine of $2.8 billion, as well as various buyback plans for the affected diesel cars. In addition, over the last several years, VW has experienced a significant decline in U.S. sales and is now trying to win back customers. Using a web search tool, locate information about this topic, and then write responses to the following questions. Be sure to support your arguments and cite your sources. Ethical Dilemma: How can VW ensure that its diesel cars now comply with U.S. emissions standards? What can VW do to regain consumers’ confidence after this worldwide scandal? Do you agree with the billions of dollars in fines that VW will have to pay to move beyond the emissions debacle? Sources: “VW Diesel Crisis: Timeline of Events,” https://www.cars.com, May 19, 2017; Jack Ewing, “Inside VW’s Campaign of Trickery,” The New York Times, http://www.nytimes.com, May 7, 2017; Christoph Rauwald, “How a Top-Secret Deal Could Have Stopped VW’s Diesel Scandal,” Bloomberg, http://www.bloomberg.com, January 12, 2017; “6 VW Execs Indicted as Carmaker Agrees to $4.3 Billion Diesel Cheat Settlement,” Fortune, http://fortune.com, January 12, 2017; Geoffrey Smith and Roger Parloff, “Hoaxwagen: Inside Volkswagen’s Diesel Fraud,” Fortune, http://fortune.com, March 7, 2016. ### Working the Net 1. The Bureau of Labor Statistics compiles demographic data. Visit http://www.bls.gov/bls/demographics.htm, and describe the different types of information it provides. What kinds of changes are likely to occur in the United States over the next 25 years? Click on Spending & Time Use and select How Americans Spend Time to read about the American Time Use Survey. What trends can you identify? 2. Go to either the Red Herring (http://www.redherring.com) or Wired (http://www.wired.com) site and research technology trends. Compile a list of three trends that sound most promising to you, and describe them briefly. How will they affect businesses? What impact, if any, will they have on you personally? 3. Use the Bureau of Labor Statistics site (http://stat.bls.gov) to determine the current trends in GDP growth, unemployment, and inflation. What do these trends tell you about the level of business activity and the business cycle? If you owned a staffing agency, how would this information affect your decision-making? 4. What’s the latest U.S. economic news? Go to the CNBC website, and select the Economy page, which categorizes news about the world economy, the U.S. economy, and other important topics (http://www.cnbc.com/economy/). Read the various articles about the U.S. economy, and then do the same for GDP Outlook. Prepare a summary of what you learned, and use it to discuss where you think the economy is headed for the next 6 to 12 months. 5. How would you spend the national budget if you were president? Here’s your chance to find out how your ideas would affect the federal budget. Go online to Committee for a Responsible Federal Budget, at http://www.crfb.org, and under Tools, click on Stabilize the Debt, which is an exercise in making difficult decisions and how government officials make trade-offs when they prepare the federal budget. Experiment with your own budget ideas at the site. What are the effects of your decisions? ### Creative Thinking Case ### Walmart Gets Serious about E-Commerce As the world’s largest retailer, Walmart has built thousands of brick-and-mortar stores in the United States, Mexico, and elsewhere. Although a success story when it comes to traditional retail locations, Walmart has struggled with its e-commerce efforts, with recent online sales accounting for about 3 percent of the company’s $300 billion in annual sales. The company has tried several different e-commerce strategies in the past, but none of them was an overwhelming success. Some company insiders objected to the pricing strategy used for online purchases; they were fearful that Walmart’s lower prices online would take customers (and sales) away from the retail locations. Doug McMillon, Walmart’s CEO since 2014, believed a significant change was needed in the company’s e-commerce business, and he recently made changes in a big way. Over the past two years, Walmart spent billions to acquire several online companies to expand its e-commerce business in an effort to take a small bite out of retail giant Amazon’s success. In 2016, Walmart purchased Jet.com, an e-commerce site that sells a little bit of everything (books, clothing, electronics, etc.) at discount prices. Once the $3 billion acquisition was completed, Jet’s cofounder and CEO, Marc Lore, who now runs Walmart’s e-commerce platform, worked with McMillon to identify other established online companies to add to their e-commerce portfolio, and add they did. First Walmart purchased footwear e-tailer ShoeBuy for $70 million in January 2017. The following month, Walmart bought outdoor specialty retailer Moosejaw for $51 million. Then in March, Walmart paid $75 million for ModCloth, an eclectic shopping site for women’s fashions. Walmart is also said to be in negotiations to buy Bonobos, a hip fashion retailer geared to millennial males. Reaction to the acquisitions has been mixed, depending on whom you ask. Retail analysts applaud the company’s radical move, pointing out that several well-known traditional retailers have closed their doors or filed bankruptcy because they failed to take part in the e-commerce revolution. Fashionistas, on the other hand, are lukewarm about the move. However, McMillon’s decision to allow the online retailers to operate independently may help retain loyal customers. The new e-commerce strategy may also lure typical in-store shoppers to take advantage of the expanded offerings available through both Walmart.com and Jet.com. 2. What are some advantages of Walmart purchasing established web businesses? 3. What impact is Walmart’s acquisition of nontraditional retailers likely to have on the shopping habits of Walmart’s customers? 4. How will the aggressive e-commerce plan implemented by Walmart affect operations at its retail locations? Sources: Brad Stone and Matthew Boyle, “Amazon Won’t Know What Hit ’Em!” Bloomberg Businessweek, http://www.bloomberg.com, May 8–May 14, 2017; “What an Acquisition of Bonobos Would Signal About Wal-Mart’s Strategy,” Forbes, http://www.forbes.com, May 9, 2017; “Walmart Acquires Niche Online Retailers, to the Dismay of Hipsters,” Denver Post, http://www.denverpost.com, March 24, 2017; Alana Abramson, “Walmart Acquires Online Women’s Retailer ModCloth,” Fortune, http://fortune.com, March 17, 2017; Phil Wahba, “Walmart’s 29% Online Holiday Season Growth Sends Shares Jumping,” Fortune, http://fortune.com, February 21, 2017; Laura Heller, “Take That Amazon: Walmart Buys Moosejaw for $51 Million,” Forbes, http://www.forbes.com, February 15, 2017; “Walmart Acquires ShoeBuy for $70 Million,” Business Insider, http://www.businessinsider.com, January 6, 2017. ### Hot Links Address Book 1. What makes a company good to work for or most admired? Find out by checking Fortune’s special lists at http://www.fortune.com. 2. Which country has the largest GDP? The most people? The answers can be found in The World Factbook at https://www.cia.gov. 3. Get the scoop on the latest technology trends affecting our lives from CNET’s website at http://www.cnet.com. The site also includes product reviews, how-to videos, and smart home features. 4. The Federal Reserve Board issues a variety of statistical information about the state of the U.S. economy. Find it at the Federal Reserve’s site by clicking on the Economic Research and Data links: http://www.federalreserve.gov. 5. Want to know the current public debt per citizen, or even what it was in 1790? Go to https://fiscaldata.treasury.gov/datasets/ and you can filter the data for any date range including 1790 to present day. 6. The U.S. Bureau of Economic Analysis (BEA) tracks national and regional economic statistics, including the GDP. To find the latest GDP statistics, visit the BEA at. 7. How are the job prospects in your area? Your region’s unemployment statistics can give you an idea of how hard it will be to find a job. Find the most recent unemployment statistics from the Bureau of Labor Statistics at http://www.bls.gov. 8. How do the PPI and the CPI differ? Get the answers to this and other questions about the PPI by visiting the Bureau of Labor Statistics PPI site at http://www.bls.gov/ppi.

# Making Ethical Decisions and Managing a Socially Responsible Business ## Introduction ### Learning Outcomes After reading this chapter, you should be able to answer these questions: 1. What philosophies and concepts shape personal ethical standards? 2. How can organizations encourage ethical business behavior? 3. What is corporate social responsibility? 4. How do businesses meet their social responsibilities to various stakeholders? 5. What are the trends in ethics and corporate social responsibility? Every day, managers and business owners make business decisions based on what they believe to be right and wrong. Through their actions, they demonstrate to their employees what is and is not acceptable behavior and shape the moral standard of the organization. As you will see in this module, personal and professional ethics are important cornerstones of an organization and shape its ultimate contributions to society in the form of corporate social responsibility. First, let’s consider how individual business ethics are formed.

# Making Ethical Decisions and Managing a Socially Responsible Business ## Understanding Business Ethics 1. What philosophies and concepts shape personal ethical standards? Ethics is a set of moral standards for judging whether something is right or wrong. The first step in understanding business ethics is learning to recognize an ethical issue. An ethical issue is a situation where someone must choose between a set of actions that may be ethical or unethical. For example, Martin Shkreli, former CEO of Turing Pharmaceuticals, raised the price of a drug used for newborns and HIV patients by more than 5000 percent, defending the price increase as a “great business decision.” Few people would call that ethical behavior. But consider the actions of the stranded, hungry people in New Orleans who lost everything in the aftermath of Hurricane Katrina. They broke into flooded stores, taking food and bottled water without paying for them. Was this unethical behavior? Or what about the small Texas plastics manufacturer that employed over 100 people and specialized in the Latin American market? The president was distraught because he knew the firm would be bankrupt by the end of the year if it didn’t receive more contracts. He knew that he was losing business because he refused to pay bribes. Bribes were part of the culture in his major markets. Closing the firm would put many people out of work. Should he start paying bribes in order to stay in business? Would this be unethical? Let’s look at the next section to obtain some guidance on recognizing unethical situations. ### Recognizing Unethical Business Activities Researchers from Brigham Young University tell us that all unethical business activities will fall into one of the following categories: 1. Taking things that don’t belong to you. The unauthorized use of someone else’s property or taking property under false pretenses is taking something that does not belong to you. Even the smallest offense, such as using the postage meter at your office for mailing personal letters or exaggerating your travel expenses, belongs in this category of ethical violations. 2. Saying things you know are not true. Often, when trying for a promotion and advancement, fellow employees discredit their coworkers. Falsely assigning blame or inaccurately reporting conversations is lying. Although “This is the way the game is played around here” is a common justification, saying things that are untrue is an ethical violation. 3. Giving or allowing false impressions. The salesperson who permits a potential customer to believe that cardboard boxes will hold the customer’s tomatoes for long-distance shipping when the salesperson knows the boxes are not strong enough has given a false impression. A car dealer who fails to disclose that a car has been in an accident is misleading potential customers. 4. Buying influence or engaging in a conflict of interest. A conflict of interest occurs when the official responsibilities of an employee or government official are influenced by the potential for personal gain. Suppose a company awards a construction contract to a firm owned by the father of the state attorney general while the state attorney general’s office is investigating that company. If this construction award has the potential to shape the outcome of the investigation, a conflict of interest has occurred. 5. Hiding or divulging information. Failing to disclose the results of medical studies that indicate your firm’s new drug has significant side effects is the ethical violation of hiding information that the product could be harmful to purchasers. Taking your firm’s product development or trade secrets to a new place of employment constitutes the ethical violation of divulging proprietary information. 6. Taking unfair advantage. Many current consumer protection laws were passed because so many businesses took unfair advantage of people who were not educated or were unable to discern the nuances of complex contracts. Credit disclosure requirements, truth-in-lending provisions, and new regulations on auto leasing all resulted because businesses misled consumers who could not easily follow the jargon of long, complex agreements. 7. Committing improper personal behavior. Although the ethical aspects of an employee’s right to privacy are still debated, it has become increasingly clear that personal conduct outside the job can influence performance and company reputation. Thus, a company driver must abstain from substance abuse because of safety issues. Even the traditional company holiday party and summer picnic have come under scrutiny due to the possibility that employees at and following these events might harm others through alcohol-related accidents. 8. Abusing power and mistreating individuals. Suppose a manager sexually harasses an employee or subjects employees to humiliating corrections or reprimands in the presence of customers. In some cases, laws protect employees. Many situations, however, are simply interpersonal abuse that constitutes an ethical violation. 9. Permitting organizational abuse. Many U.S. firms with operations overseas, such as Apple, Nike, and Levi Strauss, have faced issues of organizational abuse. The unfair treatment of workers in international operations appears in the form of child labor, demeaning wages, and excessive work hours. Although a business cannot change the culture of another country, it can perpetuate—or stop—abuse through its operations there. 10. Violating rules. Many organizations use rules and processes to maintain internal controls or respect the authority of managers. Although these rules may seem burdensome to employees trying to serve customers, a violation may be considered an unethical act. 11. Condoning unethical actions. What if you witnessed a fellow employee embezzling company funds by forging her signature on a check? Would you report the violation? A winking tolerance of others’ unethical behavior is itself unethical. After recognizing that a situation is unethical, the next question is what do you do? The action that a person takes is partially based upon his or her ethical philosophy. The environment in which we live and work also plays a role in our behavior. This section describes personal philosophies and legal factors that influence the choices we make when confronting an ethical dilemma. ### Justice—The Question of Fairness Another factor influencing individual business ethics is justice, or what is fair according to prevailing standards of society. We all expect life to be reasonably fair. You expect your exams to be fair, the grading to be fair, and your wages to be fair, based on the type of work being done. Today we take justice to mean an equitable distribution of the burdens and rewards that society has to offer. The distributive process varies from society to society. Those in a democratic society believe in the “equal pay for equal work” doctrine, in which individuals are rewarded based on the value the free market places on their services. Because the market places different values on different occupations, the rewards, such as wages, are not necessarily equal. Nevertheless, many regard the rewards as just. A politician who argued that a supermarket clerk should receive the same pay as a physician, for example, would not receive many votes from the American people. At the other extreme, communist theorists have argued that justice would be served by a society in which burdens and rewards were distributed to individuals according to their abilities and their needs, respectively. ### Utilitarianism—Seeking the Best for the Majority One of the philosophies that may influence choices between right and wrong is utilitarianism, which focuses on the consequences of an action taken by a person or organization. The notion that people should act so as to generate the greatest good for the greatest number is derived from utilitarianism. When an action affects the majority adversely, it is morally wrong. One problem with this philosophy is that it is nearly impossible to accurately determine how a decision will affect a large number of people. Another problem is that utilitarianism always involves both winners and losers. If sales are slowing and a manager decides to fire five people rather than putting everyone on a 30-hour workweek, the 20 people who keep their full-time jobs are winners, but the other five are losers. A final criticism of utilitarianism is that some “costs,” although small relative to the potential good, are so negative that some segments of society find them unacceptable. What if scientists deliberately killed animals by breaking their backs to conduct spinal cord research that someday could lead to a cure for spinal cord injuries? To a number of people, the “costs” of killing these animals are simply too horrible for this type of research to continue. ### Following Our Obligations and Duties The philosophy that says people should meet their obligations and duties when analyzing an ethical dilemma is called deontology. This means that a person will follow his or her obligations to another individual or society because upholding one’s duty is what is considered ethically correct. For instance, people who follow this philosophy will always keep their promises to a friend and will follow the law. They will produce very consistent decisions, because they will be based on the individual’s set duties. Note that this theory is not necessarily concerned with the welfare of others. Say, for example, a technician for Orkin Pest Control has decided that it’s his ethical duty (and is very practical) to always be on time to meetings with homeowners. Today he is running late. How is he supposed to drive? Is the technician supposed to speed, breaking his duty to society to uphold the law, or is he supposed to arrive at the client’s home late, breaking his duty to be on time? This scenario of conflicting obligations does not lead us to a clear ethically correct resolution, nor does it protect the welfare of others from the technician’s decision. ### Individual Rights In our society, individuals and groups have certain rights that exist under certain conditions regardless of any external circumstances. These rights serve as guides when making individual ethical decisions. The term human rights implies that certain rights—to life, to freedom, to the pursuit of happiness—are bestowed at birth and cannot be arbitrarily taken away. Denying the rights of an individual or group is considered to be unethical and illegal in most, though not all, parts of the world. Certain rights are guaranteed by the government and its laws, and these are considered legal rights. The U.S. Constitution and its amendments, as well as state and federal statutes, define the rights of American citizens. Those rights can be disregarded only in extreme circumstances, such as during wartime. Legal rights include the freedom of religion, speech, and assembly; protection from improper arrest and searches and seizures; and proper access to counsel, confrontation of witnesses, and cross-examination in criminal prosecutions. Also held to be fundamental is the right to privacy in many matters. Legal rights are to be applied without regard to race, color, creed, gender, or ability. ### Summary of Learning Outcomes 1. What philosophies and concepts shape personal ethical standards? Ethics is a set of moral standards for judging whether something is right or wrong. A utilitarianism approach to setting personal ethical standards focuses on the consequences of an action taken by a person or organization. According to this approach, people should act so as to generate the greatest good for the greatest number. Every human is entitled to certain rights such as freedom and the pursuit of happiness. Another approach to ethical decision-making is justice, or what is fair according to accepted standards.

# Making Ethical Decisions and Managing a Socially Responsible Business ## How Organizations Influence Ethical Conduct 1. How can organizations encourage ethical business behavior? People choose between right and wrong based on their personal code of ethics. They are also influenced by the ethical environment created by their employers. Consider the following headlines: 1. Investment advisor Bernard Madoff sentenced to 150 years in prison for swindling clients out of more than $65 billion. 2. Former United Airlines CEO Jeff Smisek leaves the company after a federal investigation into whether United tried to influence officials at the Port Authority of New York. 3. Renaud Laplanche, the founder of Lending Club, loses his job because of faulty practices and conflicts of interest at the online peer-to-peer lender. 4. Wells Fargo CEO John Stumpf fired after company employees opened more than 2 million fake accounts to meet aggressive sales targets. As these actual stories illustrate, poor business ethics can create a very negative image for a company, can be expensive for the firm and/or the executives involved, and can result in bankruptcy and jail time for the offenders. Organizations can reduce the potential for these types of liability claims by educating their employees about ethical standards, by leading through example, and through various informal and formal programs. ### Leading by Example Employees often follow the examples set by their managers. That is, leaders and managers establish patterns of behavior that determine what’s acceptable and what’s not within the organization. While Ben Cohen was president of Ben & Jerry’s ice cream, he followed a policy that no one could earn a salary more than seven times that of the lowest-paid worker. He wanted all employees to feel that they were equal. At the time he resigned, company sales were $140 million, and the lowest-paid worker earned $19,000 per year. Ben Cohen’s salary was $133,000, based on the “seven times” rule. A typical top executive of a $140 million company might have earned 10 times Cohen’s salary. Ben Cohen’s actions helped shape the ethical values of Ben & Jerry’s. ### Offering Ethics Training Programs In addition to providing a system to resolve ethical dilemmas, organizations also provide formal training to develop an awareness of questionable business activities and practice appropriate responses. Many companies have some type of ethics training program. The ones that are most effective, like those created by Levi Strauss, American Express, and Campbell Soup Company, begin with techniques for solving ethical dilemmas such as those discussed earlier. Next, employees are presented with a series of situations and asked to come up with the “best” ethical solution. One of these ethical dilemmas is shown in . According to a recent survey by the Ethics Resource Center, more than 80 percent of U.S. companies provide some sort of ethics training for employees, which may include online activities, videos, and even games. ### Establishing a Formal Code of Ethics Most large companies and thousands of smaller ones have created, printed, and distributed codes of ethics. In general, a code of ethics provides employees with the knowledge of what their firm expects in terms of their responsibilities and behavior toward fellow employees, customers, and suppliers. Some ethical codes offer a lengthy and detailed set of guidelines for employees. Others are not really codes at all but rather summary statements of goals, policies, and priorities. Some companies have their codes framed and hung on office walls, included as a key component of employee handbooks, and/or posted on their corporate websites. 2. Costco http://phx.corporate-ir.net/phoenix.zhtml?c=83830&p=irol-govhighlights 3. Starbucks https://www.starbucks.com/about-us/company-information/business-ethics-and-compliance 4. AT&T https://www.att.com/gen/investor-relations?pid=5595 Do codes of ethics make employees behave in a more ethical manner? Some people believe that they do. Others think that they are little more than public relations gimmicks. If senior management abides by the code of ethics and regularly emphasizes the code to employees, then it will likely have a positive influence on behavior. The “100 Best Corporate Citizens” as ranked by Corporate Responsibility magazine are selected based on seven categories, including employee relations, human rights, corporate governance (including code of ethics), philanthropy and community support, financial performance, environment, and climate change. The top corporate citizens in 2017 were: 1. Hasbro, Inc. 2. Intel Corp. 3. Microsoft Corp. 4. Altria Group, Inc. 5. Campbell Soup Company 6. Cisco Systems, Inc. 7. Accenture 8. Hormel Foods Corp. 9. Lockheed Martin Corp. 10. Ecolab, Inc. ### Making the Right Decision In many situations, there may be no simple right or wrong answers. Yet there are several questions you can ask yourself, and a couple of self-tests you can do, to help you make the right ethical decision. First, ask yourself, “Are there any legal restrictions or violations that will result from the action?” If so, take a different course of action. If not, ask yourself, “Does it violate my company’s code of ethics?” If so, again find a different path to follow. Third, ask, “Does this meet the guidelines of my own ethical philosophy?” If the answer is “yes,” then your decision must still pass two important tests. ### The Feelings Test You must now ask, “How does it make me feel?” This enables you to examine your comfort level with a particular decision. Many people find that, after reaching a decision on an issue, they still experience discomfort that may manifest itself in a loss of sleep or appetite. Those feelings of conscience can serve as a future guide in resolving ethical dilemmas. ### The Newspaper or Social Media Test The final test involves the front page of the newspaper or social media posts. The question to be asked is how an objective reporter would describe your decision in a front-page newspaper story, an online media site, or a social media platform such as Twitter or Facebook. Some managers rephrase the test for their employees: How will the headline read if I make this decision, or what will be the reaction of my social media followers? This test is helpful in spotting and resolving potential conflicts of interest. ### Summary of Learning Outcomes 1. How can organizations encourage ethical business behavior? Top management must shape the ethical culture of the organization. They should lead by example, offer ethics-training programs, and establish a formal code of ethics.

# Making Ethical Decisions and Managing a Socially Responsible Business ## Managing a Socially Responsible Business 1. What is corporate social responsibility? Acting in an ethical manner is one of the four components of the pyramid of corporate social responsibility (CSR), which is the concern of businesses for the welfare of society as a whole. It consists of obligations beyond those required by law or union contract. This definition makes two important points. First, CSR is voluntary. Beneficial action required by law, such as cleaning up factories that are polluting air and water, is not voluntary. Second, the obligations of corporate social responsibility are broad. They extend beyond investors in the company to include workers, suppliers, consumers, communities, and society at large. portrays economic responsibility as the foundation for the other three responsibilities. At the same time that a business pursues profits (economic responsibility), however, it is expected to obey the law (legal responsibility); to do what is right, just, and fair (ethical responsibility); and to be a good corporate citizen (philanthropic responsibility). These four components are distinct but together constitute the whole. Still, if the company doesn’t make a profit, then the other three responsibilities won’t matter. Many companies continue to work hard to make the world a better place to live. Recent data suggests that Fortune 500 companies spend more than $15 billion annually on CSR activities. Consider the following examples: 1. Starbucks has donated more than one million meals to local communities via its FoodShare program and alliance with Feeding America, giving 100 percent of leftover food from their seven thousand U.S. company-owned stores. 2. Salesforce encourages its employees to volunteer in community activities and pays them for doing so, up to 56 paid hours every year. For employees who participate in seven days of volunteerism in one year, Salesforce also gives them a $1,000 grant to donate to the employee’s nonprofit of choice. 3. Employees who work for Deloitte, a global audit, consulting, and financial services organization, can get paid for up to 48 hours of volunteer work each year. In a recent year, more than 27,000 Deloitte professionals contributed more than 353,000 volunteer hours to their communities around the world. ### Understanding Social Responsibility Peter Drucker, the late globally respected management expert, said that we should look first at what an organization does to society and second at what it can do for society. This idea suggests that social responsibility has two basic dimensions: legality and responsibility. ### Illegal and Irresponsible Behavior The idea of corporate social responsibility is so widespread today that it is hard to conceive of a company continually acting in illegal and irresponsible ways. Nevertheless, such actions do sometimes occur, which can create financial ruin for organizations, extreme financial hardships for many former employees, and general struggles for the communities in which they operate. Unfortunately, top executives still walk away with millions. Some, however, will ultimately pay large fines and spend time in prison for their actions. Federal, state, and local laws determine whether an activity is legal or not. The laws that regulate business are discussed later in this module. ### Irresponsible but Legal Behavior Sometimes companies act irresponsibly, yet their actions are legal. For example, the Minnesota-based company that makes MyPillow was recently fined $1 million by the state of California for making unsubstantiated claims that the “most comfortable pillow you’ll ever own” could help alleviate medical conditions such as snoring, fibromyalgia, migraines, and other disorders. The company’s CEO countered that the claims were actually made by customers; these testimonials were posted on the company’s website but later removed. In addition to the fine, the company faced several class-action lawsuits, and the Better Business Bureau has revoked MyPillow’s accreditation. ### Legal and Responsible Behavior The vast majority of business activities fall into the category of behavior that is both legal and responsible. Most companies act legally, and most try to be socially responsible. Research shows that consumers, especially those under 30, are likely to buy brands that have excellent ethical track records and community involvement. Outdoor specialty retailer REI, for example, recently announced that it gave back nearly 70 percent of its profits to the outdoor community. A member cooperative, the company invested a record $9.3 million in its nonprofit partners in 2016. ### Summary of Learning Outcomes 1. What is corporate social responsibility? Corporate social responsibility is the concern of businesses for the welfare of society as a whole. It consists of obligations beyond just making a profit and goes beyond what is required by law or union contract. Companies may engage in illegal and irresponsible behavior, irresponsible but legal behavior, or legal and responsible behavior. The vast majority of organizations act legally and try to be socially responsible.

# Making Ethical Decisions and Managing a Socially Responsible Business ## Responsibilities to Stakeholders 1. How do businesses meet their social responsibilities to various stakeholders? What makes a company be admired or perceived as socially responsible? Such a company meets its obligations to its stakeholders. Stakeholders are the individuals or groups to whom a business has a responsibility. The stakeholders of a business are its employees, its customers, the general public, and its investors. ### Responsibility to Employees An organization’s first responsibility is to provide a job to employees. Keeping people employed and letting them have time to enjoy the fruits of their labor is the finest thing business can do for society. Beyond this fundamental responsibility, employers must provide a clean, safe working environment that is free from all forms of discrimination. Companies should also strive to provide job security whenever possible. Enlightened firms are also empowering employees to make decisions on their own and suggest solutions to company problems. Empowerment contributes to an employee’s self-worth, which, in turn, increases productivity and reduces absenteeism. Each year, in collaboration with Great Place to Work®, Fortune conducts an extensive employee survey of the best places to work in the United States. For 2017, the top companies included Google, Wegmans Food Markets, Edward Jones, Genentech, Salesforce, Acuity, and Quicken Loans. Some companies offer unusual benefits to their employees. For example, biotech company Genentech offers employee compensation for taking alternative methods of transportation to work at its South San Francisco campus. Employees can earn $12 per day for walking or biking to work, and those who drive a carpool or vanpool can earn $8 and $16, respectively. In addition, the company offers free commuter bus service for all employees via 27 routes around the Bay Area. ### Responsibility to Customers To be successful in today’s business environment, a company must satisfy its customers. A firm must deliver what it promises, as well as be honest and forthright in everyday interactions with customers, suppliers, and others. Recent research suggests that many consumers, particularly millennials, prefer to do business with companies and brands that communicate socially responsible messages, utilize sustainable manufacturing processes, and practice ethical business standards. ### Responsibility to Society A business must also be responsible to society. A business provides a community with jobs, goods, and services. It also pays taxes that go to support schools, hospitals, and better roads. Some companies have taken an additional step to demonstrate their commitment to stakeholders and society as a whole by becoming Certified Benefit Corporations, or B Corps for short. Verified by B Lab, a global nonprofit organization, B Corps meet the highest standards of social and environmental performance, public transparency, and legal accountability and strive to use the power of business to solve social and environmental problems via an impact assessment that rates each company on a possible score of 200 points. To become certified as a Benefit Corporation, companies need to reach a score of at least 80 and must be recertified every two years. There are more than 2,000 companies worldwide that have been certified as B Corps, including Method, W.S. Badger Company, Fishpeople Seafood, LEAP Organics, New Belgium Brewing Company, Ben & Jerry’s, Cabot Creamery Co-op, Comet Skateboards, Etsy, Patagonia, Plum Organics, and Warby Parker. ### Environmental Protection Business is also responsible for protecting and improving the world’s fragile environment. The world’s forests are being destroyed fast. Every second, an area the size of a football field is laid bare. Plant and animal species are becoming extinct at the rate of 17 per hour. A continent-size hole is opening up in the earth’s protective ozone shield. Each year we throw out 80 percent more refuse than we did in 1960; as a result, more than half of the nation’s landfills are filled to capacity. To slow the erosion of the world’s natural resources, many companies have become more environmentally responsible. For example, Toyota now uses renewable energy sources such as solar, wind, geothermal, and water power for electricity to run its facilities. When its new $1 billion North American headquarters opened in Plano, Texas, in May 2017, Toyota said the 2.1 million square-foot campus would eventually be powered by 100% clean energy, helping the auto giant move closer to its goal of eliminating carbon emissions in all of its operations. ### Corporate Philanthropy Companies also display their social responsibility through corporate philanthropy. Corporate philanthropy includes cash contributions, donations of equipment and products, and support for the volunteer efforts of company employees. Recent statistics suggest U.S. corporate philanthropy exceeds more than $19 billion annually. American Express is a major supporter of the American Red Cross. The organization relies almost entirely on charitable gifts to carry out its programs and services, which include disaster relief, armed-forces emergency relief, blood and tissue services, and health and safety services. The funds provided by American Express have enabled the Red Cross to deliver humanitarian relief to victims of numerous disasters around the world. When Hurricane Katrina hit the Gulf Coast, Bayer sent 45,000 diabetes blood glucose monitors to the relief effort. Within weeks of the disaster, Abbott, Alcoa, Dell, Disney, Intel, UPS, Walgreens, Walmart, and others contributed more than $550 million for disaster relief. ### Responsibilities to Investors Companies’ relationships with investors also entail social responsibility. Although a company’s economic responsibility to make a profit might seem to be its main obligation to its shareholders, some investors increasingly are putting more emphasis on other aspects of social responsibility. Some investors are limiting their investments to securities (e.g., stocks and bonds) that coincide with their beliefs about ethical and social responsibility. This is called social investing. For example, a social investment fund might eliminate from consideration the securities of all companies that make tobacco products or liquor, manufacture weapons, or have a history of being environmentally irresponsible. Not all social investment strategies are alike. Some ethical mutual funds will not invest in government securities because they help to fund the military; others freely buy government securities, with managers noting that federal funds also support the arts and pay for AIDS research. Today, assets invested using socially responsible strategies total more than $7 trillion. Perhaps partly as the result of the global recession of 2007–2009, over the last several years companies have tried to meet responsibilities to their investors as well as to their other stakeholders. Recent research suggests that now more than ever, CEOs are being held to higher standards by boards of directors, investors, governments, media, and even employees when it comes to corporate accountability and ethical behavior. A recent global study by PwC reveals that over the last several years, there has been a large increase in the number of CEOs being forced out due to some sort of ethical lapse in their organizations. Strategies to prevent such missteps should include establishing a culture of integrity to prevent anyone from breaking the rules, making sure company goals and metrics do not create undue pressure on employees to cut corners, and implementing effective processes and controls to minimize the opportunity for unethical behavior. ### Summary of Learning Outcomes 1. How do businesses meet their social responsibilities to various stakeholders? Stakeholders are individuals or groups to whom business has a responsibility. Businesses are responsible to employees. They should provide a clean, safe working environment. Organizations can build employees’ self-worth through empowerment programs. Businesses also have a responsibility to customers to provide good, safe products and services. Organizations are responsible to the general public to be good corporate citizens. Firms must help protect the environment and provide a good place to work. Companies also engage in corporate philanthropy, which includes contributing cash, donating goods and services, and supporting volunteer efforts of employees. Finally, companies are responsible to investors. They should earn a reasonable profit for company owners.

# Making Ethical Decisions and Managing a Socially Responsible Business ## Trends in Ethics and Corporate Social Responsibility 1. What are the trends in ethics and corporate social responsibility? Three important trends related to ethics and corporate social responsibility are strategic changes in corporate philanthropy, a new social contract between employers and employees, and the growth of global ethics and corporate social responsibility. ### Changes in Corporate Philanthropy Historically, corporate philanthropy has typically involved companies seeking out charitable groups and giving them money or donating company products or services. Today, the focus has shifted to strategic giving, which ties philanthropy and corporate social responsibility efforts closely to a company’s mission or goals and targets donations to the communities where a company does business. Some of the top businesses recognized for their efforts in giving back to the communities in which they operate include technology giant Salesforce, San Antonio’s NuStar Energy, insurance and financial services firm Veterans United, and software leader Intuit. ### A Social Contract between Employer and Employee Another trend in social responsibility is the effort by organizations to redefine their relationship with their employees. Many people have viewed social responsibility as a one-way street that focuses on the obligations of business to society, employees, and others. Now, companies recognize that the social contract between employer and employee is an important aspect of the workplace and that both groups have to be committed to working together in order for the organization to prosper. The social contract can be defined in terms of four important aspects: compensation, management, culture, and learning and development. When it comes to compensation, companies today must recognize that most employees do not stay with one organization for decades. Thus, companies need to change their compensation structure to acknowledge the importance of short-term performance and to update their methods for determining compensation, including benefits and other nontraditional perks such as increased paid leave and telecommuting options. In the current workplace environment, where employees are likely to jump to new jobs every couple years, managers need to take a more active and engaged approach to supervising employees and perhaps change the way they think about loyalty, which may be difficult for managers used to supervising the same group of employees for a long period of time. Engaging employees on a regular basis, setting realistic expectations, and identifying specific development paths may help retain key employees. Thanks to today’s tight labor market, some employees feel empowered to demand more from their employer and its overall culture via strategies such as increased flexibility, transparency, and fairness. This increased importance of the employee’s role in the company’s culture helps workers stay engaged in the mission of the organization and perhaps makes them less likely to look elsewhere for employment. Finally, rapidly changing technology used in today’s workplace continues to shift the learning and development component of the employer-employee contract, causing immense challenges to both companies and workers. It may be more difficult to identify the employee skills that will be critical over the next several years, causing employers either to increase training of current workers or to look outside the organization for other individuals who already possess the technical skills needed to get the job done. ### Global Ethics and Social Responsibility When U.S. businesses expand into global markets, they must take their codes of ethics and policies on corporate social responsibility with them. As a citizen of several countries, a multinational corporation has several responsibilities. These include respecting local practices and customs, ensuring that there is harmony between the organization’s staff and the host population, providing management leadership, and developing a solid group of local managers who will be a credit to their community. When a multinational firm makes an investment in a foreign country, it should commit to a long-term relationship. That means involving all stakeholders in the host country in decision-making. Finally, a responsible multinational will implement ethical guidelines within the organization in the host country. By fulfilling these responsibilities, the company will foster respect for both local and international laws. Multinational corporations often must balance conflicting interests of stakeholders when making decisions regarding social responsibilities, especially in the area of human rights. Questions involving child labor, forced labor, minimum wages, and workplace safety can be particularly difficult. Recently Gap, Inc. decided to publish the list of its global factories in an effort to provide transparency about its suppliers and the efforts the company continues to make to improve working conditions around the world. The company has partnered with Verité, a nongovernmental organization focused on ensuring that people work under safe, fair, and legal conditions. By soliciting feedback from factory workers making its products, Gap is hoping to improve working conditions and help these factories become leaders in their local communities. ### Summary of Learning Outcomes 1. What are the trends in ethics and corporate social responsibility? Today, corporate philanthropy is shifting away from simply giving to any needy group and is focusing instead on strategic giving, in which the philanthropy relates more closely to the corporate mission or goals and targets donations to areas where the firm operates. A second trend is toward a new social contract between employer and employee. Instead of the employer having the sole responsibility for maintaining jobs, now the employee must assume part of the burden and find ways to add value to the organization. As the world increasingly becomes a global community, multinational corporations are now expected to assume a global set of ethics and responsibility. Global companies must understand local customs. They should also involve local stakeholders in decision-making. Multinationals must also make certain that their suppliers are not engaged in human rights violations. ### Preparing for Tomorrow’s Workplace Skills 1. Many CEOs have sold shares of their company’s stock when prices were near their high points. Even though their actions were legal, it soon became apparent that they knew that the stock was significantly overpriced. Was the CEO ethically obligated to tell the public that this was the case—even knowing that doing so could cause the stock price to plummet, thereby hurting someone who bought the stock earlier that day? (Systems) 2. Jeffrey Immelt, former chairman and CEO of General Electric, one of the world’s most-admired companies according to Fortune magazine, says that execution, growth, and great people are required to keep the company on top. Immelt said that these are predictable, but a fourth factor is not—virtue, and virtue was at the top of his list. Using a search engine, find articles on what GE is doing to enhance its corporate citizenship. Report your findings to the class. Could GE do more, or are they already doing too much? Why? (Systems, Technology) 3. Boeing Corp. makes business ethics a priority, asking employees to take refresher training every year. It encourages employees to take the Ethics Challenge with their work groups and to discuss the issues with their peers. You can take your own ethics challenge. Go to the Ethics Quick Test and answer the questions. Summarize your findings. Were there any answers that surprised you? (Information) 4. Identify the potential ethical and social responsibility issues confronting the following organizations: Microsoft, Pfizer, Nike, American Cancer Society, and R.J. Reynolds. Make recommendations on how these issues should be handled. (Systems) 5. Team Activity Divide the class into teams. Debate whether the only social responsibility of the employer to the employee is to provide a job. Include a discussion of the employee’s responsibility to bring value to the firm. Also, debate the issue of whether the only social responsibility of a firm is to earn a profit. (Interpersonal) ### Ethics Activity ### Let’s Be Honest The Honest Company is a consumer-goods business that sells nontoxic, eco-friendly items for baby and personal care, household cleaning, and a healthy lifestyle. Cofounded by actress Jessica Alba a little more than six years ago, Honest Co. is built on the promise of “telling all and doing our best to live up to your expectations.” Over the years the company has received high praise and media buzz about its ethical approach to making products that are not only good for people but good for the environment. On its website, Honest Co. goes to great lengths to share with consumers its guiding principles that products are made without harming people or the planet. A little over two years ago, however, the company experienced some bad press when The Wall Street Journal reported that two independent lab tests found samples of Honest laundry detergent contained a cleaning agent on the list of chemicals the company pledged to avoid. At first, pushback from company officials was loud and clear: they denied their products were anything but eco-friendly and safe for consumers and went as far as calling the report “false” and “junk science.” Unfortunately, the reports about Honest products and their harmful ingredients didn’t go away. After the laundry detergent story faded, the company quietly reconfigured the ingredients that went into the detergent as well as other products. But that wasn’t the end of the story. Several months later, Honest Co. voluntarily recalled organic baby powder that might cause infections and more recently recalled diaper wipes that appeared discolored. Despite these recent challenges, Honest Co. continues to be successful and was rumored to be on the short list of possible acquisitions for global conglomerates such as Procter & Gamble, Johnson & Johnson, and Unilever. These consumer-good giants are snapping up smaller, eco-friendly firms that have blossomed into full-fledged ethically and environmentally conscious organizations with strong sales and solid reputations among consumers. Recently, however, Unilever acquired one of Honest Co.’s biggest rivals, Seventh Generation, Inc., leaving Honest Co. to again rethink its business strategies, including hiring a new CEO. Using a web search tool, locate information about this topic and then write responses to the following questions. Be sure to support your arguments and cite your sources. Ethical Dilemma: Do you think the company’s reaction to reports of hazardous ingredients hurt its reputation for honesty and ethical behavior? Do you think the company’s missteps caused Unilever to shy away from acquiring the company? Or, do you take the stance that Alba’s entertainment background played a part in the press going after the company? If you were an advisor to the new CEO, what suggestions would you give him for getting the company back on track, especially when it comes to corporate social responsibility? Sources: “Our Principles,” https://www.honest.com, accessed June 27, 2017; Eun Kyung Kim, “Jessica Alba’s Honest Company Recalls Diaper Wipes over Mold Concerns,” Today, http://www.today.com, May 16, 2017; Steve Tobak, “Jessica Alba’s ‘Honest’ Mess,” Entrepreneur, https://www.entrepreneur.com, March 29, 2017; Jason Del Rey, “Jessica Alba’s Honest Company Is Replacing Its CEO after a Sale to Unilever Fell Through,” Recode, https://www.recode.net, March 16, 2017; Serena Ng, “Jessica Alba’s Honest Co. to Drop Use of Disputed Ingredient,” The Wall Street Journal, http://www.wsj.com, September 30, 2016; Kathryn Vasel, “The Honest Company Gets Sued . . . Again,” CNN Money, http://money.cnn.com, April 27, 2016. ### Working the Net 1. You will find the listing for the 100 Best Corporate Citizens at the website for Corporate Responsibility magazine (http://thecro.com). Review the current list of companies and pay close attention to those marked with a “yellow card” caution and a “red card” caution. These are companies that have either been removed from the list due to unethical behavior or have been warned that some of their actions border on unethical. What surprised you about the companies that have been flagged? Select one of the flagged companies and explain what they can do to improve their CSR profile. 2. Richard S. Scrushy, former CEO of HealthSouth Corporation, was charged with $1.4 billion in fraud. He was acquitted. Bernie Ebbers, former CEO of WorldCom, was found guilty of helping mastermind an $11 billion accounting fraud. Go to the internet and read several articles about the charges against both men. Find articles on why one was guilty on all counts and the other acquitted on all counts. Explain the ethical issues involved with each. 3. Visit the website of People for the Ethical Treatment of Animals (PETA), http://peta.org, and under the Issues tab, read about PETA’s view of Animals Used for Clothing. Do you agree with this view? Why or why not? How do you think manufacturers of fur clothing would justify their actions to someone from PETA? Would you work for a store that sold fur-trimmed clothing? Explain your answer. 4. Green Money Journal, http://www.greenmoneyjournal.com, is a bimonthly online journal that promotes socially responsibility investing. What are the current topics of concern in this area? Visit the archives to find articles on socially responsible investing and two areas of corporate social responsibility. Summarize what you have learned. 5. Double the Donation, https://doublethedonation.com, is a website that provides information on top forms of corporate philanthropy and highlights companies with strong giving programs. Research several companies and their philanthropic activities and provide details about what makes these organizations excellent corporate citizens. ### Creative Thinking Case ### Uber Hits a Bumpy Road Uber Technologies, Inc. is the world’s largest technology start-up, valued at close to $70 billion. But that doesn’t mean it has been smooth sailing for the ride-hailing company since its start in 2009. Despite disrupting and revolutionizing the transportation industry in a short period of time, Uber’s meteoric rise has caused some shortcuts in organizational structure, corporate culture, and effective HR practices that have left the company with self-inflicted wounds that may take a long time to heal. Uber has experienced several scandals over the past few years, including drivers demanding to be classified as employees (not contractors), a tool called “greyball” that allows data collected from the Uber app to identify and avoid enforcement officers trying to catch Uber drivers in cities where the service was illegal, and recent resignations of top executives, including the company’s president and the heads of product development and engineering. But nothing has been quite as damaging as a recent blog post by a former female employee, which detailed the inappropriate behavior that seemed to be commonplace in Uber’s workplace culture. The allegations of sexual harassment put forth by former Uber engineer Susan Fowler were explosive. Detailed in a February 2017 blog post, Fowler says she alerted company HR about her manager’s inappropriate behavior, even taking screenshots of his suggestive emails, but Fowler was told her boss would not be fired for sexual harassment because he was a “high performer” for the company. After Fowler’s story went public, the company hired former U.S. attorney Eric Holder to investigate the allegations and other workplace issues. Holder’s recommendations, which the Uber board of directors unanimously approved, include changes to senior leadership, enhanced oversight by the company’s board, changes to the company’s internal financial and audit controls, revisions to the company’s cultural values, mandatory leadership training for senior executives and other managers, improvements to the overall HR function and complaint process, and the establishment of an employee diversity advisory board. In addition, as the result of a separate investigation, Uber fired more than 20 other people because of harassment claims. With increasing pressure from the company’s board and other investors, CEO Travis Kalanick said he would take a leave of absence while still mourning the unexpected death of his mother in a recent boating accident. However, most board members lost faith that Kalanick would be able to come back after his leave and make things better. At the urging of the board, two venture capitalists were dispatched to Chicago, where Kalanick was interviewing COO candidates, to present him with a letter from five of Uber’s major investors demanding his resignation. After hours of discussion, Kalanick agreed to step down. According to an Uber spokesperson, a committee of 14 executives is running the company until a new CEO is hired. 2. According to recent data, only 36 percent of Uber’s current employees are women. How do you think this situation helped perpetuate a flawed corporate culture? 3. What can Uber do to ensure its competitors are not chipping away at its dominant market share as a result of such bad press? 4. Do you think installing an experienced female CEO would help the company change its culture and workplace environment? Explain your reasoning. Sources: Marisa Kendall, “Uber: Here’s Who’s Running the Show Now,” Mercury News, http://www.mercurynews.com, June 23, 2017; Eric Newcomer, “Uber CEO Travis Kalanick Quits Under Pressure from Investors,” Bloomberg News, https://www.bloomberg.com, June 21, 2017; Mike Issac, “Inside Travis Kalanick’s Resignation as Uber’s C.E.O.,” The New York Times, http://www.nytimes.com, June 21, 2017; “Holder Recommendations on Uber,” The New York Times, https://www.nytimes.com, June 13, 2017; Eric Newcomer, “Uber Fires More Than 20 Employees in Harassment Probe,” Bloomberg Technology, https://www.bloomberg.com, June 6, 2017; Erin Griffith, “The Uncomfortable Reality Behind Uber’s Culture Meltdown,” Fortune, http://fortune.com, April 20, 2017; Johana Bhuiyan, “Uber Has Published Its Much Sought After Diversity Numbers for the First Time,” Recode, https://www.recode.net, March 28, 2017; Marco della Cava, “Uber President Quits as Company Searches for COO,” USA Today, https://www.usatoday.com, March 20, 2017; Mike Isaac, “How Uber Deceives the Authorities Worldwide,” The New York Times, http://www.nytimes.com, March 3, 2017; Susan J. Fowler, “Reflecting on One Very, Very Strange Year at Uber,” https://www.susanjfowler.com/blog, February 19, 2017. ### Hot Links Address Book 1. Find out which companies test their products on animals and which don’t in the campaign section of the PETA website, http://www.peta.org. 2. How is the International Business Ethics Institute working to promote business ethics worldwide? Find out at http://www.business-ethics.org. 3. Ben & Jerry’s ice cream has always taken its responsibilities as a corporate good citizen seriously. Learn about the company’s positions on various issues and products that support social issues at its website, http://www.benjerry.com. 4. Discover what the Texas Instruments employee Ethics Quick Test includes, as well as the company’s overall ethics policies, by searching for “Ethics at TI” on the corporate home page, http://www.ti.com. 5. What does IBM require from its employees in terms of ethical business conduct? You will find the information on IBM’s website under Corporate responsibility, http://www.ibm.com. 6. Levi Strauss’s unique corporate culture rewards and recognizes employee achievement. To learn about its employee community involvement program, go to the Levi Strauss website at http://www.levistrauss.com. 7. Want to see how the global environment is changing and learn the latest about global warming? Check out http://www.climatehotmap.org. 8. General Motors is committed to continuous improvement in its environmental performance. Check out GM’s Sustainability Report at http://www.gmsustainability.com. 9. Before donating to any charity, check out its credentials and overall track record at http://charitywatch.org. 10. Learn how U.S. businesses gain competitive advantage through corporate social responsibility programs at the Business for Social Responsibility (BSR) website, http://www.bsr.org.

# Competing in the Global Marketplace ## Introduction ### Learning Outcomes After reading this chapter, you should be able to answer these questions: 1. Why is global trade important to the United States, and how is it measured? 2. Why do nations trade? 3. What are the barriers to international trade? 4. How do governments and institutions foster world trade? 5. What are international economic communities? 6. How do companies enter the global marketplace? 7. What threats and opportunities exist in the global marketplace? 8. What are the advantages of multinational corporations? 9. What are the trends in the global marketplace? This chapter examines the business world of the global marketplace. It focuses on the processes of taking a business global, such as licensing agreements and franchisees; the challenges that are encountered; and the regulatory systems governing the world market of the 21st century. Today, global revolutions are under way in many areas of our lives: management, politics, communications, and technology. The word global has assumed a new meaning, referring to a boundless mobility and competition in social, business, and intellectual arenas. The purpose of this chapter is to explain how global trade is conducted. We also discuss the barriers to international trade and the organizations that foster global trade. The chapter concludes with trends in the global marketplace.

# Competing in the Global Marketplace ## Global Trade in the United States 1. Why is global trade important to the United States, and how is it measured? No longer just an option, having a global vision has become a business imperative. Having a global vision means recognizing and reacting to international business opportunities, being aware of threats from foreign competitors in all markets, and effectively using international distribution networks to obtain raw materials and move finished products to the customer. U.S. managers must develop a global vision if they are to recognize and react to international business opportunities, as well as remain competitive at home. Often a U.S. firm’s toughest domestic competition comes from foreign companies. Moreover, a global vision enables a manager to understand that customer and distribution networks operate worldwide, blurring geographic and political barriers and making them increasingly irrelevant to business decisions. Over the past three decades, world trade has climbed from $200 billion a year to more than $1.4 trillion. U.S. companies play a major role in this growth in world trade, with 113 of the Fortune 500 companies making over 50 percent of their profits outside the United States. Among these companies are recognizable names such as Apple, Microsoft, Pfizer, Exxon Mobil, and General Electric. Starbucks Corp. is among the fastest growing global consumer brands and one of the most visible emblems of U.S. commercial culture overseas. Of Starbucks’s 24,000 total stores, almost 66 percent are international stores that contribute a substantial amount to the company’s revenues, which have grown from $4.1 billion in 2003 to $21.3 billion in 2016. Go into a Paris McDonald’s and you may not recognize where you are. There are no Golden Arches or utilitarian chairs and tables and other plastic features. The restaurants have exposed brick walls, hardwood floors, and armchairs. Some French McDonald’s even have faux marble walls. Most restaurants have TVs with continuous music videos. You can even order an espresso, beer, and a chicken on focaccia bread sandwich. It’s not America. Global business is not a one-way street, where only U.S. companies sell their wares and services throughout the world. Foreign competition in the domestic market used to be relatively rare but now occurs in almost every industry. In fact, U.S. makers of electronic goods, cameras, automobiles, fine china, tractors, leather goods, and a host of other consumer and industrial products have struggled to maintain their domestic market shares against foreign competitors. Toyota now has 14 percent of the U.S. auto market, followed by Honda at 9 percent and Nissan with 8 percent. Nevertheless, the global market has created vast new business opportunities for many U.S. firms. ### The Importance of Global Business to the United States Many countries depend more on international commerce than the United States does. For example, France, Great Britain, and Germany all derive more than 55 percent of their gross domestic product (GDP) from world trade, compared to about 28 percent for the United States. Nevertheless, the impact of international business on the U.S. economy is still impressive: 1. Trade-dependent jobs have grown at a rate three times the growth of U.S.-dependent jobs. 2. Every U.S. state has realized a growth of jobs attributable to trade. 3. Trade has an effect on both service and manufacturing jobs. These statistics might seem to imply that practically every business in the United States is selling its wares throughout the world, but most is accounted for by big business. About 85 percent of all U.S. exports of manufactured goods are shipped by 250 companies. Yet, 98 percent of all exporters are small and medium-size firms. ### The Impact of Terrorism on Global Trade The terrorist attacks on America on September 11, 2001, and the Charlie Hebdo terrorist attacks in Paris in 2015 have changed the way the world conducts business. The immediate impacts of these events have included a short-term shrinkage of global trade. Globalization, however, will continue because the world’s major markets are too vitally integrated for globalization to stop. Nevertheless, terrorism has caused the growth to be slower and costlier. Companies are paying more for insurance and to provide security for overseas staff and property. Heightened border inspections slow movements of cargo, forcing companies to stock more inventory. Tighter immigration policies curtail the liberal inflows of skilled and blue-collar workers that allowed companies to expand while keeping wages in check. The impact of terrorism may lessen over time, but multinational firms will always be on guard. ### Measuring Trade between Nations International trade improves relationships with friends and allies; helps ease tensions among nations; and—economically speaking—bolsters economies, raises people’s standard of living, provides jobs, and improves the quality of life. The value of international trade is over $16 trillion a year and growing. This section takes a look at some key measures of international trade: exports and imports, the balance of trade, the balance of payments, and exchange rates. ### Exports and Imports The developed nations (those with mature communication, financial, educational, and distribution systems) are the major players in international trade. They account for about 70 percent of the world’s exports and imports. Exports are goods and services made in one country and sold to others. Imports are goods and services that are bought from other countries. The United States is the largest importer and second largest exporter in the world. Each year the United States exports more food, animal feed, and beverages than the year before. A third of U.S. farm acreage is devoted to crops for export. The United States is also a major exporter of engineering products and other high-tech goods, such as computers and telecommunications equipment. For more than 60,000 U.S. companies (the majority of them small), international trade offers exciting and profitable opportunities. Among the largest U.S. exporters are Apple, General Motors Corp., Ford Motor Co., Procter & Gamble, and Cisco Systems. Despite our impressive list of resources and great variety of products, imports to the United States are also growing. Some of these imports are raw materials that we lack, such as manganese, cobalt, and bauxite, which are used to make airplane parts, exotic metals, and military hardware. More modern factories and lower labor costs in other countries make it cheaper to import industrial supplies (such as steel) and production equipment than to produce them at home. Most of Americans’ favorite hot beverages—coffee, tea, and cocoa—are imported. Lower manufacturing costs have resulted in huge increases in imports from China. ### Balance of Trade The difference between the value of a country’s exports and the value of its imports during a specific time is the country’s balance of trade. A country that exports more than it imports is said to have a favorable balance of trade, called a trade surplus. A country that imports more than it exports is said to have an unfavorable balance of trade, or a trade deficit. When imports exceed exports, more money from trade flows out of the country than flows into it. Although U.S. exports have been booming, we still import more than we export. We have had an unfavorable balance of trade throughout the 1990s, 2000s and 2010s. In 2016, our exports totaled $2.2 trillion, yet our imports were $2.7 trillion. Thus, in 2016 the United States had a trade deficit of $500 billion. America’s exports continue to grow, but not as fast as our imports: The export of goods, such as computers, trucks, and airplanes, is very strong. The sector that is lagging in significant growth is the export of services. Although America exports many services—ranging from airline trips to education of foreign students to legal advice—part of the problem is due to piracy, which leads companies to restrict the distribution of their services to certain regions. The FBI estimates that the theft of intellectual property from products, books and movies, and pharmaceuticals totals in the billions every year. ### Balance of Payments Another measure of international trade is called the balance of payments, which is a summary of a country’s international financial transactions showing the difference between the country’s total payments to and its total receipts from other countries. The balance of payments includes imports and exports (balance of trade), long-term investments in overseas plants and equipment, government loans to and from other countries, gifts and foreign aid, military expenditures made in other countries, and money transfers in and out of foreign banks. From 1900 until 1970, the United States had a trade surplus, but in the other areas that make up the balance of payments, U.S. payments exceeded receipts, largely due to the large U.S. military presence abroad. Hence, almost every year since 1950, the United States has had an unfavorable balance of payments. And since 1970, both the balance of payments and the balance of trade have been unfavorable. What can a nation do to reduce an unfavorable balance of payments? It can foster exports, reduce its dependence on imports, decrease its military presence abroad, or reduce foreign investment. The U.S. balance of payments deficit was over $504 billion in 2016. ### The Changing Value of Currencies The exchange rate is the price of one country’s currency in terms of another country’s currency. If a country’s currency appreciates, less of that country’s currency is needed to buy another country’s currency. If a country’s currency depreciates, more of that currency will be needed to buy another country’s currency. How do appreciation and depreciation affect the prices of a country’s goods? If, say, the U.S. dollar depreciates relative to the Japanese yen, U.S. residents have to pay more dollars to buy Japanese goods. To illustrate, suppose the dollar price of a yen is $0.012 and that a Toyota is priced at 2 million yen. At this exchange rate, a U.S. resident pays $24,000 for a Toyota ($0.012 × 2 million yen = $24,000). If the dollar depreciates to $0.018 to one yen, then the U.S. resident will have to pay $36,000 for a Toyota. As the dollar depreciates, the prices of Japanese goods rise for U.S. residents, so they buy fewer Japanese goods—thus, U.S. imports decline. At the same time, as the dollar depreciates relative to the yen, the yen appreciates relative to the dollar. This means prices of U.S. goods fall for the Japanese, so they buy more U.S. goods—and U.S. exports rise. Currency markets operate under a system called floating exchange rates. Prices of currencies “float” up and down based upon the demand for and supply of each currency. Global currency traders create the supply of and demand for a particular currency based on that currency’s investment, trade potential, and economic strength. If a country decides that its currency is not properly valued in international currency markets, the government may step in and adjust the currency’s value. In a devaluation, a nation lowers the value of its currency relative to other currencies. This makes that country’s exports cheaper and should, in turn, help the balance of payments. In other cases, a country’s currency may be undervalued, giving its exports an unfair competitive advantage. Many people believe that China’s huge trade surplus with the United States is partially because China’s currency was undervalued. In 2017, the U.S. Department of Commerce issued a fact sheet detailing how it accused China of dumping steel on the U.S. market as well as providing financial assistance to Chinese companies to produce, manufacture, and export stainless steel to the United States from the People’s Republic of China. ### Summary of Learning Outcomes 1. Why is global trade important to the United States, and how is it measured? International trade improves relations with friends and allies, eases tensions among nations, helps bolster economies, raises people’s standard of living, and improves the quality of life. The United States is still the largest importer and exporter in the world. We export a fifth of our industrial production and about a third of our farm crops. Two concepts important to global trade are the balance of trade (the difference in value between a country’s exports and its imports over some period) and the balance of payments (the difference between a country’s total payments to other countries and its total receipts from other countries). The United States now has both a negative balance of trade and a negative balance of payments. Another important concept is the exchange rate, which is the price of one country’s currency in terms of another country’s currency. Currencies float up and down based upon the supply of and demand for each currency. Sometimes a government steps in and devalues its currency relative to the currencies of other countries.

# Competing in the Global Marketplace ## Why Nations Trade 1. Why do nations trade? One might argue that the best way to protect workers and the domestic economy is to stop trade with other nations. Then the whole circular flow of inputs and outputs would stay within our borders. But if we decided to do that, how would we get resources like cobalt and coffee beans? The United States simply can’t produce some things, and it can’t manufacture some products, such as steel and most clothing, at the low costs we’re used to. The fact is that nations—like people—are good at producing different things: you may be better at balancing a ledger than repairing a car. In that case you benefit by “exporting” your bookkeeping services and “importing” the car repairs you need from a good mechanic. Economists refer to specialization like this as advantage. ### Absolute Advantage A country has an absolute advantage when it can produce and sell a product at a lower cost than any other country or when it is the only country that can provide a product. The United States, for example, has an absolute advantage in reusable spacecraft and other high-tech items. Suppose that the United States has an absolute advantage in air traffic control systems for busy airports and that Brazil has an absolute advantage in coffee. The United States does not have the proper climate for growing coffee, and Brazil lacks the technology to develop air traffic control systems. Both countries would gain by exchanging air traffic control systems for coffee. ### Comparative Advantage Even if the United States had an absolute advantage in both coffee and air traffic control systems, it should still specialize and engage in trade. Why? The reason is the principle of comparative advantage, which says that each country should specialize in the products that it can produce most readily and cheaply and trade those products for goods that foreign countries can produce most readily and cheaply. This specialization ensures greater product availability and lower prices. For example, India and Vietnam have a comparative advantage in producing clothing because of lower labor costs. Japan has long held a comparative advantage in consumer electronics because of technological expertise. The United States has an advantage in computer software, airplanes, some agricultural products, heavy machinery, and jet engines. Thus, comparative advantage acts as a stimulus to trade. When nations allow their citizens to trade whatever goods and services they choose without government regulation, free trade exists. Free trade is the policy of permitting the people and businesses of a country to buy and sell where they please without restrictions. The opposite of free trade is protectionism, in which a nation protects its home industries from outside competition by establishing artificial barriers such as tariffs and quotas. In the next section, we’ll look at the various barriers, some natural and some created by governments, that restrict free trade. ### The Fear of Trade and Globalization The continued protests during meetings of the World Trade Organization and the protests during the convocations of the World Bank and the International Monetary Fund (the three organizations are discussed later in the chapter) show that many people fear world trade and globalization. What do they fear? The negatives of global trade are as follows: 1. Millions of Americans have lost jobs due to imports or production shifting abroad. Most find new jobs, but often those jobs pay less. 2. Millions of others fear losing their jobs, especially at those companies operating under competitive pressure. 3. Employers often threaten to export jobs if workers do not accept pay cuts. 4. Service and white-collar jobs are increasingly vulnerable to operations moving offshore. Sending domestic jobs to another country is called outsourcing, a topic you can explore in more depth. Many U.S. companies, such as Dell, IBM, and AT&T, have set up call service centers in India, the Philippines, and other countries. Now even engineering and research and development jobs are being outsourced. Outsourcing and “American jobs” were a big part of the 2016 presidential election with Carrier’s plan to close a plant in Indianapolis and open a new plant in Mexico. While intervention by President Trump did lead to 800 jobs remaining in Indianapolis, Carrier later informed the state of Indiana that it would cut 632 workers from its Indianapolis factory. The manufacturing jobs will move to Monterrey, Mexico, where the minimum wage is $3.90 per day. So is outsourcing good or bad? If you happen to lose your job, it’s obviously bad for you. However, some economists say it leads to cheaper goods and services for U.S. consumers because costs are lower. Also, it should stimulate exports to fast-growing countries. No one knows how many jobs will be lost to outsourcing in coming years. According to estimates, almost 2.4 million U.S. jobs were outsourced in 2015. ### Benefits of Globalization A closer look reveals that globalization has been the engine that creates jobs and wealth. Benefits of global trade include the following: 1. Productivity grows more quickly when countries produce goods and services in which they have a comparative advantage. Living standards can increase faster. One problem is that big G20 countries have added more than 1,200 restrictive export and import measures since 2008. 2. Global competition and cheap imports keep prices down, so inflation is less likely to stop economic growth. However, in some cases this is not working because countries manipulate their currency to get a price advantage. 3. An open economy spurs innovation with fresh ideas from abroad. 4. Through infusion of foreign capital and technology, global trade provides poor countries with the chance to develop economically by spreading prosperity. 5. More information is shared between two trading partners that may not have much in common initially, including insight into local cultures and customs, which may help the two nations expand their collective knowledge and learn ways to compete globally. ### Summary of Learning Outcomes 1. Why do nations trade? Nations trade because they gain by doing so. The principle of comparative advantage states that each country should specialize in the goods it can produce most readily and cheaply and trade them for those that other countries can produce most readily and cheaply. The result is more goods at lower prices than if each country produced by itself everything it needed. Free trade allows trade among nations without government restrictions.

# Competing in the Global Marketplace ## Barriers to Trade 1. What are the barriers to international trade? International trade is carried out by both businesses and governments—as long as no one puts up trade barriers. In general, trade barriers keep firms from selling to one another in foreign markets. The major obstacles to international trade are natural barriers, tariff barriers, and nontariff barriers. ### Natural Barriers Natural barriers to trade can be either physical or cultural. For instance, even though raising beef in the relative warmth of Argentina may cost less than raising beef in the bitter cold of Siberia, the cost of shipping the beef from South America to Siberia might drive the price too high. Distance is thus one of the natural barriers to international trade. Language is another natural trade barrier. People who can’t communicate effectively may not be able to negotiate trade agreements or may ship the wrong goods. ### Tariff Barriers A tariff is a tax imposed by a nation on imported goods. It may be a charge per unit, such as per barrel of oil or per new car; it may be a percentage of the value of the goods, such as 5 percent of a $500,000 shipment of shoes; or it may be a combination. No matter how it is assessed, any tariff makes imported goods more costly, so they are less able to compete with domestic products. Protective tariffs make imported products less attractive to buyers than domestic products. The United States, for instance, has protective tariffs on imported poultry, textiles, sugar, and some types of steel and clothing, and in March of 2018 the Trump administration added tariffs on steel and aluminum from most countries. On the other side of the world, Japan imposes a tariff on U.S. cigarettes that makes them cost 60 percent more than Japanese brands. U.S. tobacco firms believe they could get as much as a third of the Japanese market if there were no tariffs on cigarettes. With tariffs, they have under 2 percent of the market. ### Arguments for and against Tariffs Congress has debated the issue of tariffs since 1789. The main arguments for tariffs include the following: 1. Tariffs protect infant industries. A tariff can give a struggling new domestic industry time to become an effective global competitor. 2. Tariffs protect U.S. jobs. Unions and others say tariffs keep foreign labor from taking away U.S. jobs. 3. Tariffs aid in military preparedness. Tariffs should protect industries and technology during peacetime that are vital to the military in the event of war. The main arguments against tariffs include the following: 1. Tariffs discourage free trade, and free trade lets the principle of competitive advantage work most efficiently. 2. Tariffs raise prices, thereby decreasing consumers’ purchasing power. In 2017, the United States imposed tariffs of 63.86 percent to 190.71 percent on a wide variety of Chinese steel products. The idea was to give U.S. steel manufacturers a fair market after the Department of Commerce concluded their antidumping and anti-subsidy probes. It is still too early to determine what the effects of these tariffs will be, but higher steel prices are likely. Heavy users of steel, such as construction and automobile industries, will see big increases in their production costs. It is also likely that China may impose tariffs on certain U.S. products and services and that any negotiations on intellectual property and piracy will bog down. ### Nontariff Barriers Governments also use other tools besides tariffs to restrict trade. One type of nontariff barrier is the import quota, or limits on the quantity of a certain good that can be imported. The goal of setting quotas is to limit imports to the specific amount of a given product. The United States protects its shrinking textile industry with quotas. A complete list of the commodities and products subject to import quotas is available on line at the U.S. Customs and Border Protection Agency website. A complete ban against importing or exporting a product is an embargo. Often embargoes are set up for defense purposes. For instance, the United States does not allow various high-tech products, such as supercomputers and lasers, to be exported to countries that are not allies. Although this embargo costs U.S. firms billions of dollars each year in lost sales, it keeps enemies from using the latest technology in their military hardware. Government rules that give special privileges to domestic manufacturers and retailers are called buy-national regulations. One such regulation in the United States bans the use of foreign steel in constructing U.S. highways. Many state governments have buy-national rules for supplies and services. In a more subtle move, a country may make it hard for foreign products to enter its markets by establishing customs regulations that are different from generally accepted international standards, such as requiring bottles to be quart size rather than liter size. Exchange controls are laws that require a company earning foreign exchange (foreign currency) from its exports to sell the foreign exchange to a control agency, usually a central bank. For example, assume that Rolex, a Swiss company, sells 300 watches to Zales Jewelers, a U.S. chain, for US$600,000. If Switzerland had exchange controls, Rolex would have to sell its U.S. dollars to the Swiss central bank and would receive Swiss francs. If Rolex wants to buy goods (supplies to make watches) from abroad, it must go to the central bank and buy foreign exchange (currency). By controlling the amount of foreign exchange sold to companies, the government controls the amount of products that can be imported. Limiting imports and encouraging exports helps a government to create a favorable balance of trade. ### Summary of Learning Outcomes 1. What are the barriers to international trade? The three major barriers to international trade are natural barriers, such as distance and language; tariff barriers, or taxes on imported goods; and nontariff barriers. The nontariff barriers to trade include import quotas, embargoes, buy-national regulations, and exchange controls. The main argument against tariffs is that they discourage free trade and keep the principle of comparative advantage from working efficiently. The main argument for using tariffs is that they help protect domestic companies, industries, and workers.

# Competing in the Global Marketplace ## Fostering Global Trade 1. How do governments and institutions foster world trade? ### Antidumping Laws U.S. firms don’t always get to compete on an equal basis with foreign firms in international trade. To level the playing field, Congress has passed antidumping laws. Dumping is the practice of charging a lower price for a product (perhaps below cost) in foreign markets than in the firm’s home market. The company might be trying to win foreign customers, or it might be seeking to get rid of surplus goods. When the variation in price can’t be explained by differences in the cost of serving the two markets, dumping is suspected. Most industrialized countries have antidumping regulations. They are especially concerned about predatory dumping, the attempt to gain control of a foreign market by destroying competitors with impossibly low prices. The United States recently imposed tariffs on softwood lumber from Canada. Canada was found guilty of pricing softwood lumber at between 7.72 and 4.49 percent below their costs. U.S. customs officers will now levy tariffs on Canadian timber exports with tax rates from 17.41 percent to 30.88 percent, depending on the business. From our discussion so far, it might seem that governments act only to restrain global trade. On the contrary, governments and international financial organizations work hard to increase it, as this section explains. ### Trade Negotiations and the World Trade Organization The Uruguay Round of trade negotiations is an agreement that dramatically lowers trade barriers worldwide. Adopted in 1994, the agreement has been now signed by 148 nations. The most ambitious global trade agreement ever negotiated, the Uruguay Round reduced tariffs by one-third worldwide, a move that is expected to increase global income by $235 billion annually. Perhaps the most notable aspect of the agreement is its recognition of new global realities. For the first time, an agreement covers services, intellectual property rights, and trade-related investment measures such as exchange controls. As a follow-up to the Uruguay Round, a negotiating round started in the capital of Qatar in 2001 is called the Doha Round. To date, the round has shown little progress in advancing free trade. Developing nations are pushing for the reduction of farm subsidies in the United States, Europe, and Japan. Poor countries say that the subsidies stimulate overproduction, which drives down global agricultural prices. Because developing nations’ primary exports are agricultural commodities, low prices mean that they cannot compete in the global marketplace. On the other hand, the United States and Europe are interested in bringing down trade barriers in services and manufacturing. The continuing talks have served as a lightning rod for protesters, who claim that the World Trade Organization (WTO) serves the interests of multinational corporations, promotes trade over preserving the environment, and treats poor nations unfairly. The World Trade Organization replaces the old General Agreement on Tariffs and Trade (GATT), which was created in 1948. The GATT contained extensive loopholes that enabled countries to evade agreements to reduce trade barriers. Today, all WTO members must fully comply with all agreements under the Uruguay Round. The WTO also has an effective dispute settlement procedure with strict time limits to resolve disputes. The WTO has emerged as the world’s most powerful institution for reducing trade barriers and opening markets. The advantage of WTO membership is that member countries lower trade barriers among themselves. Countries that don’t belong must negotiate trade agreements individually with all their trading partners. Only a few countries, such as North Korea, Turkmenistan, and Eritrea, are not members of the WTO. The United States has had mixed results in bringing disputes before the WTO. To date, it has won slightly fewer than half of the cases it has presented to the WTO. America has also won about one-third of the cases brought against it by other countries. One of America’s recent losses came in a ruling where the U.S. claimed that tuna imported from Mexico was not meeting the “dolphin safe” criteria, meaning that dolphins were not being killed during the process to catching tuna. The WTO ruled in favor of Mexico. Recently, the United States targeted Europe, India, South Korea, Canada, and Argentina to file cases against. The disputes ranged from European aviation practices to Indian trade barriers affecting U.S. automakers. One of the biggest disputes before the WTO involved the United States and the European Union. The United States claims that Europe has given Airbus $15 billion in aid to develop airplanes. The European Union claims that the U.S. government has provided $23 billion in military research that has benefited Boeing’s commercial aircraft business. It also claimed that Washington State (the home of Boeing manufacturing) has given the company $3.2 billion in unfair tax breaks. ### The World Bank and International Monetary Fund Two international financial organizations are instrumental in fostering global trade. The World Bank offers low-interest loans to developing nations. Originally, the purpose of the loans was to help these nations build infrastructure such as roads, power plants, schools, drainage projects, and hospitals. Now the World Bank offers loans to help developing nations relieve their debt burdens. To receive the loans, countries must pledge to lower trade barriers and aid private enterprise. In addition to making loans, the World Bank is a major source of advice and information for developing nations. The United States has granted the organization millions to create knowledge databases on nutrition, birth control, software engineering, creating quality products, and basic accounting systems. The International Monetary Fund (IMF) was founded in 1945, one year after the creation of the World Bank, to promote trade through financial cooperation and eliminate trade barriers in the process. The IMF makes short-term loans to member nations that are unable to meet their budgetary expenses. It operates as a lender of last resort for troubled nations. In exchange for these emergency loans, IMF lenders frequently extract significant commitments from the borrowing nations to address the problems that led to the crises. These steps may include curtailing imports or even devaluing the currency. Some global financial problems do not have a simple solution. One option would be to pump a lot more funds into the IMF, giving it enough resources to bail out troubled countries and put them back on their feet. In effect, the IMF would be turned into a real lender of last resort for the world economy. The danger of counting on the IMF, though, is the “moral hazard” problem. Investors would assume that the IMF would bail them out and would therefore be encouraged to take bigger and bigger risks in emerging markets, leading to the possibility of even deeper financial crises in the future. ### Summary of Learning Outcomes 1. How do governments and institutions foster world trade? The World Trade Organization, established by the Uruguay Round of trade negotiations, has dramatically lowered trade barriers worldwide. For the first time, a trade agreement covers services, intellectual property rights, and exchange controls. The World Bank makes loans to developing nations to help build infrastructures. The International Monetary Fund makes loans to member nations that cannot meet their budgetary expenses. Despite efforts to expand trade, terrorism can have a negative impact on trade growth.

# Competing in the Global Marketplace ## International Economic Communities 1. What are international economic communities? Nations that frequently trade with each other may decide to formalize their relationship. The governments meet and work out agreements for a common economic policy. The result is an economic community or, in other cases, a bilateral trade agreement (an agreement between two countries to lower trade barriers). For example, two nations may agree upon a preferential tariff, which gives advantages to one nation (or several nations) over others. When members of the British Commonwealth (countries that are former British territories) trade with Great Britain, they pay lower tariffs than do other nations. For example, Canada and Australia are former British territories but still members of the British Commonwealth. You will note that Queen Elizabeth still appears on Canadian currency and the Union Jack is still incorporated into the Australian flag. In other cases, nations may form free-trade associations. In a free-trade zone, few duties or rules restrict trade among the partners, but nations outside the zone must pay the tariffs set by the individual members. ### North American Free Trade Agreement (NAFTA) The North American Free Trade Agreement (NAFTA) created the world’s largest free-trade zone. The agreement was ratified by the U.S. Congress in 1993. It includes Canada, the United States, and Mexico, with a combined population of 450 million and an economy of over $20.8 trillion. NAFTA has since been modified by the U.S.-Mexico-Canada Agreement (USMCA). The USMCA was largely accepted and entered into force on July 1, 2020. Canada, one of the largest U.S. trading partners, entered a free-trade agreement with the United States in 1988. Thus, most of the new long-run opportunities opened for U.S. business under NAFTA are in Mexico, America’s third-largest trading partner. Before NAFTA, tariffs on Mexican exports to the United States averaged just 4 percent, and most goods entered the United States duty-free, so NAFTA’s primary impact was to open the Mexican market to U.S. companies. When the treaty went into effect, tariffs on about half the items traded across the Rio Grande disappeared. Since NAFTA came into effect, U.S.-Mexican trade has increased from $80 billion to $515 billion annually. The pact removed a web of Mexican licensing requirements, quotas, and tariffs that limited transactions in U.S. goods and services. For instance, the pact allows U.S. and Canadian financial-services companies to own subsidiaries in Mexico for the first time in 50 years. The real test of NAFTA and now USMCA will be whether it can deliver rising prosperity on both sides of the Rio Grande. For Mexicans, NAFTA must provide rising wages, better benefits, and an expanding middle class with enough purchasing power to keep buying goods from the United States and Canada. That scenario seems to be working. At the Delphi Corp. auto parts plant in Ciudad Juárez, just across the border from El Paso, Texas, the assembly line is a cross section of working-class Mexico. In the years since NAFTA lowered trade and investment barriers, Delphi has significantly expanded its presence in the country. Today it employs 70,000 Mexicans, who every day receive up to 70 million U.S.-made components to assemble into parts. The wages are modest by U.S. standards—an assembly-line worker with two years’ experience earns about $2.30 an hour. But that’s triple Mexico’s minimum wage, and Delphi jobs are among the most coveted in Juárez. The United States recently notified the Canadian and Mexican governments that it intends to renegotiate aspects of the NAFTA agreement. One of the largest new trade agreement is Mercosur, which includes Peru, Brazil, Argentina, Uruguay, and Paraguay. The elimination of most tariffs among the trading partners has resulted in trade revenues that currently exceed $16 billion annually. Recent recessions in Mercosur countries have limited economic growth, even though trade among Mercosur countries has continued to grow. Most recently, the largest new trade agreement is the Regional Comprehensive Economic Partnership (RCEP). This trade agreement includes fifteen (15) Asian States and signals to investors that the region is still committed to multilateral trade integration. One item that is most notable about this trade agreement is that the U.S. is not a member. ### Central America Free Trade Agreement The newest free trade agreement is the Central America Free Trade Agreement (CAFTA) passed in 2005. Besides the United States, the agreement includes Costa Rica, the Dominican Republic, El Salvador, Guatemala, Honduras, and Nicaragua. The United States is already the principal exporter to these nations, so economists don’t think that it will result in a major increase in U.S. exports. It will, however, reduce tariffs on exports to CAFTA countries. Already, some 80 percent of the goods imported into the United States from CAFTA nations are tariff-free. CAFTA countries may benefit from the new permanent trade deal if U.S. multinational firms deepen their investment in the region. ### The European Union In 1993, the member countries of the European Community (EC) ratified the Maastricht Treaty, which proposed to take the EC further toward economic, monetary, and political union. Although the heart of the treaty deals with developing a unified European Market, Maastricht was also intended to increase integration among European Union (EU) members. The EU has helped increase this integration by creating a borderless economy for the 28 European nations, shown on the map in . European Union member states have set up common institutions to which they delegate some of their sovereignty so that decisions on specific matters of joint interest can be made democratically at the European level. This pooling of sovereignty is also called European integration. In 2016, citizens of the United Kingdom voted to leave the European Union, a plan known as Brexit, which could take several years to occur. One of the principal objectives of the European Union is to promote economic progress of all member countries. The EU has stimulated economic progress by eliminating trade barriers, differences in tax laws, and differences in product standards, and by establishing a common currency. A new European Community Bank was created, along with a common currency called the euro. The European Union’s single market has created 2.5 million new jobs since it was founded and generated more than $1 trillion in new wealth. The opening of national EU markets has brought down the price of national telephone calls by 50 percent since 1998. Under pressure of competition, the prices of airfares in Europe have fallen significantly. The removal of national restrictions has enabled more than 15 million Europeans to go to another EU country to work or spend their retirement. The EU is a very tough antitrust enforcer; some would say it is tougher than the United States. The EU, for example, fined Google $2.7 billion for favoring some of its own services in its search results. Unlike in the United States, the EU can seal off corporate offices for unspecified periods to prevent destruction of evidence and enter the homes, cars, yachts, and other personal property of executives suspected of abusing their companies’ market power or conspiring to fix prices. Microsoft has been fighting the European Court since 2002, with no quick end in sight. The Court fined Microsoft for monopolizing internet access by offering Internet Explorer with its Windows software. The company is also appealing a Court decision requiring it to share code with “open source” companies. Another big U.S. company, Coca-Cola, settled a six-year antitrust dispute with the European Court by agreeing to strict limits on its sales tactics. Coke can’t sign exclusive agreements with retailers that would ban competing soft drinks or give retailers rebates based on sales volume. Furthermore, it must give rivals, like Pepsi, 20 percent of the space in Coke coolers so Pepsi can stock its own brands. If Coke violates the terms of the agreement, it will be fined 10 percent of its worldwide revenue (over $2 billion). An entirely different type of problem facing global businesses is the possibility of a protectionist movement by the EU against outsiders. For example, European automakers have proposed holding Japanese imports at roughly their current 10 percent market share. The Irish, Danes, and Dutch don’t make cars and have unrestricted home markets; they are unhappy at the prospect of limited imports of Toyotas and Hondas. Meanwhile, France has a strict quota on Japanese cars to protect its own Renault and Peugeot. These local automakers could be hurt if the quota is raised at all. Interestingly, a number of big U.S. companies are already considered more “European” than many European companies. Coke and Kellogg’s are considered classic European brand names. Ford and General Motors compete for the largest share of auto sales on the continent. Apple, IBM, and Dell dominate their markets. General Electric, AT&T, and Westinghouse are already strong all over Europe and have invested heavily in new manufacturing facilities there. The European Union proposed a constitution that would centralize powers at the Union level and decrease the powers of individual member countries. It also would create a single voice in world affairs by creating a post of foreign minister. The constitution also gave the EU control over political asylum, immigration, guaranteed freedom of speech, and collective labor bargaining. In order to become law, each EU country had to ratify the constitution. The two most powerful countries in the EU, France and Germany, voted “no” in the summer of 2005. Citizens of both countries were afraid that the constitution would draw jobs away from Western Europe and to the Eastern European EU countries. These new members of the EU have lower wage rates and fewer regulations. Voters were also worried that the constitution would result in free-market reforms along American or British lines over France and Germany’s traditional social protections. Concerns over immigration also sparked the referendum vote that is leading to the United Kingdom leaving the European Union. ### Summary of Learning Outcomes 1. What are international economic communities? International economic communities reduce trade barriers among themselves while often establishing common tariffs and other trade barriers toward nonmember countries. The best-known economic communities are the European Union, NAFTA, CAFTA, and Mercosur.

# Competing in the Global Marketplace ## Participating in the Global Marketplace 1. How do companies enter the global marketplace? Companies decide to “go global” for a number of reasons. Perhaps the most urgent reason is to earn additional profits. If a firm has a unique product or technological advantage not available to other international competitors, this advantage should result in major business successes abroad. In other situations, management may have exclusive market information about foreign customers, marketplaces, or market situations. In this case, although exclusivity can provide an initial motivation for going global, managers must realize that competitors will eventually catch up. Finally, saturated domestic markets, excess capacity, and potential for cost savings can also be motivators to expand into international markets. A company can enter global trade in several ways, as this section describes. ### Exporting When a company decides to enter the global market, usually the least complicated and least risky alternative is exporting, or selling domestically produced products to buyers in another country. A company, for example, can sell directly to foreign importers or buyers. Exporting is not limited to huge corporations such as General Motors or Apple. Indeed, small companies typically enter the global marketplace by exporting. China is the world’s largest exporter, followed by the United States. Many small businesses claim that they lack the money, time, or knowledge of foreign markets that exporting requires. The U.S. Small Business Administration (SBA) now offers the Export Working Capital Program, which helps small and medium-size firms obtain working capital (money) to complete export sales. The SBA also provides counseling and legal assistance for small businesses that wish to enter the global marketplace. Companies such as American Building Restoration Products of Franklin, Wisconsin, have benefited tremendously from becoming exporters. American Building is now selling its chemical products to building restoration companies in Mexico, Israel, Japan, and Korea. Exports account for more than 5 percent of the firm’s total sales. Plenty of governmental help is available when a company decides to begin exporting. Export Assistance Centers (EAC) provide a one-stop resource for help in exporting. Over 700 EACs are placed strategically around the country. Often the SBA is located in the same building as the EAC. The SBA can guarantee loans of $50,000 to $100,000 to help an exporter grow its business. Online help is also available at http://www.ustr.gov. The site lists international trade events, offers international marketing research, and has practical tools to help with every step of the exporting process. Companies considering exporting for the first time can go to http://www.export.gov and get answers to questions such as: What’s in it for me? Am I ready for this? What do I have to do? The site also provides a huge list of resources for the first-time exporter. ### Licensing and Franchising Another effective way for a firm to move into the global arena with relatively little risk is to sell a license to manufacture its product to a firm in a foreign country. Licensing is the legal process whereby a firm (the licensor) agrees to let another firm (the licensee) use a manufacturing process, trademark, patent, trade secret, or other proprietary knowledge. The licensee, in turn, agrees to pay the licensor a royalty or fee agreed on by both parties. International licensing is a multibillion-dollar-a-year industry. Entertainment and character licensing, such as DVD movies and characters such as Batman, is the largest single category. Trademarks are the second-largest source of licensing revenue. Caterpillar licenses its brand for both shoes and clothing, which is very popular in Europe. U.S. companies have eagerly embraced the licensing concept. For instance, Labatt Brewing Company has a license to produce Miller High Life in Canada. The Spalding Company receives more than $2 million annually from license agreements on its sporting goods. Fruit of the Loom lends its name through licensing to 45 consumer items in Japan alone, for at least 1 percent of the licensee’s gross sales. The licensor must make sure it can exercise sufficient control over the licensee’s activities to ensure proper quality, pricing, distribution, and so on. Licensing may also create a new competitor in the long run if the licensee decides to void the license agreement. International law is often ineffective in stopping such actions. Two common ways that a licensor can maintain effective control over its licensees are by shipping one or more critical components from the United States and by locally registering patents and trademarks in its own name. Franchising is a form of licensing that has grown rapidly in recent years. Many U.S. franchisors operate thousands of outlets in foreign countries. More than half of the international franchises are for fast-food restaurants and business services. McDonald’s, however, decided to sell its Chinese stores to a group of outside investors for $1.8 billion, but retained 20 percent of the equity. Having a big-name franchise doesn’t always guarantee success or mean that the job will be easy. In China, Home Depot closed its stores after opening 12 to serve the large Chinese population. Had they done market research, they would have known that the majority of urban dwellers live in recently built apartments and that DIY (Do It Yourself) is viewed with disdain in Chinese society, where it is seen as a sign of poverty. When Subway opened its first sandwich shop in China, locals stood outside and watched for a few days. Patrons were so confused that the franchisee had to print signs explaining how to order. Customers didn’t believe the tuna salad was made from a fish because they couldn’t see the head or tail. And they didn’t like the idea of touching their food, so they would hold the sandwich vertically, peel off the paper wrap, and eat it like a banana. Most of all, the Chinese customers didn’t want sandwiches. It’s not unusual for Western food chains to adapt their strategies when selling in China. McDonald’s, aware that the Chinese consume more chicken than beef, offered a spicy chicken burger. KFC got rid of coleslaw in favor of seasonal dishes such as shredded carrots or bamboo shoots. ### Contract Manufacturing In contract manufacturing, a foreign firm manufactures private-label goods under a domestic firm’s brand. Marketing may be handled by either the domestic company or the foreign manufacturer. Levi Strauss, for instance, entered into an agreement with the French fashion house of Cacharel to produce a new Levi’s line, Something New, for distribution in Germany. The advantage of contract manufacturing is that it lets a company test the water in a foreign country. By allowing the foreign firm to produce a certain volume of products to specification and put the domestic firm’s brand name on the goods, the domestic firm can broaden its global marketing base without investing in overseas plants and equipment. After establishing a solid base, the domestic firm may switch to a joint venture or direct investment, explained below. ### Joint Ventures Joint ventures are somewhat similar to licensing agreements. In a joint venture, the domestic firm buys part of a foreign company or joins with a foreign company to create a new entity. A joint venture is a quick and relatively inexpensive way to enter the global market. It can also be very risky. Many joint ventures fail. Others fall victim to a takeover, in which one partner buys out the other. Sometimes countries have required local partners in order to establish a business in their country. China, for example, had this requirement in a number of industries until recently. Thus, a joint venture was the only way to enter the market. Joint ventures help reduce risks by sharing costs and technology. Often joint ventures will bring together different strengths from each member. In the General Motors-Suzuki joint venture in Canada, for example, both parties have contributed and gained. The alliance, CAMI Automotive, was formed to manufacture low-end cars for the U.S. market. The plant, which was run by Suzuki management, produces the Chevrolet Equinox and the Pontiac Torrent, as well as the new Suzuki SUV. Through CAMI, Suzuki has gained access to GM’s dealer network and an expanded market for parts and components. GM avoided the cost of developing low-end cars and obtained models it needed to revitalize the lower end of its product line and its average fuel economy rating. After the successful joint venture, General Motors gained full control of the operation in 2011. The CAMI factory may be one of the most productive plants in North America. There GM has learned how Japanese automakers use work teams, run flexible assembly lines, and manage quality control. ### Direct Foreign Investment Active ownership of a foreign company or of overseas manufacturing or marketing facilities is direct foreign investment. Direct investors have either a controlling interest or a large minority interest in the firm. Thus, they stand to receive the greatest potential reward but also face the greatest potential risk. A firm may make a direct foreign investment by acquiring an interest in an existing company or by building new facilities. It might do so because it has trouble transferring some resources to a foreign operation or obtaining that resource locally. One important resource is personnel, especially managers. If the local labor market is tight, the firm may buy an entire foreign firm and retain all its employees instead of paying higher salaries than competitors. Sometimes firms make direct investments because they can find no suitable local partners. Also, direct investments avoid the communication problems and conflicts of interest that can arise with joint ventures. IBM, in the past, insisted on total ownership of its foreign investments because it did not want to share control with local partners. General Motors has done very well by building a $4,400 (RMB 29,800) minivan in China that gets 43 miles per gallon in city driving. The Wuling Sunshine has a quarter the horsepower of U.S. minivans, weak acceleration, and a top speed of 81 miles per hour. The seats are only a third of the thickness of seats in Western models, but look plush compared to similar Chinese cars. The minivans have made GM the largest automotive seller in China, and have made China a large profit center for GM. Walmart now has over 6,000 stores located outside the United States. In 2016, international sales were over $116 billion. About one-third of all new Walmart stores are opened in global markets. Not all of Walmart’s global investments have been successful. In Germany, Walmart bought the 21-store Wertkauf hypermarket chain and then 74 unprofitable and often decrepit Interspar stores. Problems in integrating and upgrading the stores resulted in at least $200 million in losses. Like all other German stores, Walmart stores were required by law to close at 8 p.m. on weekdays and 4 p.m. on Saturdays, and they could not open at all on Sundays. Costs were astronomical. As a result, Walmart left the German retail market. Walmart has turned the corner on its international operations. It is pushing operational authority down to country managers in order to respond better to local cultures. Walmart enforces certain core principles such as everyday low prices, but country managers handle their own buying, logistics, building design, and other operational decisions. Global firms change their strategies as local market conditions evolve. For example, major oil companies like Shell Oil and ExxonMobil had to react to dramatic changes in the price of oil due to technological advances such as more efficient automobiles, fracking, and horizontal drilling. ### Countertrade International trade does not always involve cash. Today, countertrade is a fast-growing way to conduct international business. In countertrade, part or all of the payment for goods or services is in the form of other goods or services. Countertrade is a form of barter (swapping goods for goods), an age-old practice whose origins have been traced back to cave dwellers. The U.S. Commerce Department says that roughly 30 percent of all international trade involves countertrade. Each year, about 300,000 U.S. firms engage in some form of countertrade. U.S. companies, including General Electric, Pepsi, General Motors, and Boeing, barter billions of goods and services every year. Recently, the Malaysian government bought 20 diesel-powered locomotives from China and paid for them with palm oil. ### Summary of Learning Outcomes 1. How do companies enter the global marketplace? There are a number of ways to enter the global market. The major ones are exporting, licensing, contract manufacturing, joint ventures, and direct investment.

# Competing in the Global Marketplace ## Threats and Opportunities in the Global Marketplace 1. What threats and opportunities exist in the global marketplace? To be successful in a foreign market, companies must fully understand the foreign environment in which they plan to operate. Politics, cultural differences, and the economic environment can represent both opportunities and pitfalls in the global marketplace. ### Political Considerations We have already discussed how tariffs, exchange controls, and other governmental actions threaten foreign producers. The political structure of a country may also jeopardize a foreign producer’s success in international trade. Intense nationalism, for example, can lead to difficulties. Nationalism is the sense of national consciousness that boosts the culture and interests of one country over those of all other countries. Strongly nationalistic countries, such as Iran and New Guinea, often discourage investment by foreign companies. In other, less radical forms of nationalism, the government may take actions to hinder foreign operations. France, for example, requires pop music stations to play at least 40 percent of their songs in French. This law was enacted because the French love American rock and roll. Without airtime, American music sales suffer. In another example of nationalism, U.S.-based PPG made an unsolicited bid to acquire Netherlands-based AzkoNobel NV. There was a chorus of opposition from Dutch politicians to the idea of a foreign takeover of AzkoNobel, the Dutch paint manufacturer. The government warned that it would move to defend AzkoNobel from a hostile takeover attempt. AzkoNobel played up the sentiment, tweeting about its rejection of the hostile takeover with the hashtag #DutchPride. In a hostile climate, a government may expropriate a foreign company’s assets, taking ownership and compensating the former owners. Even worse is confiscation, when the owner receives no compensation. This happened during rebellions in several African nations during the 1990s and 2000s. ### Cultural Differences Central to any society is the common set of values shared by its citizens that determine what is socially acceptable. Culture underlies the family, educational system, religion, and social class system. The network of social organizations generates overlapping roles and status positions. These values and roles have a tremendous effect on people’s preferences and thus on marketers’ options. For example, in China Walmart holds live fishing contests on the premises, and in South Korea the company hosts a food competition with variations on a popular Korean dish, kimchee. Language is another important aspect of culture. Marketers must take care in selecting product names and translating slogans and promotional messages so as not to convey the wrong meaning. For example, Mitsubishi Motors had to rename its Pajero model in Spanish-speaking countries because the term refers to a sexual activity. Toyota Motor’s MR2 model dropped the 2 in France because the combination sounds like a French swear word. The literal translation of Coca-Cola in Chinese characters means “bite the wax tadpole.” Each country has its own customs and traditions that determine business practices and influence negotiations with foreign customers. For example, attempting to do business in Western Europe during the first two weeks in August is virtually impossible. Businesses close, and everyone goes on vacation at the same time. In many countries, personal relationships are more important than financial considerations. For instance, skipping social engagements in Mexico may lead to lost sales. Negotiations in Japan often include long evenings of dining, drinking, and entertaining; only after a close personal relationship has been formed do business negotiations begin. presents some cultural dos and don’ts. ### Economic Environment The level of economic development varies considerably, ranging from countries where everyday survival is a struggle, such as Sudan and Eritrea, to countries that are highly developed, such as Switzerland and Japan. In general, complex, sophisticated industries are found in developed countries, and more basic industries are found in less developed nations. Average family incomes are higher in the more developed countries than in the least-developed markets. Larger incomes mean greater purchasing power and demand, not only for consumer goods and services but also for the machinery and workers required to produce consumer goods. provides a glimpse of global wealth. Business opportunities are usually better in countries that have an economic infrastructure in place. Infrastructure is the basic institutions and public facilities upon which an economy’s development depends. When we think about how our own economy works, we tend to take our infrastructure for granted. It includes the money and banking system that provide the major investment loans to our nation’s businesses; the educational system that turns out the incredible varieties of skills and basic research that actually run our nation’s production lines; the extensive transportation and communications systems—interstate highways, railroads, airports, canals, telephones, internet sites, postal systems, and television stations—that link almost every piece of our geography into one market; the energy system that powers our factories; and, of course, the market system itself, which brings our nation’s goods and services into our homes and businesses. ### Summary of Learning Outcomes 1. What threats and opportunities exist in the global marketplace? Domestic firms entering the international arena need to consider the politics, economies, and culture of the countries where they plan to do business. For example, government trade policies can be loose or restrictive, countries can be nationalistic, and governments can change. In the area of culture, many products fail because companies don’t understand the culture of the country where they are trying to sell their products. Some developing countries also lack an economic infrastructure, which often makes it very difficult to conduct business.

# Competing in the Global Marketplace ## The Impact of Multinational Corporations 1. What are the advantages of multinational corporations? Corporations that move resources, goods, services, and skills across national boundaries without regard to the country in which their headquarters are located are multinational corporations. Some are so rich and have so many employees that they resemble small countries. For example, the sales of both Exxon and Walmart are larger than the GDP of all but a few nations in the world. Multinational companies are heavily engaged in international trade. The successful ones take political and cultural differences into account. Many global brands sell much more outside the United States than at home. Coca-Cola, Philip Morris’s Marlboro brand, Pepsi, Kellogg, Pampers, Nescafe, and Gillette, are examples. The Fortune 500 made over $1.5 trillion in profit in 2016. In slow-growing, developed economies like Europe and Japan, a weaker dollar helps, because it means cheaper products to sell into those markets, and profits earned in those markets translate into more dollars back home. Meanwhile, emerging markets in Asia, Latin America, and Eastern Europe are growing steadily. General Electric expects 60 percent of its revenue growth to come from emerging markets over the next decade. For Brown-Forman, the spirits company, a fifth of its sales growth of Jack Daniels, the Tennessee whiskey, is coming from developing markets like Mexico and Poland. IBM had rapid sales growth in emerging markets such as Russia, India, and Brazil. The largest multinational corporations in the world are shown in . Despite the success of American multinationals abroad, there is some indication that preference for U.S. brands may be slipping. ### The Multinational Advantage Large multinationals have several advantages over other companies. For instance, multinationals can often overcome trade problems. Taiwan and South Korea have long had an embargo against Japanese cars for political reasons and to help domestic automakers. Yet Honda USA, a Japanese-owned company based in the United States, sends Accords to Taiwan and Korea. In another example, when the environmentally conscious Green movement challenged the biotechnology research conducted by BASF, a major German chemical and drug manufacturer, BASF moved its cancer and immune-system research to Cambridge, Massachusetts. Another advantage for multinationals is their ability to sidestep regulatory problems. U.S. drugmaker SmithKline and Britain’s Beecham decided to merge in part so that they could avoid licensing and regulatory hassles in their largest markets. The merged company can say it’s an insider in both Europe and the United States. “When we go to Brussels, we’re a member state [of the European Union],” one executive explains. “And when we go to Washington, we’re an American company.” Multinationals can also shift production from one plant to another as market conditions change. When European demand for a certain solvent declined, Dow Chemical instructed its German plant to switch to manufacturing a chemical that had been imported from Louisiana and Texas. Computer models help Dow make decisions like these so it can run its plants more efficiently and keep costs down. Multinationals can also tap new technology from around the world. In the United States, Xerox has introduced some 80 different office copiers that were designed and built by Fuji Xerox, its joint venture with a Japanese company. Versions of the super-concentrated detergent that Procter & Gamble first formulated in Japan in response to a rival’s product are now being sold under the Ariel brand name in Europe and under the Cheer and Tide labels in the United States. Also, consider Otis Elevator’s development of the Elevonic 411, an elevator that is programmed to send more cars to floors where demand is high. It was developed by six research centers in five countries. Otis’s group in Farmington, Connecticut, handled the systems integration, a Japanese group designed the special motor drives that make the elevators ride smoothly, a French group perfected the door systems, a German group handled the electronics, and a Spanish group took care of the small-geared components. Otis says the international effort saved more than $10 million in design costs and cut the process from four years to two. Finally, multinationals can often save a lot in labor costs, even in highly unionized countries. For example, when Xerox started moving copier-rebuilding work to Mexico to take advantage of the lower wages, its union in Rochester, New York, objected because it saw that members’ jobs were at risk. Eventually, the union agreed to change work styles and to improve productivity to keep the jobs at home. ### Summary of Learning Outcomes 1. What are the advantages of multinational corporations? Multinational corporations have several advantages. First, they can sidestep restrictive trade and licensing restrictions because they frequently have headquarters in more than one country. Multinationals can also move their operations from one country to the next depending on which location offers more favorable economic conditions. In addition, multinationals can tap into a vast source of technological expertise by drawing upon the knowledge of a global workforce.

# Competing in the Global Marketplace ## Trends in Global Competition 1. What are the trends in the global marketplace? In this section, we will examine several underlying trends that will continue to propel the dramatic growth in world trade. These trends are market expansion, resource acquisition, and the emergence of China and India. ### Market Expansion The need for businesses to expand their markets is perhaps the most fundamental reason for the growth in world trade. The limited size of domestic markets often motivates managers to seek markets beyond their national frontiers. The economies of large-scale manufacturing demand big markets. Domestic markets, particularly in smaller countries like Denmark and the Netherlands, simply can’t generate enough demand. Nestlé was one of the first businesses to “go global” because its home country, Switzerland, is so small. Nestlé was shipping milk to 16 different countries as early as 1875. Today, hundreds of thousands of businesses are recognizing the potential rich rewards to be found in international markets. ### Resource Acquisition More and more companies are going to the global marketplace to acquire the resources they need to operate efficiently. These resources may be cheap or skilled labor, scarce raw materials, technology, or capital. Nike, for example, has manufacturing facilities in many Asian countries in order to use cheaper labor. Honda opened a design studio in southern California to put that “California flair” into the design of some of its vehicles. Large multinational banks such as Bank of New York and Citigroup have offices in Geneva, Switzerland. Geneva is the private banking center of Europe and attracts capital from around the globe. ### The Emergence of China and India China and India—two of the world’s economic powerhouses—are impacting businesses around the globe, in very different ways. The boom in China’s worldwide exports has left few sectors unscathed, be they garlic growers in California, jeans makers in Mexico, or plastic-mold manufacturers in South Korea. India’s impact has altered how hundreds of service companies from Texas to Ireland compete for billions of dollars in contracts. The causes and consequences of each nation’s growth are somewhat different. China’s exports have boomed largely thanks to foreign investment: lured by low labor costs, big manufacturers have surged into China to expand their production base and push down prices globally. Now manufacturers of all sizes, making everything from windshield wipers to washing machines to clothing, are scrambling either to reduce costs at home or to outsource more of what they make in cheaper locales such as China and India. Indians are playing invaluable roles in the global innovation chain. Hewlett-Packard, Cisco Systems, and other tech giants now rely on their Indian teams to devise software platforms and multimedia features for next-generation devices. Google principal scientist Krishna Bharat set up the Google Bangalore lab complete with colorful furniture, exercise balls, and a Yamaha organ—like Google’s Mountain View, California, headquarters—to work on core search-engine technology. Indian engineering houses use 3-D computer simulations to tweak designs of everything from car engines and forklifts to aircraft wings for such clients as General Motors Corp. and Boeing Co. Barring unforeseen circumstances, within five years India should vault over Germany as the world’s fourth-biggest economy. By mid-century, China should overtake the United States as number one. By then, China and India could account for half of global output. An accelerating trend is that technical and managerial skills in both China and India are becoming more important than cheap assembly labor. China will stay dominant in mass manufacturing and is one of the few nations building multibillion-dollar electronics and heavy industrial plants. India is a rising power in software, design, services, and precision industry. ### Summary of Learning Outcomes 1. What are the trends in the global marketplace? Global business activity will continue to escalate due to several factors. Firms that desire a larger customer base or need additional resources will continue to seek opportunities outside their country’s borders. China and India are emerging as global economic powerhouses. ### Preparing for Tomorrow’s Workplace Skills 1. How can a country’s customs create barriers to trade? Ask foreign students to describe such barriers in their country. American students should give examples of problems that foreign businesspeople might experience with American customs. (Information) 2. Should the United Kingdom exit the European Union? Why might Britain not wish to exit? (Systems) 3. Do you think that CAFTA will have a major impact on the U.S. economy? Why? (Systems) 4. What do you think is the best way for a small company to enter international trade? Why? (Information) 5. How can the United States compete against China and India in the long run? (Information) 6. Identify some U.S. multinational companies that have been successful in world markets. How do you think they have achieved their success? (Information) 7. Team Activity Divide the class into teams. Each team should choose a country and research its infrastructure to determine how it will help or hinder trade. Include a variety of countries, ranging from the most highly developed to the least developed. (Resources, Interpersonal, Information, Technology) ### Ethics Activity The executives of a clothing manufacturer want to outsource some of their manufacturing to more cost-efficient locations in Indonesia. After visiting several possible sites, they choose one and begin to negotiate with local officials. They discover that it will take about six months to get the necessary permits. One of the local politicians approaches the executives over dinner and hints that he can speed up the process for an advisory fee of $5,000. Using a web search tool, locate articles about this topic, and then write responses to the following questions. Be sure to support your arguments and cite your sources. Ethical Dilemma: Is paying the advisory fee a bribe or an acceptable cost of doing business in that area of the world? What should the executives do before agreeing to pay the fee? Sources: Eric Markowitz, “The Truth about Bribery and Doing Foreign Business,” Inc., https://www.inc.com, accessed March 19, 2018; Roberto A. Ferdman, “How the World’s Biggest Companies Bribe Foreign Governments,” The Washington Post, https://www.washingtonpost.com, accessed March 19, 2018; David Rising, “The 10 Countries Most Likely to Use Bribery in Business,” Huffington Post, https://www.huffingtonpost.com, accessed March 19, 2018. ### Working the Net 1. Go to the Trade Compliance Center site at http://tcc.export.gov. Click on Foreign Trade Barrier Examples, and then search the reports. Pick a country that interests you from the index, and read the most current available reports for that country. Would this country be a good market for a small U.S. motor scooter manufacturer interested in expanding internationally? Why or why not? What are the main barriers to trade the company might face? 2. While still at the Trade Compliance Center site, http://tcc.export.gov, click on Trade Agreements and then List All Agreements. Select one that interests you, and summarize what you learn about it. 3. Review the historical data about exchange rates between the U.S. dollar and the Japanese yen available at http://www.x-rates.com. Pull up charts comparing the yen to the dollar for several years. List any trends you spot. What years would have been best for a U.S. company to enter the Japanese marketplace? Given current exchange rate conditions, do you think Japanese companies are increasing or decreasing their exporting efforts in the United States? 4. Visit Foreign Trade Online, http://www.foreign-trade.com, and browse through the resources of this international business-to-business trade portal. What types of information does the site provide? Which would be most useful to a company looking to begin exporting? To a company who already exports and wants to find new markets? Rate the usefulness of the site and the information it offers. 5. Go to http://www.fita.org, which is the Federation of International Trade Associations. Click on Really Useful Links for International Trade. Follow five of those links, and explain how they would help a U.S. manufacturer that wanted to go global. 6. Go to the World Trade Organization site at http://www.wto.org. Next, click on WTO News. Inform the class about current activities and actions at the WTO. 7. Go to http://www.worldbank.org and then to http://www.imf.org. Compare the types of information available on each website. Pick one example from each site, and report your findings to the class. ### Creative Thinking Case ### We Want Our MTV (International) MTV, a division of Viacom International Media Networks and a mainstay of American pop culture, is just as popular in Shanghai as it is in Seattle and Sydney, or in Lagos (Nigeria) as it is in Los Angeles. MTV is a division of Viacom, and their international divisions are called the Viacom International Media Networks. London-based MTV Networks International, the world’s largest global network, has taken its winning formula to 167 foreign markets on six continents, including urban and rural areas. It reaches 4 billion homes in 40 languages through locally programmed and locally operated TV channels and websites. While the United States currently generates about 70 percent of MTV’s profits, 85 percent of the company’s subscriber base lives outside the United States. The MTV brand has evolved beyond its music television roots into a multimedia lifestyle, entertainment, and culture brand for all ages. In addition to MTV and MTV2, its channel lineup includes Nickelodeon, VH1, Comedy Central, LOGO, TMF (The Music Factory), Game One, and several European music, comedy, and lifestyle channels, as well as Paramount Channel, Spike, and a growing number of flagship local networks such as Channel 5 in the UK, Telefe in Argentina, and COLORS in India. Adding to the complexity is MTV’s multimedia and interactive nature, with gaming, texting, and websites, as well as television. Another challenge is integrating acquisitions of local companies such as South American Telefe, which it purchased in 2016. The company also has an international insights team that gathers the latest consumer insights from around the world. You can get some insight into this initiative at https://insights.viacom.com. The local perspective is invaluable in helping the network understand its markets, whether in terms of musical tastes or what entertainment children like. For example, Alex Okosi, a Nigerian who went to college in the United States, is chief executive for MTV Base, which launched in sub-Saharan Africa in 2005. Okosi recommended that MTV consider each country as an individual market, rather than blending them all together. One reason for MTVNI’s success is “glocalization”—its ability to adapt programs to fit local cultures while still maintaining a consistent, special style. “When we set a channel up, we always provide a set of parameters in terms of standards of things we require,” an MTV executive explains. “Obviously an MTV channel that doesn’t look good enough is not going to do the business for us, let alone for the audience. There’s a higher expectation.” Then the local unit can tailor content to its market. MTV India conveys a “sense of the colorful street culture,” explains Bill Roedy, former MTV Networks International president, while MTV Japan has “a sense of technology edginess; MTV Italy, style and elegance.” In Africa, MTV Base features videos from top African artists as well as from emerging African music talent. According to company executives, the goal is to “provide a unique cultural meeting point for young people in Africa, using the common language of music to connect music fans from different backgrounds and cultures.” 2. Do you think that MTV’s future lies mostly in its international operations? Explain your reasoning. 3. What types of political, economic, and competitive challenges does MTV Networks International face by operating worldwide? 4. How has MTV Networks International overcome cultural differences to create a world brand? Sources: MTV Viacom Blog, http://blog.viacom.com, accessed June 30, 2017; MTV International website, http://www.mtv.com/, accessed June 30, 2017; MTV Consumer Insights website, https://insights.viacom.com, accessed June 30, 2017. ### Hot Links Address Book 1. A good starting place for help in doing business in foreign markets is the U.S. government’s export portal. Here you will find links to export basics, regulations, exchange rates, country and industry research, and much more. http://www.export.gov 2. For links to a wealth of statistics on world trade, go to the U.S. International Trade Administration’s (ITA) Office of Trade and Economic Analysis website, http://www.ita.doc.gov. 3. Check out the current U.S. balance of trade with various countries at http://www.bea.gov. 4. Get up-to-the-minute exchange rates at http://www.xe.com. 5. The World Trade Organization tracks the latest trade developments between countries and regions around the world. For the most recent global trading news, visit the WTO’s website at http://www.wto.org. 6. Gain additional insight into the workings of the International Monetary Fund at http://www.imf.org. 7. For the latest information about NAFTA, visit http://www.naftanow.org. 8. Think you’d like to work overseas? For information about jobs in foreign countries, visit http://www.internationaljobs.com.

# Forms of Business Ownership ## Introduction ### Learning Outcomes After reading this chapter, you should be able to answer these questions: 1. What are the advantages and disadvantages of the sole proprietorship form of business organization? 2. What are the advantages of operating as a partnership, and what downside risks should partners consider? 3. How does the corporate structure provide advantages and disadvantages to a company, and what are the major types of corporations? 4. What other options for business organization does a company have in addition to sole proprietorships, partnerships, and corporations? 5. What makes franchising an appropriate form of organization for some types of business, and why does it continue to grow in importance? 6. Why are mergers and acquisitions important to a company’s overall growth? 7. What current trends will affect the business organizations of the future? This chapter discusses sole proprietorships, as well as several other forms of business ownership, including partnerships and corporations, and compares the advantages and disadvantages of each. With a good idea and some cash in hand, you decide to start a business. But before you get going, you need to ask yourself some questions that will help you decide what form of business organization will best suit your needs. Would you prefer to go it alone as a sole proprietorship, or do you want others to share your burdens and challenges in a partnership? Or would the limited liability protection of a corporation, or perhaps the flexibility of a limited liability company (LLC), make more sense? There are other questions you need to consider too: Will you need financing? How easy will it be to obtain? Will you attract employees? How will the business be taxed, and who will be liable for the company’s debts? If you choose to share ownership with others, how much operating control would they want, and what costs would be associated with that? As illustrates, sole proprietorships are the most popular form of business ownership, accounting for 72 percent of all businesses, compared with 10 percent for partnerships and 18 percent for corporations. Because most sole proprietorships and partnerships remain small, corporations generate approximately 81 percent of total business revenues and 58 percent of total profits. Most start-up businesses select one of these major ownership forms. In the following pages, we will discover the advantages and disadvantages of each form of business ownership and the factors that may make it necessary to change from one form of organization to another as the needs of the business change. As a company expands from small to midsize or larger, the form of business structure selected in the beginning may no longer be appropriate.

# Forms of Business Ownership ## Going It Alone: Sole Proprietorships 1. What are the advantages and disadvantages of the sole proprietorship form of business organization? Jeremy Shepherd was working full-time for an airline when, at the age of 22, he wandered into an exotic pearl market in China, searching for a gift for his girlfriend. The strand of pearls he handpicked by instinct was later valued by a jeweler back in the States at 20 times what he paid for it. Jeremy cashed his next paycheck and hurried back to Asia, buying every pearl he could afford. Founded in 1996, his company Pearl Paradise was brought online in 2000. Shepherd chose the sole proprietorship form of business organization—a business that is established, owned, operated, and often financed by one person—because it was the easiest to set up. He did not want partners, and low liability exposure made incorporating unnecessary. Fluent in Mandarin Chinese, Japanese, and Spanish and immersed in Asian culture, Shepherd believed the internet was the way to market his pearls (http://www.pearlparadise.com). Offering a wide range of pearl jewelry through 14 websites worldwide, his company sells as many as 1,000 items per day. The recent addition of an exclusive Los Angeles showroom allows celebrity customers to shop by appointment. With $20 million in sales annually, PearlParadise.com is the industry leader in terms of sales and volume. ### Advantages of Sole Proprietorships Sole proprietorships have several advantages that make them popular: 1. Easy and inexpensive to form. As Jeremy Shepherd discovered, sole proprietorships have few legal requirements (local licenses and permits) and are not expensive to form, making them the business organization of choice for many small companies and start-ups. 2. Profits all go to the owner. The owner of a sole proprietorship obtains the start-up funds and gets all the profits earned by the business. The more efficiently the firm operates, the higher the company’s profitability. 3. Direct control of the business. All business decisions are made by the sole proprietorship owner without having to consult anyone else. 4. Freedom from government regulation. Sole proprietorships have more freedom than other forms of business with respect to government controls. 5. No special taxation. Sole proprietorships do not pay special franchise or corporate taxes. Profits are taxed as personal income as reported on the owner’s individual tax return. 6. Ease of dissolution. With no co-owners or partners, the sole proprietor can sell the business or close the doors at any time, making this form of business organization an ideal way to test a new business idea. ### Disadvantages of Sole Proprietorships Along with the freedom to operate the business as they wish, sole proprietors face several disadvantages: 1. Unlimited liability. From a legal standpoint, the sole proprietor and the company are one and the same, making the business owner personally responsible for all debts the company incurs, even if they exceed the company’s value. The owner may need to sell other personal property—their car, home, or other investments—to satisfy claims against the business. 2. Difficulty raising capital. Business assets are unprotected against claims of personal creditors, so business lenders view sole proprietorships as high risk due to the owner’s unlimited liability. Owners must often use personal funds—borrowing on credit cards, second-mortgaging their homes, or selling investments—to finance their business. Expansion plans can also be affected by an inability to raise additional funding. 3. Limited managerial expertise. The success of a sole proprietorship rests solely with the skills and talents of the owner, who must wear many different hats and make all decisions. Owners are often not equally skilled in all areas of running a business. A graphic designer may be a wonderful artist but not know bookkeeping, how to manage production, or how to market their work. 4. Trouble finding qualified employees. Sole proprietors often cannot offer the same pay, fringe benefits, and advancement as larger companies, making them less attractive to employees seeking the most favorable employment opportunities. 5. Personal time commitment. Running a sole proprietorship business requires personal sacrifices and a huge time commitment, often dominating the owner’s life with 12-hour workdays and 7-day workweeks. 6. Unstable business life. The life span of a sole proprietorship can be uncertain. The owner may lose interest, experience ill health, retire, or die. The business will cease to exist unless the owner makes provisions for it to continue operating or puts it up for sale. 7. Losses are the owner’s responsibility. The sole proprietor is responsible for all losses, although tax laws allow these to be deducted from other personal income. The sole proprietorship may be a suitable choice for a one-person start-up operation with no employees and little risk of liability exposure. For many sole proprietors, however, this is a temporary choice, and as the business grows, the owner may be unable to operate with limited financial and managerial resources. At this point, the owner may decide to take in one or more partners to ensure that the business continues to flourish. ### Summary of Learning Outcomes 1. What are the advantages and disadvantages of the sole proprietorship form of business organization? The advantages of sole proprietorships include ease and low cost of formation, the owner’s rights to all profits, the owner’s control of the business, relative freedom from government regulation, absence of special taxes, and ease of dissolution. Disadvantages include owner’s unlimited liability for debts and personal absorption of all losses, difficulty in raising capital, limited managerial expertise, difficulty in finding qualified employees, large personal time commitment, and unstable business life.

# Forms of Business Ownership ## Partnerships: Sharing the Load 1. What are the advantages of operating as a partnership, and what downside risks should partners consider? Can partnerships, an association of two or more individuals who agree to operate a business together for profit, be hazardous to a business’s health? Let’s assume partners Ron and Liz own a stylish and successful beauty salon. After a few years of operating the business, they find they have contrasting visions for their company. Liz is happy with the status quo, while Ron wants to expand the business by bringing in investors and opening salons in other locations. How do they resolve this impasse? By asking themselves some tough questions. Whose view of the future is more realistic? Does the business actually have the expansion potential Ron believes it does? Where will he find investors to make his dream of multiple locations a reality? Is he willing to dissolve the partnership and start over again on his own? And who would have the right to their clients? Ron realizes that expanding the business in line with his vision would require a large financial risk and that his partnership with Liz offers many advantages he would miss in a sole proprietorship form of business organization. After much consideration, he decides to leave things as they are. For those individuals who do not like to “go it alone,” a partnership is relatively simple to set up. Offering a shared form of business ownership, it is a popular choice for professional-service firms such as lawyers, accountants, architects, stockbrokers, and real estate companies. The parties agree, either orally or in writing, to share in the profits and losses of a joint enterprise. A written partnership agreement, spelling out the terms and conditions of the partnership, is recommended to prevent later conflicts between the partners. Such agreements typically include the name of the partnership, its purpose, and the contributions of each partner (financial, asset, skill/talent). It also outlines the responsibilities and duties of each partner and their compensation structure (salary, profit sharing, etc.). It should contain provisions for the addition of new partners, the sale of partnership interests, and procedures for resolving conflicts, dissolving the business, and distributing the assets. There are two basic types of partnerships: general and limited. In a general partnership, all partners share in the management and profits. They co-own the assets, and each can act on behalf of the firm. Each partner also has unlimited liability for all the business obligations of the firm. A limited partnership has two types of partners: one or more general partners, who have unlimited liability, and one or more limited partners, whose liability is limited to the amount of their investment. In return for limited liability, limited partners agree not to take part in the day-to-day management of the firm. They help to finance the business, but the general partners maintain operational control. There are also limited liability partnerships (LLP), which are similar to a general partnership except that partners are not held responsible for the business debt and liabilities. Another type is a limited liability limited partnership (LLLP), which is basically a limited partnership with addition of limited liability, hence protecting the general partner from the debt and liabilities of the partnership. ### Advantages of Partnerships Some advantages of partnerships come quickly to mind: 1. Ease of formation. Like sole proprietorships, partnerships are easy to form. The partners agree to do business together and draw up a partnership agreement. For most partnerships, applicable state laws are not complex. 2. Availability of capital. Because two or more people contribute financial resources, partnerships can raise funds more easily for operating expenses and business expansion. The partners’ combined financial strength also increases the firm’s ability to raise funds from outside sources. 3. Diversity of skills and expertise. Partners share the responsibilities of managing and operating the business. Combining partner skills to set goals, manage the overall direction of the firm, and solve problems increases the chances for the partnership’s success. To find the right partner, you must examine your own strengths and weaknesses and know what you need from a partner. Ideal partnerships bring together people with complementary backgrounds rather than those with similar experience, skills, and talents. In you’ll find some advice on choosing a partner. 4. Flexibility. General partners are actively involved in managing their firm and can respond quickly to changes in the business environment. 5. No special taxes. Partnerships pay no income taxes. A partnership must file a partnership return with the Internal Revenue Service, reporting how profits or losses were divided among the partners. Each partner’s profit or loss is then reported on the partner’s personal income tax return, with any profits taxed at personal income tax rates. 6. Relative freedom from government control. Except for state rules for licensing and permits, the government has little control over partnership activities. ### Disadvantages of Partnerships Business owners must consider the following disadvantages of setting up their company as a partnership: 1. Unlimited liability. All general partners have unlimited liability for the debts of the business. In fact, any one partner can be held personally liable for all partnership debts and legal judgments (such as malpractice)—regardless of who caused them. As with sole proprietorships, business failure can lead to a loss of the general partners’ personal assets. To overcome this problem, many states now allow the formation of limited liability partnerships (LLPs), which protect each individual partner from responsibility for the acts of other partners and limit their liability to harm resulting from their own actions. 2. Potential for conflicts between partners. Partners may have different ideas about how to run their business, which employees to hire, how to allocate responsibilities, and when to expand. Differences in personalities and work styles can cause clashes or breakdowns in communication, sometimes requiring outside intervention to save the business. 3. Complexity of profit sharing. Dividing the profits is relatively easy if all partners contribute equal amounts of time, expertise, and capital. But if one partner puts in more money and others more time, it might be more difficult to arrive at a fair profit-sharing formula. 4. Difficulty exiting or dissolving a partnership. As a rule, partnerships are easier to form than to leave. When one partner wants to leave, the value of their share must be calculated. To whom will that share be sold, and will that person be acceptable to the other partners? If a partner who owns more than 50 percent of the entity withdraws, dies, or becomes disabled, the partnership must reorganize or end. To avoid these problems, most partnership agreements include specific guidelines for transferring partnership interests and buy–sell agreements that make provision for surviving partners to buy a deceased partner’s interest. Partners can also purchase special life insurance policies designed to fund such a purchase. Business partnerships are often compared to marriages. As with a marriage, choosing the right partner is critical. So if you are considering forming a partnership, allow plenty of time to evaluate your and your potential partner’s goals, personality, expertise, and working style before joining forces. ### Summary of Learning Outcomes 1. What are the advantages of operating as a partnership, and what downside risks should partners consider? The advantages of partnerships include ease of formation, availability of capital, diversity of managerial skills and expertise, flexibility to respond to changing business conditions, no special taxes, and relative freedom from government control. Disadvantages include unlimited liability for general partners, potential for conflict between partners, sharing of profits, and difficulty exiting or dissolving the partnership. Partnerships can be formed as either general or limited partnerships. In a general partnership, the operations of the business are controlled by one or more general partners with unlimited liability. The partners co-own the assets and share the profits. Each partner is individually liable for all debts and contracts of the partnership. In a limited partnership, the limited partners are financial partners whose liability is limited to their investment; they do not participate in the firm’s operations.

# Forms of Business Ownership ## Corporations: Limiting Your Liability 1. How does the corporate structure provide advantages and disadvantages to a company, and what are the major types of corporations? When people think of corporations, they typically think of major, well-known companies, such as Apple, Alphabet (parent company of Google), Netflix, IBM, Microsoft, Boeing, and General Electric. But corporations range in size from large multinationals with thousands of employees and billions of dollars in sales to midsize or even smaller firms with few employees and revenues under $25,000. A corporation is a legal entity subject to the laws of the state in which it is formed, where the right to operate as a business is issued by state charter. A corporation can own property, enter into contracts, sue and be sued, and engage in business operations under the terms of its charter. Unlike sole proprietorships and partnerships, corporations are taxable entities with a life separate from their owners, who are not personally liable for its debts. When launching her company, Executive Property Management Services, Inc., 32-year-old Linda Ravden realized she needed the liability protection of the corporate form of business organization. Her company specialized in providing customized property management services to mid- and upper-level corporate executives on extended work assignments abroad, often for three to five years or longer. Taking care of substantial properties in the million-dollar range and above was no small responsibility for Ravden’s company. Therefore, the protection of a corporate business structure, along with carefully detailed contracts outlining the company’s obligations, were crucial in providing Ravden with the liability protection she needed—and the peace of mind to focus on running her business without constant worry. Note that an LLC does not provide unlimited protection; you can still get in trouble for such things as mingling personal and business funds. Corporations play an important role in the U.S. economy. As demonstrated, corporations account for only 18 percent of all businesses but generate 81 percent of all revenues and 58 percent of all profits. Company type and size vary; however, when you look at the top companies by revenue in the United States or globally, they include many familiar names that affect our daily lives. In the United States, according to magazine, the top three corporations in the 2017 were (1) Walmart Stores (revenue: $485.9 B), (2) Berkshire Hathaway (revenue: $223.6 B), and (3) Apple (revenue: $215.6 B), whereas magazine found that the top three corporations were (1) Berkshire Hathaway (revenue: $222.9B), (2) Apple (revenue: $217.5B), and (3) JPMorgan Chase (revenue: $102.5B). By comparison, the top three companies in 2017 according to the were (1) Apple, (2) Alphabet, and (3) Microsoft. These corporations rise and fall on the various lists based on their revenue in a given year and how the organizations measure revenue and the time frames that they use. ### The Incorporation Process Setting up a corporation is more complex than starting a sole proprietorship or partnership. Most states base their laws for chartering corporations on the Model Business Corporation Act of the American Bar Association, although registration procedures, fees, taxes, and laws that regulate corporations vary from state to state. A firm does not have to incorporate in the state where it is based and may benefit by comparing the rules of several states before choosing a state of incorporation. Although Delaware is a small state with few corporations actually based there, its procorporate policies make it the state of incorporation for many companies, including about half the Fortune 500. Incorporating a company involves five main steps: 1. Selecting the company’s name 2. Writing the articles of incorporation (see ) and filing them with the appropriate state office, usually the secretary of state 3. Paying required fees and taxes 4. Holding an organizational meeting 5. Adopting bylaws, electing directors, and passing the first operating resolutions The state issues a corporate charter based on information in the articles of incorporation. Once the corporation has its charter, it holds an organizational meeting to adopt bylaws, elect directors, and pass initial operating resolutions. Bylaws provide legal and managerial guidelines for operating the firm. ### The Corporate Structure As shows, corporations have their own organizational structure with three important components: stockholders, directors, and officers. Stockholders (or shareholders) are the owners of a corporation, holding shares of stock that provide them with certain rights. They may receive a portion of the corporation’s profits in the form of dividends, and they can sell or transfer their ownership in the corporation (represented by their shares of stock) at any time. Stockholders can attend annual meetings, elect the board of directors, and vote on matters that affect the corporation in accordance with its charter and bylaws. Each share of stock generally carries one vote. The stockholders elect a board of directors to govern and handle the overall management of the corporation. The directors set major corporate goals and policies, hire corporate officers, and oversee the firm’s operations and finances. Small firms may have as few as 3 directors, whereas large corporations usually have 10 to 15. The boards of large corporations typically include both corporate executives and outside directors (not employed by the organization) chosen for their professional and personal expertise. Outside directors often bring a fresh view to the corporation’s activities because they are independent of the firm. Hired by the board, the officers of a corporation are its top management and include the president and chief executive officer (CEO), vice presidents, treasurer, and secretary, who are responsible for achieving corporate goals and policies. Officers may also be board members and stockholders. ### Advantages of Corporations The corporate structure allows companies to merge financial and human resources into enterprises with great potential for growth and profits: 1. Limited liability. A key advantage of corporations is that they are separate legal entities that exist apart from their owners. Owners’ (stockholders’) liability for the obligations of the firm is limited to the amount of the stock they own. If the corporation goes bankrupt, creditors can look only to the assets of the corporation for payment. 2. Ease of transferring ownership. Stockholders of public corporations can sell their shares at any time without affecting the status of the corporation. 3. Unlimited life. The life of a corporation is unlimited. Although corporate charters specify a life term, they also include rules for renewal. Because the corporation is an entity separate from its owners, the death or withdrawal of an owner does not affect its existence, unlike a sole proprietorship or partnership. 4. Tax deductions. Corporations are allowed certain tax deductions, such as operating expenses, which reduces their taxable income. 5. Ability to attract financing. Corporations can raise money by selling new shares of stock. Dividing ownership into smaller units makes it affordable to more investors, who can purchase one or several thousand shares. The large size and stability of corporations also helps them get bank financing. All these financial resources allow corporations to invest in facilities and human resources and expand beyond the scope of sole proprietorships or partnerships. It would be impossible for a sole proprietorship or partnership to make automobiles, provide nationwide telecommunications, or build oil or chemical refineries. ### Disadvantages of Corporations Although corporations offer companies many benefits, they have some disadvantages: 1. Double taxation of profits. Corporations must pay federal and state income taxes on their profits. In addition, any profits (dividends) paid to stockholders are taxed as personal income, although at a somewhat reduced rate. 2. Cost and complexity of formation. As outlined earlier, forming a corporation involves several steps, and costs can run into thousands of dollars, including state filing, registration, and license fees, as well as the cost of attorneys and accountants. 3. More government restrictions. Unlike sole proprietorships and partnerships, corporations are subject to many regulations and reporting requirements. For example, corporations must register in each state where they do business and must also register with the Securities and Exchange Commission (SEC) before selling stock to the public. Unless it is closely held (owned by a small group of stockholders), a firm must publish financial reports on a regular basis and file other special reports with the SEC and state and federal agencies. These reporting requirements can impose substantial costs, and published information on corporate operations may also give competitors an advantage. ### Types of Corporations Three types of corporate business organization provide limited liability. The C corporation is the conventional or basic form of corporate organization. Small businesses may achieve liability protection through S corporations or limited liability companies (LLCs). An S corporation is a hybrid entity, allowing smaller corporations to avoid double taxation of corporate profits as long as they meet certain size and ownership requirements. Organized like a corporation with stockholders, directors, and officers, an S corporation is taxed like a partnership. Income and losses flow through to the stockholders and are taxed as personal income. S corporations are allowed a maximum of 100 qualifying shareholders and one class of stock. The owners of an S corporation are not personally liable for the debts of the corporation. A newer type of business entity, the limited liability company (LLC), is also a hybrid organization. Like S corporations, they appeal to small businesses because they are easy to set up and not subject to many restrictions. LLCs offer the same liability protection as corporations as well as the option of being taxed as a partnership or a corporation. First authorized in Wyoming in 1977, LLCs became popular after a 1988 tax ruling that treats them like partnerships for tax purposes. Today all states allow the formation of LLCs. summarizes the advantages and disadvantages of each form of business ownership. ### Summary of Learning Outcomes 1. How does the corporate structure provide advantages and disadvantages to a company, and what are the major types of corporations? A corporation is a legal entity chartered by a state. Its organizational structure includes stockholders who own the corporation, a board of directors elected by the stockholders to govern the firm, and officers who carry out the goals and policies set by the board. Stockholders can sell or transfer their shares at any time and are entitled to receive profits in the form of dividends. Advantages of corporations include limited liability, ease of transferring ownership, unlimited life tax deductions, and the ability to attract financing. Disadvantages include double taxation of profits, the cost and complexity of formation, and government restrictions.

# Forms of Business Ownership ## Specialized Forms of Business Organization 1. What other options for business organization does a company have in addition to sole proprietorships, partnerships, and corporations? In addition to the three main forms, several specialized types of business organization also play an important role in our economy. We will look at cooperatives and joint ventures in this section and take a detailed look at franchising in the following section. ### Cooperatives When you eat a Sunkist orange or spread Land O’Lakes butter on your toast, you are consuming foods produced by cooperatives. A cooperative is a legal entity with several corporate features, such as limited liability, an unlimited life span, an elected board of directors, and an administrative staff. Member-owners pay annual fees to the cooperative and share in the profits, which are distributed to members in proportion to their contributions. Because they do not retain any profits, cooperatives are not subject to taxes. There are currently 2.6 million cooperatives with one billion members employing more than 12.5 million employees in more than 145 countries worldwide. Cooperatives operate in every industry, including agriculture, childcare, energy, financial services, food retailing and distribution, health care, insurance, housing, purchasing and shared services, and telecommunications, among others. They range in size from large enterprises such as Fortune 500 companies to small local storefronts and fall into four distinct categories: consumer, producer, worker, and purchasing/shared services. Cooperatives are autonomous businesses owned and democratically controlled by their members—the people who buy their goods or use their services—not by investors. Unlike investor-owned businesses, cooperatives are organized solely to meet the needs of the member-owners, not to accumulate capital for investors. As democratically controlled businesses, many cooperatives practice the principle of “one member, one vote,” providing members with equal control over the cooperative. There are two types of cooperatives. Buyer cooperatives combine members’ purchasing power. Pooling buying power and buying in volume increases purchasing power and efficiency, resulting in lower prices. At the end of the year, members get shares of the profits based on how much they bought. Obtaining discounts to lower costs gives the corner Ace Hardware store the chance to survive against retailing giants such as Home Depot Inc. and Lowe’s. Founded in 1924, Ace Hardware is one of the nation’s largest cooperatives and is wholly owned by its independent hardware retailer members in stores spanning all 50 states and 70 countries. In August 2017, Ace opened its 5,000th store. In 2017, the company reported its revenues in the second quarter were $1.5 billion, which was an increase of 4.6 percent from 2016’s second quarter. The net income for the second quarter of 2017 was $51.1 million. Seller cooperatives are popular in agriculture, wherein individual producers join to compete more effectively with large producers. Member dues support market development, national advertising, and other business activities. In addition to Sunkist and Land O’Lakes, other familiar cooperatives are Calavo (avocados), Ocean Spray (cranberries and juices), and Blue Diamond (nuts). CHS Inc., the largest cooperative in the United States, sells energy, supply, food, and grain. Cooperatives empower people to improve their quality of life and enhance their economic opportunities through self-help. Throughout the world, cooperatives are providing members with credit and financial services, energy, consumer goods, affordable housing, telecommunications, and other services that would not otherwise be available to them. There are several principles that cooperatives must follow, according to San Luis Valley REC, International Co-operative Alliance, and Daman Prakash, author of The Principles of Cooperation. They include (1) open membership, which means that cooperatives are open to all people to use its services; (2) democratic member control, which means that organizations are controlled by their members; (3) members’ economic participation, which means that members contribute equally to the capital of the cooperative; (4) autonomy, which means cooperatives are self-help organizations controlled by their members; and (5) education and training, which means that cooperatives provide education and training for their members while also electing representatives, managers, and employees. ### Joint Ventures In a joint venture, two or more companies form an alliance to pursue a specific project, usually for a specified time period. There are many reasons for joint ventures. The project may be too large for one company to handle on its own, and joint ventures also afford companies access to new markets, products, or technology. Both large and small companies can benefit from joint ventures. In 2005, South Korea’s Hyundai Motor Company announced it signed a $1.24 billion deal to form a joint venture with China’s Guangzhou Automobile Group. The arrangement gave the South Korean automaker access to the commercial vehicle market in China, where its passenger cars are already the top selling foreign brand. Each side will hold equal stakes in the new entity, named Guangzhou Hyundai Motor Company. The new plant began production in 2007 with an annual capacity of 200,000 units producing small to large trucks and buses as well as commercial vehicles. According to Reuters, Hyundai made plans to build a fifth factory in China. With five factories in operation, Hyundai’s annual Chinese production capacity will be 1.65 million vehicles. ### Summary of Learning Outcomes 1. What other options for business organization does a company have in addition to sole proprietorships, partnerships, and corporations? Businesses can also organize as limited liability companies, cooperatives, joint ventures, and franchises. A limited liability company (LLC) provides limited liability for its owners but is taxed like a partnership. These two features make it an attractive form of business organization for many small firms. Cooperatives are collectively owned by individuals or businesses with similar interests that combine to achieve more economic power. Cooperatives distribute all profits to their members. Two types of cooperatives are buyer and seller cooperatives. A joint venture is an alliance of two or more companies formed to undertake a special project. Joint ventures can be set up in various ways, through partnerships or special-purpose corporations. By sharing management expertise, technology, products, and financial and operational resources, companies can reduce the risk of new enterprises.

# Forms of Business Ownership ## Franchising: A Popular Trend 1. What makes franchising an appropriate form of organization for some types of business, and why does it continue to grow in importance? When Shep Bostin decided to buy a franchise, he researched the usual suspects: Jiffy Lube, McDonald’s, and Quiznos Subs. Bostin, then 38, was a top executive at a dying Gaithersburg, Maryland, technology firm, but instead of becoming another McDonald’s franchisee, Bostin chose to remain a geek, albeit one who wheeled around in the signature black PT Cruiser of Geeks On Call, a company that provides on-site computer assistance via a large pool of experienced techies. Bostin made residential and commercial “house calls” for more than a decade as a Geeks On Call franchisee. There are approximately 123 independently owned and operated Geeks On Call franchise territories in 50 states serving over 250,000 customers. Choosing the right franchise can be challenging. Franchises come in all sizes and demand different skills and qualifications. And with somewhere around 2,500 different franchised businesses in the United States, Bostin had a lot to choose from—from cookie-bouquet peddlers and dog trainers to acupuncture specialists. shows the top franchises for 2017 from various sources. rankings utilize among other factors costs/fees, brand strength, support, and financial strength. focuses on owner satisfaction, whereas utilizes a formula with factors such as financial stability and engagement. Chances are you recognize some of the names listed in and deal with franchise systems in your neighborhood every day. When you have lunch at Taco Bell or Jamba Juice, make copies at FedEx Office, change your oil at Jiffy Lube, buy candles at Wicks ’n’ Sticks, or mail a package at The UPS Store, you are dealing with a franchised business. These and other familiar name brands mean quality, consistency, and value to consumers. Franchised businesses provided about 8.9 million direct jobs with a $890 billion economic output for the U.S. economy. Franchising is a form of business organization that involves a franchisor, the company supplying the product or service concept, and the franchisee, the individual or company selling the goods or services in a certain geographic area. The franchisee buys a package that includes a proven product or service, proven operating methods, and training in managing the business. Offering a way to own a business without starting it from scratch and to expand operations quickly into new geographic areas with limited capital investment, franchising is one of the fastest growing segments of the economy. If you are interested in franchising, food companies represent the largest number of franchises. A franchise agreement is a contract that allows the franchisee to use the franchisor’s business name, trademark, and logo. The agreement also outlines rules for running the franchise, services provided by the franchisor, and financial terms. The franchisee agrees to follow the franchisor’s operating rules by keeping inventory at certain levels, buying a standard equipment package, keeping up sales and service levels, taking part in franchisor promotions, and maintaining a relationship with the franchisor. In return, the franchisor provides the use of a proven company name and symbols, help in finding a site, building plans, guidance and training, management assistance, managerial and accounting systems and procedures, employee training, wholesale prices for supplies, and financial assistance. ### Advantages of Franchises Like other forms of business organization, franchising offers some distinct advantages: 1. Increased ability for franchisor to expand. Because franchisees finance their own units, franchisors can grow without making a major investment. 2. Recognized name, product, and operating concept. Consumers know they can depend on products from franchises such as Pizza Hut, Hertz, and Holiday Inn. As a result, the franchisee’s risk is reduced and the opportunity for success increased. The franchisee gets a widely known and accepted business with a proven track record, as well as operating procedures, standard goods and services, and national advertising. 3. Management training and assistance. The franchisor provides a structured training program that gives the new franchisee a crash course in how to start and operate their business. Ongoing training programs for managers and employees are another plus. In addition, franchisees have a peer group for support and sharing ideas. 4. Financial assistance. Being linked to a nationally known company can help a franchisee obtain funds from a lender. Also, the franchisor typically gives the franchisee advice on financial management, referrals to lenders, and help in preparing loan applications. Many franchisors also offer short-term credit for buying supplies, payment plans, and loans to purchase real estate and equipment. Although franchisors give up a share of profits to their franchisees, they receive ongoing revenues in the form of royalty payments. ### Disadvantages of Franchises Franchising also has some disadvantages: 1. Loss of control. The franchisor has to give up some control over operations and has less control over its franchisees than over company employees. 2. Cost of franchising. Franchising can be a costly form of business. Costs will vary depending on the type of business and may include expensive facilities and equipment. The franchisee also pays fees and/or royalties, which are usually tied to a percentage of sales. Fees for national and local advertising and management advice may add to a franchisee’s ongoing costs. 3. Restricted operating freedom. The franchisee agrees to conform to the franchisor’s operating rules and facilities design, as well as inventory and supply standards. Some franchises require franchisees to purchase from only the franchisor or approved suppliers. The franchisor may also restrict the franchisee’s territory or site, which could limit growth. Failure to conform to franchisor policies could mean the loss of the franchise. ### Franchise Growth Many of today’s major franchise brands, such as McDonald’s and KFC, started in the 1950s. Through the 1960s and 1970s, many more types of businesses—clothing, convenience stores, business services, and many others—used franchising to distribute their goods and services. Growth comes from expansion of established franchises—for example, Subway, Pizza Hut, and OrangeTheory Fitness—as well as new entrants such as those identified by and among other sources. According to magazine, the top three new franchises in 2017 are (1) Mosquito Joe, (2) Blaze Fast-Fire’d Pizza, and (3) uBreakiFix, whereas according to the top three new franchises in 2017 are (1) Mosquito Joe, (2) Digital Doc, and (3) Nurse Next Door Home Healthcare Services. On both rankings, Mosquito Joe ranks at the top. Mosquito Joe provides mosquito control treatment services for both residential and commercial clients. Changing demographics drive franchise industry growth, in terms of who, how, and what experiences the most rapid growth. The continuing growth and popularity of technology and personal computing is responsible for the rapidly multiplying number of eBay drop-off stores, and tech consultants such as Geeks on Call are in greater demand than ever. Other growth franchise industries are the specialty coffee market, children’s enrichment and tutoring programs, senior care, weight control, and fitness franchises. ### The Next Big Thing in Franchising All around you, people are talking about the next big thing—Subway is the new miracle weight-loss solution, the workout at OrangeTheory Fitness is the answer to America’s fitness needs—and you are ready to take the plunge and buy a trendy franchise. But consumers’ desires can change with the tide, so how do you plan an entrance—and exit—strategy when purchasing a franchise that’s a big hit today but could be old news by tomorrow? outlines some tips on purchasing a franchise. ### International Franchising Like other forms of business, franchising is part of our global marketplace economy. As international demand for all types of goods and services grows, most franchise systems are already operating internationally or planning to expand overseas. Restaurants, hotels, business services, educational products, car rentals, and nonfood retail stores are popular international franchises. Franchisors in foreign countries face many of the same problems as other firms doing business abroad. In addition to tracking markets and currency changes, franchisors must understand local culture, language differences, and the political environment. Franchisors in foreign countries also face the challenge of aligning their business operations with the goals of their franchisees, who may be located half a globe away. ### Is Franchising in Your Future? Are you ready to be a franchisee? Before taking the plunge, ask yourself some searching questions: Are you excited about a specific franchise concept? Are you willing to work hard and put in long hours? Do you have the necessary financial resources? Do you have prior business experience? Do your expectations and personal goals match the franchisor’s? Qualities that rank high on franchisors’ lists are passion about the franchise concept, desire to be your own boss, willingness to make a substantial time commitment, assertiveness, optimism, patience, and integrity. Prior business experience is also a definite plus, and some franchisors prefer or require experience in their field. So what can you do to prepare when considering the purchase of a franchise? When evaluating franchise opportunities, professional guidance can prevent expensive mistakes, so interview advisers to find those that are right for you. Selecting an attorney with franchise experience will hasten the review of your franchise agreement. Getting to know your banker will speed up the loan process if you plan to finance your purchase with a bank loan, so stop by and introduce yourself. The proper real estate is a critical component for a successful retail franchise, so establish a relationship with a commercial real estate broker to begin scouting locations. Doing your homework can spell the difference between success and failure, and some early preparation can help lay the groundwork for the successful launch of your franchised business. If the franchise route to business ownership seems right for you, begin educating yourself on the franchise process by investigating various franchise opportunities. You should research a franchise company thoroughly before making any financial commitment. Once you’ve narrowed your choices, ask for the for that franchisor, and read it thoroughly. The Federal Trade Commission (FTC) requires franchisors to prepare this document, which provides a wealth of information about the franchisor, including its history, operating style, management, past or pending litigation, the franchisee’s financial obligations, and any restrictions on the sale of units. Interviewing current and past franchisees is another essential step. And most franchise systems use computers, so if you are not computer literate, take a class in the basics. Would-be franchisees should also check recent issues of small-business magazines such as and for industry trends, ideas on promising franchise opportunities, and advice on how to choose and run a franchise. The International Franchise Association website at http://www.franchise.org has links to and other useful sites. (For other franchise-related sites, see the “Working the Net” questions.) ### Summary of Learning Outcomes 1. What makes franchising an appropriate form of organization for some types of business, and why does it continue to grow in importance? Franchising is one of the fastest-growing forms of business ownership. It involves an agreement between a franchisor, the supplier of goods or services, and a franchisee, an individual or company that buys the right to sell the franchisor’s products in a specific area. With a franchise, the business owner does not have to start from scratch but buys a business concept with a proven product or service and operating methods. The franchisor provides use of a recognized brand-name product and operating concept, as well as management training and financial assistance. Franchises can be costly to start, and operating freedom is restricted because the franchisee must conform to the franchisor’s standard procedures. The growth in franchising is attributed to its ability to expand business operations quickly into new geographic areas with limited capital investment.

# Forms of Business Ownership ## Mergers and Acquisitions 1. Why are mergers and acquisitions important to a company’s overall growth? A merger occurs when two or more firms combine to form one new company. For example, in 2016, Johnson Controls, a leading provider of building efficiency solutions, agreed to merge with Ireland’s Tyco International, a leading provider of fire and security solutions, resulting in a company that will be a leader in products, technologies, and integrated solutions for the building and energy sectors. The merger is valued at $30 billion, with new Johnson Controls PLC to be based in Ireland. Currently, AT&T and Time Warner have an $85.4 billion merger pending. “Once we complete our acquisition of Time Warner Inc., we believe there is an opportunity to build an automated advertising platform that can do for premium video and TV advertising what the search and social media companies have done for digital advertising,” AT&T’s CEO Randall Stephenson said in a prepared statement. Mergers such as this one, in a well-established industry, can produce winning results in terms of improved efficiency and cost savings. In an acquisition, a corporation or investor group finds a target company and negotiates with its board of directors to purchase it. In Verizon’s recent $4.5 billion acquisition of Yahoo, Verizon was the acquirer, and Yahoo the target company. Worldwide merger activity in the first quarter of 2017 was mixed. The volume of deals was lower but with higher dollar value. The total number of deals fell by 17.9 percent versus the first quarter of 2016; however, the overall deal value was $678.5 billion. We will discuss the increase in international mergers later in this chapter. ### Types of Mergers The three main types of mergers are horizontal, vertical, and conglomerate. In a horizontal merger, companies at the same stage in the same industry merge to reduce costs, expand product offerings, or reduce competition. Many of the largest mergers are horizontal mergers to achieve economies of scale. Its $1.25 billion acquisition of trucking company Overnite allowed UPS, the world’s largest shipping carrier, to step up expansion of its heavy freight–delivery business, thus expanding its product offerings. In a vertical merger, a company buys a firm in its same industry, often involved in an earlier or later stage of the production or sales process. Buying a supplier of raw materials, a distribution company, or a customer gives the acquiring firm more control. A good example of this is Google’s acquisition of Urchin Software Corp., a San Diego–based company that sells web analytics software and services that help companies track the effectiveness of their websites and online advertising. The move enables Google to bolster the software tools it provides to its advertisers. A conglomerate merger brings together companies in unrelated businesses to reduce risk. Combining companies whose products have different seasonal patterns or respond differently to business cycles can result in more stable sales. The Philip Morris Company, now called Altria Group, started out in the tobacco industry but diversified as early as the 1960s with the acquisition of Miller Brewing Company. It diversified into the food industry with its subsequent purchase of General Foods, Kraft Foods, and Nabisco, among others. Later spinning off many businesses, current product categories include cigarettes, smokeless tobacco such as Copenhagen and Skoal, cigars, e-vapor products such as MarkTen, and wines. A specialized, financially motivated type of merger, the leveraged buyout (LBO) became popular in the 1980s but is less common today. LBOs are corporate takeovers financed by large amounts of borrowed money—as much as 90 percent of the purchase price. LBOs can be started by outside investors or the corporation’s management. For example, the private equity firm Apollo Global Management LLC agreed to buy U.S. security company ADT Corp. in the largest leveraged buyout (LBO) of 2016. Often a belief that a company is worth more than the value of all its stock is what drives an LBO. They buy the stock and take the company private, expecting to increase cash flow by improving operating efficiency or selling off units for cash to pay off debt. Although some LBOs do improve efficiency, many do not live up to investor expectations or generate enough cash to pay their debt. ### Merger Motives Although headlines tend to focus on mega-mergers, “merger mania” affects small companies too, and motives for mergers and acquisitions tend to be similar regardless of the company’s size. The goal is often strategic: to improve overall performance of the merged firms through cost savings, elimination of overlapping operations, improved purchasing power, increased market share, or reduced competition. Oracle Corp. paid $5.85 billion to acquire Siebel Systems, its largest competitor in the sales automation programs market. Company growth, broadening product lines, acquiring technology or management skills, and the ability to quickly acquire new markets are other motives for acquiring a company. Yahoo Inc.’s $1 billion cash purchase of a 40 percent stake in China’s biggest e-commerce firm, Alibaba.com, instantly strengthened its ties to the world’s second largest internet market. Purchasing a company can also offer a faster, less risky, less costly option than developing products or markets in-house or expanding internationally. Amazon’s 2017 purchase of Whole Foods Market, an upscale grocery chain, for $13.7 billion was a move to enter the retail grocery sector. In addition to the new product market, this move offers Amazon opportunity to sell Amazon tech products in the grocery stores as well as access to an entirely new set of data on consumers. Another motive for acquisitions is financial restructuring—cutting costs, selling off units, laying off employees, and refinancing the company to increase its value to stockholders. Financially motivated mergers are based not on the potential to achieve economies of scale, but rather on the acquirer’s belief that the target has hidden value to be unlocked through restructuring. Most financially motivated mergers involve larger companies. In January 2018, Brookfield Business Partners, a subsidiary of Canada’s Brookfield Asset Management, announced that it plans to acquire Westinghouse Electric Co LLC, the bankrupt nuclear services company owned by Toshiba Corp., for $4.6 billion. Brookfield has a history of turning around distressed businesses. ### Emerging Truths Along with the technology boom of the late 1990s, merger activity also soared. Total annual transactions averaged $1.6 trillion a year. Companies were using their stock, which had been pushed to unrealistically high levels, to buy each other. When the technology bubble burst in 2000, the level of merger activity dropped as well. It fell even further after the United States was attacked on September 11, 2001. Then massive corporate wrongdoing began to surface. Stocks plummeted in reaction to these events, and merger transactions, which generally track stock market movements, fell as a result. Today, merger activity is once again on the rise. Propelled by a solid economy, low interest rates, good credit, rising stock prices, and stockpiles of cash, 2016’s $3.84 trillion of global M&A was historically a very strong year, with several blockbuster deals. Size is definitely an advantage when competing in the global marketplace, but bigger does not always mean better in the merger business. Study results show that heady mega-mergers can, in fact, be a bust for investors who own those shares. So companies are wise to consider their options before stuffing their dollars in the biggest merger slot machine they can find. In their eagerness to snare a deal, many buyers pay a premium that wipes out the merger’s entire potential economic gain. Often managers envision grand synergies that prove illusory or unworkable or buy a company that isn’t what it seems—not fully understanding what they are getting. Integrating acquisitions is both an art and a science. Acquirers often underestimate the costs and logistical nightmare of consolidating the operations of merged companies with very different cultures. As a result, they may fail to keep key employees aboard, sales forces selling, and customers happy. Companies will always continue to seek out acquisition candidates, but the fundamental business case for merging will have to be strong. So what should companies look for to identify mergers with a better-than-even chance of turning out well? 1. A purchase price that is low enough—a 10 percent premium over market as opposed to 50 percent—so the buyer doesn’t need heroic synergies to make the deal work. 2. A target that is significantly smaller than the buyer—and in a business the buyer understands. The more “transformational” the deal, such as entering a new business arena, the bigger the risk. 3. A buyer who pays in cash and not overinflated stock. 4. Evidence that the deal makes both business and financial sense and isn’t purely the brainchild of an empire-building CEO. Mergers are tough—culturally, commercially, and logistically. The most important quality a company can bring to a merger may be humility. ### Summary of Learning Outcomes 1. Why are mergers and acquisitions important to a company’s overall growth? In a merger, two companies combine to form one company. In an acquisition, one company or investor group buys another. Companies merge for strategic reasons to improve overall performance of the merged firm through cost savings, eliminating overlapping operations, improving purchasing power, increasing market share, or reducing competition. Desired company growth, broadened product lines, and the rapid acquisition of new markets, technology, or management skills are other motives. Another motive for merging is financial restructuring—cutting costs, selling off units, laying off employees, and refinancing the company to increase its value to stockholders. There are three types of mergers. In a horizontal merger, companies at the same stage in the same industry combine for more economic power, to diversify, or to win greater market share. A vertical merger involves the acquisition of a firm that serves an earlier or later stage of the production or sales process, such as a supplier or sales outlet. In a conglomerate merger, unrelated businesses come together to reduce risk through diversification.

# Forms of Business Ownership ## Trends in Business Ownership 1. What current trends will affect the business organizations of the future? As we learned earlier, an awareness of trends in the business environment is critical to business success. Many social, demographic, and economic factors affect how businesses organize. When reviewing options for starting or organizing a business or choosing a career path, consider the following trends. ### “Baby Boomers” and “Millennials” Drive Franchise Trends We all hear and read a great deal about the “graying of America,” which refers to the “baby boomer” generation heading toward retirement age. This unprecedented demographic phenomenon—in 2006 the first of 78 million members of the baby boomer generation turned 60—is driving the ongoing battle to stay young, slim, and healthy. Every day, 10,000 boomers are turning 65, and the trend is likely to continue until 2030. Boomers have transformed every life stage they’ve touched so far, and their demographic weight means that business opportunities are created wherever they go. With their interest in staying fit, Boomers are contributing to the growth of fitness and weight-loss franchises. In just the past year, this category in Entrepreneur’s Franchise 500 has grown to over 50 franchisors. And according to the IHRSA, 52.9 million Americans belong to a health club—up from 39.4 million 10 years ago—so there are plenty of consumers feeding this growing trend. Another area of boomer-driven franchise growth is eldercare. Founded in 1994, Home Instead Senior Care is recognized as one of the world’s fastest growing franchise companies in the eldercare market, with a network of over 1,000 independently owned and operated franchises in 12 countries. And as the world’s population continues to age, the need for its unique services will continue to increase. Home Instead Senior Care provides a meaningful solution for the elderly who prefer to remain at home. Compared with the annual cost for a nursing home placement ($72,000–$92,000), home care at around $45,000–$60,000 a year is somewhat more affordable. Elder quality of life is enhanced by Home Instead Senior Care’s part-time, full-time, and around-the-clock services, designed for people who are capable of managing their physical needs but require some assistance and supervision. Home Instead Senior Care provides meal preparation, companionship, light housekeeping, medication reminders, incidental transportation, and errands. These services make it possible for the elderly to remain in the familiar comfort of their own homes for a longer period of time. But the best deal yet may be adult day services, one of the fastest-growing franchises and “still one of the best-kept secrets around” according to magazine. Based on the concept of day care services for children, Sarah Adult Day Services, Inc. offers a franchising opportunity that meets the two criteria for a successful and socially responsible business: a booming demographic market with great potential for growth, and excellent elder care. Programs such as SarahCare centers are highly affordable for its clients, costing around $17,900 a year. The SarahCare franchise allows entrepreneurs to become part of an expanding industry while restoring a sense of dignity and vibrancy to the lives of older adults. Millennials—individuals born between 1980 and 2000—are the largest living generation in the United States, according to Pew Research. Millennials spend more money in restaurants per capita than any previous generation. They have been recognized as changing the restaurant scene by looking for brands that offer customized food choices, quality ingredients, freshness, authenticity, transparency, and environmental and social responsibility. According to the U.S. Chamber of Commerce Foundation’s report, two out of three millennials are interested in entrepreneurship. According to magazine, 72 percent of millennials would like to be their own boss, 74 percent want flexible work schedules, and 88 percent want “work–life integration.” When it comes to owning a franchise, growth potential and meeting a flexible, fulfilling lifestyle are both something that attracts Millennials. A survey by the CT Corporation found that 60 percent of college graduates wanted to start a business after graduation, 67 percent lacked the know-how, 45 percent didn’t think they could come up with a name, and 30 percent were not knowledgeable about how to market the business. Franchising is the perfect solution to these issues. For example, Chicago area native and millennial Sal Rehman grew up working in his family’s diner. Sal had a dream of operating his own restaurant, and he decided to take the franchising path. In 2015, at the age of 27, Sal opened his first Wing Zone store in suburban Glendale Heights, Illinois. He currently owns five Wing Zones. ### Boomers Rewrite the Rules of Retirement At age 64, Bob Drucker could be the poster child for retirement except that the concept makes him recoil. Drucker is living his dream. He and his wife have a large house on Long Island where Drucker kicks back by floating in his pool when he’s not spoiling his granddaughters with trips to Disneyland. “The only way you can get me out of here is to carry me out,” Drucker says, referring to RxUSA, the online pharmacy he founded and runs in Port Washington, New York. “I love my work, and I cannot imagine sitting home and doing nothing.” Drucker is not alone. Today’s boomers are working longer at their jobs and embracing postretirement second careers, which often means starting their own small business. As retirees opt to go into business for themselves, they are choosing different forms of business organizations depending on their needs and goals. Some may start small consulting businesses using the simple sole proprietorship form of business organization, while couples or friends might choose to become partners in a retail or franchise venture. The more healthy and energetic the baby boomer generation remains, the more interested it is in staying active and engaged—and that may mean postponing retirement or not retiring at all. The annual retirement survey by Transamerica Center for Retirement Studies found that as this record number of Americans approaches retirement age, many are not slowing down. In fact, 51 percent of boomers plan to work in some capacity during their retirement years, and 82 percent indicated that they will not retire at or before age 65. ### Mergers and Foreign Investment Boom, Too After shunning big deals for more than three years, corporate America has launched a new merger wave. In 2016, North American companies announced deals totaling almost $2.0 trillion. Many of these deals were large ones, with the largest deal, announced in 2016, AT&T’s merger with Time Warner for over $85 billion. In addition, foreign merger activity has reached a new high. Worldwide deal volume in 2015 was 44,000 transactions totaling $4.5 trillion. In 2016, the number of transactions increased to over 48,000, one of the most active periods of merger activity to date. Non-U.S. companies accounted for about two-thirds of the transactions. European companies’ cross-border transactions led the way, with deals totaling more than one trillion dollars. The increase is the result of improving economic growth and better stock prices. This current boom in mergers feels different from earlier merger mania, however. New players are entering the arena, and the number of U.S. and foreign companies making cross-border acquisitions has increased. Whether these new mergers will be good for the global economy remains to be seen. Transactions that lead to cost savings, streamlined operations, and more funding for research and capital investment in new facilities will have positive effects on profitability. Many deals, however, may fail to live up to the acquirers’ expectations. Foreign investment in U.S. companies has also increased dramatically. Annual foreign direct investment reached $373.4 billion in 2016. The jump is the result of a worldwide boom in mergers and acquisitions and the need to finance America’s growing trade deficit, as well as the continued attraction of the U.S. economy to investors worldwide. And what about American investment in foreign economies? It is skyrocketing as U.S. businesses seek out opportunities in developing countries. According to the Congressional Research Service Reports, the outflows from the United States into foreign countries now exceeds $6.4 trillion a year. In addition to the attraction of cheap labor and resources, U.S. companies of all sizes continue to tap the intellectual capital of developing economies such as China and India, outsourcing such functions as payroll, information technology (IT), web/email hosting, customer relationship management (CRM), and human resources (HR) to keep costs under control and enhance profitability. ### Summary of Learning Outcomes 1. What current trends will affect the business organizations of the future? Americans are getting older but continue to open new businesses, from sole proprietorships to partnerships, corporations to franchise operations. The service sector is booming in efforts to meet the demand for fitness, health, and eldercare. Other key trends include an escalation of worldwide foreign investment through the number of mergers taking place. All forms of business organization can benefit from outsourcing, tapping into the intellectual capital of developing countries. ### Preparing for Tomorrow’s Workplace Skills 1. Suppose you are considering two job offers for a computer programming position, one at a two-year-old consulting firm with 10 employees owned by a sole proprietor and one at a publicly traded software developer with sales of $500 million. In addition to comparing the specific job responsibilities, consider the following: Answering these and similar questions will help you decide which job meets your particular needs. (Resources, Information) 2. Before starting your own company, you should know the legal requirements in your area. Call the appropriate city or county departments, such as licensing, health, and zoning, to find out what licenses and permits you need and any other requirements you must meet. Do the requirements vary depending on the type of company? Are there restrictions on starting a home-based business? Contact your secretary of state or other agency that handles corporations to get information on how to incorporate. (Information) 3. Bridget Jones wants to open her own business selling her handmade chocolates over the internet. Although she has some money saved and could start the business on her own, she is concerned about her lack of bookkeeping and management experience. A friend mentions they knows an experienced businessperson seeking involvement with a start-up company. As Bridget’s business consultant, prepare recommendations for Bridget regarding an appropriate form of business organization, outlining the issues she should consider and the risks involved, supported by reasons for your suggestions. (Interpersonal, Information) 4. You and a partner co-own Swim-Clean, a successful pool supply and cleaning service. Because sales have tapered off, you want to expand your operations to another town 10 miles away. Given the high costs of expanding, you decide to sell Swim-Clean franchises. The idea takes off, and soon you have 25 units throughout the region. Your success results in an invitation to speak at a local Rotary Club luncheon. Prepare a brief presentation describing how you evaluated the benefits and risks of becoming a franchisor, the problems you encountered, and how you established good working relationships with your franchisees. (Information) 5. Do you have what it takes to be a successful franchisee? Start by making a list of your interests and skills, and do a self-assessment using some of the suggestions in this chapter. Next you need to narrow the field of thousands of different franchise systems. At Franchise Handbook Online (http://www.franchisehandbook.com) , you’ll find articles with checklists to help you thoroughly research a franchise and its industry, as well as a directory of franchise opportunities. Armed with this information, develop a questionnaire to evaluate a prospective franchise. (Resources, Interpersonal, Information) 6. Find news of a recent merger using an online search or a business periodical such as Bloomberg Businessweek, Fortune, or The Wall Street Journal. Research the merger using a variety of sources including the company’s website and news articles. Discover the motives behind the merger, the problems facing the new entity, and the company’s progress toward achieving its objectives. (Information) 7. Team Activity After pulling one too many all-nighters, you realize your college needs an on-campus coffee/food delivery service and decide this might be a good business opportunity for you and some friends. Split the class into small groups. Start by outlining the management, technical, and financial resources that are needed to start this company. Then evaluate what resources your group brings to the table and what you will need from partners. Using as a guide, develop a list of questions for potential partners. After each group presents its findings to the class, it should pair up with another group that seems to offer additional resources. Interview the other group’s members using your questions to decide if the teams could work together and if you would proceed with this venture. (Resources, Interpersonal) ### Ethics Activity After seeing a Quiznos franchise recruitment infomercial to recruit franchisees, you are tempted to apply to open your own Quiznos sub shop. However, your research on the company turns up some disturbing information. Many current franchisees are unhappy with the company’s management and practices, among them excessive food costs, lack of promised support, and selling new franchise locations that are too close to existing stores. A group of New Jersey franchisees sued Quiznos for selling them franchises but not providing locations 18 months after taking their franchise fees. Some franchise owners question Quiznos’s purchasing tactics, choosing food and beverage suppliers based on the referral fees it receives instead of the lowest-cost provider. Other franchisees have suffered major financial losses. Quiznos, which owned or operated more than 5,000 sub shops at one time and now has less than 1,500 locations worldwide with less than 900 in the United States, disputes the various claims. The president of the company points out that in a franchise operation, there will always be unhappy franchisees and those who can’t make a success of their units. Besides, Quiznos’s franchise offering materials clearly state that the company may open stores in any locations it selects. Using a web search tool, locate articles about this topic, and then write responses to the following questions. Be sure to support your arguments and cite your sources. Ethical Dilemma: What are Quiznos’s obligations to its franchisees? Is it ethical for the company to open new franchises very close to existing units and to choose vendors based on fees to the parent company rather than the cost to franchisees? Sources: The Franchise King, “What Happened to Quiznos?” https://www.thefranchiseking.com, accessed September 14, 2017; Karsten Strauss, “Is Quiznos Toast?” Forbes, https://www.forbes.com, June 17, 2015; Venessa Wong, “Can Quiznos Be Saved?” BuzzFeed News, https://www.buzzfeed.com, December 8, 2015; Kristi Arellano, “Quiznos’ Success Not without Problems,” Denver Post, June 19, 2005, p. K1; Dina Berta, “Quiznos Denies Franchisees’ Charges of Cost Gouging, Encroachment Problems,” Nation’s Restaurant News, June 20, 2005, P. 1+; “Quiznos Denies Fraud Suit Charges by 17 Franchisees,” Nation’s Restaurant News, May 16, 2005, p. 102. ### Working the Net 1. Consult Entrepreneur at http://www.entrepreneur.com. Search for “business legal structures” to read articles about S corporations and LLCs. If you were starting a company, which would you choose and why? 2. Research how to form a corporation and LLC in your state using search engines to find relevant sites. Here are two to get you started: http://www.incorporate.com and http://www.usa-corporate.com. Find out what steps are necessary to set up a corporation in your state. How do the fees compare with other states? If you were incorporating a business, what state would you choose and why? 3. The Federal Trade Commission is the government agency that monitors and regulates franchises. Visit the FTC site (http://www.ftc.gov), and explore the links to its resources on franchising, including details on the legal responsibilities of franchisors and franchisees. What kinds of problems should a prospective franchisee look out for when considering a franchise? What kinds of scams are typical in the franchise industry? 4. Select three franchises that interest you. Research them at sites such as the Franchise Handbook Online (http://www.franchisehandbook.com), Entrepreneur magazine’s Franchise 500 (http://www.entrepreneur.com), and Be the Boss (www.betheboss.com). Prepare a chart comparing your selections, including history, number and location of units, financial requirements (initial franchise fee, other start-up costs, royalty and advertising fees), and any other information that would help you evaluate the franchises. 5. Inc. magazine (http://www.inc.com) has many franchising articles in its section on Startup. It offers insights into how franchisors and franchisees can better manage their businesses. Using the site’s resources, discuss ways the owner of a franchise can motivate employees. What specific revenue items and expenses should you monitor daily in a franchise restaurant business to ensure that you are profitable? ### Creative Thinking Case ### I’m an Owner of a Professional Sports Team! Many of the richest individuals have added professional sports teams to their ownership portfolios. Paul Allen owns the Seattle Seahawks after founding Microsoft, and another Microsoft alumnus, Steve Balmer, now owns the Los Angeles Clippers. They, like most other owners of sports teams, including Shahid Khan (Jacksonville Jaguars), Jerry Jones (Dallas Cowboys), the Rickets family (Chicago Cubs of Major League Baseball), and Geoff Molson (Montreal Canadiens of the National Hockey League), all have corporate structures that operate as for-profit organizations. There is one exception to the corporate structure, however. The Green Bay Packers are unique among North American sports teams in that they are a community-owned not-for-profit. They do have shareholders, but the shareholders have limited rights and most shares are bought so that fans can claim ownership and use the stock certificate as a piece of pride of ownership in a unique community treasure. The shares do not pay dividends, and any proceeds from any possible sale or liquidation of the team go to a charity, not the shareholders. This system, plus transfer restrictions and a cap on the number of shares that any single individual can own, ensures that the team remains in public hands and will never leave the city of Green Bay. Every shareholder in the Green Bay Packers received a ballot for electing the team’s board of directors, who then select an executive committee of seven individuals who will meet with chief executive officer Mark Murphy, a former NFL player who also served as the athletic director at Northwestern University prior to joining the Packers. Murphy is charged with hiring other leadership positions, such as the general manager, who then hires the head coach, who is charged with hiring the assistant coaches. So, what are the negatives to what seems like a perfect organizational structure? Many owners in other cities are able to price their tickets to the market and also able to create revenue streams from corporate advertising in the stadium as well as stadium-naming rights. The Packers have some of the lowest-priced tickets in the league despite 80,000 requests on their season ticket waiting list. Also, teams in other cities can negotiate with city, county, and other government agencies for subsidies and tax breaks for building new stadiums and use the threat of a move to another city as a bargaining chip. For instance, the St. Louis Rams and San Diego Chargers recently moved to Los Angeles while the Oakland Raiders will soon call Las Vegas home. Another potential drawback is that the organizational structure of the Packers restricts the ability to make organizational changes such as changing the general manager or head coach quickly if things are going badly. Luckily for the Packers, this has not been much of a problem lately having had success with star quarterbacks such as Brett Favre and Aaron Rodgers! 2. Is the not-for-profit form of business organization appropriate for the Green Bay Packers? Why or why not? 3. Why has this form of ownership not been replicated in other cities? 4. What are the limitations and constraints that this form of business has on the operations of the Green Bay Packers? Sources: “Ted Thompson Has No Obligation to Communicate,” Total Packers, https://www.totalpackers.com, August 8, 2017; Green Bay Packers website, “Packers Hall of Fame to Host Shareholders: A Story of Resilience, Community and Pride,” http://www.packers.com, June 23, 2017; Mike Florio, “Packers Ownership Structure Works Well, Until It Doesn’t,” NBC Sports, http://profootballtalk.nbcsports.com, November 26, 2016; “Green Bay Packers Shareholder on What It’s Like to Own an NFL Team,” Sporting News, http://www.sportingnews.com, September 30, 2014; Ken Reed, “Green Bay Packers’ Ownership Structure Remains Ideal,” League of Fans, http://www.leagueoffans, April 6, 2012; Karl Taro Greenfeld, “The Green Bay Packers Have the Best Owners in Sports,” Bloomberg Businessweek, https://www.bloomberg.com, October 20, 2011. ### Hot Links Address Book 1. Which Fortune 500 company had the biggest revenue increase? The highest profits? The highest return to investors? What is the largest entertainment company? Get all the details on U.S. companies at http://www.fortune.com/fortune500. 2. Confused about the differences between regular corporations, S corporations, and LLCs? Compare these three business structures at http://www.4inc.com. 3. Did you know U.S. cooperatives serve some 120 million members, or 4 in 10 Americans? For more co-op statistics, check the National Cooperative Business Association website at http://www.ncba.coop/. 4. Combine your sweet tooth with your good business sense by owning a candy franchise. Indulge yourself by finding out the requirements for owning a Rocky Mountain Chocolate Factory franchise at http://www.rmcf.com. 5. Want to know what’s hot and what’s not in franchising? Improve your chances for success at http://www.entrepreneur.com/franchises.

# Entrepreneurship: Starting and Managing Your Own Business ## Introduction ### Learning Outcomes After reading this chapter, you should be able to answer these questions: 1. Why do people become entrepreneurs, and what are the different types of entrepreneurs? 2. What characteristics do successful entrepreneurs share? 3. How do small businesses contribute to the U.S. economy? 4. What are the first steps to take if you are starting your own business? 5. Why does managing a small business present special challenges for the owner? 6. What are the advantages and disadvantages facing owners of small businesses? 7. How does the Small Business Administration help small businesses? 8. What trends are shaping entrepreneurship and small-business ownership? Typical of many who catch the entrepreneurial bug, Natalie Tessler had a vision and pursued it single-mindedly. She is just one of thousands of entrepreneurs from all age groups and backgrounds. Even kids are starting businesses and high-tech firms. College graduates are shunning the corporate world to head out on their own. Downsized employees, midcareer executives, and retirees who have worked for others all their lives are forming the companies they have always wanted to own. Companies started by entrepreneurs and small-business owners make significant contributions to the U.S. and global economies. Hotbeds of innovation, these small businesses take leadership roles in technological change and the development of new goods and services. Just how important are small businesses to our economy? provides insight into the role of small business in today’s economy. You may be one of the millions of Americans who’s considering joining the ranks of business owners. As you read this chapter, you’ll learn why entrepreneurship continues to be one of the hottest areas of business activity. Then you’ll get the information and tools you need to help you decide whether owning your own company is the right career path for you. Next you’ll discover what characteristics you’ll need to become a successful entrepreneur. Then we’ll look at the importance of small businesses in the economy, guidelines for starting and managing a small business, the many reasons small businesses continue to thrive in the United States, and the role of the Small Business Administration. Finally, the chapter explores the trends that shape entrepreneurship and small-business ownership today.

# Entrepreneurship: Starting and Managing Your Own Business ## Entrepreneurship Today 1. Why do people become entrepreneurs, and what are the different types of entrepreneurs? Brothers Fernando and Santiago Aguerre exhibited entrepreneurial tendencies at an early age. At 8 and 9 years old respectively, they sold strawberries and radishes from a vacant lot near their parents’ home in Plata del Mar on the Atlantic coast of Argentina. At 11 and 12, they provided a surfboard repair service from their garage. As teenagers, Fer and Santi, as they call each other, opened Argentina’s first surf shop, which led to their most ambitious entrepreneurial venture of all. The flat-footed brothers found that traipsing across hot sand in flip-flops was uncomfortable, so in 1984 they sank their $4,000 savings into manufacturing their own line of beach sandals. Now offering sandals and footwear for women, men, and children, as well as clothing for men, Reef sandals have become the world’s hottest beach footwear, with a presence in nearly every surf shop in the United States. Christy Glass Lowe, who monitors surf apparel for USBX Advisory Services LLC, notes, “They [Reef] built a brand from nothing and now they’re the dominant market share leader.” The Aguerres, who currently live two blocks from each other in La Jolla, California, sold Reef to VF Corporation for more than $100 million in 2005. In selling Reef, “We’ve finally found our freedom,” Fernando says. “We traded money for time,” adds Santiago. Fernando remains active with surfing organizations, serving as president of the International Surfing Association, where he became known as “Ambassador of the Wave” for his efforts in getting all 90 worldwide members of the International Olympic Committee to unanimously vote in favor of including surfing in the 2020 Olympic Games. He has also been named “Waterman of the Year” by the Surf Industry Manufacturers Association two times in 24 years. Santi raises funds for his favorite not-for-profit, SurfAid. Both brothers are enjoying serving an industry that has served them so well. The United States is blessed with a wealth of entrepreneurs such as the Aguerres who want to start a small business. According to research by the Small Business Administration, two-thirds of college students intend to be entrepreneurs at some point in their careers, aspiring to become the next Bill Gates or Jeff Bezos, founder of Amazon.com. But before you put out any money or expend energy and time, you’d be wise to check out for some preliminary advice. The desire to be one’s own boss cuts across all age, gender, and ethnic lines. Results of a recent U.S. Census Bureau survey of business owners show that minority groups and women are becoming business owners at a much higher rate than the national average. illustrates these minority-owned business demographics. Why has entrepreneurship remained such a strong part of the foundation of the U.S. business system for so many years? Because today’s global economy rewards innovative, flexible companies that can respond quickly to changes in the business environment. Such companies are started by entrepreneurs, people with vision, drive, and creativity, who are willing to take the risk of starting and managing a business to make a profit. ### Entrepreneur or Small-Business Owner? The term entrepreneur is often used in a broad sense to include most small-business owners. The two groups share some of the same characteristics, and we’ll see that some of the reasons for becoming an entrepreneur or a small-business owner are very similar. But there is a difference between entrepreneurship and small-business management. Entrepreneurship involves taking a risk, either to create a new business or to greatly change the scope and direction of an existing one. Entrepreneurs typically are innovators who start companies to pursue their ideas for a new product or service. They are visionaries who spot trends. Although entrepreneurs may be small-business owners, not all small-business owners are entrepreneurs. Small-business owners are managers or people with technical expertise who started a business or bought an existing business and made a conscious decision to stay small. For example, the proprietor of your local independent bookstore is a small-business owner. Jeff Bezos, founder of Amazon.com, also sells books. But Bezos is an entrepreneur: He developed a new model—web-based book retailing—that revolutionized the bookselling world and then moved on to change retailing in general. Entrepreneurs are less likely to accept the status quo, and they generally take a longer-term view than the small-business owner. ### Types of Entrepreneurs Entrepreneurs fall into several categories: classic entrepreneurs, multipreneurs, and intrapreneurs. ### Classic Entrepreneurs Classic entrepreneurs are risk-takers who start their own companies based on innovative ideas. Some classic entrepreneurs are micropreneurs who start small and plan to stay small. They often start businesses just for personal satisfaction and the lifestyle. Miho Inagi is a good example of a micropreneur. On a visit to New York with college friends in 1998, Inagi fell in love with the city’s bagels. “I just didn’t think anything like a bagel could taste so good,” she said. Her passion for bagels led the young office assistant to quit her job and pursue her dream of one day opening her own bagel shop in Tokyo. Although her parents tried to talk her out of it, and bagels were virtually unknown in Japan, nothing deterred her. Other trips to New York followed, including an unpaid six-month apprenticeship at Ess-a-Bagel, where Inagi took orders, cleared trays, and swept floors. On weekends, owner Florence Wilpon let her make dough. In August 2004, using $20,000 of her own savings and a $30,000 loan from her parents, Inagi finally opened tiny Maruichi Bagel. The timing was fortuitous, as Japan was about to experience a bagel boom. After a slow start, a favorable review on a local bagel website brought customers flocking for what are considered the best bagels in Tokyo. Inagi earns only about $2,300 a month after expenses, the same amount she was making as a company employee. “Before I opened this store I had no goals,” she says, “but now I feel so satisfied.” In contrast, growth-oriented entrepreneurs want their business to grow into a major corporation. Most high-tech companies are formed by growth-oriented entrepreneurs. Jeff Bezos recognized that with Internet technology he could compete with large chains of traditional book retailers. Bezos’s goal was to build his company into a high-growth enterprise—and he chose a name that reflected his strategy: Amazon.com. Once his company succeeded in the book sector, Bezos applied his online retailing model to other product lines, from toys and house and garden items to tools, apparel, music, and services. In partnership with other retailers, Bezos is well on his way to making Amazon’s vision “to be Earth’s most customer-centric company; to build a place where people can come to find and discover anything they might want to buy online.”—a reality. ### Multipreneurs Then there are multipreneurs, entrepreneurs who start a series of companies. They thrive on the challenge of building a business and watching it grow. In fact, over half of the chief executives at Inc. 500 companies say they would start another company if they sold their current one. Brothers Jeff and Rich Sloan are a good example of multipreneurs, having turned numerous improbable ideas into successful companies. Over the past 20-plus years, they have renovated houses, owned a horse breeding and marketing business, invented a device to prevent car batteries from dying, and so on. Their latest venture, a multimedia company called StartupNation, helps individuals realize their entrepreneurial dreams. And the brothers know what company they want to start next: yours. ### Intrapreneurs Some entrepreneurs don’t own their own companies but apply their creativity, vision, and risk-taking within a large corporation. Called intrapreneurs, these employees enjoy the freedom to nurture their ideas and develop new products, while their employers provide regular salaries and financial backing. Intrapreneurs have a high degree of autonomy to run their own minicompanies within the larger enterprise. They share many of the same personality traits as classic entrepreneurs, but they take less personal risk. According to Gifford Pinchot, who coined the term intrapreneur in his book of the same name, large companies provide seed funds that finance in-house entrepreneurial efforts. These include Intel, IBM, Texas Instruments (a pioneering intrapreneurial company), Salesforce.com, and Xerox. ### Why Become an Entrepreneur? As the examples in this chapter show, entrepreneurs are found in all industries and have different motives for starting companies. The most common reason cited by CEOs of the Inc. 500, the magazine’s annual list of fastest-growing private companies, is the challenge of building a business, followed by the desire to control their own destiny. Other reasons include financial independence and the frustration of working for someone else. Two important motives mentioned in other surveys are a feeling of personal satisfaction with their work, and creating the lifestyle that they want. Do entrepreneurs feel that going into business for themselves was worth it? The answer is a resounding yes. Most say they would do it again. ### Summary of Learning Outcomes 1. Why do people become entrepreneurs, and what are the different types of entrepreneurs? Entrepreneurs are innovators who take the risk of starting and managing a business to make a profit. Most want to develop a company that will grow into a major corporation. People become entrepreneurs for four main reasons: the opportunity for profit, independence, personal satisfaction, and lifestyle. Classic entrepreneurs may be micropreneurs, who plan to keep their businesses small, or growth-oriented entrepreneurs. Multipreneurs start multiple companies, while intrapreneurs work within large corporations.

# Entrepreneurship: Starting and Managing Your Own Business ## Characteristics of Successful Entrepreneurs 1. What characteristics do successful entrepreneurs share? Do you have what it takes to become an entrepreneur? Having a great concept is not enough. An entrepreneur must be able to develop and manage the company that implements his or her idea. Being an entrepreneur requires special drive, perseverance, passion, and a spirit of adventure, in addition to managerial and technical ability. Entrepreneurs are the company; they tend to work longer hours, take fewer vacations, and cannot leave problems at the office at the end of the day. They also share other common characteristics as described in the next section. ### The Entrepreneurial Personality Studies of the entrepreneurial personality find that entrepreneurs share certain key traits. Most entrepreneurs are 1. Ambitious: They are competitive and have a high need for achievement. 2. Independent: They are individualists and self-starters who prefer to lead rather than follow. 3. Self-confident: They understand the challenges of starting and operating a business and are decisive and confident in their ability to solve problems. 4. Risk-takers: Although they are not averse to risk, most successful entrepreneurs favor business opportunities that carry a moderate degree of risk where they can better control the outcome over highly risky ventures where luck plays a large role. 5. Visionary: Their ability to spot trends and act on them sets entrepreneurs apart from small-business owners and managers. 6. Creative: To compete with larger firms, entrepreneurs need to have creative product designs, bold marketing strategies, and innovative solutions to managerial problems. 7. Energetic: Starting and operating a business takes long hours. Even so, some entrepreneurs start their companies while still employed full-time elsewhere. 8. Passionate. Entrepreneurs love their work, as Miho Inagi demonstrated by opening a bagel shop in Tokyo despite the odds against it being a success. 9. Committed. Because they are so committed to their companies, entrepreneurs are willing to make personal sacrifices to achieve their goals. Most entrepreneurs combine many of the above characteristics. Sarah Levy, 23, loved her job as a restaurant pastry chef but not the low pay, high stress, and long hours of a commercial kitchen. So she found a new one—in her parents’ home—and launched Sarah’s Pastries and Candies. Part-time staffers help her fill pastry and candy orders to the soothing sounds of music videos playing in the background. Cornell University graduate Conor McDonough started his own web design firm, OffThePathMedia.com, after becoming disillusioned with the rigid structure of his job. “There wasn’t enough room for my own expression,” he says. “Freelancing keeps me on my toes,” says busy graphic artist Ana Sanchez. “It forces me to do my best work because I know my next job depends on my performance.” ### Managerial Ability and Technical Knowledge A person with all the characteristics of an entrepreneur might still lack the necessary business skills to run a successful company. Entrepreneurs need the technical knowledge to carry out their ideas and the managerial ability to organize a company, develop operating strategies, obtain financing, and supervise day-to-day activities. Jim Crane, who built Eagle Global Logistics from a start-up into a $250 million company, addressed a group at a meeting saying, “I have never run a $250 million company before so you guys are going to have to start running this business.” Good interpersonal and communication skills are important in dealing with employees, customers, and other business associates such as bankers, accountants, and attorneys. As we will discuss later in the chapter, entrepreneurs believe they can learn these much-needed skills. When Jim Steiner started his toner cartridge remanufacturing business, Quality Imaging Products, his initial investment was $400. He spent $200 on a consultant to teach him the business and $200 on materials to rebuild his first printer cartridges. He made sales calls from 8.00 a.m. to noon and made deliveries to customers from noon until 5:00 p.m. After a quick dinner, he moved to the garage, where he filled copier cartridges until midnight, when he collapsed into bed, sometimes covered with carbon soot. And this was not something he did for a couple of months until he got the business off the ground—this was his life for 18 months. But entrepreneurs usually soon learn that they can’t do it all themselves. Often they choose to focus on what they do best and hire others to do the rest. ### Summary of Learning Outcomes 1. What characteristics do successful entrepreneurs share? Successful entrepreneurs are ambitious, independent, self-confident, creative, energetic, passionate, and committed. They have a high need for achievement and a willingness to take moderate risks. Good managerial, interpersonal, and communication skills, as well as technical knowledge are important for entrepreneurial success.

# Entrepreneurship: Starting and Managing Your Own Business ## Small Business: Driving America's Growth 1. How do small businesses contribute to the U.S. economy? Although large corporations dominated the business scene for many decades, in recent years small businesses have once again come to the forefront. Downsizings that accompany economic downturns have caused many people to look toward smaller companies for employment, and they have plenty to choose from. Small businesses play an important role in the U.S. economy, representing about half of U.S. economic output, employing about half the private sector workforce, and giving individuals from all walks of life a chance to succeed. ### What Is a Small Business? How many small businesses are there in the United States? Estimates range from 5 million to over 22 million, depending on the size limits government agencies and other groups use to define a small business or the number of businesses with or without employees. The Small Business Administration (SBA) established size standards to define whether a business entity is small and therefore eligible for government programs and preferences that are reserved for “small businesses.” Size standards are based on the types of economic activity or industry, generally matched to the North American Industry Classification System (NAICS). Small businesses are defined in many ways. Statistics for small businesses vary based on criteria such as new/start-up businesses, the number of employees, total revenue, length of time in business, nonemployees, businesses with employees, geographic location, and so on. Due to the complexity and need for consistent statistics and reporting for small businesses, several organizations are now working together to combine comprehensive data sources to get a clear and accurate picture of small businesses in the United States. provides a more detailed look at small-business owners. One of the best sources to track U.S. entrepreneurial growth activity is the Ewing Marion Kauffman Foundation. The Kauffman Foundation is among the largest private foundations in the country, with an asset base of approximately $2 billion, and focuses on projects that encourage entrepreneurship and support education through grants and research activities. They distributed over $17 million in grants in 2013. The Kauffman Foundation supports new business creation in the United States through two research programs. The annual Kauffman Index of Entrepreneurship series measures and interprets indicators of U.S. entrepreneurial activity at the national, state, and metropolitan level. The foundation also contributes to the cost of the Annual Survey of Entrepreneurs (ASE), which is a public–private partnership between the foundation, the U.S. Census Bureau, and the Minority Business Development Agency. The ASE provides annual data on select economic and demographic characteristics of employer businesses and their owners by gender, ethnicity, race, and veteran status. The Kauffman Index of Entrepreneurship series is an umbrella of annual reports that measures how people and businesses contribute to America’s overall economy. What is unique about the Kauffman reports is that the indexes don’t focus on only inputs (as most small-business reporting has been done in the past); it reports primarily on entrepreneurial outputs—the actual results of entrepreneurial activity, such as new companies, business density, and growth rates. The reports also include comprehensive, interactive data visualizations that enable users to slice and dice a myriad of data nationally, at the state level, and for the 40 largest metropolitan areas. The Kauffman Index series consists of three in-depth studies—Start-up Activity, Main Street Entrepreneurship, and Growth Entrepreneurship. 1. The Kauffman Index of Startup Activity is an early indicator of new entrepreneurship in the United States. It focuses on new business creation activity and people engaging in business start-up activity, using three components: the rate of new entrepreneurs, the opportunity share of new entrepreneurs, and start-up density. 2. The Kauffman Index of Main Street Entrepreneurship measures established small-business activity—focusing on U.S. businesses more than five years old with less than 50 employees from 1997 to 2016. Established in 2015, it takes into account three components of local, small-business activity: the rate of businesses owners in the economy, the five-year survival rate of businesses, and the established small-business density. 3. The Kauffman Growth Entrepreneurship Index is a composite measure of entrepreneurial business growth in the United States that captures growth entrepreneurship in all industries and measures business growth from both revenue and job perspectives. Established in 2016, it includes three component measures of business growth: rate of start-up growth, share of scale-ups, and high-growth company density. Data sources for the Kauffman Index calculations are based on Current Population Survey (CPS), with sample sizes of more than 900,000 observations, and the Business Dynamics Statistics (BDS), which covers approximately 5 million businesses. The Growth Entrepreneurship Index also includes Inc. 500/5000 data). Small businesses in the United States can be found in almost every industry, including services, retail, construction, wholesale, manufacturing, finance and insurance, agriculture and mining, transportation, and warehousing. Established small businesses are defined as companies that have been in business at least five years and employ at least one, but less than 50, employees. provides the number of employees by the size of established business. More than half of small businesses have between one and four employees. ### Summary of Learning Outcomes 1. How do small businesses contribute to the U.S. economy? Small businesses play an important role in the economy. They account for over 99 percent of all employer firms and produce about half of U.S. economic output. Most new private-sector jobs created in the United States over the past decade were in small firms. The Small Business Administration defines a small business as independently owned and operated, with a local base of operations, and not dominant in its field. It also defines small business by size, according to its industry. Small businesses are found in every field, but they dominate the service, construction, wholesale, and retail categories.

# Entrepreneurship: Starting and Managing Your Own Business ## Ready, Set, Start Your Own Business 1. What are the first steps to take if you are starting your own business? You have decided that you’d like to go into business for yourself. What is the best way to go about it? Start from scratch? Buy an existing business? Or buy a franchise? About 75 percent of business start-ups involve brand-new organizations, with the remaining 25 percent representing purchased companies or franchises. Franchising may have been discussed elsewhere in your course, so we’ll cover the other two options in this section. ### Getting Started The first step in starting your own business is a self-assessment to determine whether you have the personal traits you need to succeed and, if so, what type of business would be best for you. provides a checklist to consider before starting your business. ### Finding the Idea Entrepreneurs get ideas for their businesses from many sources. It is not surprising that about 80 percent of Inc. 500 executives got the idea for their company while working in the same or a related industry. Starting a firm in a field where you have experience improves your chances of success. Other sources of inspiration are personal experiences as a consumer; hobbies and personal interests; suggestions from customers, family, and friends; industry conferences; and college courses or other education. An excellent way to keep up with small-business trends is by reading entrepreneurship and small-business magazines and visiting their websites. With articles on everything from idea generation to selling a business, they provide an invaluable resource and profile some of the young entrepreneurs and their successful business ventures (). These dynamic individuals, who are already so successful in their 20s and 30s, came up with unique ideas and concepts and found the right niche for their businesses. Interesting ideas are all around you. Many successful businesses get started because someone identifies a need and then finds a way to fill it. Do you have a problem that you need to solve? Or a product that doesn’t work as well as you’d like? Raising questions about the way things are done and seeing opportunity in adversity are great ways to generate ideas. ### Choosing a Form of Business Organization A key decision for a person starting a new business is whether it will be a sole proprietorship, partnership, corporation, or limited liability company. As discussed earlier, each type of business organization has advantages and disadvantages. The choice depends on the type of business, number of employees, capital requirements, tax considerations, and level of risk involved. ### Developing the Business Plan Once you have the basic concept for a product or service, you must develop a plan to create the business. This planning process, culminating in a sound business plan, is one of the most important steps in starting a business. It can help to attract appropriate loan financing, minimize the risks involved, and be a critical determinant in whether a firm succeeds or fails. Many people do not venture out on their own because they are overwhelmed with doubts and concerns. A comprehensive business plan lets you run various “what if” analyses and evaluate your business without any financial outlay or risk. You can also develop strategies to overcome problems well before starting the business. Taking the time to develop a good business plan pays off. A venture that seems sound at the idea stage may not look so good on paper. A well-prepared, comprehensive, written business plan forces entrepreneurs to take an objective and critical look at their business venture and analyze their concept carefully; make decisions about marketing, sales, operations, production, staffing, budgeting and financing; and set goals that will help them manage and monitor its growth and performance. The business plan also serves as the initial operating plan for the business. Writing a good business plan takes time. But many businesspeople neglect this critical planning tool in their eagerness to begin doing business, getting caught up in the day-to-day operations instead. The key features of a business plan are a general description of the company, the qualifications of the owner(s), a description of the products or services, an analysis of the market (demand, customers, competition), sales and distribution channels, and a financial plan. The sections should work together to demonstrate why the business will be successful, while focusing on the uniqueness of the business and why it will attract customers. describes the essential elements of a business plan. A common use of a business plan is to persuade lenders and investors to finance the venture. The detailed information in the plan helps them assess whether to invest. Even though a business plan may take months to write, it must capture potential investors’ interest within minutes. For that reason, the basic business plan should be written with a particular reader in mind. Then you can fine-tune and tailor it to fit the investment goals of the investor(s) you plan to approach. But don’t think you can set aside your business plan once you obtain financing and begin operating your company. Entrepreneurs who think their business plan is only for raising money make a big mistake. Business plans should be dynamic documents, reviewed and updated on a regular basis—monthly, quarterly, or annually, depending on how the business progresses and the particular industry changes. Owners should adjust their sales and profit projections up or down as they analyze their markets and operating results. Reviewing your plan on a constant basis will help you identify strengths and weaknesses in your marketing and management strategies and help you evaluate possible opportunities for expansion in light of both your original mission and goals, current market trends, and business results. The Small Business Administration (SBA) offers sample business plans and online guidance for business plan preparation under the “Business Guide” tab at https://www.sba.gov. ### Financing the Business Once the business plan is complete, the next step is to obtain financing to set up your company. The funding required depends on the type of business and the entrepreneur’s own investment. Businesses started by lifestyle entrepreneurs require less financing than growth-oriented businesses, and manufacturing and high-tech companies generally require a large initial investment. Who provides start-up funding for small companies? Like Miho Inagi and her Tokyo bagel shop, 94 percent of business owners raise start-up funds from personal accounts, family, and friends. Personal assets and money from family and friends are important for new firms, whereas funding from financial institutions may become more important as companies grow. Three-quarters of Inc. 500 companies have been funded on $100,000 or less. The two forms of business financing are debt, borrowed funds that must be repaid with interest over a stated time period, and equity, funds raised through the sale of stock (i.e., ownership) in the business. Those who provide equity funds get a share of the business’s profits. Because lenders usually limit debt financing to no more than a quarter to a third of the firm’s total needs, equity financing often amounts to about 65 to 75 percent of total start-up financing. One way to finance a start-up company is bootstrapping, which is basically funding the operation with your own resources. If the resources needed are not available to an individual, there are other options. Two sources of equity financing for young companies are angel investors and venture-capital firms. Angel investors are individual investors or groups of experienced investors who provide financing for start-up businesses by investing their own money, often referred to as “seed capital.” This gives the investors more flexibility on what they can and will invest in, but because it is their own money, angels are careful. Angel investors often invest early in a company’s development, and they want to see an idea they understand and can have confidence in. offers some guidelines on how to attract angel financing. Venture capital is financing obtained from venture capitalists, investment firms that specialize in financing small, high-growth companies. Venture capitalists receive an ownership interest and a voice in management in return for their money. They typically invest at a later stage than angel investors. We’ll discuss venture capital in greater detail when discussing financing the enterprise. ### Buying a Small Business Another route to small-business ownership is buying an existing business. Although this approach is less risky, many of the same steps for starting a business from scratch apply to buying an existing company. It still requires careful and thorough analysis. The potential buyer must answer several important questions: Why is the owner selling? Do they want to retire or move on to a new challenge, or are there problems with the business? Is the business operating at a profit? If not, can this be corrected? On what basis has the owner valued the company, and is it a fair price? What are the owner’s plans after selling the company? Will they be available to provide assistance through the change of ownership of the business? And depending on the type of business it is, will customers be more loyal to the owner than to the product or service being offered? Customers could leave the firm if the current owner decides to open a similar business. To protect against this, many purchasers include a noncompete clause in the contract of sale, which generally means that the owner of the company being sold may not be allowed to compete in the same industry of the acquired business for a specific amount of time. You should prepare a business plan that thoroughly analyzes all aspects of the business. Get answers to all your questions, and determine, via the business plan, whether the business is a sound one. Then you must negotiate the price and other terms of purchase and obtain appropriate financing. This can be a complicated process and may require the use of a consultant or business broker. ### Risky Business Running your own business may not be as easy as it sounds. Despite the many advantages of being your own boss, the risks are great as well. Over a period of five years, nearly 50% percent of small businesses fail according to the Kauffman Foundation. Businesses close down for many reasons—and not all are failures. Some businesses that close are financially successful and close for nonfinancial reasons. But the causes of business failure can be interrelated. For example, low sales and high expenses are often directly related to poor management. Some common causes of business closure are: 1. Economic factors—business downturns and high interest rates 2. Financial causes—inadequate capital, low cash balances, and high expenses 3. Lack of experience—inadequate business knowledge, management experience, and technical expertise 4. Personal reasons—the owners may decide to sell the business or move on to other opportunities Inadequate early planning is often at the core of later business problems. As described earlier, a thorough feasibility analysis, from market assessment to financing, is critical to business success. Yet even with the best plans, business conditions change and unexpected challenges arise. An entrepreneur may start a company based on a terrific new product only to find that a larger firm with more marketing, financing, and distribution clout introduces a similar item. The stress of managing a business can also take its toll. The business can consume your whole life. Owners may find themselves in over their heads and unable to cope with the pressures of business operations, from the long hours to being the main decision maker. Even successful businesses have to deal with ongoing challenges. Growing too quickly can cause as many problems as sluggish sales. Growth can strain a company’s finances when additional capital is required to fund expanding operations, from hiring additional staff to purchasing more raw material or equipment. Successful business owners must respond quickly and develop plans to manage its growth. So, how do you know when it is time to quit? “Never give up” may be a good motivational catchphrase, but it is not always good advice for a small-business owner. Yet, some small-business owners keep going no matter what the cost. For example, Ian White’s company was trying to market a new kind of city map. White maxed out 11 credit cards and ran up more than $100,000 in debt after starting his company. He ultimately declared personal bankruptcy and was forced to find a job so that he could pay his bills. Maria Martz didn’t realize her small business would become a casualty until she saw her tax return showing her company’s losses in black and white—for the second year in a row. It convinced her that enough was enough and she gave up her gift-basket business to become a full-time homemaker. But once the decision is made, it may be tough to stick to. “I got calls from people asking how come I wasn’t in business anymore. It was tempting to say I’d make their basket but I had to tell myself it is finished now.” ### Summary of Learning Outcomes 1. What are the first steps to take if you are starting your own business? After finding an idea that satisfies a market need, the small-business owner should choose a form of business organization. Preparing a formal business plan helps the business owner analyze the feasibility of his or her idea. The written plan describes in detail the idea for the business and how it will be implemented and operated. The plan also helps the owner obtain both debt and equity financing for the new business.

# Entrepreneurship: Starting and Managing Your Own Business ## Managing a Small Business 1. Why does managing a small business present special challenges for the owner? Managing a small business is quite a challenge. Whether you start a business from scratch or buy an existing one, you must be able to keep it going. The small-business owner must be ready to solve problems as they arise and move quickly if market conditions change. A sound business plan is key to keeping the small-business owner in touch with all areas of his or her business. Hiring, training, and managing employees is another important responsibility because the owner’s role may change over time. As the company grows, others will make many of the day-to-day decisions while the owner focuses on managing employees and planning for the firm’s long-term success. The owner must constantly evaluate company performance and policies in light of changing market and economic conditions and develop new policies as required. They must also nurture a continual flow of ideas to keep the business growing. The types of employees needed may change too as the firm grows. For instance, a larger firm may need more managerial talent and technical expertise. ### Using Outside Consultants One way to ease the burden of managing a business is to hire outside consultants. Nearly all small businesses need a good certified public accountant (CPA) who can help with financial record keeping, decision-making, and tax planning. An accountant who works closely with the owner to help the business grow is a valuable asset. An attorney who knows about small-business law can provide legal advice and draw up essential contracts and documents. Consultants in areas such as marketing, employee benefits, and insurance can be used on an as-needed basis. Outside directors with business experience are another way for small companies to get advice. Resources such as these free the small-business owner to concentrate on medium- and long-range planning and day-to-day operations. Some aspects of business can be outsourced or contracted out to specialists. Among the more common departments that use outsourcing are information technology, marketing, customer service, order fulfillment, payroll, and human resources. Hiring an outside company—in many cases another small business—can save money because the purchasing firm buys just the services it needs and makes no investment in expensive technology. Management should review outsourced functions as the business grows because at some point it may be more cost-effective to bring them in-house. ### Hiring and Retaining Employees It is important to identify all the costs involved in hiring an employee to make sure your business can afford it. Recruiting, help-wanted ads, extra space, and taxes will easily add about 10–15 percent to their salary, and employee benefits will add even more. Hiring an employee may also mean more work for you in terms of training and management. It’s a catch-22: To grow you need to hire more people, but making the shift from solo worker to boss can be stressful. Attracting good employees is more difficult for a small firm, which may not be able to match the higher salaries, better benefits, and advancement potential offered by larger firms. Small companies need to be creative to attract the right employees and convince applicants to join their firm. Once they hire an employee, small-business owners must make employee satisfaction a top priority in order to retain good people. A company culture that nurtures a comfortable environment for workers, flexible hours, employee benefit programs, opportunities to help make decisions, and a share in profits and ownership are some ways to do this. Duane Ruh figured out how to build a $1.2 million business in a town with just 650 residents. It’s all about treating employees right. The log birdhouse and bird feeder manufacturer, Little Log Co., located in Sargent, Nebraska, boasts employee-friendly policies you read about but rarely see put into practice. Ruh offers his employees a flexible schedule that gives them plenty of time for their personal lives. During a slow period last summer, Ruh cut back on hours rather than lay anyone off. There just aren’t that many jobs in that part of Nebraska that his employees could go to, so when he received a buyout offer that would have closed his facility but kept him in place with an enviable salary, he turned it down. Ruh also encourages his employees to pursue side or summer jobs if they need to make extra money, assuring them that their Little Log jobs are safe. ### Going Global with Exporting More and more small businesses are discovering the benefits of looking beyond the United States for market opportunities. The global marketplace represents a huge opportunity for U.S. businesses, both large and small. Small businesses’ decision to export is driven by many factors, one of which is the desire for increased sales and higher profits. U.S. goods are less expensive for overseas buyers when the value of the U.S. dollar declines against foreign currencies, and this creates opportunities for U.S. companies to sell globally. In addition, economic conditions such as a domestic recession, foreign competition within the United States, or new markets opening up in foreign countries may also encourage U.S. companies to export. Like any major business decision, exporting requires careful planning. Small businesses may hire international-trade consultants or distributors to get started selling overseas. These specialists have the time, knowledge, and resources that most small businesses lack. Export trading companies (ETCs) buy goods at a discount from small businesses and resell them abroad. Export management companies (EMCs) act on a company’s behalf. For fees of 5–15 percent of gross sales and multiyear contracts, they handle all aspects of exporting, including finding customers, billing, shipping, and helping the company comply with foreign regulations. Many online resources are also available to identify potential markets for your goods and services, as well as to decipher the complexities involved in preparing to sell in a foreign country. The Small Business Association’s Office of International Trade has links to many valuable sites. The Department of Commerce offers services for small businesses that want to sell abroad. Contact its Trade Information Center, 1-800-USA-TRADE, or its Export Center (http://www.export.gov). ### Summary of Learning Outcomes 1. Why does managing a small business present special challenges for the owner? At first, small-business owners are involved in all aspects of the firm’s operations. Hiring and retaining key employees and the wise use of outside consultants can free up an owner’s time to focus on planning, strategizing, and monitoring market conditions, in addition to overseeing day-to-day operations. Expanding into global markets can be a profitable growth strategy for a small business.

# Entrepreneurship: Starting and Managing Your Own Business ## Small Business, Large Impact 1. What are the advantages and disadvantages facing owners of small businesses? An uncertain economy has not stopped people from starting new companies. The National Federation of Independent Businesses reports that 85 percent of Americans view small businesses as a positive influence on American life. This is not surprising when you consider the many reasons why small businesses continue to thrive in the United States: 1. Independence and a better lifestyle: Large corporations no longer represent job security or offer the fast-track career opportunities they once did. Mid-career employees leave the corporate world—either voluntarily or as a result of downsizing—in search of the new opportunities that self-employment provides. Many new college and business school graduates shun the corporate world altogether to start their own companies or look for work in smaller firms. 2. Personal satisfaction from work: Many small-business owners cite this as one of the primary reasons for starting their companies. They love what they do. 3. Best route to success: Business ownership provides greater advancement opportunities for women and minorities, as we will discuss later in this chapter. It also offers small-business owners the potential for profit. 4. Rapidly changing technology: Technology advances and decreased costs provide individuals and small companies with the power to compete in industries that were formerly closed to them. 5. Major corporate restructuring and downsizing: These force many employees to look for other jobs or careers. They may also provide the opportunity to buy a business unit that a company no longer wants. 6. Outsourcing: As a result of downsizing, corporations may contract with outside firms for services they used to provide in-house. Outsourcing creates opportunities for smaller companies that offer these specialized goods and services. 7. Small businesses are resilient: They are able to respond fairly quickly to changing economic conditions by refocusing their operations. There are several cities and regions that are regarded as the best locations for start-up businesses and entrepreneurs. Among them are Tulsa, Oklahoma; Tampa, Florida; Atlanta, Georgia; Raleigh, North Carolina; Oklahoma City, Oklahoma; Seattle, Washington; Minneapolis, Minnesota; and Austin, Texas. ### Why Stay Small? Owners of small businesses recognize that being small offers special advantages. Greater flexibility and an uncomplicated company structure allow small businesses to react more quickly to changing market forces. Innovative product ideas can be developed and brought to market more quickly, using fewer financial resources and personnel than would be needed in a larger company. And operating more efficiently keeps costs down as well. Small companies can also serve specialized markets that may not be cost-effective for large companies. Another feature is the opportunity to provide a higher level of personal service. Such attention brings many customers back to small businesses such as gourmet restaurants, health clubs, spas, fashion boutiques, and travel agencies. Steve Niewulis played in baseball’s minor leagues before an injury to his rotator cuff cut short his career. Niewulis decided to combine his love of the game with a clever idea that has elevated him to the big leagues. The fact that players had trouble keeping their hands dry while batting inspired his big idea: a sweat-busting rosin bag attached to a wristband so that a player can dry the bat handle between pitches. In less than two years, Niewulis’s Fort Lauderdale, Florida, company, Tap It! Inc., sold thousands of Just Tap It! wristbands. The product, which retails for $12.95, is used by baseball players, basketball players, tennis players, golfers, and even rock climbers. His secret to success? Find a small distribution network that allows small companies, with just one product line, to succeed. On the other hand, being small is not always an asset. The founders may have limited managerial skills or encounter difficulties obtaining adequate financing, potential obstacles to growing a company. Complying with federal regulations is also more expensive for small firms. Those with fewer than 20 employees spend about twice as much per employee on compliance than do larger firms. In addition, starting and managing a small business requires a major commitment by the owner. Long hours, the need for owners to do much of the work themselves, and the stress of being personally responsible for the success of the business can take a toll. But managing your company’s growing pains doesn’t need to be a one-person job. Four years after he started DrinkWorks (now Whirley DrinkWorks), a company that makes custom drinking cups, Richard Humphrey was logging 100-hour weeks. “I was concerned that if I wasn’t there every minute, the company would fall apart.” Humphrey got sick, lost weight, and had his engagement fall apart. When forced by a family emergency to leave the company in the hands of his five employees, Humphrey was amazed at how well they managed in his absence. “They stepped up to the plate and it worked out,” he says. “After that the whole company balanced out.” ### Summary of Learning Outcomes 1. What are the advantages and disadvantages facing owners of small businesses? Because of their streamlined staffing and structure, small businesses can be efficiently operated. They have the flexibility to respond to changing market conditions. Small firms can serve specialized markets more profitably than large firms, and they provide a higher level of personal service. Disadvantages include limited managerial skill, difficulty in raising capital needed for start-up or expansion, the burden of complying with increasing levels of government regulation, and the major personal commitment that is required by the owner.

# Entrepreneurship: Starting and Managing Your Own Business ## The Small Business Administration 1. How does the Small Business Administration help small businesses? Many small-business owners turn to the Small Business Administration (SBA) for assistance. The SBA’s mission is to speak on behalf of small business, and through its national network of local offices it helps people start and manage small businesses, advises them in the areas of finance and management, and helps them win federal contracts. Its toll-free number—1-800-U-ASK-SBA (1-800-827-5722)—provides general information, and its website at http://www.sba.gov offers details on all its programs. ### Financial Assistance Programs The SBA offers financial assistance to qualified small businesses that cannot obtain financing on reasonable terms through normal lending channels. This assistance takes the form of guarantees on loans made by private lenders. (The SBA no longer provides direct loans.) These loans can be used for most business purposes, including purchasing real estate, equipment, and materials. The SBA has been responsible for a significant amount of small-business financing in the United States. In the fiscal year ending on September 30, 2017, the SBA backed more than $25 billion in loans to almost 68,000 small businesses, including about $9 billion to minority-owned firms and $7.5 billion in loans to businesses owned by women. It also provided more than $1.7 billion in home and business disaster loans. Other SBA programs include the New Markets Venture Capital Program, which promotes economic development and job opportunities in low-income geographic areas, while other programs offer export financing and assistance to firms that suffer economic harm after natural or other disasters. More than 300 SBA-licensed Small Business Investment Companies (SBICs) provide about $6 billion each year in long-term financing for small businesses. The SBA’s website suggests seeking angel investors and using SBA-guaranteed loans as a way to fund the start-up. These privately owned and managed investment companies hope to earn a substantial return on their investments as the small businesses grow. ### SCORE-ing with Management Assistance Programs The SBA also provides a wide range of management advice. Its Business Development Library has publications on most business topics. Its “Starting Out” series offers brochures on how to start a wide variety of businesses—from ice-cream stores to fish farms. Business development officers at the Office of Business Development and local Small Business Development Centers counsel many thousands of small-business owners each year, offering advice, training, and educational programs. The SBA also offers free management consulting through two volunteer groups: the Service Corps of Retired Executives (SCORE), and the Active Corps of Executives (ACE). Executives in these programs use their own business backgrounds to help small-business owners. SCORE has expanded its outreach into new markets by offering email counseling through its website (http://www.score.org). The SBA also offers free online resources and courses for small-business owners and aspiring entrepreneurs in its Learning Center, located on the SBA website under the “Learning Center” tab. ### Assistance for Women and Minorities The SBA is committed to helping women and minorities increase their business participation. It offers a minority small-business program, microloans, and the publication of Spanish-language informational materials. It has increased its responsiveness to small businesses by giving regional offices more decision authority and creating high-tech tools for grants, loan transactions, and eligibility reviews. The SBA offers special programs and support services for socially and economically disadvantaged persons, including women, Native Americans, and Hispanic people through its Minority Business Development Agency. It also makes a special effort to help veterans go into business for themselves. ### Summary of Learning Outcomes 1. How does the Small Business Administration help small businesses? The Small Business Administration is the main federal agency serving small businesses. It provides guarantees of private-lender loans for small businesses. The SBA also offers a wide range of management assistance services, including courses, publications, and consulting. It has special programs for women, minorities, and veterans.

# Entrepreneurship: Starting and Managing Your Own Business ## Trends in Entrepreneurship and Small-Business Ownership 1. What trends are shaping entrepreneurship and small-business ownership? Entrepreneurship has changed since the heady days of the late 1990s, when starting a dot-com while still in college seemed a quick route to riches and stock options. Much entrepreneurial opportunity comes from major changes in demographics, society, and technology, and at present there is a confluence of all three. A major demographic group is moving into a significantly different stage in life, and minorities are increasing their business ownership in remarkable numbers. We have created a society in which we expect to have our problems taken care of, and the technological revolution stands ready with already-developed solutions. Evolving social and demographic trends, combined with the challenge of operating in a fast-paced technology-dominated business climate, are changing the face of entrepreneurship and small-business ownership. ### Into the Future: Start-ups Drive the Economy Did new business ventures drive the economic recovery from the 2001–2002 and 2007–2009 to recessions, and are they continuing to make significant contributions to the U.S. economy? The economists who review Department of Labor employment surveys and SBA statistics think so. “Small business drives the American economy,” says Dr. Chad Moutray, former chief economist for the SBA’s Office of Advocacy. “Main Street provides the jobs and spurs our economic growth. American entrepreneurs are creative and productive.” Numbers alone do not tell the whole story, however. Are these newly self-employed workers profiting from their ventures, or are they just biding their time during a period of unemployment? U.S. small businesses employed 57.9 million people in 2016, representing nearly 48 percent of the workforce. The number of net new jobs added to the economy was 1.4 million. The highest rate of growth is coming from women-owned firms, which continues to rise at rates higher than the national average—and with even stronger growth rates since the recession. There were an estimated 11.6 million women-owned businesses employing nearly 9 million people in 2016, generating more than $1.7 trillion in revenue. Between 2007 and 2017, women-owned firms increased by 114 percent, compared to a 44 percent increase among all businesses. This means that growth rates for women-owned businesses are 2.5 times faster than the national average. Employment growth was also stronger than national rates. Women-owned businesses increased 27 percent over the past 20 years, while overall business employment has increased by 13 percent since 2007. These trends show that more workers are striking out on their own and earning money doing it. It has become very clear that encouraging small-business activity leads to continued strong overall economic growth. ### Changing Demographics Create Entrepreneurial Diversity The mantra, “60 is the new 40,” describes today’s Baby Boomers who indulge in much less knitting and golf in their retirement years. The AARP predicts that silver-haired entrepreneurs will continue to rise in the coming years. According to a recent study by the Kauffman Foundation, Baby Boomers are twice as likely as Millennials to start a new business. In fact, close to 25 percent of all new entrepreneurs fall between the ages of 55 and 64. This has created a ripple effect in the way we work. Boomers have accelerated the growing acceptance of working from home, adding to the millions of U.S. workers already showing up to work in their slippers. In addition, the ongoing corporate brain drain could mean that small businesses will be able to tap into the expertise of seasoned free agents at less-than-corporate prices—and that seniors themselves will become independent consultants to businesses of all sizes. The growing numbers of Baby Boomer entrepreneurs has prompted some forward-thinking companies to recognize business opportunities in technology. At one time there was a concern that the aging of the population would create a drag on the economy. Conventional wisdom says that the early parenthood years are the big spending years. As we age, we spend less and, because Boomers are such a big demographic group, this was going to create a long-term economic decline. Not true, it now appears. The Boomer generation has built sizable wealth, and they are not afraid to spend it to make their lives more comfortable. Minorities are also adding to the entrepreneurial mix. As we saw in , minority groups and women are increasing business ownership at a much faster rate than the national average, reflecting their confidence in the U.S. economy. These overwhelming increases in minority business ownership paralleled the demand for U.S. Small Business Administration loan products. Loans to minority business owners in fiscal year 2017 set a record—more than $9.5 billion, or 31 percent, of SBA’s total loan portfolio. The latest Kauffman Foundation Index of Startup Activity found that immigrants and Hispanic/Latino people have swelled the growing numbers of self-employed Americans in recent years, increasing the diversity of the country’s entrepreneurial class. Overall, minority-owned businesses increased 38 percent. The SBA notes that the number of Hispanic-owned businesses has increased more than 46 percent between 2007 and 2012. ### How Far Will You Go to Get Rich? With enough intelligence and determination, people can get rich almost anywhere in the United States. Whether you own chains of dry cleaners in Queens, car dealerships in Chicago, or oil wells in West Texas, fortunes have been made in every state in the Union. There are some places, however, where the chances of creating wealth are much greater than others. That is the reason why people who hope to strike it rich move to places such as Manhattan or Palo Alto. It’s not because the cost of living is low or the quality of life as a struggling entrepreneur is fun. Whether starting a software or soft-drink company, entrepreneurs tend to follow the money But not all companies follow the herd. Guild Education, founded in 2015 by Rachel Carlson and Brittany Stich at Stanford University, left San Francisco due to the high cost of living that could slow down the company’s growth. “We have a lot of women who are executives and department heads here, starting with myself and my cofounder,” CEO Rachel Carlson said. “So when we left, we deliberately chose a place where you can have a family.” Guild Education’s mission is to help large employers offer college education and tuition reimbursement as a benefit to the 64 million working-age adults who lack a college degree. Since moving to Denver, Guild Education has raised another $21 million in venture capital, bringing the total funding to $31.5 million with a company valuation of $125 million. The company headquarters in Denver is next door to a Montessori school and employs 58 employees. “We were joking that we’re the polar opposite of Apple,” said Carlson. “Remember when the new ‘mothership’ came out? Every single parent noticed that it had a huge gym but not a day care.” According to PwC’s quarterly venture capital study, “MoneyTree Report,” the top regions in the United States for venture-backed deals in the third quarter of 2017 were San Francisco ($4.1 billion), New York Metro ($4.2 billion), Silicon Valley (Bay Area $2.2 billion), and New England ($1.8 billion). In 2017, equity financing in U.S. start-ups rose for the third straight quarter, reaching $19 billion, according to the PwC/CB Insights “MoneyTree Report Q3 2017.” “Financing was boosted by a large number of mega-rounds,” says Tom Ciccolella, Partner, U.S. Ventures Leader at PwC. Twenty-six mega-rounds of $100 million in companies such as WeWork, 23andMe, Fanatics, and NAUTO contributed to the strong activity levels in the first three quarters of 2017. The top five U.S. industry sectors with the most deals and funding were Internet, Healthcare, Mobile and Telecommunications, Software (Non-Internet/Mobile), and Consumer Products. ### Summary of Learning Outcomes 1. What trends are shaping entrepreneurship and small-business ownership? Changes in demographics, society, and technology are shaping the future of entrepreneurship and small business in America. More than ever, opportunities exist for entrepreneurs of all ages and backgrounds. The numbers of women and minority business owners continues to rise, and older entrepreneurs are changing the small-business landscape. Catering to the needs of an older population and a surge in web-based companies fuel continues technology growth. Entrepreneurs typically follow the money and set up shop in places where there is venture capital money easily available. ### Preparing for Tomorrow’s Workplace Skills 1. After working in software development with a major food company for 12 years, you are becoming impatient with corporate “red tape” (regulations and routines). You have an idea for a new snack product for nutrition-conscious consumers and are thinking of starting your own company. What entrepreneurial characteristics do you need to succeed? What other factors should you consider before quitting your job? Working with a partner, choose one to be the entrepreneurial employee and one to play the role of his or her current boss. Develop notes for a script. The employee will focus on why this is a good idea—reasons they will succeed—and the employer will play devil’s advocate to convince him or her that staying on at the large company is a better idea. Then switch roles and repeat the discussion. (Information, Interpersonal) 2. What does it really take to become an entrepreneur? Find out by interviewing a local entrepreneur or researching an entrepreneur you’ve read about in this chapter or in the business press. Get answers to the following questions, as well as any others you’d like to ask: (Information, Interpersonal, Systems) 3. A small catering business in your city is for sale for $250,000. The company specializes in business luncheons and small social events. The owner has been running the business for four years from her home but is expecting her first child and wants to sell. You will need outside investors to help you purchase the business. Develop questions to ask the owner about the business and its prospects, as well as a list of documents you want to see. What other types of information would you need before making a decision to buy this company? Summarize your findings in a memo to a potential investor that explains the appeal of the business for you and how you plan to investigate the feasibility of the purchase. (Information, Interpersonal) 4. Research various types of assistance available to women and minority business owners. Call or visit the nearest SBA office to find out what services and resources it offers. Contact trade associations such as the National Foundation for Women Business Owners (NFWBO), the National Alliance of Black Entrepreneurs, the U.S. Hispanic Chamber of Commerce, and the U.S. Department of Commerce Minority Business Development Agency (MBDA). Call these groups or use the internet to develop a list of their resources and how a small-business owner could use them. (Information, Interpersonal, Technology) 5. Do you have what it takes to be an entrepreneur or small-business owner? You can find many online quizzes to help you figure this out. The Success website offers a quiz to determine whether you have an entrepreneurial mindset at https://www.success.com. What did your results tell you, and were you surprised by what you learned? (Information, Technology) 6. Prepare a detailed outline for the business plan, including the objectives for the business and the types of information you would need to develop product, marketing, and financing strategies. Each group will then present its outline for the class to critique. (Information, Interpersonal, Systems) ### Ethics Activity As the owner of a small factory that makes plastic sheeting, you are constantly seeking ways to increase profits. As the new year begins, one of your goals is to find additional funds to offer annual productivity and/or merit bonuses to your loyal, hardworking employees. Then a letter from a large national manufacturer of shower curtains seems to provide an answer. As part of a new “supplier diversity” program it is putting in place, the manufacturer is offering substantial purchase contracts to minority-owned suppliers. Even though the letter clearly states that the business must be minority owned to qualify for the program, you convince yourself to apply for it based on the fact that all your employees are members of racial or ethnic minorities. You justify your decision by deciding they will benefit from the increased revenue a larger contract will bring, some of which you plan to pass on to them in the form of bonuses later in the year. Using a web search tool, locate articles about this topic, and then write responses to the following questions. Be sure to support your arguments and cite your sources. Ethical Dilemma: Is it wrong for this business owner to apply for this program even though it will end up benefiting his employees as well as his business? ### Working the Net 1. Visit Sample Business Plans at http://www.bplans.com to review examples of all types of business plans. Select an idea for a company in a field that interests you and, using information from the site, prepare an outline for its business plan. 2. Find a business idea you like or dislike by searching the web. Explain why you think this is a good business idea or not. List additional information the entrepreneur should have to consider for this business, and research the industry on the web using a search engine. 3. Evaluate the export potential of your product idea at the Small Business Exporters Network website. Explore three information areas, including market research, export readiness, and financing. Select a trade link site from government, university, or private categories. Compare them in terms of the information offered to small businesses that want to venture into overseas markets. Which is the most useful, and why? 4. Explore the SBA website at http://www.sba.gov. What resources are available to you locally? What classes does the Learning Center offer? What about financing assistance? Do you think the website lives up to the SBA’s goal of being a one-stop shopping resource for the small-business owner? Why or why not? 5. You want to buy a business but don’t know much about valuing small companies. Using the “Business for Sale” column available online at http://www.inc.com, develop a checklist of questions to ask when buying a business. Also summarize several ways that businesses arrive at their sale price (“Business for Sale” includes the price rationale for each profiled business). ### Creative Thinking Case ### Fostering Entrepreneurship in "Innovation Deserts" You may have heard of food deserts or Internet deserts -- those places where groceries or online access are difficult to come by. But certain communities fall into similar “innovation deserts,” where the population is cut off from educational, technical, and other resources connected to small business and entrepreneurial success. Often coinciding with economically distressed locations, innovation deserts force residents to look elsewhere for opportunities and support, causing both a talent and economic drain that exacerbates the problem. Felecia Hatcher has committed herself to ridding communities of these deserts. A self-described C-student in high school, she found creative ways to achieve and finance her education and early career. As a freshman at Lynn University, she launched a company focused on mentoring high school students. Upon graduating, she went on to lead social media campaigns for major brands such as Nintendo, Sony, Microsoft, and Little Debbie. Soon after, she landed a major position with the Minnesota Lynx of the WNBA. She left it to start an ice cream company. That company, Feverish Ice Cream, went from a small food truck and cart operation to a venture capital-backed promotional partner to some of the biggest brands in the world. Her success -- and the financial resources it provided -- enabled Felecia to pivot once again. In 2012, Hatcher started Code Fever, an organization focused on teaching Miami residents how to integrate technical knowledge into their skillset. Soon after, Hatcher and her partners brought Black Girls Code to Miami, and hosted numerous camps and events for local youth. In 2015, they started Black Tech Week to further the cause of creating inclusive innovation communities. The conference hosted several thousand attendees and some of the nation’s top entrepreneurs, venture capitalists, educators, and tech professionals. The following year, Hatcher’s organizations further expanded their entrepreneurship programs. They began a VC-in-residence program to connect Black innovators with potential mentors and investors. They also partnered with PowerMoves to launch bootcamps and pitch competitions. Black Tech Week soon expanded from Miami to eight other cities. Like many communities in South Florida, the Overton section of Miami was an innovation desert. Social mobility was relatively low, and potential entrepreneurs had few support networks or access to resources. Even though Miami was the nation’s densest city for co-working spaces (seen as particularly helpful for start-ups), Overton didn’t have one. Hatcher sought to directly fill the gap by opening a co-working space named a Space Called Tribe. The two-story hub offers individuals or small companies low-cost access to WiFi, office space, conference rooms, collaboration opportunities, and a wide array of workshops and guest speaker events. Even though members are from different companies serving different industries and customers, their shared experience can create networking and support relationships. Felecia Hatcher and her group recently rebranded to The Center for Black Innovation; beyond the services and events described above, they work as a think tank and advocacy organization to further promote investment and innovation in the Black community, and better help all marginalized communities. During the COVID-19 pandemic, they launched a number of educational programs to help those affected launch “side hustles” to supplement their income. The Center also continues to serve as an incubator and capital investment networker to help people develop and scale their start-ups. And after helping thousands of business people, the Center frequently collaborates with past participants to mentor new ones and continue the cycle of innovation. 2. What qualities or characteristics might lead to the emergence of an innovation desert? Is it always a geographical definition, or could it be defined in other ways? 3. In her efforts to help marginalized people gain technical and business experience, how was Felecia Hatcher’s progression similar to business growth and grand expansion? 4. How might a Space Called Tribe and the larger efforts of the Center for Black Innovation lead to opportunity for local entrepreneurs? Sources: Center for Black Innovation website, https://www.centerforblackinnovation.org/#what-we-do ; Felecia Hatcher-Pearson, “Ridding Communities of Innovation Deserts,” Impakter, September 5, 2019, https://impakter.com/ridding-communities-of-innovation-deserts-how-corporations-and-governments-can-support-black-communities-innovation-potential/ ; Blair Levin and Larry Downes, “Cities, Not Rural Areas, Are The Real Internet Deserts,” Washington Post, September 13, 2019, https://www.washingtonpost.com/technology/2019/09/13/cities-not-rural-areas-are-real-internet-deserts/ ; Rob Wile, “In a long-neglected Miami neighborhood, a new co-working space stirs to life,” Miami Herald, May 30, 2018, https://www.miamiherald.com/news/business/technology/article212112389.html; ### Hot Links Address Book 1. Do you have a great business idea? Taking the quiz at http://www.edwardlowe.org, the Edward Lowe Foundation’s website, will help you determine how feasible the idea is. 2. Do you have what it takes to become an entrepreneur? Take the quiz at https://www.entrepreneur.com/article/247560 to find out. 3. Before your business travels to foreign shores, pay a visit to the SBA’s Office of International Trade to learn the best ways to enter global markets at https://www.sba.gov/offices/headquarters/oit/resources. 4. How can you find qualified overseas companies to buy your products? Find out how BuyUSA.com can help you become part of an e-marketplace at http://www.buyusa.com. 5. If you are considering starting a business at home, you’ll find tips and advice at the American Association of Home-Based Businesses website at http://www.aahbb.org. 6. To learn about the services the U.S. Department of Commerce’s Minority Business Development Agency provides for small-business owners, check out http://www.mbda.gov.

# Management and Leadership in Today's Organizations ## Introduction ### Learning Outcomes After reading this chapter, you should be able to answer these questions: 1. What is the role of management? 2. What are the four types of planning? 3. What are the primary functions of managers in organizing activities? 4. How do leadership styles influence a corporate culture? 5. How do organizations control activities? 6. What roles do managers take on in different organizational settings? 7. What set of managerial skills is necessary for managerial success? 8. What trends will affect management in the future? Today’s companies rely on managers to guide daily operations using human, technological, financial, and other resources to create a competitive advantage. For many beginning business students, being in “management” is an attractive but somewhat vague future goal. This vagueness is due in part to an incomplete understanding of what managers do and how they contribute to organizational success or failure. This chapter introduces the basic functions of management and the skills managers need to drive an organization toward its goals. We will also discuss how leadership styles influence a corporate culture and highlight the trends that are shaping the future role of managers.

# Management and Leadership in Today's Organizations ## The Role of Management 1. What is the role of management? Management is the process of guiding the development, maintenance, and allocation of resources to attain organizational goals. Managers are the people in the organization responsible for developing and carrying out this management process. Management is dynamic by nature and evolves to meet needs and constraints in the organization’s internal and external environments. In a global marketplace where the rate of change is rapidly increasing, flexibility and adaptability are crucial to the managerial process. This process is based in four key functional areas of the organization: planning, organizing, leading, and controlling. Although these activities are discussed separately in the chapter, they actually form a tightly integrated cycle of thoughts and actions. From this perspective, the managerial process can be described as (1) anticipating potential problems or opportunities and designing plans to deal with them, (2) coordinating and allocating the resources needed to implement plans, (3) guiding personnel through the implementation process, and (4) reviewing results and making any necessary changes. This last stage provides information to be used in ongoing planning efforts, and thus the cycle starts over again. The four functions are highly interdependent, with managers often performing more than one of them at a time and each of them many times over the course of a normal workday. The four management functions can help managers increase organizational efficiency and effectiveness. Efficiency is using the least possible amount of resources to get work done, whereas effectiveness is the ability to produce a desired result. Managers need to be both efficient and effective in order to achieve organizational goals. For example in 2016, Delta, one of the most efficient network U.S. airlines, operated at revenue of 12.15 cents per seat-mile, which is the revenue the company makes on one seat (occupied or not) the distance of one mile. No other airline came close to operating this efficiently except Southwest, which flew seats that produced 12.51 cents a mile, the best performance of all U.S. airlines. There are many ways that airlines can manage to produce higher revenue per seat-mile. For instance, they can raise ticket prices, fill more of their seats, operate more efficient aircraft that utilize less fuel, or negotiate favorable salaries with their employees. While efficiency and effectiveness are sometimes lauded by investors, airlines also need to account for customer satisfaction, which can mean extra costs. To meet the demands of rapid growth, Skechers hired a new chief financial officer, John Vandemore, which allowed their existing CFO (David Weinberg) to concentrate on international expansion. Skechers CEO Robert Greenberg commented: “As international now represents more than 50 percent of our total business, we must continue to ramp up operations and infrastructure to meet the demand. David (Weinberg) understands how to do it the right way at the right speed to maintain our forward momentum. With John (Vandemore) handling CFO responsibilities, David will now have the bandwidth to travel and find opportunities to maximize our efficiencies around the globe.” As these examples and show, good management uses the four management functions to increase a company’s efficiency and effectiveness, which leads to the accomplishment of organizational goals and objectives. Let’s look more closely at what each of the management functions entails. ### Summary of Learning Outcomes 1. What is the role of management? Management is the process of guiding the development, maintenance, and allocation of resources to attain organizational goals. Managers are the people in the organization responsible for developing and carrying out this management process. The four primary functions of managers are planning, organizing, leading, and controlling. By using the four functions, managers work to increase the efficiency and effectiveness of their employees, processes, projects, and organizations as a whole.

# Management and Leadership in Today's Organizations ## Planning 1. What are the four types of planning? Planning begins by anticipating potential problems or opportunities the organization may encounter. Managers then design strategies to solve current problems, prevent future problems, or take advantage of opportunities. These strategies serve as the foundation for goals, objectives, policies, and procedures. Put simply, planning is deciding what needs to be done to achieve organizational objectives, identifying when and how it will be done, and determining who should do it. Effective planning requires extensive information about the external business environment in which the firm competes, as well as its internal environment. There are four basic types of planning: strategic, tactical, operational, and contingency. Most of us use these different types of planning in our own lives. Some plans are very broad and long term (more strategic in nature), such as planning to attend graduate school after earning a bachelor’s degree. Some plans are much more specific and short term (more operational in nature), such as planning to spend a few hours in the library this weekend. Your short-term plans support your long-term plans. If you study now, you have a better chance of achieving some future goal, such as getting a job interview or attending graduate school. Like you, organizations tailor their plans to meet the requirements of future situations or events. A summary of the four types of planning appears in . Strategic planning involves creating long-range (one to five years), broad goals for the organization and determining what resources will be needed to accomplish those goals. An evaluation of external environmental factors such as economic, technological, and social issues is critical to successful strategic planning. Strategic plans, such as the organization’s long-term mission, are formulated by top-level managers and put into action at lower levels in the organization. For example, when Mickey Drexler took over as CEO of J.Crew, the company was floundering and had been recently purchased by a private equity group. One of Drexler’s first moves was to change the strategic direction of the company by moving it out of the crowded trend-following retail segment, where it was competing with stores such as Gap, American Eagle, and Abercrombie and back into the preppie, luxury segment where it began. Rather than trying to sell abundant inventory to a mass market, J.Crew cultivated scarcity, making sure items sold out early rather than hit the sale rack later in the season. The company also limited the number of new stores it opened during a two-year span but planned to double the number of stores in the next five to six years. Drexler led the company through public offerings and back to private ownership before bringing on a new CEO in 2017. He remained chairman with ownership in the company. An organization’s mission is formalized in its mission statement, a document that states the purpose of the organization and its reason for existing. For example, Twitter’s mission statement formalizes both concepts while staying within its self-imposed character limit; see . In all organizations, plans and goals at the tactical and operational levels should clearly support the organization’s mission statement. Tactical planning begins the implementation of strategic plans. Tactical plans have a shorter (less than one year) time frame than strategic plans and more specific objectives designed to support the broader strategic goals. Tactical plans begin to address issues of coordinating and allocating resources to different parts of the organization. Under Mickey Drexler, many new tactical plans were implemented to support J.Crew’s new strategic direction. For example, he severely limited the number of stores opened each year, with only nine new openings in the first two years of his tenure (he closed seven). Instead, he invested the company’s resources in developing a product line that communicated J.Crew’s new strategic direction. Drexler dumped trend-driven apparel because it did not meet the company’s new image. He even cut some million-dollar volume items. In their place, he created limited editions of a handful of garments that he thought would be popular, many of which fell into his new luxury strategy. For example, J.Crew now buys shoes directly from the same shoe manufacturers that produce footwear for designers such as Prada and Gucci. In general, J.Crew drastically tightened inventories, a move designed to keep reams of clothes from ending up on sale racks and to break its shoppers’ habit of waiting for discounts. This part of the plan generated great results. Prior to Drexler’s change in strategy, half of J.Crew’s clothing sold at a discount. After implementing tactical plans aimed to change that situation, only a small percentage does. The shift to limited editions and tighter inventory controls has not reduced the amount of new merchandise, however. On the contrary, Drexler created a J.Crew bridal collection, a jewelry line, and Crew Cuts, a line of kids’ clothing. The results of Drexler’s tactical plans were impressive. J.Crew saw same-store sales rise 17 percent in one year. Operational planning creates specific standards, methods, policies, and procedures that are used in specific functional areas of the organization. Operational objectives are current, narrow, and resource focused. They are designed to help guide and control the implementation of tactical plans. In an industry where new versions of software have widely varying development cycles, Autodesk, maker of software tools for designers and engineers, implemented new operational plans that dramatically increased profits. Former CEO Carol Bartz shifted the company away from the erratic release schedule it had been keeping to regular, annual software releases. By releasing upgrades on a defined and predictable schedule, the company is able to use annual subscription pricing, which is more affordable for small and midsize companies. The new schedule keeps Autodesk customers on the most recent versions of popular software and has resulted in an overall increase in profitability. The key to effective planning is anticipating future situations and events. Yet even the best-prepared organization must sometimes cope with unforeseen circumstances, such as a natural disaster, an act of terrorism, or a radical new technology. Therefore, many companies have developed contingency plans that identify alternative courses of action for very unusual or crisis situations. The contingency plan typically stipulates the chain of command, standard operating procedures, and communication channels the organization will use during an emergency. An effective contingency plan can make or break a company. Consider the example of Marriott Hotels in Puerto Rico. Anticipating Hurricane Maria in 2017, workers at the San Juan Marriott had to shift from their regular duties to handling the needs of not only customers, but everyone who needed assistance in the wake of the hurricane that devastated the island. A contingency plan and training for events such as this were a key part of managing this crisis. The company achieved its goal of being able to cater to guest and general needs due to planning and training while having a contingency plan in place. One guest commented on TripAdvisor, “Could not believe how friendly, helpful & responsive staff were even during height of hurricane. Special thanks to Eydie, Juan, Jock, Ashley and security Luis. They kept us safe & were exemplary. Will always stay at Marriott from now on.” Within one month after Hurricane Maria hit, operations were back to normal at the San Juan Marriott. ### Summary of Learning Outcomes 1. What are the four types of planning? Planning is deciding what needs to be done, identifying when and how it will be done, and determining who should do it. Managers use four different types of planning: strategic, tactical, operational, and contingency planning. Strategic planning involves creating long-range (one to five years), broad goals and determining the necessary resources to accomplish those goals. Tactical planning has a shorter time frame (less than one year) and more specific objectives that support the broader strategic goals. Operational planning creates specific standards, methods, policies, and procedures that are used in specific functional areas of the organization. Contingency plans identify alternative courses of action for very unusual or crisis situations.

# Management and Leadership in Today's Organizations ## Organizing 1. What are the primary functions of managers in organizing activities? A second key function of managers is organizing, which is the process of coordinating and allocating a firm’s resources in order to carry out its plans. Organizing includes developing a structure for the people, positions, departments, and activities within the firm. Managers can arrange the structural elements of the firm to maximize the flow of information and the efficiency of work processes. They accomplish this by doing the following: 1. Dividing up tasks (division of labor) 2. Grouping jobs and employees (departmentalization) 3. Assigning authority and responsibilities (delegation) These and other elements of organizational structure are discussed in detail elsewhere. In this chapter, however, you should understand the three levels of a managerial hierarchy. This hierarchy is often depicted as a pyramid, as in . The fewest managers are found at the highest level of the pyramid. Called top management, they are the small group of people at the head of the organization (such as the CEO, president, and vice president). Top-level managers develop strategic plans and address long-range issues such as which industries to compete in, how to capture market share, and what to do with profits. These managers design and approve the firm’s basic policies and represent the firm to other organizations. They also define the company’s values and ethics and thus set the tone for employee standards of behavior. For example, Jack Welch, the former CEO of General Electric, was a role model for his managers and executives. Admirers say that he had an extraordinary capacity to inspire hundreds of thousands of people in many countries and he could change the direction of a huge organization like General Electric as if it were a small firm. Following his leadership, General Electric’s executives turned in impressive results. During his tenure, General Electric’s average annual shareholder return was 25 percent. The second and third tiers of the hierarchy are called middle management and supervisory (first-line) management, respectively. Middle managers (such as division heads, departmental managers, and regional sales managers) are responsible for beginning the implementation of strategic plans. They design and carry out tactical plans in specific areas of the company. They begin the process of allocating resources to meet organizational goals, and they oversee supervisory managers throughout the firm. Supervisors, the most numerous of the managers, are at the bottom of the managerial pyramid. These managers design and carry out operational plans for the ongoing daily activities of the firm. They spend a great deal of their time guiding and motivating the employees who actually produce the goods and services. ### Summary of Learning Outcomes 1. What are the primary functions of managers in organizing activities? Organizing involves coordinating and allocating a firm’s resources in order to carry out its plans. It includes developing a structure for the people, positions, departments, and activities within the firm. This is accomplished by dividing up tasks (division of labor), grouping jobs and employees (departmentalization), and assigning authority and responsibilities (delegation).

# Management and Leadership in Today's Organizations ## Leading, Guiding, and Motivating Others 1. How do leadership styles influence a corporate culture? Leadership, the third key management function, is the process of guiding and motivating others toward the achievement of organizational goals. A leader can be anyone in an organization, regardless of position, able to influence others to act or follow, often by their own choice. Managers are designated leaders according to the organizational structure but may need to use negative consequences or coercion to achieve change. In the organization structure, top managers use leadership skills to set, share, and gain support for the company’s direction and strategy—mission, vision, and values, such as Jeff Bezos does at Amazon. Middle and supervisory management use leadership skills in the process of directing employees on a daily basis as the employees carry out the plans and work within the structure created by management. Top-level leadership demonstrated by Bezos was also exhibited by Jack Welch while leading General Electric and led to many studies of his approach to leadership. Organizations, however, need strong effective leadership at all levels in order to meet goals and remain competitive. To be effective leaders, managers must be able to influence others’ behaviors. This ability to influence others to behave in a particular way is called power. Researchers have identified five primary sources, or bases, of power: 1. Legitimate power, which is derived from an individual’s position in an organization 2. Reward power, which is derived from an individual’s control over rewards 3. Coercive power, which is derived from an individual’s ability to threaten negative outcomes 4. Expert power, which is derived from an individual’s extensive knowledge in one or more areas 5. Referent power, which is derived from an individual’s personal charisma and the respect and/or admiration the individual inspires Many leaders use a combination of all of these sources of power to influence individuals toward goal achievement. While CEO of Procter & Gamble, A. G. Lafley got his legitimate power from his position. His reward power came from reviving the company and making the stock more valuable. Also, raises and bonus for managers who met their goals was another form of reward power. Lafley also was not hesitant to use his coercive power. He eliminated thousands of jobs, sold underperforming brands, and killed weak product lines. With nearly 40 years of service to the company, Lafley had a unique authority when it came to P&G’s products, markets, innovations, and customers. The company’s sales doubled during his nine years as CEO, and its portfolio of brands increased from 10 to 23. He captained the purchase of Clairol, Wella AG, and IAMS, as well as the multibillion-dollar merger with Gillette. As a result, Lafley had a substantial amount of referent power. Lafley is also widely respected, not only by people at P&G, but by the general business community as well. Ann Gillin Lefever, a managing director at Lehman Brothers, said, “Lafley is a leader who is liked. His directives are very simple. He sets a strategy that everybody understands, and that is more difficult than he gets credit for.” ### Leadership Styles Individuals in leadership positions tend to be relatively consistent in the way they attempt to influence the behavior of others, meaning that each individual has a tendency to react to people and situations in a particular way. This pattern of behavior is referred to as leadership style. As shows, leadership styles can be placed on a continuum that encompasses three distinct styles: autocratic, participative, and free rein. Autocratic leaders are directive leaders, allowing for very little input from subordinates. These leaders prefer to make decisions and solve problems on their own and expect subordinates to implement solutions according to very specific and detailed instructions. In this leadership style, information typically flows in one direction, from manager to subordinate. The military, by necessity, is generally autocratic. When autocratic leaders treat employees with fairness and respect, they may be considered knowledgeable and decisive. But often autocrats are perceived as narrow-minded and heavy-handed in their unwillingness to share power, information, and decision-making in the organization. The trend in organizations today is away from the directive, controlling style of the autocratic leader. Instead, U.S. businesses are looking more and more for participative leaders, meaning leaders who share decision-making with group members and encourage discussion of issues and alternatives. Participative leaders use a democratic, consensual, consultative style. One CEO known for her participative leadership style is Meg Whitman, former CEO at Hewlett Packard. When Whitman worked at eBay, a team in the German-based operation began a promotional “treasure hunt,” launching registration pages, clues, and an hourly countdown clock. Trouble was, the launch violated eBay’s well-established corporate project-development processes. When the treasure hunt began, 10 million contestants logged on, crashing the local servers. Rather than shut the project down, the VP in charge of the German operation allowed the promotion to be fixed and fly under the radar of corporate headquarters. Successful innovations emerged, such as an Easy Lister feature and separate registration processes for private and business sellers. When the VP shared this experience with Meg Whitman, she fostered the idea of rapid prototyping throughout the organization, which “breaks rules to get something done,” and modeled such behavior for the entire organization. Participative leadership has three types: democratic, consensual, and consultative. Democratic leaders solicit input from all members of the group and then allow the group members to make the final decision through a voting process. This approach works well with highly trained professionals. The president of a physicians’ clinic might use the democratic approach. Consensual leaders encourage discussion about issues and then require that all parties involved agree to the final decision. This is the general style used by labor mediators. Consultative leaders confer with subordinates before making a decision but retain the final decision-making authority. This technique has been used to dramatically increase the productivity of assembly-line workers. The third leadership style, at the opposite end of the continuum from the autocratic style, is free-rein or laissez-faire (French for “leave it alone”) leadership. Managers who use this style turn over all authority and control to subordinates. Employees are assigned a task and then given free rein to figure out the best way to accomplish it. The manager doesn’t get involved unless asked. Under this approach, subordinates have unlimited freedom as long as they do not violate existing company policies. This approach is also sometimes used with highly trained professionals as in a research laboratory. Although one might at first assume that subordinates would prefer the free-rein style, this approach can have several drawbacks. If free-rein leadership is accompanied by unclear expectations and lack of feedback from the manager, the experience can be frustrating for an employee. Employees may perceive the manager as being uninvolved and indifferent to what is happening or as unwilling or unable to provide the necessary structure, information, and expertise. No leadership style is effective all the time. Effective leaders recognize employee growth and use situational leadership, selecting a leadership style that matches the maturity and competency levels of those completing the tasks. Newly hired employees may respond well to authoritative leadership until they understand the job requirements and show the ability to handle routine decisions. Once established, however, those same employees may start to feel undervalued and perform better under a participative or free-rein leadership style. Using situational leadership empowers employees as discussed next. ### Employee Empowerment Participative and free-rein leaders use a technique called empowerment to share decision-making authority with subordinates. Empowerment means giving employees increased autonomy and discretion to make their own decisions, as well as control over the resources needed to implement those decisions. When decision-making power is shared at all levels of the organization, employees feel a greater sense of ownership in, and responsibility for, organizational outcomes. Management use of employee empowerment is on the rise. This increased level of involvement comes from the realization that people at all levels in the organization possess unique knowledge, skills, and abilities that can be of great value to the company. For example, when Hurricane Katrina hit the Gulf Coast, five miles of railroad tracks were ripped off a bridge connecting New Orleans to Slidell, Louisiana. Without the tracks, which fell into Lake Pontchartrain, Norfolk Southern Railroad couldn’t transport products between the East and West Coasts. Before the storm hit, however, Jeff McCracken, a chief engineer at the company, traveled to Birmingham with equipment he thought he might need and then to Slidell with 100 employees. After conferring with dozens of company engineers and three bridge companies, McCracken decided to try to rescue the miles of track from the lake. (Building new tracks would have taken several weeks at the least.) To do so, he gathered 365 engineers, machine operators, and other workers, who lined up eight huge cranes and, over the course of several hours, lifted the five miles of sunken tracks in one piece out of the lake and bolted it back on the bridge. By giving employees the autonomy to make decisions and access to required resources, Norfolk Southern was able to avoid serious interruptions in its nationwide service. ### Corporate Culture The leadership style of managers in an organization is usually indicative of the underlying philosophy, or values, of the organization. The set of attitudes, values, and standards of behavior that distinguishes one organization from another is called corporate culture. A corporate culture evolves over time and is based on the accumulated history of the organization, including the vision of the founders. It is also influenced by the dominant leadership style within the organization. Evidence of a company’s culture is seen in its heroes (e.g., the late Andy Grove of Intel, myths (stories about the company passed from employee to employee), symbols (e.g., the Nike swoosh), and ceremonies. The culture at Google, working in teams and fostering innovation, sometimes is overlooked while its employee perks are drooled over. But both are important to the company’s corporate culture. Since 2007 Google has been at or near the top of Fortune’s list of the “100 Best Companies to Work For,” an annual list based on employee survey results tabulated by an independent company: Great Place to Work®. “We have never forgotten since our startup days that great things happen more frequently within the right culture and environment,” a company spokesperson said in response to the company first taking over the top spot. Culture may be intangible, but it has a tremendous impact on employee morale and a company’s success. Google approaches morale analytically. When it found that mothers were leaving the company in higher rates than other employee groups, the company improved its parental-leave policies. The result was a 50 percent reduction in attrition for working moms. An analytical approach along with culture-building activities such as town halls led by Black employees and allies, support for transgender employees, and unconscious-bias workshops are why employees say Google is a safe and inclusive place to work. Clearly Google leaders recognize culture is critical to the company’s overall success. ### Summary of Learning Outcomes 1. How do leadership styles influence a corporate culture? Leading is the process of guiding and motivating others toward the achievement of organizational goals. Managers have unique leadership styles that range from autocratic to free-rein. The set of attitudes, values, and standards of behavior that distinguishes one organization from another is called corporate culture. A corporate culture evolves over time and is based on the accumulated history of the organization, including the vision of the founders.

# Management and Leadership in Today's Organizations ## Controlling 1. How do organizations control activities? The fourth key function that managers perform is controlling. Controlling is the process of assessing the organization’s progress toward accomplishing its goals. It includes monitoring the implementation of a plan and correcting deviations from that plan. As shows, controlling can be visualized as a cyclical process made up of five stages: Performance standards are the levels of performance the company wants to attain. These goals are based on its strategic, tactical, and operational plans. The most effective performance standards state a measurable behavioral objective that can be achieved in a specified time frame. For example, the performance objective for the sales division of a company could be stated as “$200,000 in gross sales for the month of January.” Each individual employee in that division would also have a specified performance goal. Actual firm, division, or individual performance can be measured against desired performance standards to see if a gap exists between the desired level of performance and the actual level of performance. If a performance gap does exist, the reason for it must be determined and corrective action taken. Feedback is essential to the process of control. Most companies have a reporting system that identifies areas where performance standards are not being met. A feedback system helps managers detect problems before they get out of hand. If a problem exists, the managers take corrective action. Toyota uses a simple but effective control system on its automobile assembly lines. Each worker serves as the customer for the process just before his or hers. Each worker is empowered to act as a quality control inspector. If a part is defective or not installed properly, the next worker won’t accept it. Any worker can alert the supervisor to a problem by tugging on a rope that turns on a warning light (i.e., feedback). If the problem isn’t corrected, the worker can stop the entire assembly line. Why is controlling such an important part of a manager’s job? First, it helps managers to determine the success of the other three functions: planning, organizing, and leading. Second, control systems direct employee behavior toward achieving organizational goals. Third, control systems provide a means of coordinating employee activities and integrating resources throughout the organization. ### Summary of Learning Outcomes 1. How do organizations control activities? Controlling is the process of assessing the organization’s progress toward accomplishing its goals. The control process is as follows: (1) set performance standards (goals), (2) measure performance, (3) compare actual performance to established performance standards, (4) take corrective action (if necessary), and (5) use information gained from the process to set future performance standards.

# Management and Leadership in Today's Organizations ## Managerial Roles 1. What roles do managers take on in different organizational settings? In carrying out the responsibilities of planning, organizing, leading, and controlling, managers take on many different roles. A role is a set of behavioral expectations, or a set of activities that a person is expected to perform. Managers’ roles fall into three basic categories: informational roles, interpersonal roles, and decisional roles. These roles are summarized in . In an informational role, the manager may act as an information gatherer, an information distributor, or a spokesperson for the company. A manager’s interpersonal roles are based on various interactions with other people. Depending on the situation, a manager may need to act as a figurehead, a company leader, or a liaison. When acting in a decisional role, a manager may have to think like an entrepreneur, make decisions about resource allocation, help resolve conflicts, or negotiate compromises. ### Managerial Decision Making In every function performed, role taken on, and set of skills applied, a manager is a decision maker. Decision-making means choosing among alternatives. Decision-making occurs in response to the identification of a problem or an opportunity. The decisions managers make fall into two basic categories: programmed and nonprogrammed. Programmed decisions are made in response to routine situations that occur frequently in a variety of settings throughout an organization. For example, the need to hire new personnel is a common situation for most organizations. Therefore, standard procedures for recruitment and selection are developed and followed in most companies. Infrequent, unforeseen, or very unusual problems and opportunities require nonprogrammed decisions by managers. Because these situations are unique and complex, the manager rarely has a precedent to follow. The earlier example of the Norfolk Southern employee, who had to decide the best way to salvage a five-mile-long piece of railroad track from the bottom of Lake Pontchartrain, is an example of a nonprogrammed decision. Likewise, when Hurricane Katrina was forecast to make landfall, Thomas Oreck, then CEO of the vacuum manufacturer that bears his name, had to make a series of nonprogrammed decisions. Oreck’s corporate headquarters were in New Orleans, and its primary manufacturing facility was in Long Beach, Mississippi. Before the storm hit, Oreck transferred its computer systems and call-center operations to backup locations in Colorado and planned to move headquarters to Long Beach. The storm, however, brutally hit both locations. Oreck executives began searching for lost employees, tracking down generators, assembling temporary housing for workers, and making deals with UPS to begin distributing its product (UPS brought food and water to Oreck from Atlanta and took vacuums back to the company’s distribution center there). All of these decisions were made in the middle of a very challenging crisis environment. Whether a decision is programmed or nonprogrammed, managers typically follow five steps in the decision-making process, as illustrated in 1. Recognize or define the problem or opportunity. Although it is more common to focus on problems because of their obvious negative effects, managers who do not take advantage of new opportunities may lose competitive advantage to other firms. 2. Gather information so as to identify alternative solutions or actions. 3. Select one or more alternatives after evaluating the strengths and weaknesses of each possibility. 4. Put the chosen alternative into action. 5. Gather information to obtain feedback on the effectiveness of the chosen plan. It can be easy (and dangerous) for managers to get stuck at any stage of the decision-making process. For example, entrepreneurs can become paralyzed evaluating the options. For the Gabby Slome, the cofounder of natural pet food maker Ollie, the idea for starting the company came after her rescue dog began having trouble digesting store-bought pet food after living on scraps. Slome decided that the pet food industry, a $30 billion a year business, was ripe for a natural food alternative. She laments, however, that she let perfect be the enemy of the very good by indulging in “analysis paralysis.” ### Summary of Learning Outcomes 1. What roles do managers take on in different organizational settings? In an informational role, the manager may act as an information gatherer, an information distributor, or a spokesperson for the company. A manager’s interpersonal roles are based on various interactions with other people. Depending on the situation, a manager may need to act as a figurehead, a company leader, or a liaison.

# Management and Leadership in Today's Organizations ## Managerial Skills 1. What set of managerial skills is necessary for managerial success? In order to be successful in planning, organizing, leading, and controlling, managers must use a wide variety of skills. A skill is the ability to do something proficiently. Managerial skills fall into three basic categories: technical, human relations, and conceptual skills. The degree to which each type of skill is used depends upon the level of the manager’s position as seen in . Additionally, in an increasingly global marketplace, it pays for managers to develop a special set of skills to deal with global management issues. ### Technical Skills Specialized areas of knowledge and expertise and the ability to apply that knowledge make up a manager’s technical skills. Preparing a financial statement, programming a computer, designing an office building, and analyzing market research are all examples of technical skills. These types of skills are especially important for supervisory managers because they work closely with employees who are producing the goods and/or services of the firm. ### Human Relations Skills Human relations skills are the interpersonal skills managers use to accomplish goals through the use of human resources. This set of skills includes the ability to understand human behavior, to communicate effectively with others, and to motivate individuals to accomplish their objectives. Giving positive feedback to employees, being sensitive to their individual needs, and showing a willingness to empower subordinates are all examples of good human relations skills. Identifying and promoting managers with human relations skills are important for companies. A manager with little or no people skills can end up using an authoritarian leadership style and alienating employees. ### Conceptual Skills Conceptual skills include the ability to view the organization as a whole, understand how the various parts are interdependent, and assess how the organization relates to its external environment. These skills allow managers to evaluate situations and develop alternative courses of action. Good conceptual skills are especially necessary for managers at the top of the management pyramid, where strategic planning takes place. ### Summary of Learning Outcomes 1. What set of managerial skills is necessary for managerial success? Managerial skills fall into three basic categories: technical, human relations, and conceptual skills. Specialized areas of knowledge and expertise and the ability to apply that knowledge make up a manager’s technical skills. Human relations skills include the ability to understand human behavior, to communicate effectively with others, and to motivate individuals to accomplish their objectives. Conceptual skills include the ability to view the organization as a whole, understand how the various parts are interdependent, and assess how the organization relates to its external environment.

# Management and Leadership in Today's Organizations ## Trends in Management and Leadership 1. What trends will affect management in the future? Four important trends in management today are crisis management, outside directors, the growing use of information technology, and the increasing need for global management skills. ### Crisis Management Crises, both internal and external, can hit even the best-managed organization. Sometimes organizations can anticipate crises, in which case managers develop contingency plans, and sometimes they can’t. Take, for example, the sudden death of McDonald’s CEO Jim Cantalupo. The company had a solid succession plan in place and immediately named Charlie Bell as new CEO. Only a few months later, Bell announced that he had terminal cancer. Even though the company had prepared for the event of its leader’s untimely death, surely it couldn’t have anticipated that his successor would also be stricken by a terminal illness at almost the same time. Likewise, consider the devastation caused by Hurricanes Harvey, Irma, Maria, and Nate in 2017. Part of Marriott Hotels’ crisis management plan included relaxing its “no pets” policy and allowing patrons fleeing the storm to check in with their pets because it was the right thing to do. Crises cannot be fully anticipated, but managers can develop contingency plans to help navigate through the aftermath of a disaster. For example, consider the challenges that faced Rajiv Joseph, the author of several plays including Bengal Tiger at the Baghdad Zoo, who was in Houston preparing to open his new play, Describe the Night, at the Alley Theater when Hurricane Harvey hit and flooded the theater a few weeks prior to opening night. The six New York–based actors, the director, the stage manager, and Joseph decided to help in the relief efforts and made their way to the George Brown Convention Center, which had become the central location for relief efforts. When they arrived and the staffers discovered they were theater artists, they were deployed to handle the writing and deployment of public address announcements and manage the incoming crowds. What made the relief efforts successful was planning—matching the skill sets of volunteers with tasks they are best able to perform. Even though those in charge of the relief efforts had contingency plans, they still needed to make dozens of nonprogrammed decisions to effectively manage the ever-changing situation. No manager or executive can be completely prepared for these types of unexpected crises. However, how a manager handles the situation could mean the difference between disaster, survival, and even financial gain. No matter the crisis, there are some basic guidelines managers should follow to minimize negative outcomes. Managers should not become immobilized by the problem or ignore it. Managers should face the problem head on. Managers should always tell the truth about the situation and then put the best people on the job to correct the problem. Managers should ask for help if they need it, and finally, managers must learn from the experience to avoid the same problem in the future. describes what CEOs and other leaders learned about crisis management. ### Managers and Information Technology The second trend having a major impact on managers is the proliferation of data and analytics in information technology. An increasing number of organizations are selling technology, and an increasing number are looking for cutting-edge technology to make and market the products and services they sell. One particularly useful type of technology is dashboard software. Much like the dashboard in a car, dashboard software gives managers a quick look into the relevant information they need to manage their companies. Most large companies are organized in divisions, and often each division relies on a particular type of application or database software. Dashboard software allows employees to access information from software they don’t routinely use, for example, from an application used by a different division from their own. More important, however, is the ability of a dashboard to show up-to-the-minute information and to allow employees to see all the information they need—such as financial and performance data—on a single screen. Such integrated functionality made dashboards extremely popular. A Gartner commentary suggests that companies put data and analytics at the heart of every company business decision. Despite the increasing popularity of dashboard technology, the control tool has some drawbacks, such as focusing too intently on short-term results and ignoring the overall progress toward long-term goals. And some employees might bristle at being monitored as closely as dashboard tools allow. Nonetheless, companies are seeing real results from implementing dashboard software. Robert Romanoff, a partner at the law firm of Levenfeld Romanoff in Chicago, uses dashboards that aggregate data from clients, strategic partners, and internal staff from the mailroom to the boardroom to improve what he calls the 3 Ps. The 3 Ps are process efficiency, project management, and strategic pricing. ### Managing Multinational Cultures The increasing globalization of the world market has created a need for managers who have global management skills, that is, the ability to operate in diverse cultural environments. With more and more companies choosing to do business in multiple locations around the world, employees are often required to learn the geography, language, and social customs of other cultures. It is expensive to train employees for foreign assignments and pay their relocation costs; therefore, choosing the right person for the job is especially important. Individuals who are open minded, flexible, willing to try new things, and comfortable in a multicultural setting are good candidates for international management positions. As companies expand around the globe, managers will continue to face the challenges of directing the behavior of employees around the world. They must recognize that because of cultural differences, people respond to similar situations in very different ways. The burden, therefore, falls on the manager to produce results while adapting to the differences among the employees they manage. How a manager gets results, wins respect, and leads employees varies greatly among countries, cultures, and individuals. For example, different cultures have different approaches to time. American, German, and Swiss cultures, among others, take a linear view of time, whereas southern European counties such as Italy take a multi-active time approach, and many Eastern cultures, such as China, take a cyclic approach. An American manager with a linear view of time will approach scheduling planning with a different approach than colleagues with a multi-active or cyclic approach. Despite differences such as these (examples of which can be cited for every country in the world), managing within a different culture is only an extension of what managers do every day: working with differences in employees, processes, and projects. ### Summary of Learning Outcomes 1. What trends will affect management in the future? Three important trends in management today are preparing for crises management, the increasing use of information technology, and the need to manage multinational cultures. Crisis management requires quick action, telling the truth about the situation, and putting the best people on the task to correct the situation. Finally, management must learn from the crisis in order to prevent it from happening again. Using the latest information technology, such as dashboard software, managers can make quicker, better-informed decisions. As more companies “go global,” the need for multinational cultural management skills is growing. Managers must set a good example, create personal involvement for all employees, and develop a culture of trust. ### Preparing for Tomorrow’s Workplace Skills 1. Would you be a good manager? Do a self-assessment that includes your current technical, human relations, and conceptual skills. What skills do you already possess, and which do you need to add? Where do your strengths lie? Based on this exercise, develop a description of an effective manager. (Resources, Information) 2. Successful managers map out what they want to do with their time (planning), determine the activities and tasks they need to accomplish in that time frame (organizing), and make sure they stay on track (controlling). How well do you manage your time? Do you think ahead, or do you tend to procrastinate? Examine how you use your time, and identify at least three areas where you can improve your time management skills. (Resources) 3. Often researchers cast leadership in an inspirational role in a company and management in more of an administrative role. That tendency seems to put leadership and management in a hierarchy. Do you think one is more important than the other? Do you think a company can succeed if it has bad managers and good leaders? What about if it has good managers and bad leaders? Are managers and leaders actually the same? (Systems) 4. Today’s managers must be comfortable using all kinds of technology. Do an inventory of your computer skills, and identify any gaps. After listing your areas of weakness, make a plan to increase your computer competency by enrolling in a computer class on or off campus. You may want to practice using common business applications such as Microsoft Excel by building a spreadsheet to track your budget, Microsoft PowerPoint by creating slides for your next class project, and Microsoft Outlook by uploading your semester schedule. (Information, Technology) 5. Team Activity One of the most common types of planning that managers do is operational planning, or the creation of policies, procedures, and rules and regulations. Assemble a team of three classmates, and work together to draft an operational plan that addresses employee attendance (or absenteeism). (Interpersonal, Systems) ### Ethics Activity Are top executives paid too much? A study of CEO compensation revealed that CEO bonuses rose considerably—from 20 percent to 30 percent—even at companies whose revenues or profits dropped or those that reported significant employee layoffs. Such high pay for CEOs at underperforming companies, as well as CEO compensation at companies with stellar results, has raised many questions from investors and others. The highest gap in pay was in 2000. CEO pay at the largest U.S. firms was 376 times higher than that of average workers. The gap has shrunk to only 271 times higher in 2016, but that is still a lot higher than the 59-to-1 ratio in 1989. The Securities and Exchange Commission (SEC) now requires public companies to disclose full details of executive compensation, including salaries, bonuses, pensions, benefits, stock options, and severance and retirement packages. Even some CEOs question the high levels of CEO pay. Edgar Woolard, Jr., former CEO and chairman of DuPont, thinks so. “CEO pay is driven today primarily by outside consultant surveys,” he says. Companies all want their CEOs to be in the top half, and preferably the top quarter, of all CEOs. This leads to annual increases. He also criticizes the enormous severance packages that company boards give to CEOs that fail. For example, Carly Fiorina of Hewlett-Packard received $20 million when she was fired. Using a web search tool, locate articles about this topic, and then write responses to the questions in the Ethical Dilemma section below. Be sure to support your arguments and cite your sources. Ethical Dilemma: Are CEOs entitled to increases in compensation when their company’s financial situation worsens, because their job becomes more challenging? If they fail, are they entitled to huge severance packages for their efforts? Should companies be required to divulge all details of compensation for their highest top managers, and what effect is such disclosure likely to have on executive pay? Sources: U.S. Securities and Exchange Commission, “SEC Adopts Rule for Pay Ratio Disclosure,” https://www.sec.gov, accessed September 21, 2017; Jeff Cox, “CEOs Make 271 Times the Pay of Most Workers,” CNBC, https://www.cnbc.com, July 20, 2017; Irv Becker, “Why CEOs Aren’t Overpaid,” Fortune, http://fortune.com, June 11, 2017; “CEOs are Overpaid, Says Former DuPont CEO Edgar Woolard Jr.,” PR Newswire, February 9, 2006, http://proquest.umi.com; Elizabeth Souder, “Firm Questions Exxon CEO’s Pay,” Dallas Morning News, December 15, 2005, http://galenet.thomsonlearning.com; “Weaker Company Performance Does Not Seem to Slow CEO Pay Increases,” Corporate Board, September-October 2005, p. 27, http://galenet.thomsonlearning.com; “What Price CEO Pay?” The Blade (Toledo, Ohio), January 20, 2006, http://www.toledoblade.com. ### Working the Net 1. Are you leadership material? See how you measure up at Your Leadership Legacy, http://www.yourleadershiplegacy.com/assessment.html. Read the commentary, and take the test. Study the outcome, and provide an example of how you would put each item into action. 2. Strategic Advantage, http://www.balancedscorecard.org/, offers many reasons why companies should develop strategic plans, as well as a strategy tip of the month, assessment tools, planning exercises, and resource links. Explore the site to learn the effect of strategic planning on financial performance, and present your evidence to the class. Then select a planning exercise, and with a group of classmates, perform it as it applies to your school. 3. Congratulations! You’ve just been promoted to your first supervisory position. However, you are at a loss as to how to actually manage your staff. This guide to general management, https://www.thebalance.com/management-4073997, brings together a variety of materials to help you. Check out Management Skills, as well as other resources. Develop a plan for yourself to follow. 4. How do entrepreneurs develop the corporate culture of their companies? Do a search of the term “corporate culture” on Inc. (https://www.inc.com), Entrepreneur (https://www.entrepreneur.com), or Fast Company (https://www.fastcompany.com). Prepare a short presentation for your class that explains the importance of corporate culture and how it is developed in young firms. 5. Good managers and leaders know how to empower their employees. The Business e-Coach at http://www.1000ventures.com explains why employee empowerment is so important in today’s knowledge economy. After reviewing the information at this site, prepare a brief report on the benefits of employee empowerment. Include several ideas you would like a manager to use to empower you. 6. Get some leadership tips from 7 Steps to Closure at the Learning Center, http://www.learningcenter.net. Complete the Closure Planning Form to develop your own personal Success-Oriented Action Plan. ### Creative Thinking Case ### Managing an Extreme Makeover During a tour of a Toyota Corolla assembly plant located near their headquarters in Bangalore, India, executives of Wipro Ltd. hit on a revolutionary idea—why not apply Toyota’s successful manufacturing techniques to managing their software development and clients’ back-office operations business? “Toyota preaches continuous improvement, respect for employees, learning, and embracing change,” says T. K. Kurien, 45, former head of Wipro’s 13,600-person business-process outsourcing unit. “What we do is apply people, technology, and processes to solve a business problem.” Among the problems spotted early on by Kurien? Cubicles. They’re normal for programmers but interrupt the flow for business-process employees. Deciding to position people side by side at long tables assembly-line style “was a roaring disaster,” admits Kurien. “The factory idea concerned people.” So based on feedback from his middle managers, Kurien arranged classes to explain his concepts and how they would ultimately make life easier for employees. Wipro also adopted Toyota’s kaizen system of soliciting employee suggestions. Priya, who has worked for Wipro for years, submitted several kaizen and was delighted when her bosses responded promptly to her suggestions. “Even though it’s something small, it feels good. You’re being considered,” she says. Empowerment in the workplace washed over into her private life. As the first woman in her family to attend college, she told her parents they may arrange her marriage only to a man who will not interfere with her career. Kurien and his managers work hard at boosting employee morale, offering rewards—pens, caps, or shirts—to employees who submit suggestions to kaizen boxes. And each week, a top-performing employee receives a cake. Murthy, an accountant who hopes to be Wipro’s chief financial officer someday, spearheaded an effort to cut government import approval times from 30 to 15 days. He got a cake with his name written on it in honey. “I was surprised management knew what I was doing,” he says. “Now I want to do more projects.” With multibillions in revenues, thousands of employees, and a U.S.-traded stock that advanced 230 percent in a two-year period, Wipro is a star of India’s burgeoning information technology industry. The company’s paperwork processing operations bear a clear resemblance to a Toyota plant. Two shifts of young people line long rows of tables. At the start of each shift, team leaders discuss the day’s goals and divide up tasks. And just like in a Toyota factory, electronic displays mounted on the walls shift from green to red if things get bogged down. This obsession with management efficiency has helped India become the back-office operation for hundreds of Western companies, resulting in the transfer of many thousands of jobs offshore. “If the Indians get this right, in addition to their low labor rates, they can become deadly competition,” says Jeffrey K. Liker, a business professor at the University of Michigan and author of The Toyota Way, a book about Toyota’s lean manufacturing techniques. If Kurien’s management initiatives succeed, experts may soon be extolling the Wipro way. 2. What type of manager is T. K. Kurien? How would you characterize his leadership style? 3. What managerial role does T. K. Kurien assume in his approach to attaining his division’s goal of improved customer service? 4. What management skill sets does he exhibit? Sources: Steve Hamm, “Taking a Page from Toyota’s Playbook,” Bloomberg Businessweek, https://www.bloomberg.com, accessed November 17, 2017; Shilpa Phadnis, “T K Kurien to Leave Wipro This Month,” The Times of India, https://timesofindia.indiatimes.com, January 23, 2017; Toyota Resumes Efficiency Drive,” BBC News, http://www.bbc.com, March 26, 2015. ### Hot Links Address Book 1. Visit the International Business Leaders Forum (IBLF) at http://www.iblfglobal.org to discover what today’s international business leaders are focusing on. 2. To learn more about how firms develop contingency plans for all sorts of crises, visit Mind Tools at https://www.mindtools.com. 3. Who are the leaders of this year’s Inc. 500, and what do they have to say about their success? Find out at the Inc. 500 site at https://www.inc.com. 4. Want to learn more about Bill Gates’s management style? Go to his personal website, https://www.gatesnotes.com/Bio, to read his official biography, books, and other information. 5. Most successful managers work hard at continually updating their managerial skills. One organization that offers many ongoing training and education programs is the American Management Association. Visit its site at http://www.amanet.org. 6. Search Questia’s online library at https://www.questia.com for leadership resources. You’ll be able to preview a wide variety of books, journals, and other materials.

# Designing Organizational Structures ## Introduction ### Learning Outcomes After reading this chapter, you should be able to answer these questions: 1. What are the traditional forms of organizational structure? 2. What contemporary organizational structures are companies using? 3. Why are companies using team-based organizational structures? 4. What tools do companies use to establish relationships within their organizations? 5. How can the degree of centralization/decentralization be altered to make an organization more successful? 6. How do mechanistic and organic organizations differ? 7. How does the informal organization affect the performance of the company? 8. What trends are influencing the way businesses organize? This module focuses on the different types of organizational structure, the reasons an organization might prefer one structure over another, and how the choice of an organizational structure ultimately can impact that organization’s success. In today’s dynamic business environment, organizational structures need to be designed so that the organization can quickly respond to new competitive threats and changing customer needs. Future success for companies will depend on their ability to be flexible and respond to the needs of customers. In this chapter, we’ll look first at how companies build organizational structures by implementing traditional, contemporary, and team-based models. Then, we’ll explore how managers establish the relationships within the structures they have designed, including determining lines of communication, authority, and power. Finally, we’ll examine what managers need to consider when designing organizational structures and the trends that are changing the choices companies make about organizational design.

# Designing Organizational Structures ## Building Organizational Structures 1. What are the traditional forms of organizational structure? The key functions that managers perform include planning, organizing, leading, and controlling. This module focuses specifically on the organizing function. Organizing involves coordinating and allocating a firm’s resources so that the firm can carry out its plans and achieve its goals. This organizing, or structuring, process is accomplished by: 1. Determining work activities and dividing up tasks (division of labor) 2. Grouping jobs and employees (departmentalization) 3. Assigning authority and responsibilities (delegation) The result of the organizing process is a formal structure within an organization. An organization is the order and design of relationships within a company or firm. It consists of two or more people working together with a common objective and clarity of purpose. Formal organizations also have well-defined lines of authority, channels for information flow, and means of control. Human, material, financial, and information resources are deliberately connected to form the business organization. Some connections are long-lasting, such as the links among people in the finance or marketing department. Others can be changed at almost any time—for example, when a committee is formed to study a problem. Every organization has some kind of underlying structure. Typically, organizations base their frameworks on traditional, contemporary, or team-based approaches. Traditional structures are more rigid and group employees by function, products, processes, customers, or regions. Contemporary and team-based structures are more flexible and assemble employees to respond quickly to dynamic business environments. Regardless of the structural framework a company chooses to implement, all managers must first consider what kind of work needs to be done within the firm. ### Division of Labor The process of dividing work into separate jobs and assigning tasks to workers is called division of labor. In a fast-food restaurant, for example, some employees take or fill orders, others prepare food, a few clean and maintain equipment, and at least one supervises all the others. In an auto assembly plant, some workers install rearview mirrors, while others mount bumpers on bumper brackets. The degree to which the tasks are subdivided into smaller jobs is called specialization. Employees who work at highly specialized jobs, such as assembly-line workers, perform a limited number and variety of tasks. Employees who become specialists at one task, or a small number of tasks, develop greater skill in doing that particular job. This can lead to greater efficiency and consistency in production and other work activities. However, a high degree of specialization can also result in employees who are disinterested or bored due to the lack of variety and challenge. ### Traditional Structures After a company divides the work it needs to do into specific jobs, managers then group the jobs together so that similar or associated tasks and activities can be coordinated. This grouping of people, tasks, and resources into organizational units is called departmentalization. It facilitates the planning, leading, and control processes. An organization chart is a visual representation of the structured relationships among tasks and the people given the authority to do those tasks. In the organization chart in , each figure represents a job, and each job includes several tasks. The sales manager, for instance, must hire salespeople, establish sales territories, motivate and train the salespeople, and control sales operations. The chart also indicates the general type of work done in each position. As shows, five basic types of departmentalization are commonly used in organizations: 1. , which is based on the primary functions performed within an organizational unit (marketing, finance, production, sales, and so on). Ethan Allen Interiors, a vertically integrated home furnishings manufacturer, continues its successful departmentalization by function, including retail, manufacturing and sourcing, product design, logistics, and operations, which includes tight financial controls. 1. , which is based on the goods or services produced or sold by the organizational unit (such as outpatient/emergency services, pediatrics, cardiology, and orthopedics). For example, ITT is a diversified leading manufacturer of highly engineered components and customized technology solutions for the transportation, industrial, and oil and gas markets. The company is organized into four product divisions: Industrial Process (pumps, valves, and wastewater treatment equipment), Control Technologies (motion control and vibration isolation products), Motion Technologies (shock absorbers, brake pads, and friction materials), and Interconnect Solutions (connectors for a variety of markets). 2. , which is based on the production process used by the organizational unit (such as lumber cutting and treatment, furniture finishing, and shipping). For example, the organization of Gazprom Neft, a Russian oil company, reflects the activities the company needs to perform to extract oil from the ground and turn it into a final product: exploration and research, production (drilling), refining, and marketing and distribution. Pixar, the animated-movie company now part of Disney, is divided into three parallel yet interactive process-based groups: technology development, which delivers computer-graphics tools; creative development, which creates stories and characters and animates them; and production, which coordinates the film-making process. 3. , which is based on the primary type of customer served by the organizational unit (such as wholesale or retail purchasers). The PNC Financial Services Group offers a wide range of services for all of its customers and is structured by the type of consumer it serves: retail banking for consumers; the asset management group, with specific focus on individuals as well as corporations, unions, municipalities, and others; and corporate and institutional banking for middle-market companies nationwide. 1. , which is based on the geographic segmentation of organizational units (such as U.S. and Canadian marketing, European marketing, and Latin American marketing). People are assigned to a particular organizational unit because they perform similar or related tasks, or because they are jointly responsible for a product, client, or market. Decisions about how to departmentalize affect the way management assigns authority, distributes resources, rewards performance, and sets up lines of communication. Many large organizations use several types of departmentalization. For example, Procter & Gamble (P&G), the multibillion-dollar consumer-products company, integrates four different types of departmentalization, which the company refers to as “four pillars.” First, the Global Business Units (GBU) divide the company according to products (baby, feminine, and family care; beauty; fabric and home care; and health and grooming). Then, P&G uses a geographical approach, creating business units to market its products around the world. There are Selling and Market Operations (SMO) groups for North America; Latin America; Europe; Asia Pacific; Greater China; and India, the Middle East, and Africa. P&G’s third pillar is Global Business Services division (GBS), which also uses geographic departmentalization. GBS provides technology processes and standard data tools to enable the GBUs and SMOs to better understand the business and to serve consumers and customers better. It supports P&G business units in areas such as accounting and financial reporting, information technology, purchases, payroll and benefits administration, and facilities management. Finally, the divisions of the Corporate Functions pillar provide a safety net to all the other pillars. These divisions are comprised of functional specialties such as customer business development; external relations; human resources; legal, marketing, consumer, and market knowledge; research and development; and workplace services. ### Line-and-Staff Organization The line organization is designed with direct, clear lines of authority and communication flowing from the top managers downward. Managers have direct control over all activities, including administrative duties. An organization chart for this type of structure would show that all positions in the firm are directly connected via an imaginary line extending from the highest position in the organization to the lowest (where production of goods and services takes place). This structure, with its simple design and broad managerial control, is often well-suited to small, entrepreneurial firms. As an organization grows and becomes more complex, the line organization can be enhanced by adding staff positions to the design. Staff positions provide specialized advisory and support services to line managers in the line-and-staff organization, shown in . In daily operations, individuals in line positions are directly involved in the processes used to create goods and services. Individuals in staff positions provide the administrative and support services that line employees need to achieve the firm’s goals. Line positions in organizations are typically in areas such as production, marketing, and finance. Staff positions are found in areas such as legal counseling, managerial consulting, public relations, and human resource management. ### Summary of Learning Outcomes 1. What are the traditional forms of organizational structure? Firms typically use traditional, contemporary, or team-based approaches when designing their organizational structure. In the traditional approach, companies first divide the work into separate jobs and tasks. Managers then group related jobs and tasks together into departments. Five basic types of departmentalization are commonly used in organizations: 1. Functional: Based on the primary functions performed within an organizational unit 2. Product: Based on the goods or services produced or sold by the organizational unit 3. Process: Based on the production process used by the organizational unit 4. Customer: Based on the primary type of customer served by the organizational unit 5. Geographic: Based on the geographic segmentation of organizational units

# Designing Organizational Structures ## Contemporary Structures 1. What contemporary organizational structures are companies using? Although traditional forms of departmentalization still represent how many companies organize their work, newer, more flexible organizational structures are in use at many firms. Let’s look at matrix and committee structures and how those two types of organizations are helping companies better leverage the diverse skills of their employees. ### Matrix Structure The matrix structure (also called the project management approach) is sometimes used in conjunction with the traditional line-and-staff structure in an organization. Essentially, this structure combines two different forms of departmentalization, functional and product, that have complementary strengths and weaknesses. The matrix structure brings together people from different functional areas of the organization (such as manufacturing, finance, and marketing) to work on a special project. Each employee has two direct supervisors: the line manager from her or his specific functional area and the project manager. shows a matrix organization with four special project groups (A, B, C, D), each with its own project manager. Because of the dual chain of command, the matrix structure presents some unique challenges for both managers and subordinates. Advantages of the matrix structure include: 1. Teamwork. By pooling the skills and abilities of various specialists, the company can increase creativity and innovation and tackle more complex tasks. 2. Efficient use of resources. Project managers use only the specialized staff they need to get the job done, instead of building large groups of underused personnel. 3. Flexibility. The project structure is flexible and can adapt quickly to changes in the environment; the group can be disbanded quickly when it is no longer needed. 4. Ability to balance conflicting objectives. The customer wants a quality product and predictable costs. The organization wants high profits and the development of technical capability for the future. These competing goals serve as a focal point for directing activities and overcoming conflict. The marketing representative can represent the customer, the finance representative can advocate high profits, and the engineers can push for technical capabilities. 5. Higher performance. Employees working on special project teams may experience increased feelings of ownership, commitment, and motivation. 6. Opportunities for personal and professional development. The project structure gives individuals the opportunity to develop and strengthen technical and interpersonal skills. Disadvantages of the matrix structure include: 1. Power struggles. Functional and product managers may have different goals and management styles. 2. Confusion among team members. Reporting relationships and job responsibilities may be unclear. 3. Lack of cohesiveness. Team members from different functional areas may have difficulty communicating effectively and working together as a team. Although project-based matrix organizations can improve a company’s flexibility and teamwork, some companies are trying to unravel complex matrix structures that create limited accountability and complicate day-to-day operations. Some CEOs and other top managers suggest that matrix structures make it easier to blame others when things don’t go as planned. ### Committee Structure In committee structure, authority and responsibility are held by a group rather than an individual. Committees are typically part of a larger line-and-staff organization. Often the committee’s role is only advisory, but in some situations the committee has the power to make and implement decisions. Committees can make the coordination of tasks in the organization much easier. For example, Novartis, the huge Swiss pharmaceutical company, has a committee structure, which reports to its board of directors. The company’s executive committee is responsible for overseeing the business operations of group companies within the global organization and consists of the CEO, CFO, head of HR, general counsel, president of operations, head of biomedical research, global head of drug development, CEOs of the pharmaceutical and oncology units, and CEOs of Sandoz and Alcon, other Novartis companies. Members of the executive committee are selected by the company’s board of directors. Committees bring diverse viewpoints to a problem and expand the range of possible solutions, but there are some drawbacks. Committees can be slow to reach a decision and are sometimes dominated by a single individual. It is also more difficult to hold any one individual accountable for a decision made by a group. Committee meetings can sometimes go on for long periods of time with seemingly little being accomplished. ### Summary of Learning Outcomes 1. What contemporary organizational structures are companies using? In recent decades, companies have begun to expand beyond traditional departmentalization methods and use matrix, committee, and team-based structures. Matrix structures combine two types of traditional organizational structures (for example, geographic and functional). Matrix structures bring together people from different functional areas of the organization to work on a special project. As such, matrix organizations are more flexible, but because employees report to two direct supervisors, managing matrix structures can be extremely challenging. Committee structures give authority and responsibility to a group rather than to an individual. Committees are part of a line-and-staff organization and often fulfill only an advisory role. Team-based structures also involve assigning authority and responsibility to groups rather than individuals, but, different from committees, team-based structures give these groups autonomy to carry out their work.

# Designing Organizational Structures ## Using Teams to Enhance Motivation and Performance 1. Why are companies using team-based organizational structures? One of the most apparent trends in business today is the use of teams to accomplish organizational goals. Using a team-based structure can increase individual and group motivation and performance. This section gives a brief overview of group behavior, defines work teams as specific types of groups, and provides suggestions for creating high-performing teams. ### Understanding Group Behavior Teams are a specific type of organizational group. Every organization contains groups, social units of two or more people who share the same goals and cooperate to achieve those goals. Understanding some fundamental concepts related to group behavior and group processes provides a good foundation for understanding concepts about work teams. Groups can be formal or informal in nature. Formal groups are designated and sanctioned by the organization; their behavior is directed toward accomplishing organizational goals. Informal groups are based on social relationships and are not determined or sanctioned by the organization. Formal organizational groups, like the sales department at Apple, must operate within the larger Apple organizational system. To some degree, elements of the larger Apple system, such as organizational strategy, company policies and procedures, available resources, and the highly motivated employee corporate culture, determine the behavior of smaller groups, such as the sales department, within the company. Other factors that affect the behavior of organizational groups are individual member characteristics (e.g., ability, training, personality), the roles and norms of group members, and the size and cohesiveness of the group. Norms are the implicit behavioral guidelines of the group, or the standards for acceptable and unacceptable behavior. For example, an Apple sales manager may be expected to work at least two Saturdays per month without extra pay. Although this isn’t written anywhere, it is the expected norm. Group cohesiveness refers to the degree to which group members want to stay in the group and tend to resist outside influences (such as a change in company policies). When group performance norms are high, group cohesiveness will have a positive impact on productivity. Cohesiveness tends to increase when the size of the group is small, individual and group goals are similar, the group has high status in the organization, rewards are group-based rather than individual-based, and the group competes with other groups within the organization. Work group cohesiveness can benefit the organization in several ways, including increased productivity, enhanced worker self-image because of group success, increased company loyalty, reduced employee turnover, and reduced absenteeism. Southwest Airlines is known for its work group cohesiveness. On the other hand, cohesiveness can also lead to restricted output, resistance to change, and conflict with other work groups in the organization. The opportunity to turn the decision-making process over to a group with diverse skills and abilities is one of the arguments for using work groups (and teams) in organizational settings. For group decision-making to be most effective, however, both managers and group members must understand its strengths and weaknesses (see ). ### Work Groups versus Work Teams We have already noted that teams are a special type of organizational group, but we also need to differentiate between work groups and work teams. Work groups share resources and coordinate efforts to help members better perform their individual duties and responsibilities. The performance of the group can be evaluated by adding up the contributions of the individual group members. Work teams require not only coordination but also collaboration, the pooling of knowledge, skills, abilities, and resources in a collective effort to attain a common goal. A work team creates synergy, causing the performance of the team as a whole to be greater than the sum of team members’ individual contributions. Simply assigning employees to groups and labeling them a team does not guarantee a positive outcome. Managers and team members must be committed to creating, developing, and maintaining high-performance work teams. Factors that contribute to their success are discussed later in this section. ### Types of Teams The evolution of the team concept in organizations can be seen in three basic types of work teams: problem-solving, self-managed, and cross-functional. Problem-solving teams are typically made up of employees from the same department or area of expertise and from the same level of the organizational hierarchy. They meet on a regular basis to share information and discuss ways to improve processes and procedures in specific functional areas. Problem-solving teams generate ideas and alternatives and may recommend a specific course of action, but they typically do not make final decisions, allocate resources, or implement change. Many organizations that experienced success using problem-solving teams were willing to expand the team concept to allow team members greater responsibility in making decisions, implementing solutions, and monitoring outcomes. These highly autonomous groups are called self-managed work teams. They manage themselves without any formal supervision, taking responsibility for setting goals, planning and scheduling work activities, selecting team members, and evaluating team performance. Today, approximately 80 percent of Fortune 1000 companies use some sort of self-managed teams. One example is Zappos’s shift to self-managed work teams in 2013, where the traditional organizational structure and bosses were eliminated, according to a system called holacracy. Another version of self-managing teams can be found at W. L. Gore, the company that invented Gore-Tex fabric and Glide dental floss. The three employees who invented Elixir guitar strings contributed their spare time to the effort and persuaded a handful of colleagues to help them improve the design. After working three years entirely on their own—without asking for any supervisory or top management permission or being subjected to any kind of oversight—the team finally sought the support of the larger company, which they needed to take the strings to market. Today, W. L. Gore’s Elixir is the number one selling string brand for acoustic guitar players. An adaptation of the team concept is called a cross-functional team. These teams are made up of employees from about the same hierarchical level but different functional areas of the organization. Many task forces, organizational committees, and project teams are cross-functional. Often the team members work together only until they solve a given problem or complete a specific project. Cross-functional teams allow people with various levels and areas of expertise to pool their resources, develop new ideas, solve problems, and coordinate complex projects. Both problem-solving teams and self-managed teams may also be cross-functional teams. ### Building High-Performance Teams A great team must possess certain characteristics, so selecting the appropriate employees for the team is vital. Employees who are more willing to work together to accomplish a common goal should be selected, rather than employees who are more interested in their own personal achievement. Team members should also possess a variety of skills. Diverse skills strengthen the overall effectiveness of the team, so teams should consciously recruit members to fill gaps in the collective skill set. To be effective, teams must also have clearly defined goals. Vague or unclear goals will not provide the necessary direction or allow employees to measure their performance against expectations. Next, high-performing teams need to practice good communication. Team members need to communicate messages and give appropriate feedback that seeks to correct any misunderstandings. Feedback should also be detached; that is, team members should be careful to critique ideas rather than criticize the person who suggests them. Nothing can degrade the effectiveness of a team like personal attacks. Lastly, great teams have great leaders. Skilled team leaders divide work so that tasks are not repeated, help members set and track goals, monitor their team’s performance, communicate openly, and remain flexible to adapt to changing goals or management demands. ### Summary of Learning Outcomes 1. Why are companies using team-based organizational structures? Work groups share resources and coordinate efforts to help members better perform their individual duties and responsibilities. The performance of the group can be evaluated by adding up the contributions of the individual group members. Work teams require not only coordination but also collaboration, the pooling of knowledge, skills, abilities, and resources in a collective effort to attain a common goal. Four types of work teams are used: problem solving, self-managed, cross-functional, and virtual teams. Companies are using teams to improve individual and group motivation and performance.

# Designing Organizational Structures ## Authority—Establishing Organizational Relationships 1. What tools do companies use to establish relationships within their organizations? Once companies choose a method of departmentalization, they must then establish the relationships within that structure. In other words, the company must decide how many layers of management it needs and who will report to whom. The company must also decide how much control to invest in each of its managers and where in the organization decisions will be made and implemented. ### Managerial Hierarchy Managerial hierarchy (also called the management pyramid) is defined by the levels of management within an organization. Generally, the management structure has three levels: top, middle, and supervisory management. In a managerial hierarchy, each organizational unit is controlled and supervised by a manager in a higher unit. The person with the most formal authority is at the top of the hierarchy. The higher a manager, the more power they have. Thus, the amount of power decreases as you move down the management pyramid. At the same time, the number of employees increases as you move down the hierarchy. Not all companies today are using this traditional configuration. One company that has eliminated hierarchy altogether is The Morning Star Company, the largest tomato processor in the world. Based in Woodland, California, the company employs 600 permanent “colleagues” and an additional 4,000 workers during harvest season. Founder and sole owner Chris Rufer started the company and based its vision on the philosophy of self-management, in which professionals initiate communication and coordination of their activities with colleagues, customers, suppliers, and others, and take personal responsibility for helping the company achieve its corporate goals. An organization with a well-defined hierarchy has a clear chain of command, which is the line of authority that extends from one level of the organization to the next, from top to bottom, and makes clear who reports to whom. The chain of command is shown in the organization chart and can be traced from the CEO all the way down to the employees producing goods and services. Under the unity of command principle, everyone reports to and gets instructions from only one boss. Unity of command guarantees that everyone will have a direct supervisor and will not be taking orders from a number of different supervisors. Unity of command and chain of command give everyone in the organization clear directions and help coordinate people doing different jobs. Matrix organizations automatically violate the unity of command principle because employees report to more than one boss, if only for the duration of a project. For example, Unilever, the consumer-products company that makes Dove soap, Ben & Jerry’s ice cream, and Hellmann’s mayonnaise, used to have a matrix structure with one CEO for North America and another for Europe. But employees in divisions that operated in both locations were unsure about which CEO’s decisions took precedence. Today, the company uses a product departmentalization structure. Companies like Unilever tend to abandon matrix structures because of problems associated with unclear or duplicate reporting relationships, in other words, with a lack of unity of command. Individuals who are part of the chain of command have authority over other persons in the organization. Authority is legitimate power, granted by the organization and acknowledged by employees, that allows an individual to request action and expect compliance. Exercising authority means making decisions and seeing that they are carried out. Most managers delegate, or assign, some degree of authority and responsibility to others below them in the chain of command. The delegation of authority makes the employees accountable to their supervisor. Accountability means responsibility for outcomes. Typically, authority and responsibility move downward through the organization as managers assign activities to, and share decision-making with, their subordinates. Accountability moves upward in the organization as managers in each successively higher level are held accountable for the actions of their subordinates. ### Span of Control Each firm must decide how many managers are needed at each level of the management hierarchy to effectively supervise the work performed within organizational units. A manager’s span of control (sometimes called span of management) is the number of employees the manager directly supervises. It can be as narrow as two or three employees or as wide as 50 or more. In general, the larger the span of control, the more efficient the organization. As shows, however, both narrow and wide spans of control have benefits and drawbacks. If hundreds of employees perform the same job, one supervisor may be able to manage a very large number of employees. Such might be the case at a clothing plant, where hundreds of sewing machine operators work from identical patterns. But if employees perform complex and dissimilar tasks, a manager can effectively supervise only a much smaller number. For instance, a supervisor in the research and development area of a pharmaceutical company might oversee just a few research chemists due to the highly complex nature of their jobs. ### Summary of Learning Outcomes 1. What tools do companies use to establish relationships within their organizations? The managerial hierarchy (or the management pyramid) comprises the levels of management within the organization, and the managerial span of control is the number of employees the manager directly supervises. In daily operations, individuals in line positions are directly involved in the processes used to create goods and services. Individuals in staff positions provide the administrative and support services that line employees need to achieve the firm’s goals. Line positions in organizations are typically in areas such as production, marketing, and finance. Staff positions are found in areas such as legal counseling, managerial consulting, public relations, and human resource management.

# Designing Organizational Structures ## Degree of Centralization 1. How can the degree of centralization/decentralization be altered to make an organization more successful? The optimal span of control is determined by the following five factors: 1. Nature of the task. The more complex the task, the narrower the span of control. 2. Location of the workers. The more locations, the narrower the span of control. 3. Ability of the manager to delegate responsibility. The greater the ability to delegate, the wider the span of control. 4. Amount of interaction and feedback between the workers and the manager. The more feedback and interaction required, the narrower the span of control. 5. Level of skill and motivation of the workers. The higher the skill level and motivation, the wider the span of control. The final component in building an effective organizational structure is deciding at what level in the organization decisions should be made. Centralization is the degree to which formal authority is concentrated in one area or level of the organization. In a highly centralized structure, top management makes most of the key decisions in the organization, with very little input from lower-level employees. Centralization lets top managers develop a broad view of operations and exercise tight financial controls. It can also help to reduce costs by eliminating redundancy in the organization. But centralization may also mean that lower-level personnel don’t get a chance to develop their decision-making and leadership skills and that the organization is less able to respond quickly to customer demands. Decentralization is the process of pushing decision-making authority down the organizational hierarchy, giving lower-level personnel more responsibility and power to make and implement decisions. Benefits of decentralization can include quicker decision-making, increased levels of innovation and creativity, greater organizational flexibility, faster development of lower-level managers, and increased levels of job satisfaction and employee commitment. But decentralization can also be risky. If lower-level personnel don’t have the necessary skills and training to perform effectively, they may make costly mistakes. Additionally, decentralization may increase the likelihood of inefficient lines of communication, competing objectives, and duplication of effort. Several factors must be considered when deciding how much decision-making authority to delegate throughout the organization. These factors include the size of the organization, the speed of change in its environment, managers’ willingness to give up authority, employees’ willingness to accept more authority, and the organization’s geographic dispersion. Decentralization is usually desirable when the following conditions are met: 1. The organization is very large, like ExxonMobil, Ford, or General Electric. 2. The firm is in a dynamic environment where quick, local decisions must be made, as in many high-tech industries. 3. Managers are willing to share power with their subordinates. 4. Employees are willing and able to take more responsibility. 5. The company is spread out geographically, such as Nordstrom, Caterpillar, or Ford. As organizations grow and change, they continually reevaluate their structure to determine whether it is helping the company to achieve its goals. ### Summary of Learning Outcomes 1. How can the degree of centralization/decentralization be altered to make an organization more successful? In a highly centralized structure, top management makes most of the key decisions in the organization, with very little input from lower-level employees. Centralization lets top managers develop a broad view of operations and exercise tight financial controls. In a highly decentralized organization, decision-making authority is pushed down the organizational hierarchy, giving lower-level personnel more responsibility and power to make and implement decisions. Decentralization can result in faster decision-making and increased innovation and responsiveness to customer preferences.

# Designing Organizational Structures ## Organizational Design Considerations 1. How do mechanistic and organic organizations differ? You are now familiar with the different ways to structure an organization, but as a manager, how do you decide which design will work the best for your business? What works for one company may not work for another. In this section, we’ll look at two generic models of organizational design and briefly examine a set of contingency factors that favors each. ### Mechanistic versus Organic Structures Structural design generally follows one of the two basic models described in : mechanistic or organic. A mechanistic organization is characterized by a relatively high degree of job specialization, rigid departmentalization, many layers of management (particularly middle management), narrow spans of control, centralized decision-making, and a long chain of command. This combination of elements results in what is called a tall organizational structure. The U.S. Army and the United Nations are typical mechanistic organizations. In contrast, an organic organization is characterized by a relatively low degree of job specialization, loose departmentalization, few levels of management, wide spans of control, decentralized decision-making, and a short chain of command. This combination of elements results in what is called a flat organizational structure. Colleges and universities tend to have flat organizational structures, with only two or three levels of administration between the faculty and the president. shows examples of flat and tall organizational structures. ### Factors Influencing the Choice between Mechanistic and Organic Structures Although few organizations are purely mechanistic or purely organic, most organizations tend more toward one type or the other. The decision to create a more mechanistic or a more organic structural design is based on factors such as the firm’s overall strategy, the size of the organization, and the stability of its external environment, among others. A company’s organizational structure should enable it to achieve its goals, and because setting corporate goals is part of a firm’s overall strategy-making process, it follows that a company’s structure depends on its strategy. That alignment can be challenging for struggling companies trying to accomplish multiple goals. For example, a company with an innovation strategy will need the flexibility and fluid movement of information that an organic organization provides. But a company using a cost-control strategy will require the efficiency and tight control of a mechanistic organization. Often, struggling companies try to simultaneously increase innovation and rein in costs, which can be organizational challenges for managers. Such is the case at Microsoft, where CEO Satya Nadella cut more than 18,000 jobs in 2014 after taking the helm at the technology giant. Most of the cuts were the result of the company’s failed acquisition of Nokia’s mobile phone business. More recently, the company eliminated additional jobs in sales and marketing (mostly overseas) as Microsoft shifts from a software developer to a cloud computing software delivery service. At the same time, Nadella is also trying to encourage employees and managers to break down barriers between divisions and increase the pace of innovation across the organization. Size is another factor that affects how mechanistic or organic a company’s organizational structure is. Much research has been conducted that shows a company’s size has a significant impact on its organizational structure. Smaller companies tend to follow the more organic model, in part because they can. It’s much easier to be successful with decentralized decision-making, for example, if you have only 50 employees. A company with that few employees is also more likely, by virtue of its size, to have a lesser degree of employee specialization. That’s because, when there are fewer people to do the work, those people tend to know more about the entire process. As a company grows, it becomes more mechanistic, as systems are put in place to manage the greater number of employees. Procedures, rules, and regulations replace flexibility, innovation, and independence. That isn’t always the case, however. W. L. Gore has nearly 10,000 employees and more than $3 billion in annual revenues, but, as noted earlier, uses an extremely organic organizational structure. Employees have no bosses, participate on teams, and often create roles for themselves to fill functional gaps within the company. Lastly, the business in which a company operates has a significant impact on its organizational structure. In complex, dynamic, and unstable environments, companies need to organize for flexibility and agility. That is, their organizational structures need to respond to rapid and unexpected changes in the business environment. For companies operating in stable environments, however, the demands for flexibility and agility are not so great. The environment is predictable. In a simple, stable environment, therefore, companies benefit from the efficiencies created by a mechanistic organizational structure. ### Summary of Learning Outcomes 1. How do mechanistic and organic organizations differ? A mechanistic organization is characterized by a relatively high degree of work specialization, rigid departmentalization, many layers of management (particularly middle management), narrow spans of control, centralized decision-making, and a long chain of command. This combination of elements results in a tall organizational structure. In contrast, an organic organization is characterized by a relatively low degree of work specialization, loose departmentalization, few levels of management, wide spans of control, decentralized decision-making, and a short chain of command. This combination of elements results in a flat organizational structure.

# Designing Organizational Structures ## The Informal Organization 1. How does the informal organization affect the performance of the company? Up to this point, we have focused on formal organizational structures that can be seen in the boxes and lines of the organization chart. Yet many important relationships within an organization do not show up on an organization chart. Nevertheless, these relationships can affect the decisions and performance of employees at all levels of the organization. The network of connections and channels of communication based on the informal relationships of individuals inside the organization is known as the informal organization. Informal relationships can be between people at the same hierarchical level or between people at different levels and in different departments. Some connections are work-related, such as those formed among people who carpool or ride the same train to work. Others are based on nonwork commonalties such as belonging to the same church or health club or having children who attend the same school. ### Functions of the Informal Organization The informal organization has several important functions. First, it provides a source of friendships and social contact for organization members. Second, the interpersonal relationships and informal groups help employees feel better-informed about and connected with what is going on in their firm, thus giving them some sense of control over their work environment. Third, the informal organization can provide status and recognition that the formal organization cannot or will not provide employees. Fourth, the network of relationships can aid the socialization of new employees by informally passing along rules, responsibilities, basic objectives, and job expectations. Finally, the organizational grapevine helps employees to be more aware of what is happening in their workplace by transmitting information quickly and conveying it to places that the formal system does not reach. ### Informal Communication Channels The informal channels of communication used by the informal organization are often referred to as the grapevine or the rumor mill. Managers need to pay attention to the grapevines in their organization, because their employees increasingly put a great deal of stock in the information that travels along it, especially in this era of social media. A recent survey found that many business leaders have their work cut out for them in the speeches and presentations they give employees. Survey participants were asked if they would believe a message delivered in a speech by a company leader or one that they heard over the grapevine. Forty-seven percent of those responding said they would put more credibility in the grapevine. Only 42 percent said they would believe senior leadership, and another 11 percent indicated they would believe a blend of elements from both messages. Perhaps even more interesting is how accurate employees perceive their company grapevine to be: 57 percent gave it favorable ratings. “The grapevine may not be wholly accurate, but it is a very reliable indicator that something is going on,” said one survey respondent. With this in mind, managers need to learn to use the existing informal organization as a tool that can potentially benefit the formal organization. An excellent way of putting the informal organization to work for the good of the company is to bring informal leaders into the decision-making process. That way, at least the people who use and nurture the grapevine will have more accurate information to send it. ### Summary of Learning Outcomes 1. How does the informal organization affect the performance of a company? The informal organization is the network of connections and channels of communication based on the informal relationships of individuals inside the organization. Informal relationships can be between people at the same hierarchical level or between people at different levels and in different departments. Informal organizations give employees more control over their work environment by delivering a continuous stream of company information throughout the organization, thereby helping employees stay informed.

# Designing Organizational Structures ## Trends in Organizational Structure 1. What trends are influencing the way businesses organize? To improve organizational performance and achieve long-term objectives, some organizations seek to reengineer their business processes or adopt new technologies that open up a variety of organizational design options, such as virtual corporations and virtual teams. Other trends that have strong footholds in today’s organizations include outsourcing and managing global businesses. ### Reengineering Organizational Structure Periodically, all businesses must reevaluate the way they do business. This includes assessing the effectiveness of the organizational structure. To meet the formidable challenges of the future, companies are increasingly turning to reengineering—the complete redesign of business structures and processes in order to improve operations. An even simpler definition of reengineering is “starting over.” In effect, top management asks, “If we were a new company, how would we run this place?” The purpose of reengineering is to identify and abandon the outdated rules and fundamental assumptions that guide current business operations. Every company has many formal and informal rules, based on assumptions about technology, people, and organizational goals, that no longer hold. Thus, the goal of reengineering is to redesign business processes to achieve improvements in cost control, product quality, customer service, and speed. The reengineering process should result in a more efficient and effective organizational structure that is better suited to the current (and future) competitive climate of the industry. ### The Virtual Corporation One of the biggest challenges for companies today is adapting to the technological changes that are affecting all industries. Organizations are struggling to find new organizational structures that will help them transform information technology into a competitive advantage. One alternative that is becoming increasingly prevalent is the virtual corporation, which is a network of independent companies (suppliers, customers, even competitors) linked by information technology to share skills, costs, and access to one another’s markets. This network structure allows companies to come together quickly to exploit rapidly changing opportunities. The key attributes of a virtual corporation are: 1. Technology. Information technology helps geographically distant companies form alliances and work together. 2. Opportunism. Alliances are less permanent, less formal, and more opportunistic than in traditional partnerships. 3. Excellence. Each partner brings its core competencies to the alliance, so it is possible to create an organization with higher quality in every functional area and increase competitive advantage. 4. Trust. The network structure makes companies more reliant on each other and forces them to strengthen relationships with partners. 5. No borders. This structure expands the traditional boundaries of an organization. In the concept’s purest form, each company that links up with others to create a virtual corporation is stripped to its essence. Ideally, the virtual corporation has neither a central office nor an organization chart, no hierarchy, and no vertical integration. It contributes to an alliance only its core competencies, or key capabilities. It mixes and matches what it does best with the core competencies of other companies and entrepreneurs. For example, a manufacturer would only manufacture, while relying on a product design firm to decide what to make and a marketing company to sell the end result. Although firms that are purely virtual organizations are still relatively scarce, many companies are embracing several characteristics of the virtual structure. One example is Cisco Systems. Cisco uses many manufacturing plants to produce its products, but the company owns none of them. In fact, Cisco now relies on contract manufacturers for all of its manufacturing needs. Human hands probably touch fewer than 10 percent of all customer orders, with fewer than half of all orders processed by a Cisco employee. To the average customer, the interdependency of Cisco’s suppliers and inventory systems makes it look like one huge, seamless company. ### Virtual Teams Technology is also enabling corporations to create virtual work teams. Geography is no longer a limitation when employees are considered for a work team. Virtual teams mean reduced travel time and costs, reduced relocation expenses, and utilization of specialized talent regardless of an employee’s location. When managers need to staff a project, all they need to do is make a list of required skills and a general list of employees who possess those skills. When the pool of employees is known, the manager simply chooses the best mix of people and creates the virtual team. Special challenges of virtual teams include keeping team members focused, motivated, and communicating positively despite their locations. If feasible, at least one face-to-face meeting during the early stages of team formation will help with these potential problems. ### Outsourcing Another organizational trend that continues to influence today’s managers is outsourcing. For decades, companies have outsourced various functions. For example, payroll functions such as recording hours, managing benefits and wage rates, and issuing paychecks have been handled for years by third-party providers. Today, however, outsourcing includes a much wider array of business functions: customer service, production, engineering, information technology, sales and marketing, and more. Historically, companies have outsourced for two main reasons: cost reduction and labor needs. Often, to satisfy both requirements, companies outsource work to firms in foreign countries. In 2017, outsourcing remains a key component of many businesses’ operations but is not strictly limited to low-level jobs. Some of the insights highlighted in Deloitte’s recent Global Outsourcing Survey bear this out. According to survey respondents from 280 global organizations, outsourcing continues to be successful because it is adapting to changing business environments. According to the survey, outsourcing continues to grow across mature functions such as HR and IT, but it has successfully moved to nontraditional business functions such as facilities management, purchasing, and real estate. In addition, some businesses view outsourcing as a way of infusing their operations with innovation and using it to maintain a competitive advantage—not just as a way to cut costs. As companies increasingly view outsourcing as more than a cost-cutting strategy, they will be expecting more of their vendors in terms of supplying innovation and other benefits. Another form of outsourcing has become prevalent over the last several years, in part as the result of the slow economic recovery from the global recession of 2007–2009. As many U.S. businesses hesitated to hire full-time workers even as they began to experience gradual growth, some companies began to offer contract work to freelancers, who were not considered full-time employees eligible for company benefits. Known as the gig economy, this work approach has advantages and disadvantages. Some gig workers like the independence of being self-employed, while others acknowledge that they are taking on multiple small projects because they can’t find full-time work as company employees. Another group of individuals work as full-time employees but may sign up for gigs such as driving for Uber or Lyft to supplement their income. Recent estimates suggest that the gig economy may impact more than one-third of the U.S. workforce over the next few years. Despite the challenges, outsourcing programs can be effective. To be successful in outsourcing efforts, managers must do the following: 1. Identify a specific business problem. 2. Consider all possible solutions. 3. Decide whether outsourcing the work is the appropriate answer to the problem. 4. Develop a strategic outsourcing partnership with vendors and a solid framework that promotes seamless collaboration and communication. 5. Engage with outsourcing partners on a regular basis to instill trust between the two entities. 6. Remain flexible when it comes to working with outsourcing providers in terms of accommodating requests or adjusting needs when necessary in an effort to build a long-term strategic partnership beneficial to both parties. ### Structuring for Global Mergers Recent mergers creating mega-firms (such as Microsoft and LinkedIn, Amazon and Whole Foods, and Verizon and Yahoo) raise some important questions regarding corporate structure. How can managers hope to organize the global pieces of these huge, complex new firms into a cohesive, successful whole? Should decision-making be centralized or decentralized? Should the firm be organized around geographic markets or product lines? And how can managers consolidate distinctly different corporate cultures? These issues and many more must be resolved if mergers of global companies are to succeed. Beyond designing a new organizational structure, one of the most difficult challenges when merging two large companies is uniting the cultures and creating a single business. The merger between Pfizer and Pharmacia, makers of Dramamine and Rogaine, is no exception. Failure to effectively merge cultures can have serious effects on organizational efficiency. As part of its strategic plan for the giant merger, Pfizer put together 14 groups that would make recommendations concerning finances, human resources, operation support, capital improvements, warehousing, logistics, quality control, and information technology. An outside consultant was hired to facilitate the process. One of the first tasks for the groups was to deal with the conqueror (Pfizer) versus conquered (Pharmacia) attitudes. Company executives wanted to make sure all employees knew that their ideas were valuable and that senior management was listening. As more and more global mergers take place, sometimes between the most unlikely suitors, companies must ensure that the integration plan includes strategies for dealing with cultural differences, establishing a logical leadership structure, implementing a strong two-way communications channel at all levels of the organization, and redefining the “new” organization’s vision, mission, values, and culture. ### Summary of Learning Outcomes 1. What trends are influencing the way businesses organize? Reengineering is a complete redesign of business structures and processes in order to improve operations. The goal of reengineering is to redesign business processes to achieve improvements in cost control, product quality, customer service, and speed. The virtual corporation is a network of independent companies (suppliers, customers, even competitors) linked by information technology to share skills, costs, and access to one another’s markets. This network structure allows companies to come together quickly to exploit rapidly changing opportunities. Many companies are now using technology to create virtual teams. Team members may be down the hall or across the ocean. Virtual teams mean that travel time and expenses are eliminated and the best people can be placed on the team regardless of where they live. Sometimes, however, it may be difficult to keep virtual team members focused and motivated. Outsourcing business functions—both globally and domestically—continues to be a regular business practice for companies large and small. Companies choose to outsource either as a cost-saving measure or as a way to gain access to needed human resource talent and innovation. To be successful, outsourcing must solve a clearly articulated business problem. In addition, managers must use outsourcing providers that fit their company’s actual needs and strive to engage these providers as strategic partners for the long term. A recent phenomenon known as the gig economy has taken on more importance as it pertains to the U.S. labor force and outsourcing. More people are working as freelancers on a per-project basis, either because they can’t get hired as full-time employees or because they prefer to work as self-employed individuals. Global mergers raise important issues in organizational structure and culture. The ultimate challenge for management is to take two organizations and create a single, successful, cohesive organization. ### Preparing for Tomorrow’s Workplace Skills 1. When people talk of climbing the corporate ladder, they are referring to moving vertically upward through the organizational structure. Many employees plot career paths that will take them to increasingly higher levels of management. Do you think you would be more interested in climbing higher in an organization, or being a middle-management bridge between the employees who do the work and the executives who set the strategy? Explain the reasons for your choice. (Resources, Interpersonal) 2. Teams are an increasingly popular method of organizing corporations, but not all people are suited for teamwork. As a manager, what do you do with employees who are talented but unapproachable? Can you think of a way to involve people who are uncomfortable in team settings so that your teams have the perspective of these employees as well? (Interpersonal) 3. Think about how gossip and rumors travel through a grapevine. Draw as many grapevines as you can think of that reflect the different ways rumors move through an organization. Can you think of information that a manager would want to disseminate through the grapevine? Is there information that is inappropriate to disseminate through informal channels? Provide examples. (Information) 4. Do you think companies that outsource will inevitably become virtual corporations? Why or why not? (Resources, Systems) 5. It used to be that only high-level executives and CEOs were able to work out of the office. Mobile computing, however, is trickling down the organizational chart. In your opinion, is there a point in the organizational structure at which working remotely (at home, on the road) should stop? Should all employees in the hierarchy be allowed to work in a virtual environment, or should there be limits? Explain your reasoning. (Technology, Systems) 6. Team Activity Have you ever worked on a team with an underperforming member, such as a slacker, a complainer, or a critic? Assemble a team of three to five students and brainstorm a list of “bad” team members you have experience working with. Once you have a list of types, discuss how that person affected the work of the team and the outcome the team produced. Brainstorm ways to better manage and mitigate the negative effects of “bad” team members. Share your results with the class. (Interpersonal, Systems) ### Ethics Activity ### Training IT Replacements Recently the University of California at San Francisco (UCSF) announced it would lay off more than 80 IT workers and outsource their jobs to India. This change is part of a larger plan by UCSF to increase its technology outsourcing, which over time could save the organization more than $30 million. A large part of UCSF’s IT work focuses on its hospital services, and many other health care facilities have already outsourced these types of “back-end” jobs to foreign countries. Working through a multinational contractor that will manage the outsourcing process, UCSF has also asked workers who will soon be out of a job to train their overseas replacements via videoconferencing calls to India. One such worker remarked, “I’m speechless. How can they do this to us?” A UCSF spokesperson explained that the organization provides millions of dollars in charity care for the poor, and that to continue providing those services, the school has to focus on more specialized tech work related to patients and medical research and send other IT work overseas. UCSF is not alone in sending IT jobs overseas and making the laid-off workers train their Indian replacements. Recently ManpowerGroup, a staffing and workforce services firm with more than 3,000 offices worldwide, issued pink slips to 150 workers in Milwaukee whose jobs were outsourced to India. Using a web search tool, locate articles about this topic and then write responses to the following questions. Be sure to support your arguments and cite your sources. Ethical Dilemma: Are UCSF and other companies justified in outsourcing technology jobs to India? Do they have any obligation to find other jobs or provide training for displaced workers? Should organizations ask employees who are being laid off to train their replacements? Sources: Sam Harnett, “Outsourced: In a Twist, Some San Francisco IT Jobs Are Moving to India,” All Tech Considered, http://www.npr.org, accessed July 19, 2017; Dan Shafer, “Exclusive: ManpowerGroup HQ Workers Being Laid Off Required to Train Overseas Replacements,” Milwaukee Business Journal, https://www.bizjournals.com, March 30, 2017; Bill Whitaker, “Are U.S. Jobs Vulnerable to Workers with H-1B Visas?” 60 Minutes, http://www.cbsnews.com, March 19, 2017; Louis Hansen, “After Pink Slips, USCF Tech Workers Train Their Foreign Replacements,” The Mercury News, http://www.mercurynews.com, November 3, 2016. ### Working the Net 1. Using a search engine, look for the term “company organizational charts,” and find at least three examples of organizational charts for corporations, not-for-profits, or government agencies. Analyze each entity’s organizational structure. Is it organized by function, product/service, process, customer type, or geographic location? 2. Search the archives at the Bloomberg Businessweek (https://www.bloomberg.com), Fortune (http://fortune.com), or Forbes (http://www.forbes.com) website for stories about companies that have reorganized. Pick two examples, and prepare a summary of their reorganization efforts, including the underlying reasons the company chose to reorganize, the key elements of the reorganization plan, and if possible, how successful it has been. 3. Visit the Inc. magazine website, http://www.inc.com, and use the search engine to find articles about virtual corporations. Using a search engine, find the website of at least one virtual corporation, and look for information about how the company uses span of control, informal organization, and other concepts from this module. 4. FlexJobs (http://www.flexjobs.com) is an online company devoted to matching job hunters with flexible job experiences, whether they are telecommuting jobs, contract work, or part-time gigs. Read more on how the company started and the void its services have filled over the past decade for people looking for a flexible job situation. Share your findings with classmates, and lead a discussion on the pros and cons of the flexible job movement. 5. Managing change in an organization is no easy task, as you’ve discovered in your new job with a consulting firm that specializes in change management. To get up to speed, go to Bpubs.com, the Business Publications Search Engine (http://www.bpubs.com), and navigate to the Change Management section of the Management Science category. Select three articles that discuss how companies approached the change process, and summarize their experiences. 6. After managing your first project team, you think you might enjoy a career in project management. The Project Management Institute is a professional organization for project managers. Its website, http://www.pmi.org, has many resources about this field. Start at the Professional Practices section to learn what project management is, then go to the professional Development and Careers pages. What are the requirements to earn the Project Management Professional designation? Explore other free areas of the site to learn more about the job of project manager. Prepare a brief report on the career and its opportunities. Does what you’ve learned make you want to follow this career path? 7. Many companies are outsourcing portions of their IT departments. Should they, and why? Develop a position on this issue by researching outsourcing trends on Information Week, (http://www.informationweek.com), or an IT website of your choosing. Then divide the class into two groups, those that support outsourcing and those that oppose it, and have a debate on this subject. ### Creative Thinking Case ### Gore’s Flat Structure Works Well Imagine an organization with more than 10,000 employees working in 30 countries around the world—with no hierarchy structure. W. L. Gore & Associates, headquartered in Newark, Delaware, is a model of unusual business practices. Wilbert Gore, who left Dupont to explore new uses for Teflon, started the company in 1958. Best known for its breathable, weatherproof Gore-Tex fabric, Glide dental floss, and Elixir guitar strings, the company has no bosses, no titles, no departments, and no formal job descriptions. There is no managerial hierarchy at Gore, and top management treats employees, called associates, as peers. In 2005, the company named 22-year associate Terri Kelly as its new chief executive officer. Unlike large public corporations, Gore’s announcement was made without much fanfare. Today, more than 12 years later, Kelly continues as chief executive but is the first to admit that it’s not about the CEO at Gore—it’s about the people who work there and their relationships with one another. The company focuses on its products and company values rather than on individuals. Committees, comprised of employees, make major decisions such as hiring, firing, and compensation. They even set top executives’ compensation. Employees work on teams, which are switched around every few years. In fact, all employees are expected to make minor decisions instead of relying on the “boss” to make them. “We’re committed to how we get things done,” Kelly says. “That puts a tremendous burden on leaders because it’s easier to say ‘Just do it’ than to explain the rationale. But in the long run, you’ll get much better results because people are making a commitment.” Because no formal lines of authority exist, employees can speak to anyone in the company at any time. This arrangement also forces employees to spend considerable time developing relationships. As one employee described it, instead of trying to please just one “boss,” you have to please everyone. Several years ago the company underwent a “strategy refresh,” conducting surveys and discussions with employees about how they fit into the organization’s culture. Not surprisingly, there was a cultural divide based on multiple generations of workers and length of service stature, which Kelly and her associates have worked hard to overcome. She realizes that not everyone will become a “lifer” at Gore, but recognizes the importance of younger employees who have helped the company become more tech-savvy in communications and stay well-connected in a fast-moving business world. The informal organizational structure continues to work well. With revenues of $3 billion, the company produces thousands of advanced technology products for the electronics, industrial, fabrics, and medical markets. Its corporate structure fosters innovation and has been a significant contributor to associate satisfaction. Employee turnover is a low 3 percent a year, and the company can choose new associates from the thousands of job applications it receives annually. In 2017, Gore was named one of the 12 legends on Fortune’s “100 Best Companies to Work For.” These companies have made Fortune’s list for all 20 years the magazine has published its annual “Best” rankings. 2. Given the lack of formal structure, how important do you think Gore’s informal structure becomes? 3. Is W. L. Gore a mechanistic or an organic organization? Support your answer with examples from the case. 4. How do you think Gore’s flat organizational structure affects innovation at the company? Sources: “Our Story,” https://www.gore.com, accessed July 18, 2017; Jeremy Hobson, “What It’s Like to Lead a Non-Hierarchical Workplace,” http://www.wbur.org, accessed July 18, 2017; Alan Deutschman, “The Un-CEO,” Fast Company, https://www.fastcompany.com, accessed July 18, 2017; Claire Zillman, “Secrets from Best Companies All Stars,” Fortune, http://fortune.com, March 9, 2017; Daniel Roberts, “At W.L. Gore, 57 Years of Authentic Culture,” Fortune, http://fortune.com, March 5, 2015. ### Hot Links Address Book 1. Like corporations, government agencies have organization charts, too. Learn how the Department of Health and Human Services is structured at http://www.hhs.gov/about/orgchart.html. 2. Find team-building resources galore, from team-building activities and training exercises to guidance in solving team problems, at Team Builders Plus website, http://teambuildersplus.com. 3. To read articles on current best practices in outsourcing for both buyers and providers and find other outsourcing resources, visit http://outsourcing.com. 4. What benefits can a company gain by using web-based organizational charting software? Check out the features Organimi offers companies at http://www.organimi.com. 5. How can your organization develop better group skills? A good place to start is Management Help’s Group Skills page. Go to http://managementhelp.org and click on Group/Team Skills for links to resources on many topics, including self-directed and self-managed work teams and virtual teams.

# Managing Human Resources and Labor Relations ## Introduction ### Learning Outcomes After reading this chapter, you should be able to answer these questions: 1. What is the human resource management process, and how are human resource needs determined? 2. How do firms recruit applicants? 3. How do firms select qualified applicants? 4. What types of training and development do organizations offer their employees? 5. How are performance appraisals used to evaluate employee performance? 6. What are the types of compensation and methods for paying workers? 7. What is a labor union and how is it organized, what is collective bargaining, and what are some of the key negotiation issues? 8. How are grievances between management and labor resolved, and what tactics are used to force a contract settlement? 9. What are the key laws and federal agencies affecting human resource management and labor relations? 10. What trends and issues are affecting human resource management and labor relations? This chapter looks at the role of human resources within an organization, from the general processes of developing and planning to the more specific tasks of employee evaluation and compensation. Human resource management and labor relations involve acquisition, development, use, and maintenance of a human resource mix (people and positions) to achieve strategic organizational goals and objectives. Successful human resource management is based on a company’s ability to attract and hire the best employees, equip them with the knowledge and skills they need to excel, compensate them fairly, and motivate them to reach their full potential and perform at high levels. Today’s business environment presents numerous challenges to effectively managing employees: 1. Technology continues to advance, which places great importance on knowledge workers, especially when demand outstrips the supply of high-talent individuals. 2. Global business operations involve rapid data transfer and necessitate accelerated decision-making by executive and technical employees. 3. The workforce is increasingly more diversified and multicultural, which places increased emphasis on communication and cultural understanding. 4. Work, life, and family priorities are more difficult to balance as dual-worker families populate the labor force. 5. Employment and labor laws continue to greatly influence employee recruitment and hiring, compensation decisions, and employee retention and turnover in both union and nonunion organizations. Each day, human resource experts and front-line supervisors deal with these challenges while sharing responsibility for attracting and retaining skilled, motivated employees. Whether faced with a large or small human resources problem, supervisors need some understanding of difficult employee-relations issues, especially if there are legal implications. In this chapter, you will learn about the elements of the human resource management process, including human resource planning and job analysis and design, employee recruitment and selection, training and development of employees, performance planning and evaluation, and compensation of the workforce. The chapter also describes labor unions and their representation of millions of American workers in construction, manufacturing, transportation, and service-based industries.

# Managing Human Resources and Labor Relations ## Achieving High Performance through Human Resources Management 1. What is the human resource management process, and how are human resource needs determined? Human resource (HR) management is the process of hiring, developing, motivating, and evaluating employees to achieve organizational goals. The goals and strategies of the firm’s business model form the basis for making human resource management decisions. HR practices and systems comprise the firm’s human resource decision support system that is intended to make employees a key element for gaining competitive advantage. To this end, the HR management process contains the following sequenced activities: 1. Job analysis and design 2. Human resource planning and forecasting 3. Employee recruitment 4. Employee selection 5. Training and development 6. Performance planning and evaluation 7. Compensation and benefits The human resource management process shown in encourages the development of high-performance employees. The process is sequential because employees can’t be trained and paid until selected and placed in jobs, which follows recruitment, which is preceded by human resource planning and job analysis and design. Good HR practices used along this sequence foster performance improvement, knowledge and skill development, and loyal employees who desire to remain with the organization. ### HR Planning and Job Analysis and Design Two important, and somewhat parallel, aspects of the human resource management process are determining employee needs of the firm and the jobs to be filled. When Alcon Labs gained approval from the Food and Drug Administration for sales of a new contact lens disinfectant solution in its Opti-Free product line, it had to determine if additional sales representatives were needed and whether new sales positions with different knowledge and skill requirements should be established. Human resource planning at Alcon means having the right number of people, with the right training, in the right jobs, to meet its sales goals for the new product. Once the need for sales representatives is determined, human resource specialists assess the skills of the firm’s existing employees to see whether new people must be hired or current people can be trained. See for a representation of the human resource management process. Human resource planners must know what skills different jobs require. Information about a specific job typically begins with a job analysis, which is a study of the tasks required to do a job well. This information is used to specify the essential skills, knowledge, and abilities required for the job. When Hubert Joly started as the CEO at Best Buy, the retailer was facing serious financial pressures. The threat of online competition from Amazon was real. Joly was also facing a staffing issue with a lot of turnover. He and his team instituted a plan to keep and promote staff as a core competency that would differentiate Best Buy from online retailers. Also, a key HR responsibility is that jobs are examined to make any changes in job duty and task responsibilities. The tasks and responsibilities of a job are listed in a job description. The skills, knowledge, and abilities a person must have to fill a job are spelled out in a job specification. These two documents help human resource planners find the right people for specific jobs. A sample job description and specification is shown in . ### HR Planning and Forecasting Forecasting an organization’s human resource needs, known as an HR demand forecast, is an essential aspect of HR planning. This process involves two forecasts: (1) determining the number of people needed by some future time (in one year, for example) and (2) estimating the number of people currently employed by the organization who will be available to fill various jobs at some future time; this is an internal supply forecast. The Advancement Planning process at Best Buy involved reducing the turnover that occurs in most retail environments. The company has achieved a second-place ranking, behind only Costco, and its general managers’ tenure at a store averages five years. The performance of managers at Best Buy is reviewed to identify people who can fill vacancies and be promoted, a process known as succession planning. If Best Buy has a temporary shortage of sales professionals, at the holiday shopping season, for example, they can hire an experienced contractor or interim executive as a temporary or contingent worker, someone who wants to work but not on a permanent, continuous basis. summarizes the process of planning and forecasting an organization’s personnel needs. ### Summary of Learning Outcomes 1. What is the human resource management process, and how are human resource needs determined? The human resource management process consists of a sequence of activities that begins with the job analysis and HR planning; progresses to employee recruitment and selection; then focuses on employee training, performance appraisal, and compensation; and ends when the employee leaves the organization. Creating a strategy for meeting human resource needs is called human resource planning, which begins with the job analysis. Job analysis is a process of studying a job to determine its tasks and duties for setting pay, determining employee job performance, specifying hiring requirements, and designing training programs. Information from the job analysis is used to prepare a job description, which lists the tasks and responsibilities of the job. A job specification describes the skills, knowledge, and abilities a person needs to fill the job described in the job description. By examining the human resource demand forecast and the internal supply forecast, human resource professionals can determine if the company faces a personnel surplus or shortage.

# Managing Human Resources and Labor Relations ## Employee Recruitment 1. How do firms recruit applicants? When a firm creates a new position or an existing one becomes vacant, the firm starts looking for people with qualifications that meet the requirements of the job. Two sources of job applicants are the internal and external labor markets. The internal labor market consists of employees currently employed by the firm; the external labor market is the pool of potential applicants outside the firm. ### Internal Labor Market Internal recruitment can be greatly facilitated by using a human resource information system that contains an employee database with information about each employee’s previous work experience, skills, education and certifications, job and career preferences, performance, and attendance. Promotions and job transfers are the most common results of internal recruiting. BNSF Railway, Walmart, Boeing, Ritz-Carlton Hotels, and most other firms, large and small, promote from within and manage the upward mobility of their employees. ### External Labor Market The external labor market consists of prospects to fill positions that cannot be filled from within the organization. Recruitment is the process of attracting qualified people to form an applicant pool. Numerous methods are used to attract applicants, including print, radio, web, and television advertising. Hospitality and entertainment firms, such as Ritz-Carlton Hotels and Six Flags, frequently use job fairs to attract applicants. A job fair, or corporate open house, is usually a one- or two-day event at which applicants are briefed about job opportunities, given tours, and encouraged to apply for jobs. For firms needing accountants, engineers, sales managers, and others for professional and scientific positions, college recruiting is very common. These firms (Deloitte, Cisco Systems, Salesforce.com, and thousands of others) schedule job fairs and on-campus interviews with graduating seniors. ### Online Recruiting and Job Search The internet, social media, and specialized software have completely changed the employee recruitment process. Dozens of companies such as Monster.com, Indeed, StartWire, and Glassdoor enable applicants to search for job openings, post their résumés, and apply for jobs that companies have posted. Most companies provide links to their company website and to the career page on their site so applicants can learn about the company culture, listen to or read testimonials from employees about what it is like to work for the company, and search for additional openings that may interest them. Large firms may receive thousands of online applications per month. To review and evaluate thousands of online résumés and job applications, firms depend on software to scan and track applicant materials using key words to match skills or other requirements for a particular job. Social media has also changed how companies search for applicants and verify applicant information. ### Recruitment Branding Recruitment branding involves presenting an accurate and positive image of the firm to those being recruited. Carbone Smolan Agency (CSA) is a New York–based image consulting firm that assists in developing a recruitment branding strategy. The materials developed by CSA comprise a realistic job preview, which informs job candidates about organizational realities of the job and the firm so they can more accurately evaluate jobs and firm expectations concerning work assignments, performance standards, promotional opportunities, company culture, and many other characteristics of the job. ### Summary of Learning Outcomes 1. How do firms recruit applicants? When a job vacancy occurs, most firms begin by trying to fill the job from within the ranks of their own employees, known as the internal labor market. If a suitable internal candidate is not available, the firm turns to the external labor market. Firms use local media to recruit nontechnical, unskilled, and nonsupervisory workers. To locate highly trained recruits, employers use college recruiters, executive search firms, job fairs, and company websites to promote job openings. During the job search process, firms present an accurate and positive image of the company to those being recruited, called recruitment branding.

# Managing Human Resources and Labor Relations ## Employee Selection 1. How do firms select qualified applicants? After a firm has attracted enough job applicants, employment specialists begin the selection process. Selection is the process of determining which people in the applicant pool possess the qualifications necessary to be successful on the job. The steps in the employee selection process are shown in . An applicant who can jump over each step, or hurdle, will very likely receive a job offer; thus, this is known as the successive hurdles approach to applicant screening. Alternatively, an applicant can be rejected at any step or hurdle. Selection steps or hurdles are described below: 1. 2. HR Senior Vice President Martha LaCroix of the 3. 4. 5. 6. An important aspect of employee recruitment and selection involves treating job applicants as valued customers; in fact, some applicants may be customers of the firm. ### Summary of Learning Outcomes 1. How do firms select qualified applicants? The selection process helps identify the candidates in the applicant pool who possess the best qualifications for the open position. Typically, an applicant submits an application or résumé and then receives a short, structured interview. If an applicant makes it past the initial screening, he or she may be asked to take an aptitude, personality, or skills test. The next step is the selection interview, which is an in-depth discussion of the applicant’s work experience, skills and abilities, education, and career interests. If the applicant passes the selection interview, most firms conduct background checks and talk with their references. Physical exams and drug testing may also be part of the selection process.

# Managing Human Resources and Labor Relations ## Employee Training and Development 1. What types of training and development do organizations offer their employees? To ensure that both new and experienced employees have the knowledge and skills to perform their jobs successfully, organizations invest in training and development activities. Training and development involves learning situations in which the employee acquires additional knowledge or skills to increase job performance. Training objectives specify performance improvements, reductions in errors, job knowledge to be gained, and/or other positive organizational results. The process of creating and implementing training and development activities is shown in . Training is done either on the job or off the job. ### On-the-Job Training New-employee training is essential and usually begins with orientation, which entails getting the new employee ready to perform on the job. Formal orientation (often a half-day classroom program) provides information about the company history, company values and expectations, policies, and the customers the company serves, as well as an overview of products and services. More important, however, is the specific job orientation by the new employee’s supervisor concerning work rules, equipment, and performance expectations. This second briefing tends to be more informal and may last for several days or even weeks. Beyond employee orientation, job training takes place at the job site or workstation and is directly related to the job. This training involves specific job instruction, coaching (guidance given to new employees by experienced ones), special project assignments, or job rotation. Job rotation is the reassignment of workers to several different jobs over time. At Walmart, management trainees rotate through three or more merchandizing departments, customer service, credit, and even the human resource department during the first year or two on the job. Two other forms of on-the-job training are apprenticeship and mentoring. An apprenticeship usually combines specific on-the-job instruction with classroom training. It may last as long as four years and can be found in the skilled trades of carpentry, plumbing, and electrical work. Mentoring involves a senior manager or other experienced employee providing job- and career-related information to a mentee. Inexpensive and providing instantaneous feedback, mentoring is becoming increasingly popular with many firms, including FedEx, Merrill Lynch, Dow Chemical, and Bank of America. Whereas mentoring is typically conducted through ongoing face-to-face interactions between mentor and mentee, technology now allows for a long-distance mentoring relationship. Dow Chemical uses e-mail and video conferencing to facilitate long-distance mentoring between persons who are working in different countries. For a mentee whose second language is English, writing e-mail messages in English helps the individual become fluent in English, which is a requirement of all Dow Chemical employees regardless of location and country of origin. ### Off-the-Job Training Even with the advantages of on-the-job training, many firms recognize that it is often necessary to train employees away from the workplace. With off-the-job training, employees learn the job away from the job. There are numerous popular methods of off-the-job training. It frequently takes place in a classroom, where cases, role-play exercises, films, videos, lectures, and computer demonstrations are used to develop workplace skills. Web-based technology is increasingly being used along with more traditional off-the-job training methods. E-learning and e-training involve online computer presentation of information for learning new job tasks. Union Pacific Railroad has tens of thousands of its employees widely dispersed across much of the United States, so it delivers training materials online to save time and travel costs. Technical and safety training at Union Pacific are made available as programmed instruction, an online, self-paced, and highly structured training method that presents trainees with concepts and problems using a modular format. Software provided can make sure that employees receive, undergo, and complete, as well as sign off on, various training modules. Web-based training can also be done using a simulation, for example, a scaled-down version of a manufacturing process or even a mock cockpit of a jet airplane. American Airlines uses a training simulator for pilots to practice hazardous flight maneuvers or learn the controls of a new aircraft in a safe, controlled environment with no passengers. The simulator allows for more direct transfer of learning to the job. ### Summary of Learning Outcomes 1. What types of training and development do organizations offer their employees? Training and development programs are designed to increase employees’ knowledge, skills, and abilities in order to foster job performance improvements. Formal training (usually classroom in nature and off-the-job) takes place shortly after being hired. Development programs prepare employees to assume positions of increasing authority and responsibility. Job rotation, executive education programs, mentoring, and special-project assignments are examples of employee development programs.

# Managing Human Resources and Labor Relations ## Performance Planning and Evaluation 1. How are performance appraisals used to evaluate employee performance? Along with employee orientation and training, new employees learn about performance expectations through performance planning and evaluation. Managers provide employees with expectations about the job. These are communicated as job objectives, schedules, deadlines, and product and/or service quality requirements. As an employee performs job tasks, the supervisor periodically evaluates the employee’s efforts. A performance appraisal is a comparison of actual performance with expected performance to determine an employee’s contributions to the organization and to make decisions about training, compensation, promotion, and other job changes. The performance planning and appraisal process is shown in and described below. 1. The manager establishes performance standards. 2. The employee works to meet the standards and expectations. 3. The employee’s supervisor evaluates the employee’s work in terms of quality and quantity of output and various characteristics such as job knowledge, initiative, relationships with others, and attendance and punctuality. 4. Following the performance evaluation, reward (pay raise) and job change (promotion) decisions can be made. If work is unsatisfactory, the employee may be put on a performance improvement plan, which outlines the behaviors or performance that must be improved, the milestones and time periods to improve performance, and what will occur if performance is not improved. 5. Rewards are positive feedback and provide reinforcement, or encouragement, for the employee to continue improving their performance. It was once common practice for performance appraisals to be conducted on an annual basis, but most companies have moved away from that standard. Instead, managers are encouraged to provide employees with continuous real-time feedback so that skill development and job performance can be improved more rapidly. Information for performance appraisals can be assembled using rating scales, supervisor logs of employee job incidents, and reports of sales and production statistics. Regardless of the source, performance information should be accurate and a record of the employee’s job behavior and efforts. illustrates a rating scale for one aspect of a college recruiter’s job. A rating of “9” is considered outstanding job behavior and performance; a rating of “1” is viewed as very poor to unacceptable. ### Summary of Learning Outcomes 1. How are performance appraisals used to evaluate employee performance? A performance appraisal compares an employee’s actual performance with the expected performance. Performance appraisals serve several purposes, but are typically used to determine an employee’s compensation, training needs, and advancement opportunities.

# Managing Human Resources and Labor Relations ## Employee Compensation and Benefits 1. What are the types of compensation and methods for paying workers? Compensation, which includes both pay and benefits, is closely connected to performance appraisals. Employees who perform better tend to get bigger pay raises. Several factors affect an employee’s pay: 1. Pay structure and internal influences. Wages, salaries, and benefits are based on skills, experience, and the level of the job. The most important high-level positions, such as president, chief information officer, and chief financial officer, are compensated at the highest rates. Likewise, different jobs of equal importance to the firm are compensated at similar rates. As the level of management responsibility increases, so does pay. For instance, if a drill-press operator and a lathe operator are considered of equal importance, they may both be paid $21 per hour. 2. Pay level and external influences. In deciding how much to pay workers, the firm must also be concerned with the salaries paid by competitors. If competitors are paying higher wages, a firm may lose its best employees. HR professionals regularly evaluate salaries by geography, job position, and competitor and market wages. Wage and salary surveys conducted by the U.S. Chamber of Commerce and the U.S. Department of Labor can also be useful. There are also several websites such as Glassdoor that post salaries for jobs by company. An employer can decide to pay at, above, or below the going rate. Most firms try to offer competitive wages and salaries within a geographic area or an industry. If a company pays below-market wages, it may not be able to hire skilled people. The level of a firm’s compensation is determined by the firm’s financial condition (or profitability), efficiency, and employee productivity, as well as the going rates paid by competitors. For example, MillerCoors Brewing Co. is considered a high-paying firm ($29–$33 per hour for production employees). ### Types of Compensation or Pay There are two basic types of compensation: direct and indirect. Direct pay is the wage or salary received by the employee; indirect pay consists of various employee benefits and services. Employees are usually paid directly on the basis of the amount of time they work, the amount they produce, the type of work performed, or some combination of skill, time, and output. An hourly rate of pay or a monthly salary is considered base pay, or an amount of pay received by the employee regardless of output level. In many jobs, such as sales and manufacturing, an employee can earn additional pay as a result of a commission or an incentive pay arrangement. The accelerated commission schedule for a salesperson shown below indicates that as sales increase the incentive becomes increasingly more attractive and rewarding; therefore, pay can function as a powerful motivator. In this example, a salesperson receives a base monthly salary of $1,000, then earns 3 percent on the first $50,000 of product sold, 4 percent on the next $30,000, and 5 percent on any sales beyond $80,000. Two other incentive pay arrangements are bonuses and profit-sharing. Employees may be paid bonuses for reaching certain monthly or annual performance goals or achieving a specific cost-saving objective. In this instance, employees are rewarded based on achieving certain goals. In a profit-sharing plan, employees may receive some portion of the firm’s profit. Employee profit shares are usually based on annual company financial performance and therefore are paid once a year. With either a bonus or a profit share, an important incentive pay consideration is whether the bonus or profit share is the same for all employees or whether it is differentiated by level in the organization, base pay, or some other criterion. Choice Homes, a large-scale builder of starter homes, pays an annual incentive share that is the same for everyone; the president receives the same profit share or bonus as the lowest-paid employee. Indirect pay includes pensions, health insurance, vacation time, and many others. Some forms of indirect pay are required by law: unemployment compensation, worker’s compensation, and Social Security, which are all paid in part by employers. Unemployment compensation provides former employees with money for a certain period while they are unemployed. To be eligible, the employee must have worked a minimum number of weeks, be without a job, and be willing to accept a suitable position offered by the state Unemployment Compensation Commission. Some state laws permit payments to strikers. Worker’s compensation pays employees for lost work time caused by work-related injuries and may also cover rehabilitation after a serious injury. Social Security is mainly a government pension plan, but it also provides disability and survivor benefits and benefits for people undergoing kidney dialysis and transplants. Medicare (health care for seniors) and Medicaid (health care for the poor) are also part of Social Security. Many employers also offer benefits not required by law. Among these are paid time off (vacations, holidays, sick days, even pay for jury duty), health insurance (including dental and vision), supplemental benefits (disability, life, pet insurance, legal benefits), 401K contributions, pensions and retirement savings accounts, and stock purchase options. Some firms with numerous benefits allow employees to mix and match benefit items or select items based on individual needs. A younger employee with a family may desire to purchase medical, disability, and life insurance, whereas an older employee may want to put more benefit dollars into a retirement savings plan. Pay and benefits are obviously important elements of human resource management and are frequently studied as aspects of employee job satisfaction. Pay can be perceived as very satisfactory, or it can be a point of job dissatisfaction. In a study of job satisfaction conducted by SAP, direct compensation was the most important element of job satisfaction by employees from various companies. As the cost of health insurance and other benefits has risen sharply over the past few years, benefits have become increasingly important to workers. ### Summary of Learning Outcomes 1. What are the types of compensation and methods for paying workers? Direct pay is the hourly wage or monthly salary paid to an employee. In addition to the base wage or salary, direct pay may include bonuses and profit shares. Indirect pay consists of various benefits and services. Some benefits are required by law and include unemployment compensation, worker’s compensation, and Social Security. Many employers also offer benefits not required by law. These include paid vacations and holidays, pensions, health and other insurance, employee wellness programs, and college tuition reimbursement.

# Managing Human Resources and Labor Relations ## The Labor Relations Process 1. What is a labor union and how is it organized, what is collective bargaining, and what are some of the key negotiation issues? Tens of thousands of American firms are unionized, and millions of U.S. workers belong to unions. Historically, the mining, manufacturing, construction, and transportation industries have been significantly unionized, but in recent years, service-based firms, including health care organizations, have been unionized. A labor union, such as the International Brotherhood of Teamsters, is an organization that represents workers in dealing with management over disputes involving wages, hours, and working conditions. The labor relations process that produces a union-management relationship consists of three phases: union organizing, negotiating a labor agreement, and administering the agreement. In phase one, a group of employees within a firm may form a union on their own, or an established union (United Auto Workers, for example) may target an employer and organize many of the firm’s workers into a local labor union. The second phase constitutes collective bargaining, which is the process of negotiating a labor agreement that provides for compensation and working arrangements mutually acceptable to the union and to management. Finally, the third phase of the labor relations process involves the daily administering of the labor agreement. This is done primarily through handling worker grievances and other workforce management problems that require interaction between managers and labor union officials. ### The Modern Labor Movement The basic structure of the modern labor movement consists of three parts: local unions, national and international unions, and union federations. There are approximately 60,000 local unions, 75 national and international unions, and two federations. Union membership has been declining over the past three decades and is now half what it once was. The number of employed union members has declined by 2.9 million since 1983, the first year union statistics were reported. In 1983, union membership was 20.1 percent of workers, with 17.7 million union workers. In 2017, membership declined to 10.7 percent of workers, with 14.8 million members. A local union is a branch or unit of a national union that represents workers at a specific plant or over a specific geographic area. Local 276 of the United Auto Workers represents assembly employees at the General Motors plant in Arlington, Texas. A local union (in conformance with its national union rules) determines the number of local union officers, procedures for electing officers, the schedule of local meetings, financial arrangements with the national organization, and the local’s role in negotiating labor agreements. The three main functions of the local union are collective bargaining, worker relations and membership services, and community and political activities. Collective bargaining takes place every three or four years. Local union officers and shop stewards in the plant oversee labor relations on a day-to-day basis. A shop steward is an elected union official who represents union members to management when workers have complaints. For most union members, his or her primary contact with the union is through union officials at the local level. A national union can range in size from a few thousand members (Screen Actors Guild) to more than a million members (Teamsters). A national union may have a few to as many as several hundred local unions. The number of national unions has steadily declined since the early twentieth century. Much of this decline has resulted from union mergers. In 1999, for example, the United Papermakers International Union (UPICU) and the Oil, Chemical and Atomic Workers Union (OCAW) agreed to merge under the new name of PACE, or Paper, Allied-Industrial, Chemical and Energy International Union. PACE has about 245,000 members. For 50 years, one union federation (the American Federation of Labor-Congress of Industrial Organization, or AFL-CIO) dominated the American labor movement. A federation is a collection of unions banded together to further organizing, public relations, political, and other mutually-agreed-upon purposes of the member unions. In the summer of 2005, several unions (Teamsters, Service Employees International Union, Laborers’ International Union, United Farm Workers, Carpenters and Joiners, Unite Here, and the United Food and Commercial Workers Union) split from the AFL-CIO and formed a new federation named the Change to Win Coalition. The new federation and its member unions represent more than 5.5 million union members. Change to Win Coalition member unions left the AFL-CIO over leadership disagreements and ineffective organizing strategies of the AFL-CIO; one of its primary goals is to strengthen union-organizing drives and reverse the decline in union membership. ### Union Organizing A nonunion employer becomes unionized through an organizing campaign. The campaign is started either from within, by unhappy employees, or from outside, by a union that has picked the employer for an organizing drive. Once workers and the union have made contact, a union organizer tries to convince all the workers to sign authorization cards. These cards prove the worker’s interest in having the union represent them. In most cases, employers resist this card-signing campaign by speaking out against unions in letters, posters, and employee assemblies. However, it is illegal for employers to interfere directly with the card-signing campaign or to coerce employees into not joining the union. Once the union gets signed authorization cards from at least 30 percent of the employees, it can ask National Labor Relations Board (NLRB) for a union certification election. This election, by secret ballot, determines whether the workers want to be represented by the union. The NLRB posts an election notice and defines the bargaining unit—employees who are eligible to vote and who will be represented by the particular union if it is certified. Supervisors and managers cannot vote. The union and the employer then engage in a pre-election campaign conducted through speeches, memos, and meetings. Both try to convince workers to vote in their favor. lists benefits usually emphasized by the union during a campaign and common arguments employers make to convince employees a union is unnecessary. The election itself is conducted by the NLRB. If a majority vote for the union, the NLRB certifies the union as the exclusive bargaining agent for all employees who had been designated as eligible voters. The employer then has to bargain with the union over wages, hours, and other terms of employment. The complete organizing process is summarized in . In some situations, after one year, if the union and employer don’t reach an agreement, the workers petition for a decertification election, which is similar to the certification election but allows workers to vote out the union. Decertification elections are also held when workers become dissatisfied with a union that has represented them for a longer time. In recent years, the number of decertification elections has increased to several hundred per year. ### Negotiating Union Contracts through Collective Bargaining A labor agreement, or union contract, is created through collective bargaining. Typically, both management and union negotiation teams are made up of a few people. One person on each side is the chief spokesperson. Bargaining begins with union and management negotiators setting a list of contract issues that will be discussed. Much of the bargaining over specific details takes place through face-to-face meetings and the exchange of written proposals. Demands, proposals, and counterproposals are exchanged during several rounds of bargaining. The resulting contract must be approved by top management and ratified by the union members. Once both sides approve, the contract is a legally binding agreement that typically covers such issues as union security, management rights, wages, benefits, and job security. The collective bargaining process is shown in . We will now explore some of the bargaining issues. ### Union Security A union wants all employees to be union members. This can be accomplished by negotiating a union security clause. The most common union security arrangement is the union shop, whereby nonunion workers can be hired by the firm, but then they must join the union, normally within 30 to 60 days. An agency shop does not require employees to join the union, but to remain employees, workers must pay the union a fee (known as the agency fee) to cover the union’s expenses in representing them. The union must fairly represent all workers, including those in the bargaining unit who do not become members. Under the Taft-Hartley Act of 1947, a state can make any and all forms of union security illegal by enacting a right-to-work law. In the 28 states that have these laws, employees can work at a unionized company without having to join the union. This arrangement is commonly known as an open shop. Workers don’t have to join the union or pay dues or fees to the union. ### Management Rights When a company becomes unionized, management loses some of its decision-making abilities. But management still has certain rights that can be negotiated in collective bargaining. One way to resist union involvement in management matters is to put a management rights clause in the labor agreement. Most union contracts have one. A typical clause gives the employer all rights to manage the business except as specified in the contract. For instance, if the contract does not specify the criteria for promotions, with a management rights clause, managers will have the right to use any criteria they wish. Another way to preserve management rights is to list areas that are not subject to collective bargaining. This list might secure management’s right to schedule work hours; hire and fire workers; set production standards; determine the number of supervisors in each department; and promote, demote, and transfer workers. ### Wage and Benefits Much bargaining effort focuses on wage adjustments and changes in benefits. Once agreed to, they remain in effect for the length of the contract. For example, in 2015, the United Auto Workers negotiated a four-year contract containing modest hourly wage increases with U.S. car manufacturers; pay hikes were about 3 percent for first and third years and 4 percent in year four. Hourly rates of pay can also increase under some agreements when the cost of living increases above a certain level each year, say 4 percent. No cost-of-living adjustment is made when annual living cost increases are under 4 percent, which has been the case for the early years of the twenty-first century. In addition to requests for wage increases, unions usually want better benefits. In some industries, such as steel and auto manufacturing, benefits are 40 percent of the total cost of compensation. Benefits may include higher wages for overtime work, holiday work, and less desirable shifts; insurance programs (life, health and hospitalization, dental care); payment for certain nonwork time (rest periods, vacations, holiday, sick time); pensions; and income-maintenance plans. Supplementary unemployment benefits (income-maintenance) found in the auto industry are provided by the employer and are in addition to state unemployment compensation given to laid-off workers. The unemployment compensation from the state and supplementary unemployment pay from the employer together maintain as much as 80 percent of an employee’s normal pay. ### Job Security and Seniority Wage adjustments, cost-of-living increases, supplementary unemployment pay, and certain other benefits give employees under union contracts some financial security. But most financial security is directly related to job security—the assurance, to some degree, that workers will keep their jobs. Of course, job security depends primarily on the continued success and financial well-being of the company. For example, thousands of airline employees lost their jobs after the 9/11 terrorist attack in 2001; these were employees with the least seniority. Seniority, the length of an employee’s continuous service with a firm, is discussed in about 90 percent of all labor contracts. Seniority is a factor in job security; usually, unions want the workers with the most seniority to have the most job security. ### Summary of Learning Outcomes 1. What is a labor union and how is it organized, what is collective bargaining, and what are some of the key negotiation issues? A labor union is an organization that represents workers in dealing with management over disputes involving wages, hours, and working conditions. A company is unionized through an organizing drive that begins either inside, with a small group of existing employees, or outside, with an established union that targets the employer. When the union gets signed authorization cards from 30 percent of the firm’s employees, the NLRB conducts a union certification election. A majority vote is needed to certify the union as the exclusive bargaining agent. The union and the employer then begin collective bargaining and have one year in which to reach an agreement. Collective bargaining is the process of negotiating, administering, and interpreting labor agreements. Both union and management negotiators prepare a bargaining proposal. The two sides meet and exchange demands and ideas. Bargaining consists of compromises and concessions that lead to a tentative agreement. Top management then approves or disapproves the agreement for the management team. Union members vote to either approve or reject the contract. The key issues included in a union contract are wage increases, fringe benefits, and job security.

# Managing Human Resources and Labor Relations ## Managing Grievances and Conflicts 1. How are grievances between management and labor resolved, and what tactics are used to force a contract settlement? In a unionized work environment, employees follow a step-by-step process for handling grievances or disputes between management and labor. Conflicts over contracts, however, are far more challenging to resolve and may result in the union or employer imposing economic pressure, as described in this section. ### Grievance Handling and Arbitration The union’s main way of policing the contract is the grievance procedure. A grievance is a formal complaint by an employee or the union that management has violated some part of the contract. Under a typical contract, the employee starts by presenting the grievance to the supervisor, either in person or in writing. The typical grievance procedure is illustrated in . An example grievance is a situation in which an employee is disciplined with a one-day suspension (and loss of pay) for being late for work several times in one month. If the problem isn’t solved, the grievance is put in writing. The employee, one or more union officials, the supervisor, and perhaps the plant manager then discuss the grievance. If the matter still can’t be resolved, another meeting takes place with higher-level representatives of both parties present. If top management and the local union president can’t resolve the grievance, it goes to arbitration. Arbitration is the process of settling a labor-management dispute by having a third party—a single arbitrator or a panel—make a decision. The decision is final and binding on the union and employer. The arbitrator reviews the grievance at a hearing and then makes the decision, which is presented in a document called the award. In the one-day suspension mentioned above, the arbitrator might rule that the discipline was improperly made because the employee’s attendance record for the month was not accurately maintained by the firm. ### Tactics for Pressuring a Contract Settlement Virtually all labor agreements specify peaceful resolution of conflicts, usually through arbitration. However, when a contract expires and a new agreement has not been reached, the union is free to strike or engage in other efforts to exert economic pressure on the employer. A strike occurs when employees refuse to work. The United Auto Workers union used a selective strike strategy, a strategy of conducting a strike at a critical plant that supplies parts to other plants, against General Motors. The union conducted its strike at a stamping and parts facility in Flint, Michigan, that supplied critical parts to other plants. The 54-day strike caused the company to stop production at many of its assembly plants because parts were not available from the Flint plant. General Motors lost approximately $2.2 billion during that dispute. Likewise, the employer can put pressure on the union through a lockout or by hiring strike replacements if the union has called a strike. For example, in 2018 aluminum producer Alcoa locked out more than 1,000 union workers from its smelter facility in Quebec, Canada, after union members went on strike. provides a summary of union and employer pressure strategies for forcing a contract settlement. ### Summary of Learning Outcomes 1. How are grievances between management and labor resolved, and what tactics are used to force a contract settlement? In most labor agreements, the grievance procedure consists of three or four steps. In the initial step, the employee files a grievance; this is an oral and/or written presentation to the supervisor and may involve a union steward as representative of the grievant. Steps two and three involve meetings of the employee, one or more union officials, the appropriate supervisor, and one or more management officials. If the grievance is not resolved at step three, either party (union or management) can request that an arbitrator, or neutral third party, hear and decide the grievance. The arbitrator reviews the grievance at a hearing and then makes the decision, which is presented in a document called the award. When a union contract expires and a new agreement has not been reached, the union may impose economic pressure on the firm. These tactics may take the form of strikes, boycotts, picketing, or corporate campaigns. Similarly, employers may implement lockouts, hire replacements, or move production to another facility to place pressure on a union to accept a new contract.

# Managing Human Resources and Labor Relations ## Legal Environment of Human Resources and Labor Relations 1. What are the key laws and federal agencies affecting human resource management and labor relations? Federal laws help ensure that job applicants and employees are treated fairly and not discriminated against. Hiring, training, and job placement must be unbiased. Promotion and compensation decisions must be based on performance. These laws help all Americans who have talent, training, and the desire to get ahead. The key laws that currently impact human resource management and labor relations are listed in . Several laws govern wages, pensions, and unemployment compensation. For instance, the Fair Labor Standards Act sets the federal minimum wage, which is periodically raised by Congress. Many minimum-wage jobs are found in service firms, such as fast-food chains and retail stores. The Pension Reform Act protects the retirement income of employees and retirees. Federal tax laws also affect compensation, including employee profit-sharing and stock purchase plans. When John F. Kennedy signed the Equal Pay Act into law in 1963, the goal was to stop the practice of paying women lower wages for the same job based on their gender. At the time, women with full-time jobs earned between 59 and 64 cents for every dollar their male counterparts earned in the same jobs. Although this law has been in place for several decades, progress has been slow. On April 17, 2012, President Barack Obama proclaimed National Equal Pay Day, noting that women who work full time earn only 77 cents for every dollar their male counterparts make. In 2016, the wage gap changed slightly, with women making 80.5 percent of what men earn. Employers must also be aware of changes to laws concerning employee safety, health, and privacy. The Occupational Safety and Health Act (OSH Act) requires employers to provide a workplace free of health and safety hazards. For instance, manufacturers must require their employees working on loading docks to wear steel-toed shoes so their feet won’t be injured if materials are dropped. Drug and AIDS testing are also governed by federal laws. Another employee law that continues to affect the workplace is the Americans with Disabilities Act. To be considered disabled, a person must have a physical or mental impairment that greatly limits one or more major life activities. More than 40 million Americans, 12.6 percent of the population, were disabled in 2015, according to the U.S. Census Bureau. Employers may not discriminate against disabled persons. They must make “reasonable accommodations” so that qualified employees can perform the job, unless doing so would cause “undue hardship” for the business. Altering work schedules, modifying equipment so a wheelchair-bound person can use it, and making buildings accessible by ramps and elevators are considered reasonable. Two companies often praised for their efforts to hire the disabled are McDonald’s and DuPont. The Family and Medical Leave Act went into effect in 1993. The law guarantees continuation of paid health benefits, plus a return to the same or equivalent job, and applies to employers with 50 or more employees. It requires these employers to provide unpaid leave of up to 12 weeks during any 12-month period to workers who have been employed for at least a year and worked at least 1,250 hours during the past year. The reasons for the leave include the birth or adoption of a child; the serious illness of a child, spouse, or parent; or a serious illness that prevents the worker from doing the job. According to the Bureau of Labor Statistics, only 11 percent of all private industry workers have access to paid family leave. Low-wage earners fare even worse. Only 5 percent of low-wage earners get any paid maternity leave, and nearly half will not take time off because they cannot afford to go without income. The United States continues to be one of only four countries in the world (along with Liberia, Suriname, and Papua New Guinea) that do not guarantee paid parental leave. The Wagner and Taft-Hartley Acts govern the relationship between an employer and union. Employees have the right to unionize and bargain collectively with the company. The employer must deal with the union fairly, bargain in good faith, and not discriminate against an employee who belongs to the union. The union must also represent all employees covered by a labor agreement fairly and deal with the employer in good faith. Several federal agencies oversee employment, safety, compensation, and related areas. The Occupational Safety and Health Administration (OSHA) sets workplace safety and health standards, provides safety training, and inspects places of work (assembly plants, construction sites, and warehouse facilities, for example) to determine employer compliance with safety regulations. The Wage and Hour division of the Department of Labor enforces the federal minimum-wage law and overtime provisions of the Fair Labor Standards Act. Employers covered by this law must pay certain employees a premium rate of pay (or time and one-half) for all hours worked beyond 40 in one week. The Equal Employment Opportunity Commission (EEOC) was created by the 1964 Civil Rights Act. It is one of the most influential agencies responsible for enforcing employment laws. The EEOC has three basic functions: processing discrimination complaints, issuing written regulations, and gathering and disseminating information. An employment discrimination complaint can be filed by an individual or a group of employees who work for a company. The group may comprise a protected class, such as women, African Americans, or Hispanic Americans. The protected group may pursue a class-action complaint that may eventually become a lawsuit. As a measure to prevent employment discrimination, many employers set up affirmative action programs to expand job opportunities for women and minorities Even with affirmative action and other company efforts to follow the law, each year the EEOC receives tens of thousands of complaints from current or former employees. The monetary benefits that the EEOC wins for employees has grown substantially during the past 10 years. Large monetary settlements often occur when the EEOC files a class-action suit against an employer. For example, the Ford Motor Company settled sexual and racial harassment claims by more than 30 women for more than $10 million at two Chicago-area manufacturing plants in 2017. Also, Sears, Motorola, and AT&T have had to make large back-pay awards and to offer special training to minority employees after the court found they had been discriminated against. The NLRB was established to enforce the Wagner Act. Its five members are appointed by the president; the agency’s main office is in Washington, DC, and regional and field offices are scattered throughout the United States. NLRB field agents investigate charges of employer and union wrongdoing (or unfair labor practices) and supervise elections held to decide union representation. Judges conduct hearings to determine whether employers and unions have violated the law. The Federal Mediation and Conciliation Service helps unions and employers negotiate labor agreements. Agency specialists, who serve as impartial third parties between the union and company, use two processes: conciliation and mediation, both of which require expert communication and persuasion. In conciliation, the specialist assists management and the union with focusing on the issues in dispute and acts as a go-between, or communication channel through which the union and employer send messages to and share information with each other. The specialist takes a stronger role in mediation by suggesting compromises to the disputing organizations. ### Summary of Learning Outcomes 1. What are the key laws and federal agencies affecting human resource management and labor relations? A number of federal laws (listed in ) affect human resource management. Federal law prohibits discrimination based on age, race, gender, color, national origin, religion, or disability. The Americans with Disabilities Act bans discrimination against disabled workers and requires employers to change the work environment to accommodate the disabled. The Family and Medical Leave Act requires employers, with certain exceptions, to provide employees up to 12 weeks of unpaid leave a year. The leave can be for the birth or adoption of a child or due to serious illness of the worker or a family member. Federal agencies that deal with human resource administration are the EEOC, OSHA, the Office of Federal Contract Compliance Programs (OFCCP), and the Wage and Hour Division of the Department of Labor. The EEOC and OFCCP are primary agencies for the enforcement of employment discrimination laws, OSHA enforces safety regulations, and the Wage and Hour Division enforces the minimum wage and related laws. Many companies employ affirmative action and safety officers to ensure compliance with antidiscrimination and workplace safety laws. The Wagner and Taft-Hartley Acts govern the union-management relationship, in part through the functions performed by the National Labor Relations Board. The law gives workers the right to form and join labor unions and obligates the employer to deal with the union fairly.

# Managing Human Resources and Labor Relations ## Trends in Human Resource Management and Labor Relations 1. What trends and issues are affecting human resource management and labor relations? Some of today’s most important trends in human resource management are using employee diversity as a competitive advantage, improving efficiency through outsourcing and technology, and hiring employees who fit the organizational culture. Although overall labor union enrollment continues to decline, a possible surge in membership in service unions is anticipated. ### Employee Diversity and Competitive Advantage American society and its workforce are becoming increasingly more diverse in terms of racial and ethnic status, age, educational background, work experience, and gender. A company with a demographic employee profile that looks like its customers may be in a position to gain a competitive advantage, which is a set of unique features of a company and its product or service that are perceived by the target market as superior to those of the competition. Competitive advantage is the factor that causes customers to patronize a firm and not the competition. Many things can be a source of competitive advantage: for Southwest Airlines it is route structure and high asset utilization; for Ritz-Carlton hotels it is very high-quality guest services; for Toyota it is manufacturing efficiency and product durability; and for Starbucks it is location, service, and outstanding coffee products. For these firms, a competitive advantage is also created by their HR practices. Many firms are successful because of employee diversity, which can produce more effective problem-solving, a stronger reputation for hiring women and minorities, greater employee diversity, quicker adaptation to change, and more robust product solutions because a diverse team can generate more options for improvement. In order for an organization to use employee diversity for competitive advantage, top management must be fully committed to hiring and developing women and minority individuals. An organization that highly values employee diversity is the United States Postal Service (USPS). In 1992 the Postal Service launched a diversity development program to serve as the organization’s “social conscience and to increase employees’ awareness of and appreciation for ethnic and cultural diversity both in the postal workplace and among customers.” Twenty-five years later, 39 percent of postal service employees are minority persons: 21 percent African-American, 8 percent Hispanic, and more than 8.0 percent other minorities. In addition, women make up 40 percent of the organization’s workforce. ### Outsourcing HR and Technology The role of the HR professional has changed noticeably over the past 20 years. One significant change has been the use of technology in handling relatively routine HR tasks, such as payroll processing, initial screening of applicants, and benefits enrollments. Large firms such as Nokia and Lockheed Martin purchase specialized software (SAP and Oracle/PeopleSoft) to perform the information-processing aspects of many HR tasks. Other firms, such as Jacobs Engineering Group (a large professional services firm), outsource—or contract out—these tasks to HR service providers such as Aon Hewitt and Workforce Solutions. HR outsourcing is done when another firm can perform a task better and more efficiently, thus saving costs. Sometimes HR activities are outsourced because HR requirements are extraordinary and too overwhelming to execute in-house in a timely fashion. Frequently, HR activities are outsourced simply because a provider has greater expertise. For example, media conglomerate CBS Corp. recently announced that it hired Fidelity Investments to manage its 401(k) plan, which has more than $4 billion in assets. ### Organizational Culture and Hiring for Fit Regardless of general business and economic conditions, many firms are expanding operations and hiring additional employees. For many growing firms, corporate culture can be a key aspect of developing employees into a competitive advantage for the firm. Corporate culture refers to the core values and beliefs that support the mission and business model of the firm and guide employee behavior. Companies such as JetBlue, Ritz-Carlton, and Cypress frequently hire for fit with their corporate cultures. This necessitates recruitment and selection of employees who exhibit the values of the firm. Ritz-Carlton and Cypress use carefully crafted applicant questionnaires to screen for values and behaviors that support the corporate culture. JetBlue uses behavioral-based interview questions derived from its corporate values of safety, integrity, caring, fun, and passion. Southwest Airlines has non-HR employees (flight attendants, gate agents, and pilots) and even frequent flyer passengers interview applicants to screen for cultural fit as well as strong customer-service orientation. In addition to cultural fit, firms are increasingly hiring for technical knowledge and skills fit to the job. Tech companies such as IBM, Amazon, and Microsoft receive thousands of résumés and job applications each year and continue to look for the best and the brightest when it comes to technical knowledge and skills. For example, IBM is now focusing on a skills-based approach rather than a candidate’s education level and number of academic degrees. Amazon is all about the customer and looks for employees who continue to be “relentlessly curious.” Microsoft continues to raise the talent bar by embracing job applicants who have demonstrated leadership, achieved concrete results, and can prove that they love to learn. ### More Service Workers Joining Labor Unions Organized labor has faced tumultuous times during the last several decades due to declining union membership, loss of factory jobs, dwindling political clout, and the shifting of jobs outside the United States. With union membership now down to a little more than 10 percent of the U.S. workforce, some wonder if labor unions, who organize as a united front against poor working conditions, still have a place in the country. Mary Kay Henry, international president of Service Employees International Union (SEIU), is optimistic that unions are capable of resurgence by organizing the growing number of service workers into labor unions. The SEIU is the fastest-growing union in the nation, having jumped to 2 million members from 1.1 million a decade ago. Henry’s goal is to focus on recruiting the country’s millions of low-wage service workers, positions that are primarily filled by the working poor. These workers are disproportionately women, immigrants, and members of minority groups, which have all been traditionally more open to unionization. If these workers are successfully recruited into the SEIU, Henry believes that their wages and benefits would increase in much the same way unions brought factory workers into the middle class in the 1930s. The SEIU believes that the service industry provides a target of opportunity, with the largest expected employment growth through 2026 in low-paid local services: Many believe that the future of labor lies primarily in the success of recruitment efforts and in enrolling the massive numbers of employees who are in fast-growing, low-wage service jobs. For example, the SEIU was successful recently in unionizing hundreds of workers who provide services to people with disabilities in California, with an eye toward raising standards for their work and increasing hourly wages and benefits. Reversing labor’s decline will be challenging, but the SEIU looks positively toward the future. ### Summary of Learning Outcomes 1. What trends and issues are affecting human resource management and labor relations? Human resource managers recognize that diverse workforces create an environment that nurtures creative decision-making, effective problem-solving, more agility in adapting to change, and a strong competitive advantage. Therefore, firms are becoming committed to recruiting and hiring a diverse workforce. To maximize efficiency, many firms are outsourcing HR functions and using technology to reduce costs and improve efficiency. Firms are also striving to hire employees who possess qualities that match those of the corporate culture. Although labor unions have faced declining membership in the last several decades, enrollment of service workers into labor unions may increase as low-wage earners seek improved working conditions, pay, and health benefits. ### Preparing for Tomorrow’s Workplace Skills 1. Would an overseas job assignment be good for your career development? If you think so, what country would you prefer to live and work in for two or three years, and what type of job would you like to have in that country? (Resources) 2. The benefits package of many employers includes numerous items such as health insurance, life insurance, 401(k) plan, paid vacations, tuition reimbursement, employee price discounts on products of the firm, and paid sick leave. At your age, what are the three or four most important benefits? Why? Twenty years from now, what do you think will be your three or four most important benefits? Why? (Resources) 3. Assume you have been asked to speak at a local meeting of human resource and labor relations professionals. The topic is whether union membership will increase or decline in the next 50 years. Take either the increase or the decline position and outline your presentation. (Information) 4. Go to the government documents section in your college or university library, and inspect publications of the Department of Labor (DOL), including Employment and Earnings, Compensation and Working Conditions, Monthly Labor Review, Occupational Outlook Handbook, and Career Guide to Industries. Alternatively, go to the DOL Bureau of Labor Statistics website at http://stats.bls.gov. Access the most recent DOL publications and locate the following information. (Information) 5. Assume you are a director of labor relations for a firm faced with a union certification election in 30 days. Draft a letter to be sent to your employees in which you urge them to vote “no union”; be persuasive in presenting your arguments against the union. (Information) 6. Using the internet, research articles featuring a recent strike or a labor contract settlement. Report to your class the specifics of the strike or settlement. (Technology, Resources) 7. Team Activity Select two teams of five. One team will take the position that employees are simply a business expense to be managed. The second team will argue that employees are an asset to be developed to enable the firm to gain a competitive advantage. The remainder of the class will judge which team provided the stronger argument. (Interpersonal) 8. Have you or a family member ever been a union member? If so, name the union and describe it in terms of membership size, membership characteristics, strike history, recent bargaining issues, and employers under union contracts. (Information) 9. Team Activity Divide the class into two groups. One group will take the position that workers should be required to join unions and pay dues. The other group will take the position that workers should not be required to join unions. Hold a debate in which a spokesperson from each group is given 10 minutes to present the group’s arguments. (Interpersonal) ### Ethics Activity Tracking employee information through global positioning systems (GPS)—in particular, on company vehicles driven by employees—is becoming commonplace. Location information is transmitted to a server via the cell phone network (and sometimes via satellite phone service) and is then available to the company through the web or mobile apps. As the cost of GPS drops and the number of mobile workers rises—by some accounts, to as much as 75 percent of the workforce by 2020—companies are depending on GPS to monitor the movement of personnel and products to improve customer service and help with time management. “I wanted to see how much time was spent on each job,” says one small business owner with a fleet of seven service vehicles. “We’ve had a few problems in the past—people weren’t where they said they’d be. With GPS, we can defend ourselves to the customers. We know how fast the drivers drove, what route they took, and how long they spent on each job.” Late in 2017, four wastewater plant mechanics employed by the city of Modesto, California, were fired after GPS showed they used “work hours to socialize at the lift stations with [each other], go home, shop, sleep and drive around in the City utility vehicle.” Companies are not only tracking vehicles, but many now track employees through their mobile phones. Understandably, many employees don’t like the idea of Big Brother following their every move; most states allow employers to track their employees’ location even in off hours. Many employees take their company vehicles home after their shifts, but even employees with company-owned phones may be tracked after hours, too. Surveys show that many GPS-tracked employees have serious concerns about after-hours tracking, micromanagement, and privacy [https://www.tsheets.com/gps-survey]. In 2015, a woman in California sued her employer, claiming that she was tracked 24 hours a day through her company-issued iPhone. And when she uninstalled the tracking app, she was fired. Using a web search tool, locate articles about this topic, and then write responses to the following questions. Be sure to support your arguments and cite your sources. Ethical Dilemma: Do GPS devices constitute an invasion of employee privacy? Are there guidelines companies can develop for appropriate GPS use? Sources: Kevin Valine, “Modesto Disciplines Sewer Workers for Goofing Off,” The Modesto Bee, http://www.modbee.com, January 1, 2018; Kaveh Waddell, “Why Bosses Can Track Their Employees 24/7,” The Atlantic, https://www.theatlantic.com, January 6, 2017; Andrew Burger, “IDC: Mobile Workers Will Make Up Nearly 75 Percent of U.S. Workforce,” http://www.telecompetitor.com, June 23, 2015; David Kravets, “Worker Fired for Disabling GPS App That Tracked Her 24 Hours a Day,” Ars Technica, https://arstechnica.com, May 11, 2015. ### Working the Net 1. Go to the blog page of the College Recruiter website at https://www.collegerecruiter.com/blog, and read the relevant articles to learn how to prepare a résumé that will get results. Develop a list of rules for creating effective résumés. What tips were the most useful to you? 2. Working as a contingent employee can help you explore your career options. Visit the Manpower website at http://www.manpower.com, and use the Job Search feature to look for several types of jobs that interest you. Choose your current city and one where you would like to live, either in the United States or abroad. What are the advantages of being a temporary worker? What other services does Manpower offer job seekers? 3. As a corporate recruiter, you must know how to screen prospective employees. The Integrity Center website at http://www.integctr.com offers a brief tutorial on pre-employment screening, a glossary of key words and phrases, and related information. Prepare a short report that tells your assistant how to go about this process. 4. You’ve been asked to give a speech about the current status of affirmative action and equal employment to your company’s managers. Starting with the website of the American Association for Access Equity and Diversity (https://www.aaaed.org) and its links to related sites, research the topic and prepare an outline for your talk. Include current legislation and recent court cases. 5. Web-based training is popular at many companies as a way to bring a wider variety of courses to more people at lower costs. The Web-Based Training Information Center site at http://www.webbasedtraining.com provides a good introduction. Learn about the basics of online training at its Primer page. Then link to the Resources section, try a demo, and explore other areas that interest you. Prepare a brief report on your findings, including the pros and cons of using the web for training, to present to your class. 6. What are the key issues facing labor unions today? Visit the AFL-CIO website, http://www.aflcio.org, and Labornet, http://www.labornet.org. Select three current topics and summarize the key points for the class. 7. Not everyone believes that unions are good for workers. The National Right to Work Legal Defense Foundation offers free legal aid to employees whose “human and civil rights have been violated by compulsory unionism abuses.” Read the materials on its site (http://www.nrtw.org), and prepare a short report on its position regarding the disadvantages of labor unions. 8. Although we tend to think of labor unions as representing manufacturing employees, many office and service-industry employees, teachers, and professional belong to unions. Visit the websites of two of the following nonmanufacturing unions and discuss how they help their members: the Office and Professional Employees International Union (http://www.opeiu.org), the American Federation of State, County, and Municipal Employees (http://www.afscme.org), the National Education Association (http://www.nea.org), the Actor’s Equity Association (http://www.actorsequity.org), and the American Federation of Musicians (http://www.afm.org). What are the differences, if any, between these unions and those in other industries? ### Creative Thinking Case ### Discrimination in the Workplace Continues Although we live in enlightened times, a recent Gallup Poll found that 15 percent of American workers still experienced some form of workplace discrimination. The study was conducted to mark the anniversary of the Civil Rights Act of 1964 and the creation of the EEOC. The poll found that the two most frequently cited types of discrimination are sexual discrimination (31 percent) and discrimination based on race or ethnicity (36 percent). Also mentioned were age, disability, sexual orientation, and religion. The work areas found to be most susceptible to discrimination are promotion and pay. Being selected for a job and treatment in the workplace were also cited. Wage discrimination and sexual harassment are two big battles women continue to fight. Both topics were in the headlines in 2017; one took center stage and the other was brushed under the covers (at least for now). Thanks to Harvey Weinstein, the topic of sexual harassment was in the spotlight, setting off a tsunami as women around the world reacted with their #MeToo stories. As the movement progressed from Hollywood, to media companies, to Capitol Hill, and finally into corporate America, the topic had a platform. From the boardroom to the factory floor, women who had been sexually harassed shared their stories. As companies rushed to put zero-tolerance policies into place and issue new training requirements, lawsuits and class-action cases were settled more quickly, some very publicly. In August 2017, the EEOC reached a $10 million settlement with Ford motor company for sexual and racial harassment at two Chicago plants. In contrast, little was reported on the reversal of the new regulation designed to combat the wage gap between men and women. The revised EEO-1 would have gone into effect March 31, 2018, and required companies with 100 or more employees and federal contractors with 50 or more employees to report W-2 wage information and total hours worked for all employees. The EEO-1 form already requires employers to report data on race/ethnicity and gender. The Office of Management and Budget (OMB) initiated a review and immediate stay to the U.S. EEOC “in accordance with its authority under the Paperwork Reduction Act (PRA),” reversing the regulation that had been revised on September 29, 2016. Pay equity advocates who had supported expanded pay-data reporting were critical of the suspension. “We see through the Trump administration’s call to halt the equal pay rule that requires employers to collect and submit pay data by gender, race, and ethnicity to the government,” said Fatima Goss Graves, president and CEO of the National Women’s Law Center in Washington, D.C. “Make no mistake—it’s an all-out attack on equal pay. [It] sends a clear message to employers: if you want to ignore pay inequities and sweep them under the rug, this administration has your back.” How important is equal pay? According to the analyses of the 2014–2016 Annual Social and Economic supplement published by the Institute for Women’s Policy Research, the United States economy would have produced additional income of $512.6 billion if women received equal pay; this represents 2.8 percent of 2016 gross domestic product (GDP). In addition, poverty rates would drop from 10.8 percent to 4.4 percent, and the number of children with working mothers living in poverty would be nearly cut in half, dropping from 5.6 million to 3.1 million. 2. Why is workplace diversity so important in today’s business environment? 3. What are the major sources of workplace discrimination? Cite specific examples from the case. 4. What steps are companies taking to ensure that employees are not discriminated against? Sources: Susan Chira and Catrin Einhorn, “How Tough Is It to Change a Culture of Harassment? Ask Women at Ford,” The New York Times, https://www.nytimes.com, December 19, 2017; “Statement of Acting Chair Victoria A. Lipnic about OMB Decision on EEO-1 Pay Data Collection,” https://www.eeoc.gov, August 29, 2017; Stephen Miller, “White House Suspends Pay-Data Reporting on Revised EEO-1 Form,” https://www.shrm.org, August 31, 2017; Heidi Hartmann, Jeff Hayes, and Jennifer Clark, “How Equal Pay for Working Women Would Reduce Poverty and Grow the American Economy,” http://www.iwpr.org, January 13, 2014; “Gallup Poll on Employment Discrimination Shows Progress, Problems, 40 Years after Founding of EEOC” (press release), https://www.eeoc.gov, December 8, 2005. ### Hot Links Address Book 1. Search the extensive job database of CareerBuilder.com (http://www.careerbuilder.com) for a job in a new city. 2. Get advice for brushing up your interview skills at the Job Hunting Advice page of The Wall Street Journal’s career site, http://careers.wsj.com. 3. How does the Equal Employment Opportunity Commission promote equal opportunity in employment? Visit http://www.eeoc.gov to learn what the agency does. 4. For the latest news in the human resources field, visit the website of the Society for Human Resource Management at http://www.shrm.org. 5. Many companies are using the web to help manage employees. Visit ADP, http://www.adp.com, to learn how online services can streamline their HR tasks. 6. At the NLRB website, http://www.nlrb.gov, you’ll learn about the agency’s many activities and how it protects workers’ rights. 7. Visit the Social Security Administration site to track the latest cost-of-living adjustment at http://www.ssa.gov. You’ll find it in the Publications section.

# Motivating Employees ## Introduction ### Learning Outcomes After reading this chapter, you should be able to answer these questions: 1. What are the basic principles of Frederick Taylor’s concept of scientific management? 2. What did Elton Mayo’s Hawthorne studies reveal about worker motivation? 3. What is Maslow’s hierarchy of needs, and how do these needs relate to employee motivation? 4. How are McGregor’s Theories X and Y and Ouchi’s Theory Z used to explain worker motivation? 5. What are the basic components of Herzberg’s motivator-hygiene theory? 6. What four contemporary theories on employee motivation offer insights into improving employee performance? 7. How can managers redesign existing jobs to increase employee motivation and performance? 8. What initiatives are organizations using today to motivate and retain employees? This chapter details motivational theory, both historically and currently, and applies that theory to the business world, where motivation, whether in the form of a rock band or not, is a key to success. People can be a firm’s most important resource. They can also be the most challenging resource to manage well. Employees who are motivated and work hard to achieve personal and organizational goals can become a crucial competitive advantage for a firm. The key then is understanding the process of motivation, what motivates individuals, and how an organization can create a workplace that allows people to perform to the best of their abilities.

# Motivating Employees ## Early Theories of Motivation 1. What are the basic principles of Frederick Taylor’s concept of scientific management? Motivation is the set of forces that prompt a person to release energy in a certain direction. As such, motivation is essentially a need- and want-satisfying process. A need is best defined as the gap between what is and what is required. Similarly, a want is the gap between what is and what is desired. Unsatisfied needs and wants create a state of tension that pushes (motivates) individuals to practice behavior that will result in the need being met or the want being fulfilled. That is, motivation is what pushes us to move from where we are to where we want to be, because expending that effort will result in some kind of reward. Rewards can be divided into two basic categories: intrinsic and extrinsic. Intrinsic rewards come from within the individual—things like satisfaction, contentment, sense of accomplishment, confidence, and pride. By contrast, extrinsic rewards come from outside the individual and include things like pay raises, promotions, bonuses, prestigious assignments, and so forth. illustrates the motivation process. Successful managers are able to marshal the forces to motivate employees to achieve organizational goals. And just as there are many types of gaps between where organizations are and where they want to be, there are many motivational theories from which managers can draw to inspire employees to bridge those gaps. In this chapter, we will first examine motivational theories that grew out of the industrial revolution and early ideas of organizational psychology. Then we will examine needs-based theories and more contemporary ideas about employee motivation like equity, expectancy, goals, and reinforcement theories. Finally, we will show you how managers are applying these theories in real-world situations. How can managers and organizations promote enthusiastic job performance, high productivity, and job satisfaction? Many studies of human behavior in organizations have contributed to our current understanding of these issues. A look at the evolution of management theory and research shows how managers have arrived at the practices used today to manage human behavior in the workplace. A sampling of the most influential of these theorists and research studies are discussed in this section. ### Frederick Taylor’s Scientific Management One of the most influential figures of the classical era of management, which lasted from about 1900 to the mid-1930s, was Frederick W. Taylor, a mechanical engineer sometimes called the “father of scientific management.” Taylor’s approach to improved performance was based on economic incentives and the premise that there is “one best way” to perform any job. As a manager at the Midvale and Bethlehem Steel companies in Philadelphia in the early 1900s, Taylor was frustrated at the inefficiency of the laborers working in the mills. Convinced that productivity could be improved, Taylor studied the individual jobs in the mill and redesigned the equipment and the methods used by workers. Taylor timed each job with a stopwatch and broke down every task into separate movements. He then prepared an instruction sheet telling exactly how each job should be done, how much time it should take, and what motions and tools should be used. Taylor’s ideas led to dramatic increases in productivity in the steel mills and resulted in the development of four basic principles of scientific management: 1. Develop a scientific approach for each element of a person’s job. 2. Scientifically select, train, teach, and develop workers. 3. Encourage cooperation between workers and managers so that each job can be accomplished in a standard, scientifically determined way. 4. Divide work and responsibility between management and workers according to who is better suited to each task. Taylor published his ideas in The Principles of Scientific Management. His pioneering work vastly increased production efficiency and contributed to the specialization of labor and the assembly-line method of production. Taylor’s approach is still being used nearly a century later in companies such as UPS, where industrial engineers maximize efficiency by carefully studying every step of the delivery process looking for the quickest possible way to deliver packages to customers. Though Taylor’s work was a giant step forward in the evolution of management, it had a fundamental flaw in that it assumed that all people are primarily motivated by economic means. Taylor’s successors in the study of management found that motivation is much more complex than he envisioned. ### Summary of Learning Outcomes 1. What are the basic principles of Frederick Taylor’s concept of scientific management? Scientific management is based on the belief that employees are motivated by economic incentives and that there is “one best way” to perform any job. The four basic principles of scientific management developed by Taylor are as follows: 1. Develop a scientific approach for each element of a person’s job. 2. Scientifically select, train, teach, and develop workers. 3. Encourage cooperation between workers and managers so that each job can be accomplished in a standard, scientifically determined way. 4. Divide work and responsibility between management and workers according to who is better suited to each task.

# Motivating Employees ## The Hawthorne Studies 1. What did Elton Mayo’s Hawthorne studies reveal about worker motivation? The classical era of management was followed by the human relations era, which began in the 1930s and focused primarily on how human behavior and relations affect organizational performance. The new era was ushered in by the Hawthorne studies, which changed the way many managers thought about motivation, job productivity, and employee satisfaction. The studies began when engineers at the Hawthorne Western Electric plant decided to examine the effects of varying levels of light on worker productivity—an experiment that might have interested Frederick Taylor. The engineers expected brighter light to lead to increased productivity, but the results showed that varying the level of light in either direction (brighter or dimmer) led to increased output from the experimental group. In 1927, the Hawthorne engineers asked Harvard professor Elton Mayo and a team of researchers to join them in their investigation. From 1927 to 1932, Mayo and his colleagues conducted experiments on job redesign, length of workday and workweek, length of break times, and incentive plans. The results of the studies indicated that increases in performance were tied to a complex set of employee attitudes. Mayo claimed that both experimental and control groups from the plant had developed a sense of group pride because they had been selected to participate in the studies. The pride that came from this special attention motivated the workers to increase their productivity. Supervisors who allowed the employees to have some control over their situation appeared to further increase the workers’ motivation. These findings gave rise to what is now known as the Hawthorne effect, which suggests that employees will perform better when they feel singled out for special attention or feel that management is concerned about employee welfare. The studies also provided evidence that informal work groups (the social relationships of employees) and the resulting group pressure have positive effects on group productivity. The results of the Hawthorne studies enhanced our understanding of what motivates individuals in the workplace. They indicate that in addition to the personal economic needs emphasized in the classical era, social needs play an important role in influencing work-related attitudes and behaviors. ### Summary of Learning Outcomes 1. What did Elton Mayo’s Hawthorne studies reveal about worker motivation? The pride that comes from special attention motivates workers to increase their productivity. Supervisors who allow employees to have some control over their situation appeared to further increase the workers’ motivation. The Hawthorne effect suggests that employees will perform better when they feel singled out for special attention or feel that management is concerned about employee welfare.

# Motivating Employees ## Maslow's Hierarchy of Needs 1. What is Maslow’s hierarchy of needs, and how do these needs relate to employee motivation? Another well-known theorist from the behavioral era of management history, psychologist Abraham Maslow, proposed a theory of motivation based on universal human needs. Maslow believed that each individual has a hierarchy of needs, consisting of physiological, safety, social, esteem, and self-actualization needs, as shown in . Maslow’s theory of motivation contends that people act to satisfy their unmet needs. When you’re hungry, for instance, you look for and eat food, thus satisfying a basic physiological need. Once a need is satisfied, its importance to the individual diminishes, and a higher-level need is more likely to motivate the person. According to Maslow’s hierarchy of needs, the most basic human needs are physiological needs, that is, the needs for food, shelter, and clothing. In large part, it is the physiological needs that motivate a person to find a job. People need to earn money to provide food, shelter, and clothing for themselves and their families. Once people have met these basic needs, they reach the second level in Maslow’s hierarchy, which is safety needs. People need to feel secure, to be protected from physical harm, and to avoid the unexpected. In work terms, they need job security and protection from work hazards. Physiological needs and safety are physical needs. Once these are satisfied, individuals focus on needs that involve relationships with other people. At Maslow’s third level are social needs, or needs for belonging (acceptance by others) and for giving and receiving friendship and love. Informal social groups on and off the job help people satisfy these needs. At the fourth level in Maslow’s hierarchy are esteem needs, which are needs for the respect of others and for a sense of accomplishment and achievement. Satisfaction of these needs is reflected in feelings of self-worth. Praise and recognition from managers and others in the firm contribute to the sense of self-worth. Finally, at the highest level in Maslow’s hierarchy are self-actualization needs, or needs for fulfillment, for living up to one’s potential, and for using one’s abilities to the utmost. In order to give you a better understanding of how Maslow’s hierarchy applies in the real business world, let’s look at a detailed example about Wegmans supermarkets. When you think of your first-choice job, you probably aren’t thinking about working in a supermarket. With grueling hours, low pay, and annual turnover often approaching 100 percent, supermarkets are generally not considered the best places to work—unless you work at Wegmans, which has been on ’s “Best Company to Work For” every year since the list started, earning Wegmans a spot on s “Great Place to Work Legends” list. Part of what makes Wegmans successful is the company’s attention to its employees’ needs at all levels of Maslow’s hierarchy. The company pays above-market wages (the sous chef at a Pittsburgh store used to work for Thomas Keller’s French Laundry in Napa Valley, and talent like that doesn’t come cheap), and until 2003, Wegmans paid 100 percent of its employees’ medical insurance premiums (physiological needs). Wegmans’ most comparable competitor has a turnover rate of about 19 percent, which doesn’t even come close to Wegmans’ 5 percent. More than half of Wegmans’ store managers began working there in their teens (safety needs). Because employees stay so long, the Wegmans culture has become stronger and more ingrained over time. Edward McLaughlin, director of Cornell’s Food Industry Management Program, says, “When you’re a 16-year-old kid, the last thing you want to do is wear a geeky shirt and work for a supermarket. But at Wegmans, it’s a badge of honor. You are not a geeky cashier. You are part of the social fabric,” (social needs). Sara Goggins, a 19-year-old college student, was recently complimented on the display she helped prepare for the store’s French-inspired patisserie—by Danny Wegman himself (esteem needs). Sara keeps a photo of her and Danny Wegman behind the counter. Maria Benjamin used to bake “chocolate meatball cookies” to celebrate coworkers’ birthdays. They were so popular that she asked Danny Wegman if the store would sell them in the bakery department. He said yes, and it did. Employees like Sara and Maria are routinely recognized for their contributions to the company (esteem needs). Wegmans has spent over $54 million for college scholarships to more than 17,500 full- and part-time employees over the past 20 years. Top management thinks nothing of sending store department managers on training expeditions. A cheese manager might take a 10-day trip to visit and study cheesemakers in London, Paris, and Italy; a wine manager might take a company-sponsored trip through the Napa Valley (self-actualization needs). As you can see from this extended example, Wegmans works hard to meet its employees’ needs at all levels. Maslow’s theory is not without criticism, however. Maslow claimed that a higher-level need was not activated until a lower-level need was met. He also claimed that a satisfied need is not a motivator. A farmer who has plenty to eat is not motivated by more food (the physiological hunger need). Research has not verified these principles in any strict sense. The theory also concentrates on moving up the hierarchy without fully addressing moving back down the hierarchy. Despite these limitations, Maslow’s ideas are very helpful for understanding the needs of people at work and for determining what can be done to satisfy them. ### Summary of Learning Outcomes 1. What is Maslow’s hierarchy of needs, and how do these needs relate to employee motivation? Maslow believed that each individual has a hierarchy of needs, consisting of physiological, safety, social, esteem, and self-actualization needs. Managers who accept Maslow’s ideas attempt to increase employee motivation by modifying organizational and managerial practices to increase the likelihood that employees will meet all levels of needs. Maslow’s theory has also helped managers understand that it is hard to motivate people by appealing to already-satisfied needs.

# Motivating Employees ## McGregor's Theories X and Y 1. How are McGregor’s Theories X and Y and Ouchi’s Theory Z used to explain worker motivation? Douglas McGregor, one of Maslow’s students, influenced the study of motivation with his formulation of two contrasting sets of assumptions about human nature—Theory X and Theory Y. The Theory X management style is based on a pessimistic view of human nature and assumes the following: 1. The average person dislikes work and will avoid it if possible. 2. Because people don’t like to work, they must be controlled, directed, or threatened with punishment to get them to make an effort. 3. The average person prefers to be directed, avoids responsibility, is relatively unambitious, and wants security above all else. This view of people suggests that managers must constantly prod workers to perform and must closely control their on-the-job behavior. Theory X managers tell people what to do, are very directive, like to be in control, and show little confidence in employees. They often foster dependent, passive, and resentful subordinates. In contrast, a Theory Y management style is based on a more optimistic view of human nature and assumes the following: 1. Work is as natural as play or rest. People want to and can be self-directed and self-controlled and will try to achieve organizational goals they believe in. 2. Workers can be motivated using positive incentives and will try hard to accomplish organizational goals if they believe they will be rewarded for doing so. 3. Under proper conditions, the average person not only accepts responsibility but seeks it out. Most workers have a relatively high degree of imagination and creativity and are willing to help solve problems. Managers who operate on Theory Y assumptions recognize individual differences and encourage workers to learn and develop their skills. An administrative assistant might be given the responsibility for generating a monthly report. The reward for doing so might be recognition at a meeting, a special training class to enhance computer skills, or a pay increase. In short, the Theory Y approach builds on the idea that worker and organizational interests are the same. It is not difficult to find companies that have created successful corporate cultures based on Theory Y assumptions. In fact, Fortune’s list of “100 Best Companies to Work For” and the Society for Human Resource Management’s list of “Great Places to Work” are full of companies that operate using a Theory Y management style. Starbucks, J. M. Smucker, SAS Institute, Whole Foods Market, and Wegmans are all examples of companies that encourage and support their workers. Genencor, a biotechnology firm listed on America’s Best Places to Work five times, has a culture that celebrates success in all aspects of its business. Employees can reward colleagues with on-the-spot awards for extraordinary effort. According to the company’s former CEO, Robert Mayer, “Genencor is truly unique among U.S. companies of any size. It is a model for innovation, teamwork, and productivity—and a direct result of our ‘work hard, play hard, change the world’ philosophy. Investing in our employees has always been good business for Genencor.” ### Theory Z William Ouchi (pronounced O Chee), a management scholar at the University of California, Los Angeles, has proposed a theory that combines U.S. and Japanese business practices. He calls it Theory Z. compares the traditional U.S. and Japanese management styles with the Theory Z approach. Theory Z emphasizes long-term employment, slow career development, moderate specialization, group decision-making, individual responsibility, relatively informal control over the employee, and concern for workers. Theory Z has many Japanese elements. But it reflects U.S. cultural values. In the past decade, admiration for Japanese management philosophy that centers on creating long-term relationships has declined. The cultural beliefs of groupthink, not taking risks, and employees not thinking for themselves are passé. Such conformity has limited Japanese competitiveness in the global marketplace. Today there is a realization that Japanese firms need to be more proactive and nimble in order to prosper. It was that realization that led Japanese icon Sony to name a foreigner as the CEO of Japan’s most famous company. Over the years, Sony’s performance has declined, until in April 2005, the company posted its biggest loss ever. Nobuki Idei, the former CEO who inherited Sony’s massive debts and stagnant product lines, realized his strategy wasn’t working, so he became determined to appoint a successor who would be able to transform Sony from the lumbering giant it had become back into the forward-thinking company it had been. Idei tapped Sir Howard Stringer, a Welsh-born American who had been running Sony’s U.S. operations. In doing so, Idei hoped to shock company insiders and industry analysts alike. “It’s funny, 100 percent of the people around here agree we need to change, but 90 percent of them don’t really want to change themselves,” he says. “So I finally concluded that we needed our top management to quite literally speak another language.” After seven years as CEO, Stringer assumed the position of Chairman and appointed Kazuro Hirai as President and Chief Executive Officer. ### Summary of Learning Outcomes 1. How are McGregor’s Theories X and Y and Ouchi’s Theory Z used to explain worker motivation? Douglas McGregor influenced the study of motivation with his formulation of two contrasting sets of assumptions about human nature—designated Theory X and Theory Y. Theory X says people don’t like to work and will avoid it if they can. Because people don’t like to work, they must be controlled, directed, or threatened to get them to make an effort. Theory Y says that people want to be self-directed and will try to accomplish goals that they believe in. Workers can be motivated with positive incentives. McGregor personally believed that Theory Y assumptions describe most employees and that managers seeking to motivate subordinates should develop management practices based on those assumptions. William Ouchi’s Theory Z combines U.S. and Japanese business practices. Theory Z emphasizes long-term employment, slow career development, and group decision-making. The long-term decline of the Japanese economy has resulted in most U.S. firms moving away from Japanese management practices.

# Motivating Employees ## Herzberg's Motivator-Hygiene Theory 1. What are the basic components of Herzberg’s motivator-hygiene theory? Another important contribution to our understanding of individual motivation came from Frederick Herzberg’s studies, which addressed the question, “What do people really want from their work experience?” In the late 1950s, Herzberg surveyed numerous employees to find out what particular work elements made them feel exceptionally good or bad about their jobs. The results indicated that certain job factors are consistently related to employee job satisfaction, while others can create job dissatisfaction. According to Herzberg, motivating factors (also called job satisfiers) are primarily intrinsic job elements that lead to satisfaction. Hygiene factors (also called job dissatisfiers) are extrinsic elements of the work environment. A summary of motivating and hygiene factors appears in . One of the most interesting results of Herzberg’s studies was the implication that the opposite of satisfaction is not dissatisfaction. Herzberg believed that proper management of hygiene factors could prevent employee dissatisfaction, but that these factors could not serve as a source of satisfaction or motivation. Good working conditions, for instance, will keep employees at a job but won’t make them work harder. But poor working conditions, which are job dissatisfiers, may make employees quit. According to Herzberg, a manager who wants to increase employee satisfaction needs to focus on the motivating factors, or satisfiers. A job with many satisfiers will usually motivate workers, provide job satisfaction, and prompt effective performance. But a lack of job satisfiers doesn’t always lead to dissatisfaction and poor performance; instead, a lack of job satisfiers may merely lead to workers doing an adequate job, rather than their best. Although Herzberg’s ideas have been widely read and his recommendations implemented at numerous companies over the years, there are some very legitimate concerns about Herzberg’s work. Although his findings have been used to explain employee motivation, in fact his studies focused on job satisfaction, a different (though related) concept from motivation. Other criticisms focus on the unreliability of Herzberg’s methodology, the fact that the theory ignores the impact of situational variables, and the assumed relationship between satisfaction and productivity. Nevertheless, the questions raised by Herzberg about the nature of job satisfaction and the effects of intrinsic and extrinsic factors on employee behavior have proved a valuable contribution to the evolution of theories of motivation and job satisfaction. ### Summary of Learning Outcomes 1. What are the basic components of Herzberg’s motivator-hygiene theory? Frederick Herzberg’s studies indicated that certain job factors are consistently related to employee job satisfaction whereas others can create job dissatisfaction. According to Herzberg, motivating factors (also called satisfiers) are primarily intrinsic job elements that lead to satisfaction, such as achievement, recognition, the (nature of) work itself, responsibility, advancement, and growth. What Herzberg termed hygiene factors (also called dissatisfiers) are extrinsic elements of the work environment such as company policy, relationships with supervisors, working conditions, relationships with peers and subordinates, salary and benefits, and job security. These are factors that can result in job dissatisfaction if not well managed. One of the most interesting results of Herzberg’s studies was the implication that the opposite of satisfaction is not dissatisfaction. Herzberg believed that proper management of hygiene factors could prevent employee dissatisfaction, but that these factors could not serve as a source of satisfaction or motivation.

# Motivating Employees ## Contemporary Views on Motivation 1. What four contemporary theories on employee motivation offer insights into improving employee performance? The early management scholars laid a foundation that enabled managers to better understand their workers and how best to motivate them. Since then, new theories have given us an even better understanding of worker motivation. Four of these theories are explained in this section: the expectancy theory, the equity theory, the goal-setting theory, and reinforcement theory. ### Expectancy Theory One of the best-supported and most widely accepted theories of motivation is expectancy theory, which focuses on the link between motivation and behavior. According to expectancy theory, the probability of an individual acting in a particular way depends on the strength of that individual’s belief that the act will have a particular outcome and on whether the individual values that outcome. The degree to which an employee is motivated depends on three important relationships, shown in . 1. The link between effort and performance, or the strength of the individual’s expectation that a certain amount of effort will lead to a certain level of performance 2. The link between performance and outcome, or the strength of the expectation that a certain level of performance will lead to a particular outcome 3. The link between outcomes and individual needs, or the degree to which the individual expects the anticipated outcome to satisfy personal needs. Some outcomes have more valence, or value, for individuals than others do. ### Equity Theory Another contemporary explanation of motivation, equity theory is based on individuals’ perceptions about how fairly they are treated compared with their coworkers. Equity means justice or fairness, and in the workplace it refers to employees’ perceived fairness of the way they are treated and the rewards they earn. For example, imagine that after graduation you were offered a job that paid $55,000 a year and had great benefits. You’d probably be ecstatic, even more so if you discovered that the coworker in the next cubicle was making $45,000 for the same job. But what if that same colleague were making $59,000 for the same job? You’d probably think it unfair, particularly if the coworker had the same qualifications and started at the same time as you did. Your determination of the fairness of the situation would depend on how you felt you compared to the other person, or referent. Employees evaluate their own outcomes (e.g., salary, benefits) in relation to their inputs (e.g., number of hours worked, education, and training) and then compare the outcomes-to-inputs ratio to one of the following: (1) the employee’s own past experience in a different position in the current organization, (2) the employee’s own past experience in a different organization, (3) another employee’s experience inside the current organization, or (4) another employee’s experience outside the organization. According to equity theory, if employees perceive that an inequity exists, they will make one of the following choices: 1. Change their work habits (exert less effort on the job) 2. Change their job benefits and income (ask for a raise, steal from the employer) 3. Distort their perception of themselves (“I always thought I was smart, but now I realize I’m a lot smarter than my coworkers.”) 4. Distort their perceptions of others (“Joe’s position is really much less flexible than mine.”) 5. Look at the situation from a different perspective (“I don’t make as much as the other department heads, but I make a lot more than most graphic artists.”) 6. Leave the situation (quit the job) Managers can use equity theory to improve worker satisfaction. Knowing that every employee seeks equitable and fair treatment, managers can make an effort to understand an employee’s perceptions of fairness and take steps to reduce concerns about inequity. ### Goal-Setting Theory Goal-setting theory is based on the premise that an individual’s intention to work toward a goal is a primary source of motivation. Once set, the goal clarifies for the employee what needs to be accomplished and how much effort will be required for completion. The theory has three main components: (1) specific goals lead to a higher level of performance than do more generalized goals (“do your best”); (2) more difficult goals lead to better performance than do easy goals (provided the individual accepts the goal); and (3) feedback on progress toward the goal enhances performance. Feedback is particularly important because it helps the individual identify the gap between the real (the actual performance) and the ideal (the desired outcome defined by the goal). Given the trend toward employee empowerment in the workplace, more and more employees are participating in the goal-setting process. To help employees during the peak 2017 holiday delivery season, UPS, FedEx, and the U.S. Postal Service paid additional overtime to help achieve their goals. UPS even deployed some office personnel to help deliver packages and created team goals to ensure there was cooperation and shared reward with employees from different departments within the organization. The strategy seems to have worked, with UPS reporting an on-time delivery rate of 99.1% for the week before Christmas. ### Reinforcement Theory Reinforcement theory says that behavior is a function of its consequences. In other words, people do things because they know other things will follow. So, depending on what type of consequences follows, people will either practice a behavior or refrain from it. There are three basic types of consequences: positive, negative, and none. In general, we think of positive consequences as rewards, but a reward is anything that increases the particular behavior. By contrast, punishment is anything that decreases the behavior. Motivating with the reinforcement theory can be tricky because the theory is functional. All of its components are defined by their function rather than their structure. That is, consequences can operate differently for different people and in different situations. What is considered a punishment by one person may, in fact, be a reward for another. Nonetheless, managers can successfully use reinforcement theory to motivate workers to practice certain behaviors and avoid others. Often, managers use both rewards and punishment to achieve the desired results. For example, retailers have long needed additional help during peak selling days like Black Friday and Cyber Monday. To help meet these needs, Urban Outfitters recruited salaried workers for a six-hour shift at its new fulfillment facility to help out some of their colleagues and sold the idea to salaried employees as a team-building activity. The workers were offered transportation and paid lunches and asked to wear comfortable shoes. Although it was not mandatory, an Urban Outfitters spokesperson commented: “After successfully opening our new fulfillment center in June, we asked salaried employees at our home office to volunteer for shifts that would help support the new center through a busy month of October. Unsurprisingly, we received a tremendous response, including many of our senior management.” ### Summary of Learning Outcomes 1. What four contemporary theories on employee motivation offer insights into improving employee performance? According to expectancy theory, the probability of an individual acting in a particular way depends on the strength of that individual’s belief that the act will have a particular outcome and on whether the individual values that outcome. Equity theory is based on individuals’ perceptions about how fairly they are treated compared with their coworkers. Goal-setting theory states that employees are highly motivated to perform when specific goals are established and feedback on progress is offered. Reinforcement theory states that behavior is a function of consequences; that is, people do things because they know other things will follow.

# Motivating Employees ## From Motivation Theory to Application 1. How can managers redesign existing jobs to increase employee motivation and performance? The material presented thus far in this chapter demonstrates the wide variety of theorists and research studies that have contributed to our current understanding of employee motivation. Now we turn our attention to more practical matters, to ways that these concepts can be applied in the workplace to meet organizational goals and improve individual performance. ### Motivational Job Design How might managers redesign or modify existing jobs to increase employee motivation and performance? The following three options have been used extensively in the workplace: 1. Job enlargement. The horizontal expansion of a job, increasing the number and variety of tasks that a person performs, is called job enlargement. Increasing task diversity can enhance job satisfaction, particularly when the job is mundane and repetitive in nature. A potential drawback to job enlargement is that employees may perceive that they are being asked to work harder and do more with no change in their level of responsibility or compensation. This can cause resentment and lead to dissatisfaction. 2. Job enrichment. Job enrichment is the vertical expansion of an employee’s job. Whereas job enlargement addresses the breadth or scope of a job, enrichment attempts to increase job depth by providing the employee with more autonomy, responsibility, and decision-making authority. In an enriched job, the employee can use a variety of talents and skills and has more control over the planning, execution, and evaluation of the required tasks. In general, job enrichment has been found to increase job satisfaction and reduce absenteeism and turnover. 3. Job rotation. Also called cross-training, job rotation is the shifting of workers from one job to another. This may be done to broaden an employee’s skill base or because an employee has ceased to be interested in or challenged by a particular job. The organization may benefit from job rotation because it increases flexibility in scheduling and production and because employees can be shifted to cover for absent workers or changes in production or operations. It is also a valuable tool for training lower-level managers in a variety of functional areas. Drawbacks of job rotation include an increase in training costs and decreased productivity while employees are getting “up to speed” in new task areas. ### Work-Scheduling Options As companies try to meet the needs of a diverse workforce and retain quality employees while remaining competitive and financially prosperous, managers are challenged to find new ways to keep workers motivated and satisfied. Increasingly popular are alternatives to the traditional work schedule, such as flextime, compressed workweek, four-day workweek, telecommuting, and job sharing. One option for employees who want an adjustable schedule is flextime, in use at 57 percent of U.S. companies. Flextime allows employees to decide what their work hours will be. Employees are generally expected to work a certain number of hours per week but have some discretion as to when they arrive at work and when they leave for the day. Another option for employees who want to maximize their leisure hours, indulge in three-day weekends, and avoid commuting during morning and evening rush hours is the compressed workweek. Employees work the traditional 40 hours, but fit those hours into a shorter workweek. Most common is the 4-40 schedule, where employees work four 10-hour days a week. Organizations that offer this option claim benefits ranging from increased motivation and productivity to reduced absenteeism and turnover. According to the Society for Human Resource Management, 29 percent of U.S. companies offered employees a compressed workweek in 2017, down from 35 percent in 2013. One of the reasons for the downward trend may be the increasing popularity of a four-day workweek. In 2017 the Society for Human Resource Management began tracking the popularity of a four-day workweek, offered in 13 percent of U.S. companies. In this option, employees work only four days a week, the same as a compressed workweek, but work 32 hours or less. The year before, Amazon announced a pilot project that allows some tech teams in their human resources department to work fewer hours for 75 percent of pay but retain the same benefits as full-time employees. In contrast, Tower Paddle Boards made permanent its pilot of reducing the workday to only five hours for the entire company. Employees retain the same pay and obligations as before so are challenged to be more productive in less time. In addition, the company started a 5 percent profit-sharing plan. Founder Stephan Aarstol says he expected to lose some revenue for a bit, but that didn’t happen. Revenue the first year was up 40 percent. Telecommuting is a work-scheduling option that allows employees to work from home via a computer that is linked with their office, headquarters, or colleagues. Often employers will use a mix of these scheduling options depending on the situation. Jacqueline Pawela-Crew was a group leader in Intel’s management engineering unit who worked a compressed schedule. She worked Monday through Thursday, and on two of those days she telecommuted from her home. On the other two days, she worked a flexible schedule, sometimes getting to the office at 6 a.m., so she could be home when her children came home from school. Her former manager, Dan Enloe, was a U.S. Navy reservist and divorced dad, so he also used Intel’s flexible schedule to meet his military and family needs. He sees the flexible scheduling as a key motivator for Intel’s employees. “I’ve had workers tell me flat out, they were going to leave Intel if they didn’t have the option of some flexibility with their schedules,” he says. Ricardo Semler, CEO of Semco, a Brazilian conglomerate with 3,000 employees, sums up flexible work schedules this way: “The essence to us [at Semco] was that people who are free people, who [can act] based on self-interest, who can balance their own lives, are much happier, more productive people. If you take a business call on a Sunday afternoon, for instance, why not go to the movies on a Monday?” Semco’s employees not only choose their own schedules, they often choose which part of the business to work for and even how much they’ll be paid. Job sharing is a scheduling option that allows two individuals to split the tasks, responsibilities, and work hours of one 40-hour-per-week job. Though used less frequently than flextime and the compressed workweek, this option can also provide employees with job flexibility. The primary benefit to the company is that it gets “two for the price of one”—the company can draw on two sets of skills and abilities to accomplish one set of job objectives. Mary Kaye Stuart is an account executive at a broadcasting company is Austin, Texas. After her doctor warned her that the stress of her 100-mile commute could shorten her life, she pursued job sharing. She teamed up with a former coworker, and each works three days a week, working together on Wednesdays. “Job sharing is a great solution to keeping people from burning out and preventing turnover,” says Melissa Nicholson. She believes in the power of job sharing so much that, after years of doing it herself, she founded Work Muse to help companies set up job-share arrangements. Not all partnerships have been successful, she admits, but when they are, she loves having the ability to be flexible and for the workers to cover each other and support each other. “I’m able to just not think about email or work for four days a week,” she said. “That’s just an impossibility for most people.” Although each of these work-scheduling options may have some drawbacks for the sponsoring organizations, the benefits far outweigh the problems. The number of companies offering flexible work options has grown, and the trend is expected to continue. ### Recognition and Empowerment All employees have unique needs that they seek to fulfill through their jobs. Organizations must devise a wide array of incentives to ensure that a broad spectrum of employee needs can be addressed in the work environment, thus increasing the likelihood of motivated employees. A sampling of these motivational tools is discussed here. Formal recognition of superior effort by individuals or groups in the workplace is one way to enhance employee motivation. Recognition serves as positive feedback and reinforcement, letting employees know what they have done well and that their contribution is valued by the organization. Recognition can take many forms, both formal and informal. Some companies use formal awards ceremonies to acknowledge and celebrate their employees’ accomplishments. Others take advantage of informal interaction to congratulate employees on a job well done and offer encouragement for the future. Recognition can take the form of a monetary reward, a day off, a congratulatory e-mail, or a verbal “pat on the back.” Recognition does not have to come from superiors to be meaningful, however. At The Motley Fool, a financial services company dedicated to helping people invest better, employees use the app YouEarnedIt to recognize the contributions of coworkers. In the app, employees are given “gold” to spend by thanking or complimenting one other along with a statement of what the recipient did to earn it. The recipients cash in the gold for real prizes or gift cards. Employees say this type of recognition may be better than management recognition. Employee empowerment, sometimes called employee involvement or participative management, involves delegating decision-making authority to employees at all levels of the organization, trusting employees to make the right decision. Employees are given greater responsibility for planning, implementing, and evaluating the results of decisions. Empowerment is based on the premise that human resources, especially at lower levels in the firm, are an underutilized asset. Employees are capable of contributing much more of their skills and abilities to organizational success if they are allowed to participate in the decision-making process and are given access to the resources needed to implement their decisions. Netflix removes obstacles from employees’ paths to success by eliminating policies and procedures to show its trust in employee decision-making, including in decisions about expenses and vacations. Netflix hires “fully formed adults” and tells them to use their best judgment to act in the company’s best interest. The company believes employees will be more productive if not bound by processes. As a result of following these practices, Netflix is noted among companies 40 percent more productive than others. ### Economic Incentives Any discussion of motivation has to include the use of monetary incentives to enhance performance. Currently, companies are using a variety of variable-pay programs such as piece-rate plans, profit sharing, gain sharing, stock options, and bonuses to encourage employees to be more productive. Unlike the standard salary or hourly wage, variable pay means that a portion of an employee’s pay is directly linked to an individual or organizational performance measure. In piece-rate pay plans, for example, employees are paid a given amount for each unit they produce, directly linking the amount they earn to their productivity. Profit-sharing plans are based on overall company profitability. Using an established formula, management distributes some portion of company profits to all employees. Gain-sharing plans are incentive programs based on group productivity. Employees share in the financial gains attributed to the increased productivity of their group. This encourages employees to increase productivity within their specific work area regardless of the overall profit picture for the organization as a whole. One well-known approach to monetary incentives is the award of stock options, or giving employees the right to purchase a given amount of stock at below-market prices. Stock can be a strong motivator because those who receive the options have the chance to make a lot of money. Government tax incentive changes have affected how much equity (stock) companies offer each year, indicating that stock options are declining in popularity. One popular incentive is the bonus. A bonus is simply a one-time lump-sum monetary award. In many cases, employees receive bonuses for achieving a particular performance level, such as meeting or exceeding a sales quota, and it is not uncommon for bonuses to be substantial. Google created a Founders’ Award and once gave $12 million in restricted stock to the winners, a huge spot bonus for great work on a project. For line and staff employees, bonuses can add up to 3 to 5 percent of their annual pay; for middle managers, that figure rises to the low double-digit percentage range. For executives, specifically senior executives, bonuses can constitute up to 50 percent of their annual compensation. That’s not to say that small bonuses aren’t good motivators. Google discovered the large range in values for the award created jealousy instead of fostering better teamwork. Based on employee input, Google changed from monetary awards to experiential awards, such as gifts and trips, and everyone was happier. “Spot” bonuses allow companies to target employees that impact the bottom line and can help motivate average employees. Sarah Clausen received her first bonus from Dallas-based Associa, a property management company, for overseeing the rollout of video-based town halls. “It really creates a feeling that your work is being valued and appreciated,” she says. “It definitely leads me to want to stay here and do a good job.” Regardless of their size, bonuses are replacing the raise as the way companies compensate employees for a job well done and motivate them to perform at even higher levels. That is because bonuses can vary according to outcomes. Financial incentives that allow variability in compensation to reflect an individual employee’s contribution are generally known as pay-for-performance programs. One of the many companies that use pay-for-performance programs is Allstate, which assigns employees’ individual performance one of five grades. The size of an employee’s bonus depends on his or her grade. For example, one worker may receive a bonus of 5.5 percent of her annual pay, but the worker in the next cubicle doing the exact same job—though less efficiently or productively—may receive only 2 percent. The pay-for-performance approach can also be used for CEOs. Tesla announced that CEO Elon Musk’s compensation could be worth up to $55.8 billion over the next ten years, or nothing. Musk’s compensation is tied to the market capitalization of the company. The percentage of annual payroll companies commit for pay-for-performance bonuses has fluctuated slightly in recent years but remains above 12 percent and is expected to continue. ### Summary of Learning Outcomes 1. How can managers redesign existing jobs to increase employee motivation and performance? The horizontal expansion of a job, which involves increasing the number and variety of tasks that a person performs, is called job enlargement. Increasing task diversity can enhance job satisfaction, particularly when the job is mundane and repetitive in nature. Job enrichment is the vertical expansion of an employee’s job to provide the employee with more autonomy, responsibility, and decision-making authority. Other popular motivational tools include work-scheduling options, employee-recognition programs, empowerment, and variable-pay programs.

# Motivating Employees ## Trends in Employee Motivation 1. What initiatives are organizations using today to motivate and retain employees? This chapter has focused on understanding what motivates people and how employee motivation and satisfaction affect productivity and organizational performance. Organizations can improve performance by investing in people. In reviewing the ways companies are currently choosing to invest in their human resources, we can spot four positive trends: (1) education and training, (2) employee ownership, (3) work-life benefits, and (4) nurturing knowledge workers. All of the companies making Fortune’s annual list of the “100 Best Companies to Work For” know the importance of treating employees right. They all have programs that allow them to invest in their employees through programs such as these and many more. Today’s businesses also face the challenge of increased costs of absenteeism. This section discusses each of these trends in motivating employees. ### Education and Training Companies that provide educational and training opportunities for their employees reap the benefits of a more motivated, as well as a more skilled, workforce. Employees who are properly trained in new technologies are more productive and less resistant to job change. Education and training provide additional benefits by increasing employees’ feelings of competence and self-worth. When companies spend money to upgrade employee knowledge and skills, they convey the message “we value you and are committed to your growth and development as an employee.” ### Employee Ownership A trend that seems to have leveled off is employee ownership, most commonly implemented as employee stock ownership plans, or ESOPs. ESOPs are not the same as stock options, however. In an ESOP, employees receive compensation in the form of company stock. Recall that stock options give employees the opportunity to purchase company stock at a set price, even if the market price of the stock increases above that point. Because ESOP employees are compensated with stock, over time they can become the owners of the company, an attractive exit strategy for current owners seeking a smooth transition. Behind employee ownership programs is the belief that employees who think like owners are more motivated to take care of customers’ needs, reduce unnecessary expenses, make operations smoother, and stay with the company longer. According to the National Center for Employee Ownership, there are roughly 6,717 ESOPs in the United States, with a total of 14 million participants. Despite changes in tax laws that resulted in a decrease in the number of publicly traded companies with ESOPs and the closure of dubious plans, the amount of stock held by ESOPs continues to increase. Multiple studies over 30 years conclude definitively that employee ownership results in a powerful competitive tool when combined with participative management. ESOPs, however, also have drawbacks. The biggest concern is that some employees have so much of their nest eggs tied to their company’s ESOP. If the company’s performance starts to decline, they risk losing a significant portion of their wealth. This is what happened at Piggly Wiggly Carolina, a chain of grocery stores. Business started to decline. Employee and retirees watched as senior management made decisions to raise prices and then sell stores. The share value started declining each year, losing 90 percent of its value, until employees received notice the company did not have enough value to pay distributions that year. The notice stated that trustees planned to continue selling assets in the hope of making future payments. Former employees filed a lawsuit alleging senior management decisions resulted in lining their own pockets at the cost of the company’s value. Still, many companies successfully implement ESOPs. Axia Home Loans, a national residential mortgage lender based in Seattle, experienced record-breaking production and was able to attract top talent in the first year after creating its ESOP. After taking questions from non-managing shareholders about exit strategies, Gellert Dornay, president and CEO, looked into an ESOP and thought it would fit with the company’s innovative and forward-thinking culture. “Studies show that employee-owned companies experience increased employee satisfaction, retention, and productivity gains,” Dornay said, adding, “an ESOP rewards employees who contribute to the company’s success by allowing them to share in the company’s future increase in value.” So what enables one company with an ESOP, such as Axia Home Loans, to be more successful than another, such as Piggly Wiggly? It has a lot to do with the way companies treat employees. You can’t just call an employee an owner and expect them to respond positively. You have to do something to make them feel like an owner and then involve them as owners. Piggly Wiggly illustrates that employee ownership is not a magic elixir. “When employees run the company, our decision methodology is different. Everything is in the primary best interest of the shareholders, who are the employees,” Dornay said. ### Work-Life Benefits In another growing trend in the workplace, companies are helping their employees to manage the numerous and sometimes competing demands in their lives. Organizations are taking a more active role in helping employees achieve a balance between their work responsibilities and their personal obligations. The desired result is employees who are less stressed, better able to focus on their jobs, and, therefore, more productive. One tool companies are using to help their employees achieve work-life balance is the sabbatical. Sabbaticals can be traced back to the need for an incentive that would attract potential faculty members to Harvard University in the late 1800s. Today, sabbaticals can mean time off of a month or more, paid or unpaid. In today’s business environment, companies are juggling cutting costs and increasing profits while simultaneously battling to keep employees motivated and positive about work. Sabbaticals can be an important tool to help managers achieve this balancing act. Reports vary on whether the use of sabbaticals is rising or declining, but all agree that everyone benefits when employees take them. One benefit is that employees return refreshed and recharged. Morris Financial Concepts, Inc., a small financial planning firm, offers all full-time employees a paid, month-long sabbatical every five years. Kyra Morris, president and owner, says employees were working during vacations, even when discouraged not to. They are required to unplug during sabbaticals. Morris says sabbaticals work for both millennials and older employees and are a great recruiting tool. Zillow, the online real estate giant, offers six-week half-paid sabbaticals to employees at all levels of the organization after six years. Amy Bohutinsky, Zillow Group’s chief operating officer, says the company wants to reward long-term employees, encourage them to have a life outside of work, and have them come back recharged. Another benefit is the opportunity to learn new skills, which can be an alternative to layoffs. Buffer, a social media management platform, avoided laying off an employee by creating a 12-week, in-house sabbatical at 50 percent pay for him to learn new skills—skills the company needed—to successfully transition into another department. Learning sabbaticals fit the company’s value of self-improvement. ### Nurturing Knowledge and Learning Workers Most organizations have specialized workers, and managing them all effectively is a big challenge. In many companies, knowledge workers may have a supervisor, but they are not “subordinates.” They are “associates.” Within their area of knowledge, they are supposed to do the telling. Because knowledge is effective only if specialized, knowledge workers are not homogeneous, particularly the fast-growing group of knowledge technologists such as computer systems specialists, lawyers, programmers, and others. And because knowledge work is specialized, it is deeply splintered. A knowledge-based workforce is qualitatively different from a less-skilled workforce. Increasingly, the success—indeed, the survival—of every business will depend on the performance of its knowledge workforce. The challenging part of managing knowledge workers is finding ways to motivate proud, skilled professionals to share expertise and cooperate in such a way that they advance the frontiers of their knowledge to the benefit of the shareholders and society in general. To achieve that auspicious goal, several companies have created what they call “communities of practice.” ### Coping with the Rising Costs of Absenteeism With today’s companies trying to do more work with fewer employees, managers must be attentive to two major trends that affect the performance and morale of their employees: absenteeism and turnover. According to the Bureau of Labor Statistics, the absence rate for full-time workers has remained relatively steady in recent years, slightly below 3 percent, for absences due to the employee’s own illness, injury, or medical problems; child care problems; other family or personal obligations; civic or military duty; and maternity or paternity leave. Every day almost 3 percent of the full-time workforce does not show up for work, and this costs companies billions per year. However, not all reasons for unscheduled absences are genuine. CareerBuilder, a global end-to-end human capital solutions company, reports that 40 percent of unscheduled absences in 2017 were due to employees calling in sick when not. The top two reasons employees gave were a doctor’s appointment and just didn’t feel like going to work. Needing to relax, needing to catch up on sleep, running errands, catching up on housework, and plans with family and friends were also listed. While some employees are taking a day off, employees covering for unscheduled absences are pushed to do more. The result is lower productivity and lower morale, especially if chronic absenteeism is not addressed. In addition to an attendance policy, offering incentives for attendance, wellness programs, employee assistance programs, and other benefits that show care for employees can lower absenteeism rates. Another trend related to employee morale and absenteeism is turnover. The number of employees who are job-searching is on the rise. A recent Gallup survey found that 51 percent of current employees are looking to leave their current job, but an IBM survey found only 16 percent are actively seeking new employment. Both figures are great cause for concern. A high rate of turnover can be expensive and dampen the morale of other employees who watch their colleagues leave the company. The biggest reasons behind increasing turnover rates: career opportunities elsewhere and to get away from a bad manager. High rates of turnover (or absenteeism) at the management level can be destabilizing for employees, who need to develop specific strategies to manage a steady flow of new bosses. High rates of turnover (or absenteeism) at the employee level compromises the company’s ability to perform at its highest levels. In order to stay competitive, companies need to have programs in place to motivate employees to come to work each day and to stay with the company year after year. ### Summary of Learning Outcomes 1. What initiatives are organizations using today to motivate and retain employees? Today firms are using several key tactics to motivate and retain workers. First, companies are investing more in employee education and training, which makes employees more productive and confident in their jobs. Second, managers are giving employees the opportunity to participate in the ownership of the company, which can strongly increase employee commitment. Employers are providing more work-life benefits to employees, and a small but growing percentage of companies is offering employees paid sabbaticals in addition to regular vacation and sick time. As the composition of the workforce changes, it is becoming increasingly important for companies to understand how to manage knowledge workers. One method of doing this is establishing communities of practice that enable workers to share expertise across the organization. Finally, managers in today’s business environment need to pay special attention to managing absence rates and employee (and management) turnover. ### Preparing for Tomorrow’s Workplace Skills 1. Are you motivated more by intrinsic rewards (satisfaction, sense of accomplishment, etc.) or by extrinsic rewards (money, bonuses, etc.)? Interview some friends and classmates to find out what motivates them. Discuss your differences in perspective. (Interpersonal, Information) 2. Think of a task or project you have completed recently that required a great deal of effort. What motivated you to exert so much energy to complete the task or project? Describe your motivation in terms of the theories presented in the chapter. (Systems) 3. Not all jobs are intrinsically motivating. For example, many entry-level jobs often involve repetitive and simple tasks that can become rapidly boring. (You may have worked a job that fits that description.) How can managers motivate frontline employees (such as fast-food cashiers, trash collectors, supermarket cashiers, etc.) to perform at high levels? (Systems, Interpersonal) 4. If you were offered the opportunity to job-share, would you need to have a partner who was motivated by the same things as you are? Why or why not? (Interpersonal) 5. Team Activity Assemble a team of three to five students. Imagine that you are the management team for a start-up business with limited resources but a need for a highly motivated, skilled workforce. Brainstorm ways you could motivate your employees other than large bonuses and high salaries. (Resources) ### Ethics Activity You join a large bank that encourages and promotes employee volunteerism, allowing employees one day a month, or up to 12 days a year, to volunteer for a cause of their choosing. Shortly after you start working there as a junior teller, your boss’s wife is diagnosed with a particularly aggressive form of breast cancer that carries a very poor prognosis. Realizing it will win you kudos with your boss, you choose the local chapter of the Susan G. Komen for the Cure foundation—a breast cancer charity that sponsors an annual Race for the Cure—for your company-sponsored volunteer work. In addition to working at the foundation’s office one day a month, you spend your own time actively soliciting other staffers at your firm to sign up for the charity walk in a few months’ time. Impressed with your qualities of tireless dedication, your boss puts your name forward for promotion to junior bank officer, well before the customary two years of service normally required for being considered for promotion. Using a web search tool, locate articles about this topic and then write responses to the following questions. Be sure to support your arguments and cite your sources. Ethical Dilemma: Your company is generous in its approach to employee volunteerism. It gives you paid time off, and you acquire enhanced job skills through your volunteer activities. Have you just been smart in recognizing the value of volunteering for a charity that you know will earn your boss’s personal appreciation? Or are you taking unfair advantage of your boss’s vulnerability and manipulating the situation? ### Working the Net 1. Looking for 1,001 ways to motivate or reward your employees? Bob Nelson can help. Visit his Nelson Motivation site at http://www.nelson-motivation.com to get some ideas you can put to use to help you do a better job, either as a manager or as an employee. 2. Some companies offer their employees stock ownership plans. To learn the differences between an ESOP and stock options, visit the National Center for Employee Ownership (NCEO) at http://www.nceo.org and the Foundation for Enterprise Development (FED) at http://www.fed.org. Which stock plan would you rather have? Why? 3. Open-book management is one of the better-known ways to create a participatory work environment. Over 2,000 companies have adopted this practice, which involves sharing financial information with nonmanagement employees and training them to understand financial information. Does it really motivate employees and improve productivity? The NCEO website, http://www.nceo.org, has a number of articles on open-book management. Read several of the articles to get more insight into this practice, and then develop your answers to this question. 4. You’ve been asked to develop a staff recognition program for your company but don’t have a clue where to start. Three sites with articles and other useful information are Incentive magazine, http://www.incentivemag.com, the National Association for Employee Recognition, http://www.recognition.org, and the U.S. Office of Personnel Management, https://www.opm.gov. Using the material you’ll find there, outline the plan you would recommend for your company. 5. You have two great job opportunities. Both are equally attractive in terms of job content and offer the same salary. However, one offers year-end bonuses, whereas the other includes stock options for employees. How do you compare the offers? Learn how to evaluate stock options at the Money section of How Stuff Works, https://money.howstuffworks.com. Prepare a comparison of bonuses versus stock options, and determine which appeals to you more. Explain your reasons. 6. Use a search engine to find companies that offer “work-life benefits.” Link to several companies and review their employee programs in this area. How do they compare? Which benefits would be most important to you if you were job hunting, and why? ### Creative Thinking Case ### Motivating Employees: A Monster of a Problem As mentioned earlier, U.S. businesses will face a decrease in the available workforce due in part to a smaller generation of talented workers replacing retiring baby boomers. “Our study reveals that recruiters and hiring managers are not only cognizant of the issue but are concerned about its current and future impact on organizational growth,” said Dr. Jesse Harriott, former vice president of research at monster.com (http://www.monster.com), one of the leading global online career and recruitment resources. “Businesses of all sizes and across all industries must develop and implement creative programs and strategies to attract and hire top candidates while retaining and motivating current employees. As the talent pool shrinks, it is imperative that immediate action is taken to ensure businesses are properly prepared and staffed for the future.” In a sampling of over 600 human resource managers, Monster’s survey showed that over 75 percent believe compensation is one of the top three motivators that prevent employees from leaving their job. The fact that money motivates top-performing employees is supported by almost half the human resources professionals surveyed for a Rewards Program and Incentive Compensation Survey released by the Society of Human Resource Management. The survey also found that neither monetary nor nonmonetary rewards were effective motivators for underperformers. While compensation is clearly a significant issue, not all companies can offer this advantage. Other strategies that motivate employee loyalty and commitment are necessary. Some of these include making supervisors more accountable for worker retention, promoting work-life balance for employees, fostering a workplace where employee expectations are clearly articulated, creating learning and development programs that groom employees for future management roles, implementing performance-based systems that identify and proactively manage top employees and when possible promote from within, creating mentoring programs that match new employees with seasoned veterans, monitoring sentiment throughout the employee life cycle, and creating an employment brand “experience” that not only motivates and energizes employees but can also be used to attract new talent. Diana Pohly, president, CEO, and owner of The Pohly Company, keeps vigilant watch over the morale of the office, ensuring that employees are satisfied. “Business owners of growing companies must possess strong leadership and management skills in order to solidify the foundation of their business,” said Pohly. “Effective team leadership is imperative to sustain efficient team workflows and contribute to employee morale.” “Employees are the lifeblood of any organization. Building a positive work environment is an important strategy in attracting, retaining and motivating a team,” says Michelle Swanda, corporate marketing manager of The Principal. Improving employee morale with creative and effective management tactics ultimately boosts employee productivity, and that goes straight to the bottom line. 2. How are social and economic factors influencing companies’ approach to hiring, motivating, and retaining employees? 3. What are some of the nonmonetary strategies companies must develop to attract and reward employees and keep them motivated? 4. What “reward factors” would be important to you when working for a company? List at least five in order of importance, and list your reasons for each. Sources: “Company Overview of Globoforce Group plc,” https://www.bloomberg.com, accessed January 24, 2018; “Diana Pohly,” The Pohly Company, https://www.pohlyco.com, accessed January 24, 2018; “Michelle Swanson,” Zoom Info, https://www.zoominfo.com, accessed January 24, 2018; “70 Percent of HR Managers Concerned about Workforce Retention, According to Monster Study,” Business Wire, Jan 9, 2006, http://www.findarticles.com; “Poll Says Top-Performing Workers Motivated By Money,” Nation’s Restaurant News, April 25, 2005, http://www.findarticles.com; “Team Motivation: Women Business Owners Increase Productivity Through Effective Leadership,” Business Wire, Oct 27, 2005, http://www.findarticles.com. ### Hot Links Address Book 1. What makes a company a good place to work? Find out by reading about the companies on Fortune magazine’s “100 Best Companies to Work For” at http://www.fortune.com. 2. Expand your knowledge about motivation in the workplace at Accel-Team’s site, http://dheise.andrews.edu/Content/leadership/comps/6b/1biblio/accel-team.htm 3. How do you keep employees satisfied? The Business Research Lab has a series of tips and articles, which you’ll find at the Articles & Stories page of http://busreslab.com. 4. For many resources to help motivate, reward, and retain employees, visit https://www.thebalance.com/employee-motivation-4073608. 5. Wish you could have flexible hours? For advice on making this wish come true, visit this Career Planning page on flextime, https://www.thebalance.com/flextime-hours-and-benefits-1177979. 6. Association for Training Development is a professional association and leading resource on workplace learning and performance issues. Visit its site, https://www.td.org/, to learn more about it and these topics.

# Achieving World-Class Operations Management ## Introduction ### Learning Outcomes After reading this chapter, you should be able to answer these questions: 1. Why is production and operations management important in both manufacturing and service firms? 2. What types of production processes do manufacturers and service firms use? 3. How do organizations decide where to put their production facilities? What choices must be made in designing the facility? 4. Why are resource-planning tasks such as inventory management and supplier relations critical to production? 5. How do operations managers schedule and control production? 6. How can quality-management and lean-manufacturing techniques help firms improve production and operations management? 7. What roles do technology and automation play in manufacturing and service-industry operations management? 8. What key trends are affecting the way companies manage production and operations? Nearly every type of business organization needs to find the most efficient and effective methods of producing the goods or services it sells to its customers. Technological advances, ongoing competition, and consumer expectations force companies to rethink where, when, and how they will produce products or services. Manufacturers have discovered that it is no longer enough to simply push products through the factory and onto the market. Consumers demand high quality at reasonable prices. They also expect manufacturers to deliver products in a timely manner. Firms that can’t meet these expectations often face strong competition from businesses that can. To compete, many manufacturers are streamlining how they make their products—by automating their factories, developing new production processes, focusing on quality-control techniques, and improving relationships with suppliers. Service organizations also face challenges. Their customers are demanding better service, shorter waiting periods, and more individualized attention. Like manufacturers, service companies are using new methods to deliver what their customers need and want. Banks, for example, are using technology such as online banking and mobile apps to make their services more accessible to customers. Colleges offer online courses to accommodate the schedules of working students. Tax services file tax returns via the cloud. This chapter examines how manufacturers and service firms manage and control the creation of products and services. We’ll discuss production planning, including the choices firms must make concerning the type of production process they will use; the location where production will occur; the design of the facility; and the management of resources needed in production. Next, we’ll explain routing and scheduling, two critical tasks for controlling production and operations efficiency. Then we will look at how firms can improve production and operations by employing quality management and lean-manufacturing techniques. Finally, we will review some of the trends affecting production and operations management.

# Achieving World-Class Operations Management ## Production and Operations Management—An Overview 1. Why is production and operations management important in both manufacturing and service firms? Production, the creation of products and services, is an essential function in every firm. Production turns inputs, such as natural resources, raw materials, human resources, and capital, into outputs, which are products and services. This process is shown in . Managing this conversion process is the role of operations management. The goal of customer satisfaction is an important part of effective production and operations. In the past, the manufacturing function in most companies was inwardly focused. Manufacturing had little contact with customers and didn’t always understand their needs and desires. In the 1980s, many U.S. industries, such as automotive, steel, and electronics, lost customers to foreign competitors because their production systems could not provide the quality customers demanded. As a result, today most American companies, both large and small, consider a focus on quality to be a central component of effective operations management. Stronger links between marketing and manufacturing also encourage production managers to be more outwardly focused and to consider decisions in light of their effect on customer satisfaction. Service companies find that making operating decisions with customer satisfaction in mind can be a competitive advantage. Operations managers, the people charged with managing and supervising the conversion process, play a vital role in today’s firm. They control about three-fourths of a firm’s assets, including inventories, wages, and benefits. They also work closely with other major divisions of the firm, such as marketing, finance, accounting, and human resources, to ensure that the firm produces its goods profitably and satisfies its customers. Marketing personnel help them decide which products to make or which services to offer. Accounting and human resources help them face the challenge of combining people and resources to produce high-quality goods on time and at reasonable cost. They are involved in the development and design of goods and determine what production processes will be most effective. Production and operations management involve three main types of decisions, typically made at three different stages: 1. Production planning. The first decisions facing operations managers come at the planning stage. At this stage, managers decide where, when, and how production will occur. They determine site locations and obtain the necessary resources. 2. Production control. At this stage, the decision-making process focuses on controlling quality and costs, scheduling, and the actual day-to-day operations of running a factory or service facility. 3. Improving production and operations. The final stage of operations management focuses on developing more efficient methods of producing the firm’s goods or services. All three decisions are ongoing and may occur simultaneously. In the following sections, we will take a closer look at the decisions and considerations firms face in each stage of production and operations management. ### Gearing Up: Production Planning An important part of operations management is production planning. Production planning allows the firm to consider the competitive environment and its own strategic goals to find the best production methods. Good production planning has to balance goals that may conflict, such as providing high-quality service while keeping operating costs low, or keeping profits high while maintaining adequate inventories of finished products. Sometimes accomplishing all these goals is difficult. Production planning involves three phases. Long-term planning has a time frame of three to five years. It focuses on which goods to produce, how many to produce, and where they should be produced. Medium-term planning decisions cover about two years. They concern the layout of factory or service facilities, where and how to obtain the resources needed for production, and labor issues. Short-term planning, within a one-year time frame, converts these broader goals into specific production plans and materials management strategies. Four important decisions must be made in production planning. They involve the type of production process that will be used, site selection, facility layout, and resource planning. ### Summary of Learning Outcomes 1. Why is production and operations management important in both manufacturing and service firms? In the 1980s, many U.S. manufacturers lost customers to foreign competitors because their production and operations management systems did not support the high-quality, reasonably priced products consumers demanded. Service organizations also rely on effective operations management in order to satisfy consumers. Operations managers, the personnel charged with managing and supervising the conversion of inputs into outputs, work closely with other functions in organizations to help ensure quality, customer satisfaction, and financial success.

# Achieving World-Class Operations Management ## The Production Process: How Do We Make It? 1. What types of production processes do manufacturers and service firms use? In production planning, the first decision involves which type of production process—the way a good or service is created—best fits with company goals and customer demand. An important consideration is the type of good or service being produced, because different goods may require different production processes. In general, there are three types of production: mass production, mass customization, and customization. In addition to production type, operations managers also classify production processes in two ways: (1) how inputs are converted into outputs and (2) the timing of the process. ### One for All: Mass Production Mass production, manufacturing many identical goods at once, was a product of the Industrial Revolution. Henry Ford’s Model-T automobile is a good example of early mass production. Each car turned out by Ford’s factory was identical, right down to its color. If you wanted a car in any color except black, you were out of luck. Canned goods, over-the-counter drugs, and household appliances are other examples of goods that are mass-produced. The emphasis in mass production is on keeping manufacturing costs low by producing uniform products using repetitive and standardized processes. As products became more complicated to produce, mass production also became more complex. Automobile manufacturers, for example, must now incorporate more sophisticated electronics into their car designs. As a result, the number of assembly stations in most automobile manufacturing plants has increased. ### Just for You: Customizing Goods In mass customization, goods are produced using mass-production techniques, but only up to a point. At that point, the product or service is custom-tailored to the needs or desires of individual customers. For example, American Leather, a Dallas-based furniture manufacturer, uses mass customization to produce couches and chairs to customer specifications within 30 days. The basic frames in the furniture are the same, but automated cutting machinery precuts the color and type of leather ordered by each customer. Using mass-production techniques, they are then added to each frame. Customization is the opposite of mass production. In customization, the firm produces goods or services one at a time according to the specific needs or wants of individual customers. Unlike mass customization, each product or service produced is unique. For example, a print shop may handle a variety of projects, including newsletters, brochures, stationery, and reports. Each print job varies in quantity, type of printing process, binding, color of ink, and type of paper. A manufacturing firm that produces goods in response to customer orders is called a job shop. Some types of service businesses also deliver customized services. Doctors, for instance, must consider the illnesses and circumstances of each individual patient before developing a customized treatment plan. Real estate agents may develop a customized service plan for each customer based on the type of house the person is selling or wants to buy. The differences between mass production, mass customization, and customization are summarized in . ### Converting Inputs to Outputs As previously stated, production involves converting inputs (natural resources, raw materials, human resources, capital) into outputs (products or services). In a manufacturing company, the inputs, the production process, and the final outputs are usually obvious. Harley-Davidson, for instance, converts steel, rubber, paint, and other inputs into motorcycles. But the production process in a service company involves a less obvious conversion. For example, a hospital converts the knowledge and skills of its medical personnel, along with equipment and supplies from a variety of sources, into health care services for patients. provides examples of the inputs and outputs used by various other businesses. There are two basic processes for converting inputs into outputs. In process manufacturing, the basic inputs (natural resources, raw materials) are broken down into one or more outputs (products). For instance, bauxite (the input) is processed to extract aluminum (the output). The assembly process is just the opposite. The basic inputs, like natural resources, raw materials, or human resources, are either combined to create the output or transformed into the output. An airplane, for example, is created by assembling thousands of parts, which are its raw material inputs. Steel manufacturers use heat to transform iron and other materials into steel. In services, customers may play a role in the transformation process. For example, a tax preparation service combines the knowledge of the tax preparer with the client’s information about personal finances in order to complete the tax return. ### Production Timing A second consideration in choosing a production process is timing. A continuous process uses long production runs that may last days, weeks, or months without equipment shutdowns. This is best for high-volume, low-variety products with standardized parts, such as nails, glass, and paper. Some services also use a continuous process. Your local electric company is an example. Per-unit costs are low, and production is easy to schedule. In an intermittent process, short production runs are used to make batches of different products. Machines are shut down to change them to make different products at different times. This process is best for low-volume, high-variety products such as those produced by mass customization or customization. Job shops are examples of firms using an intermittent process. Although some service companies use continuous processes, most service firms rely on intermittent processes. For instance, a restaurant preparing gourmet meals, a physician performing surgical procedures, and an advertising agency developing ad campaigns for business clients all customize their services to suit each customer. They use the intermittent process. Note that their “production runs” may be very short—one grilled salmon or one physical exam at a time. ### Summary of Learning Outcomes 1. What types of production processes do manufacturers and service firms use? Products are made using one of three types of production processes. In mass production, many identical goods are produced at once, keeping production costs low. Mass production, therefore, relies heavily on standardization, mechanization, and specialization. When mass customization is used, goods are produced using mass-production techniques up to a point, after which the product or service is custom-tailored to individual customers by adding special features. When a firm’s production process is built around customization, the firm makes many products one at a time according to the very specific needs or wants of individual customers.

# Achieving World-Class Operations Management ## Location, Location, Location: Where Do We Make It? 1. How do organizations decide where to put their production facilities? What choices must be made in designing the facility? A big decision that managers must make early in production and operations planning is where to put the facility, be it a factory or a service office. The facility’s location affects operating and shipping costs and, ultimately, the price of the product or service and the company’s ability to compete. Mistakes made at this stage can be expensive, because moving a factory or service facility once production begins is difficult and costly. Firms must weigh a number of factors to make the right decision. ### Availability of Production Inputs As we discussed earlier, organizations need certain resources to produce products and services for sale. Access to these resources, or inputs, is a huge consideration in site selection. Executives must assess the availability of raw materials, parts, equipment, and available manpower for each site under consideration. The cost of shipping raw materials and finished goods can be as much as 25 percent of a manufacturer’s total cost, so locating a factory where these and other costs are as low as possible can make a major contribution to a firm’s success. Companies that use heavy or bulky raw materials, for example, may choose to be located close to their suppliers. Mining companies want to be near ore deposits, oil refiners near oil fields, paper mills near forests, and food processors near farms. Bottlers are discovering that rural western communities in need of an economic boost make rich water sources. In Los Lunas, New Mexico, it made sense for Niagara Purified Drinking Water to produce purified bottled water in a 166,000 square foot building that was vacant. The business helps diversify the town’s economy and created 40 new, much-needed jobs. The availability and cost of labor are also critical to both manufacturing and service businesses, and the unionization of local labor is another point to consider in many industries. Payroll costs can vary widely from one location to another due to differences in the cost of living; the number of jobs available; and the size, skills, and productivity of the local workforce. In the case of the water-bottling company, a ready pool of relatively inexpensive labor was available due to high unemployment in the areas. ### Marketing Factors Businesses must evaluate how their facility location will affect their ability to serve their customers. For some firms it may not be necessary to be located near customers. Instead, the firm will need to assess the difficulty and costs of distributing its goods to customers from its chosen location. Other firms may find that locating near customers can provide marketing advantages. When a factory or service center is close to customers, the firm can often offer better service at a lower cost. Other firms may gain a competitive advantage by locating their facilities so that customers can easily buy their products or services. The location of competitors may also be a consideration. And businesses with more than one facility may need to consider how far to spread their locations in order to maximize market coverage. ### Manufacturing Environment Another factor to consider is the manufacturing environment in a potential location. Some localities have a strong existing manufacturing base. When a large number of manufacturers in a certain industry are already located in an area, that area is likely to offer greater availability of resources, such as manufacturing workers, better accessibility to suppliers and transportation, and other factors that can increase a plant’s operating efficiency. Nestlé is proposing to open a new bottled water plant in the desert city of Phoenix. The plants have provided much-needed employment to replace jobs lost in the recession of 2008. The city of Phoenix faced opposition to the plant because some locals thought that diverting water from tap water to a for-profit entity was not a sound idea. Phoenix officials contend that the source of water is adequate for decades to come. ### Local Incentives Incentives offered by countries, states, or cities may also influence site selection. Tax breaks are a common incentive. A locality may reduce the amount of taxes a firm must pay on income, real estate, utilities, or payroll. Local governments may offer financial assistance and/or exemptions from certain regulations to attract or keep production facilities in their area. For example, many U.S. cities are competing to attract a second Amazon headquarters and, in addition to touting local attractions and a strong workforce, most of them are offering a host of tax incentives. ### International Location Considerations There are often sound financial reasons for considering a foreign location. Labor costs are considerably lower in countries such as Singapore, China, India, and Mexico. Foreign countries may also have fewer regulations governing how factories operate. A foreign location may also move production closer to new markets. Automobile manufacturers such as Toyota, BMW, and Hyundai are among many that build plants in the United States to reduce shipping costs. ### Designing the Facility After the site location decision has been made, the next focus in production planning is the facility’s layout. The goal is to determine the most efficient and effective design for the particular production process. A manufacturer might opt for a U-shaped production line, for example, rather than a long, straight one, to allow products and workers to move more quickly from one area to another. Service organizations must also consider layout, but they are more concerned with how it affects customer behavior. It may be more convenient for a hospital to place its freight elevators in the center of the building, for example, but doing so may block the flow of patients, visitors, and medical personnel between floors and departments. There are three main types of facility layouts: process, product, and fixed-position. All three layouts are illustrated in . Cellular manufacturing is another type of facility layout. ### Process Layout: All Welders Stand Here The process layout arranges workflow around the production process. All workers performing similar tasks are grouped together. Products pass from one workstation to another (but not necessarily to every workstation). For example, all grinding would be done in one area, all assembling in another, and all inspection in yet another. The process layout is best for firms that produce small numbers of a wide variety of products, typically using general-purpose machines that can be changed rapidly to new operations for different product designs. For example, a manufacturer of custom machinery would use a process layout. ### Product Layout: Moving Down the Line Products that require a continuous or repetitive production process use the product (or assembly-line) layout. When large quantities of a product must be processed on an ongoing basis, the workstations or departments are arranged in a line with products moving along the line. Automobile and appliance manufacturers, as well as food-processing plants, usually use a product layout. Service companies may also use a product layout for routine processing operations. ### Fixed-Position Layout: Staying Put Some products cannot be put on an assembly line or moved about in a plant. A fixed-position layout lets the product stay in one place while workers and machinery move to it as needed. Products that are impossible to move—ships, airplanes, and construction projects—are typically produced using a fixed-position layout. Limited space at the project site often means that parts of the product must be assembled at other sites, transported to the fixed site, and then assembled. The fixed-position layout is also common for on-site services such as housecleaning services, pest control, and landscaping. ### Cellular Manufacturing: A Start-to-Finish Focus Cellular manufacturing combines some aspects of both product and fixed-position layouts. Work cells are small, self-contained production units that include several machines and workers arranged in a compact, sequential order. Each work cell performs all or most of the tasks necessary to complete a manufacturing order. There are usually five to 10 workers in a cell, and they are trained to be able to do any of the steps in the production process. The goal is to create a team environment wherein team members are involved in production from beginning to end. ### Summary of Learning Outcomes 1. How do organizations decide where to put their production facilities? What choices must be made in designing the facility? Site selection affects operating costs, the price of the product or service, and the company’s ability to compete. In choosing a production site, firms must weigh the availability of resources—raw materials, manpower, and even capital—needed for production, as well as the ability to serve customers and take advantage of marketing opportunities. Other factors include the availability of local incentives and the manufacturing environment. Once a site is selected, the firm must choose an appropriate design for the facility. The three main production facility designs are process, product, and fixed-position layouts. Cellular manufacturing is another type of facility layout.

# Achieving World-Class Operations Management ## Pulling It Together: Resource Planning 1. Why are resource-planning tasks such as inventory management and supplier relations critical to production? As part of the production-planning process, firms must ensure that the resources needed for production—such as raw materials, parts, equipment, and labor—will be available at strategic moments in the production process. This can be a huge challenge. The components used to build just one Boeing airplane, for instance, number in the millions. Cost is also an important factor. In many industries, the cost of materials and supplies used in the production process amounts to as much as half of sales revenues. Resource planning is therefore a big part of any firm’s production strategy. Resource planning begins by specifying which raw materials, parts, and components will be required, and when, to produce finished goods. To determine the amount of each item needed, the expected quantity of finished goods must be forecast. A bill of material is then drawn up that lists the items and the number of each required to make the product. Purchasing, or procurement, is the process of buying production inputs from various sources. ### Make or Buy? The firm must decide whether to make its own production materials or buy them from outside sources. This is the make-or-buy decision. The quantity of items needed is one consideration. If a part is used in only one of many products, buying the part may be more cost-effective than making it. Buying standard items, such as screws, bolts, rivets, and nails, is usually cheaper and easier than producing them internally. Purchasing larger components from another manufacturer can be cost-effective as well. When items are purchased from an outside source instead of being made internally, it is called outsourcing. Harley-Davidson, for example, purchases its tires, brake systems, and other motorcycle components from manufacturers that make them to Harley’s specifications. However, if a product has special design features that need to be kept secret to protect a competitive advantage, a firm may decide to produce all parts internally. In deciding whether to make or buy, a firm must also consider whether outside sources can provide the high-quality supplies it needs in a reliable manner. Having to shut down production because vital parts aren’t delivered on time can be a costly disaster. Just as bad are inferior parts or materials, which can damage a firm’s reputation for producing high-quality goods. Therefore, firms that buy some or all of their production materials from outside sources should make building strong relationships with quality suppliers a priority. ### Inventory Management: Not Just Parts A firm’s inventory is the supply of goods it holds for use in production or for sale to customers. Deciding how much inventory to keep on hand is one of the biggest challenges facing operations managers. On the one hand, with large inventories, the firm can meet most production and customer demands. Buying in large quantities can also allow a company to take advantage of quantity discounts. On the other hand, large inventories can tie up the firm’s money, are expensive to store, and can become obsolete. Inventory management involves deciding how much of each type of inventory to keep on hand and the ordering, receiving, storing, and tracking of it. The goal of inventory management is to keep down the costs of ordering and holding inventories while maintaining enough on hand for production and sales. Good inventory management enhances product quality, makes operations more efficient, and increases profits. Poor inventory management can result in dissatisfied customers, financial difficulties, and even bankruptcy. One way to determine the best inventory levels is to look at three costs: holding inventory, frequent reordering, and not keeping enough inventory on hand. Managers must measure all three costs and try to minimize them. To control inventory levels, managers often track the use of certain inventory items. Most companies keep a perpetual inventory, a continuously updated list of inventory levels, orders, sales, and receipts, for all major items. Today, companies mostly use computers to track inventory levels, calculate order quantities, and issue purchase orders at the right times. ### Computerized Resource Planning Many manufacturing companies have adopted computerized systems to control the flow of resources and inventory. Materials requirement planning (MRP) is one such system. MRP uses a master schedule to ensure that the materials, labor, and equipment needed for production are at the right places in the right amounts at the right times. The schedule is based on forecasts of demand for the company’s products. It says exactly what will be manufactured during the next few weeks or months and when the work will take place. Sophisticated computer programs coordinate all the elements of MRP. The computer comes up with materials requirements by comparing production needs to the materials the company already has on hand. Orders are placed so items will be on hand when they are needed for production. MRP helps ensure a smooth flow of finished products. Manufacturing resource planning II (MRPII) was developed in the late 1980s to expand on MRP. It uses a complex computerized system to integrate data from many departments, including finance, marketing, accounting, engineering, and manufacturing. MRPII can generate a production plan for the firm, as well as management reports, forecasts, and financial statements. The system lets managers make more accurate forecasts and assess the impact of production plans on profitability. If one department’s plans change, the effects of these changes on other departments are transmitted throughout the company. Whereas MRP and MRPII systems are focused internally, enterprise resource planning (ERP) systems go a step further and incorporate information about the firm’s suppliers and customers into the flow of data. ERP unites all of a firm’s major departments into a single software program. For instance, production can call up sales information and know immediately how many units must be produced to meet customer orders. By providing information about the availability of resources, including both the human resources and materials needed for production, the system allows for better cost control and eliminates production delays. The system automatically notes any changes, such as the closure of a plant for maintenance and repairs on a certain date or a supplier’s inability to meet a delivery date, so that all functions adjust accordingly. Both large and small organizations use ERP to improve operations. ### Keeping the Goods Flowing: Supply-Chain Management In the past, the relationship between purchasers and suppliers was often competitive and antagonistic. Businesses used many suppliers and switched among them frequently. During contract negotiations, each side would try to get better terms at the expense of the other. Communication between purchasers and suppliers was often limited to purchase orders and billing statements. Today, however, many firms are moving toward a new concept in supplier relationships. The emphasis is increasingly on developing a strong supply chain. The supply chain can be thought of as the entire sequence of securing inputs, producing goods, and delivering goods to customers. If any links in this process are weak, chances are customers—the end point of the supply chain—will end up dissatisfied. Effective supply-chain strategies reduce costs. For example, integration of the shipper and customer’s supply chains allows companies to automate more processes and save time. Technology also improves supply-chain efficiency by tracking goods through the various supply-chain stages and helping with logistics. With better information about production and inventory, companies can order and receive goods at the optimal point to keep inventory holding costs low. Companies also need contingency plans for supply-chain disruptions. Is there an alternative source of supply if a blizzard closes the airport so that cargo planes can’t land or a drought causes crop failures in the Midwest? By thinking ahead, companies can avert major losses. The length and distance involved in a supply line is also a consideration. Importing parts from or outsourcing manufacturing to Asia creates a long supply chain for a manufacturer in Europe or the United States. Perhaps there are closer suppliers or manufacturers who can meet a company’s needs at a lower overall cost. Companies should also reevaluate outsourcing decisions periodically. ### Strategies for Supply-Chain Management Ensuring a strong supply chain requires that firms implement supply-chain management strategies. Supply-chain management focuses on smoothing transitions along the supply chain, with the ultimate goal of satisfying customers with quality products and services. A critical element of effective supply-chain management is to develop tight bonds with suppliers. This may mean reducing the number of suppliers used and asking them to offer more services or better prices in return for an ongoing relationship. General Motors plans to pare the number of its suppliers to give larger, longer-term contracts to a strategically selected group to be based in a new supplier park near its Texas-based SUV plant. GM is one of several manufacturing firms reconsidering far-flung suppliers in their supply chain. Global parts networks have long been seen as critical to cutting costs, but more companies are concluding they’re a risky bet due to political shifts, protectionist measures, and natural disasters. Instead of being viewed as “outsiders” in the production process, many suppliers play an important role in supporting the operations of their customers. They are expected to meet high quality standards, offer suggestions that can help reduce production costs, and even contribute to the design of new products. ### E-Procurement, Electronic Data Interchange, and Blockchain Effective supply chain management depends on strong communications with suppliers. Technology, particularly the internet, is providing new ways to do this. E-procurement, the process of purchasing supplies and materials online, is booming. Many manufacturing firms use the internet to keep key suppliers informed about their requirements. Intel, for example, has set up a special website for its suppliers and potential suppliers. Would-be suppliers can visit the site to get information about doing business with Intel; once they are approved, they can access a secure area to make bids on Intel’s current and future resource needs. The internet also streamlines purchasing by providing firms with quick access to a huge database of information about the products and services of hundreds of potential suppliers. Many large companies now participate in reverse auctions online, which can slash procurement costs. In a reverse auction, the manufacturer posts its specifications for the materials it requires. Potential suppliers then bid against each other to get the job. However, there are risks with reverse auctions. It can be difficult to establish and build ongoing relationships with specific suppliers using reverse auctions because the job ultimately goes to the lowest bidder. Therefore, reverse auctions may not be an effective procurement process for critical production materials. Other types of corporations can use these auctions as well. The U.S. Army utilizes reverse auctions to leverage technology to fight the reality and perception that it is inefficient in its procurement practices. The General Services Administration found that government agencies had 31 suppliers that were charging between $9.76 and $48.77 for the same hammer. In 2005 the U.S. Army began to partner with FedBid, Inc., the largest commercial marketplace for reverse auctions, for a variety of products, from paper to computers to helicopters. Costs dropped by $388 million according to independent government cost estimates over the past decade. Another communications tool is electronic data interchange (EDI), in which two trading partners exchange information electronically. EDI can be conducted via a linked computer system or over the internet. The advantages of exchanging information with suppliers electronically include speed, accuracy, and lowered communication costs. EDI plays a critical role in Ford Motor Company’s efforts to produce and distribute vehicles worldwide. With the emergence of blockchain technology, there is the potential to automate these types of processes to cover multiple transactions with a variety of participating organizations. ### Summary of Learning Outcomes 1. Why are resource-planning tasks such as inventory management and supplier relations critical to production? Production converts input resources, such as raw materials and labor, into outputs, finished products and services. Firms must ensure that the resources needed for production will be available at strategic moments in the production process. If they are not, productivity, customer satisfaction, and quality may suffer. Carefully managing inventory can help cut production costs while maintaining enough supply for production and sales. Through good relationships with suppliers, firms can get better prices, reliable resources, and support services that can improve production efficiency.

# Achieving World-Class Operations Management ## Production and Operations Control 1. How do operations managers schedule and control production? Every company needs to have systems in place to see that production and operations are carried out as planned and to correct errors when they are not. The coordination of materials, equipment, and human resources to achieve production and operating efficiencies is called production control. Two of its key aspects are routing and scheduling. ### Routing: Where to Next? Routing is the first step in production control. It sets out a work flow, the sequence of machines and operations through which a product or service progresses from start to finish. Routing depends on the type of goods being produced and the facility layout. Good routing procedures increase productivity and cut unnecessary costs. One useful tool for routing is value-stream mapping, whereby production managers “map” the flow from suppliers through the factory to customers. Simple icons represent the materials and information needed at various points in the flow. Value-stream mapping can help identify where bottlenecks may occur in the production process and is a valuable tool for visualizing how to improve production routing. Awning manufacturer Rader Awning & Upholstery used value-stream mapping to automate some of its operations. With the assistance of New Mexico Manufacturing Extension Partnership (MEP), the company evaluated how orders were processed from sales to manufacturing over two days. With the implementation of the processes suggested by MEP, productivity improved by 20 percent per salesperson, production defects decreased by 15 percent, and installation corrections dropped by 25 percent. ### Scheduling: When Do We Do It? Closely related to routing is scheduling. Scheduling involves specifying and controlling the time required for each step in the production process. The operations manager prepares timetables showing the most efficient sequence of production and then tries to ensure that the necessary materials and labor are in the right place at the right time. Scheduling is important to both manufacturing and service firms. The production manager in a factory schedules material deliveries, work shifts, and production processes. Trucking companies schedule drivers, clerks, truck maintenance, and repairs in accordance with customer transportation needs. Scheduling at a college entails deciding when to offer which courses, in which classrooms, with which instructors. A museum must schedule special exhibits, ship works to be displayed, market its offerings, and conduct educational programs and tours. Scheduling can range from simple to complex. Giving numbers to customers waiting to be served in a bakery and making interview appointments with job applicants are examples of simple scheduling. Organizations that must produce large quantities of products or services or service a diverse customer base face more complex scheduling problems. Three common scheduling tools used for complex situations are Gantt charts, the critical path method, and PERT. ### Tracking Progress with Gantt Charts Named after their originator, Henry Gantt, Gantt charts are bar graphs plotted on a time line that show the relationship between scheduled and actual production. In the example shown in , the left side of the chart lists the activities required to complete the job or project. Both the scheduled time and the actual time required for each activity are shown, so the manager can easily judge progress. Gantt charts are most helpful when only a few tasks are involved, when task times are relatively long (days or weeks rather than hours), and when job routes are short and simple. One of the biggest shortcomings of Gantt charts is that they are static. They also fail to show how tasks are related. These problems can be solved, however, by using two other scheduling techniques, the critical path method and PERT. ### The Big Picture: Critical Path Method and PERT To control large projects, operations managers need to closely monitor resources, costs, quality, and budgets. They also must be able to see the “big picture”—the interrelationships of the many different tasks necessary to complete the project. Finally, they must be able to revise scheduling and divert resources quickly if any tasks fall behind schedule. The critical path method (CPM) and the program evaluation and review technique (PERT) are related project management tools that were developed in the 1950s to help managers accomplish this. In the critical path method (CPM), the manager identifies all of the activities required to complete the project, the relationships between these activities, and the order in which they need to be completed. Then, the manager develops a diagram that uses arrows to show how the tasks are dependent on each other. The longest path through these linked activities is called the critical path. If the tasks on the critical path are not completed on time, the entire project will fall behind schedule. To better understand how CPM works, look at , which shows a CPM diagram for constructing a house. All of the tasks required to finish the house and an estimated time for each have been identified. The arrows indicate the links between the various steps and their required sequence. As you can see, most of the jobs to be done can’t be started until the house’s foundation and frame are completed. It will take five days to finish the foundation and another seven days to erect the house frame. The activities linked by brown arrows form the critical path for this project. It tells us that the fastest possible time the house can be built is 38 days, the total time needed for all of the critical path tasks. The noncritical path jobs, those connected with black arrows, can be delayed a bit or done early. Short delays in installing appliances or roofing won’t delay construction of the house because these activities don’t lie on the critical path. Like CPM, the program evaluation and review technique (PERT) helps managers identify critical tasks and assess how delays in certain activities will affect operations or production. In both methods, managers use diagrams to see how operations and production will flow. PERT differs from CPM in one important respect. CPM assumes that the amount of time needed to finish a task is known with certainty; therefore, the CPM diagram shows only one number for the time needed to complete each activity. In contrast, PERT assigns three time estimates for each activity: an optimistic time for completion, the most probable time, and a pessimistic time. These estimates allow managers to anticipate delays and potential problems and schedule accordingly. ### Summary of Learning Outcomes 1. How do operations managers schedule and control production? Routing is the first step in scheduling and controlling production. Routing analyzes the steps needed in production and sets out a workflow, the sequence of machines and operations through which a product or service progresses from start to finish. Good routing increases productivity and can eliminate unnecessary cost. Scheduling involves specifying and controlling the time and resources required for each step in the production process. Operations managers use three methods to schedule production: Gantt charts, the critical path method, and PERT.

# Achieving World-Class Operations Management ## Looking for a Better Way: Improving Production and Operations 1. How can quality-management and lean-manufacturing techniques help firms improve production and operations management? Competing in today’s business world is challenging. To compete effectively, firms must keep production costs down. At the same time, however, it’s becoming increasingly complex to produce and deliver the high-quality goods and services customers demand. Methods to help meet these challenges include quality-management techniques, lean manufacturing, and technology and automation. ### Putting Quality First Successful businesses recognize that quality and productivity must go hand in hand. Quality goods and services meet customer expectations by providing reliable performance. Defective products waste materials and time, increasing costs. Worse, poor quality causes customer dissatisfaction, which usually results in lost sales. A consumer measures quality by how well a product serves its purpose. From the manufacturer’s point of view, quality is the degree to which the product conforms to a set of predetermined standards. Quality control involves creating quality standards, producing goods that meet them, and measuring finished goods and services against them. It takes more than just inspecting goods at the end of the assembly line to ensure quality control, however. Quality control requires a company-wide dedication to managing and working in a way that builds excellence into every facet of operations. Dr. W. Edwards Deming, an American management consultant, was the first to say that quality control should be a company-wide goal. His ideas were adopted by the Japanese in the 1950s but largely ignored in the United States until the 1970s. Deming believed that quality control starts with top management, who must foster a company-wide culture dedicated to producing quality. Deming’s concept of Total Quality Management (TQM) emphasizes the use of quality principles in all aspects of a company’s production and operations. It recognizes that all employees involved with bringing a product or service to customers—marketing, purchasing, accounting, shipping, manufacturing—contribute to its quality. TQM focuses on continuous improvement, a commitment to constantly seek better ways of doing things in order to achieve greater efficiency and improve quality. Company-wide teams work together to prevent problems and systematically improve key processes instead of troubleshooting problems only as they arise. Continuous improvement continually measures performance using statistical techniques and looks for ways to apply new technologies and innovative production methods. Another quality-control method is the Six Sigma quality program. Six Sigma is a company-wide process that focuses on measuring the number of defects that occur and systematically eliminating them in order to get as close to “zero defects” as possible. In fact, Six Sigma quality aims to have every process produce no more than 3.4 defects per million. Six Sigma focuses on designing products that not only have fewer defects but that also satisfy customer needs. A key process of Six Sigma is called DMAIC. This stands for Define, Measure, Analyze, Improve, and Control. Employees at all levels define what needs to be done to ensure quality, then measure and analyze production results using statistics to see if standards are met. They are also charged with finding ways to improve and control quality. General Electric was one of the first companies to institute Six Sigma throughout the organization. GE employees are trained in Six Sigma concepts, and many analysts believe this has given GE a competitive manufacturing advantage. Service firms and government entities have applied Six Sigma to their quality initiatives as well. ### Malcolm Baldrige National Quality Award Named for a former secretary of commerce, the Malcolm Baldrige National Quality Award was established by the U.S. Congress in 1987 to recognize U.S. companies that offer goods and services of world-class quality. The award promotes awareness of quality and allows the business community to assess which quality control programs are most effective. Administered by the U.S. Department of Commerce’s National Institute of Standards and Technologies (NIST), the award’s most important criterion is a firm’s effectiveness at meeting customer expectations, as well as demonstrating that it offers quality goods and services. To qualify for the award, a company must also show continuous improvement in internal operations. Company leaders and employees must be active participants in the firm’s quality program, and they must respond quickly to data and analysis. Organizations in a wide variety of industries have won the Baldrige Award since it was first presented in 1987. In 2017, for example, the Baldrige Award winners included Bristol Tennessee Essential Services, an electricity and fiber services utility company, in the small business sector; the city of Fort Collins, Colorado, in the nonprofit sector; and Southcentral Foundation in Anchorage, Alaska, in the health care sector. ### Worldwide Excellence: International Quality Standards The International Organization for Standardization (ISO), located in Geneva, Switzerland, is an industry organization that has developed standards of quality that are used by businesses around the world. ISO 9000, introduced in the 1980s, is a set of five technical standards designed to offer a uniform way of determining whether manufacturing plants and service organizations conform to sound quality procedures. To register, a company must go through an audit of its manufacturing and customer service processes, covering everything from how it designs, produces, and installs its products, to how it inspects, packages, and markets them. Over 500,000 organizations worldwide have met ISO 9000 standards. ISO 14000, launched after ISO 9000, was designed in response to environmental issues such as global warming and water pollution and promotes clean production processes. To meet ISO 14000 standards, a company must commit to continually improving environmental management and reducing pollution resulting from its production processes. ### Lean Manufacturing Trims the Fat Manufacturers are discovering that they can better respond to rapidly changing customer demands, while keeping inventory and production costs down, by adopting lean-manufacturing techniques. Lean manufacturing streamlines production by eliminating steps in the production process that do not add benefits customers want. In other words, non-value-added production processes are cut so that the company can concentrate its production and operations resources on items essential to satisfying customers. Toyota was a pioneer in developing these techniques, but today manufacturers in many industries have adopted the lean-manufacturing philosophy. Another Japanese concept, just-in-time (JIT), goes hand in hand with lean manufacturing. JIT is based on the belief that materials should arrive exactly when they are needed for production, rather than being stored on-site. Relying closely on computerized systems such as MRP, MRPII, and ERP, manufacturers determine what parts will be needed and when and then order them from suppliers so they arrive “just in time.” Under the JIT system, inventory and products are “pulled” through the production process in response to customer demand. JIT requires close teamwork between vendors and purchasing and production personnel because any delays in deliveries of supplies could bring JIT production to a halt. Unexpected events like the September 11 terrorist attacks or the shutdown of ports due to Hurricane Harvey and the devastation and flooding caused by Hurricane Maria in Puerto Rico can cause chaos in the supply chains of manufacturers, resulting in problems for firms relying on JIT. But if employed properly, and in spite of these risks, a JIT system can greatly reduce inventory-holding costs and smooth production highs and lows. ### Summary of Learning Outcomes 1. How can quality-management and lean-manufacturing techniques help firms improve production and operations management? Quality and productivity go hand in hand. Defective products waste materials and time, increasing costs. Poor quality also leads to dissatisfied customers. By implementing quality-control methods, firms can reduce these problems and streamline production. Lean manufacturing also helps streamline production by eliminating unnecessary steps in the production process. When activities that don’t add value for customers are eliminated, manufacturers can respond to changing market conditions with greater flexibility and ease.

# Achieving World-Class Operations Management ## Transforming the Factory Floor with Technology 1. What roles do technology and automation play in manufacturing and service-industry operations management? Technology is helping many firms improve their operating efficiency and ability to compete. Computer systems in particular are enabling manufacturers to automate factories in ways never before possible. Among the technologies helping to automate manufacturing are computer-aided design and manufacturing systems, robotics, flexible manufacturing systems, and computer-integrated manufacturing. ### Computer-Aided Design and Manufacturing Systems Computers have transformed the design and manufacturing processes in many industries. In computer-aided design (CAD), computers are used to design and test new products and modify existing ones. Engineers use these systems to draw products and look at them from different angles. They can analyze the products, make changes, and test prototypes before manufacturing a single item. Computer-aided manufacturing (CAM) uses computers to develop and control the production process. These systems analyze the steps required to make the product, then automatically send instructions to the machines that do the work. CAD/CAM systems combine the advantages of CAD and CAM by integrating design, testing, and manufacturing control into one linked computer system. The system helps design the product, control the flow of resources needed to produce the product, and operate the production process. Companies can further improve the design and manufacturing processes through the use of additive manufacturing, commonly referred to as 3D printing. Specialized printers can create products or parts for use in early prototypes, and some industries print certain components on site rather than shipping them. Cardianove Inc., a Montreal-based manufacturer of medical and surgical equipment, used CAD software to develop the world’s smallest heart pump. The company says using computer-aided design shaved two years off the normal design time for cardiac devices. The company’s CAD program ran complex three-dimensional simulations to confirm that the design would function properly inside the human body. Using CAD software, Cardianove tested over 100 virtual prototypes before the top three designs were produced for real-life testing. ### Robotics Robots are computer-controlled machines that can perform tasks independently. Robotics is the technology involved in designing, constructing, and operating robots. The first robot, or “steel-collar worker,” was used by General Motors in 1961. Robots can be mobile or fixed in one place. Fixed robots have an arm that moves and does what the computer instructs. Some robots are quite simple, with limited movement for a few tasks such as cutting sheet metal and spot welding. Others are complex, with hands or grippers that can be programmed to perform a series of movements. Some robots are even equipped with sensing devices for sight and touch. Robots usually operate with little or no human intervention. Replacing human effort with robots is most effective for tasks requiring accuracy, speed, or strength. Although manufacturers such as Harley-Davidson are most likely to use robots, some service firms are also finding them useful. Hospitals, for example, may use robots to sort and process blood samples, freeing medical personnel from a tedious, sometimes hazardous, repetitive task. ### Adaptable Factories: Flexible and Computer-Integrated Manufacturing Systems A flexible manufacturing system (FMS) automates a factory by blending computers, robots, machine tools, and materials-and-parts-handling machinery into an integrated system. These systems combine automated workstations with computer-controlled transportation devices. Automatic guided vehicles (AGV) move materials between workstations and into and out of the system. Flexible manufacturing systems are expensive. But once in place, a system requires little labor to operate and provides consistent product quality. It can also be adjusted easily and inexpensively. FMS equipment can quickly be reprogrammed to perform a variety of jobs. These systems work well when small batches of a variety of products are required or when each product is made to individual customer specifications. Computer-integrated manufacturing (CIM) combines computerized manufacturing processes (such as robots and flexible manufacturing systems) with other computerized systems that control design, inventory, production, and purchasing. With CIM, when a part is redesigned in the CAD system, the changes are quickly transmitted both to the machines producing the part and to all other departments that need to know about and plan for the change. ### Technology and Automation at Your Service Manufacturers are not the only businesses benefiting from technology. Nonmanufacturing firms are also using automation to improve customer service and productivity. Banks now offer services to customers through automated teller machines (ATM), via automated telephone systems, and even over the internet. Retail stores of all kinds use point-of-sale (POS) terminals that track inventories, identify items that need to be reordered, and tell which products are selling well. Walmart, the leader in retailing automation, has its own satellite system connecting POS terminals directly to its distribution centers and headquarters. ### Summary of Learning Outcomes 1. What roles do technology and automation play in manufacturing and service-industry operations management? Many firms are improving their operational efficiency by using technology to automate parts of production. Computer-aided design and manufacturing systems, for example, help design new products, control the flow of resources needed for production, and even operate much of the production process. By using robotics, human time and effort can be minimized. Factories are being automated by blending computers, robots, and machinery into flexible manufacturing systems that require less labor to operate. Service firms are automating operations too, using technology to cut labor costs and control quality.

# Achieving World-Class Operations Management ## Trends in Production and Operations Management 1. What key trends are affecting the way companies manage production and operations? What trends will impact U.S. production and operations management both now and in the future? Manufacturing employment has added one million manufacturing factory jobs since the end of the great recession, up to a level of 12.5 million in December 2017. U.S. exports have quadrupled over the past 25 years, and the integration of technology into manufacturing processes has made U.S. manufacturers more competitive. These statistics portray a U.S. economy that is steaming ahead. Yet rapid changes in technology and intense global competition—particularly from Asia—create anxiety about the future. Is technology replacing too many jobs? Or, with qualified workers predicted to be in short supply, is the increased reliance on technology imperative to the United States’ ability to compete in a global marketplace? Will the United States lose its edge in the ongoing war for leadership in innovation? And what should it be doing to ensure that today’s students are tomorrow’s innovators and scientists? Recent surveys show finding qualified workers continues to be a major concern facing U.S. industry today. If the United States is to maintain its competitive edge, more investment—both private and federal—is needed for science and research. And what about the crucial role of technology? These are some of the trends facing companies today that we will examine. U.S. workers no longer compete simply against one another but also against workers in less-developed countries with lower wages and increasing access to modern technology and production techniques. This is particularly true for manufacturers who account for the bulk of U.S. exports and compete directly with most imports. A more integrated global economy with more import competition and more export opportunities offers both new challenges and new opportunities to the United States and its workforce. To maintain its position as the world’s leading innovator, it is essential that the United States remain committed to innovation and the concerted development of a more highly educated and skilled workforce. ### Looming Workforce Crisis Threatens U.S. Competitiveness According to the latest National Association of Manufacturers Skills Gap Report, manufacturing executives rank a “high-performing workforce” as the most important factor in their firms’ future success. This finding concurs with a recent study by the U.S. Department of Labor, which concluded that 85 percent of future jobs in the United States will require advanced training, an associate degree, or a four-year college degree. Minimum skills will be adequate for only 15 percent of future jobs. But the National Association of Manufacturers predicts that 3.5 million new jobs will be filled over the next decade, but two million jobs will go unfilled due to a skills gap. When asked to identify the most serious problem for their company, survey respondents ranked “finding qualified employees” above high energy costs and the burdens of taxes, federal regulations, and litigation. Only the cost of health insurance and import competition ranked as more pressing concerns. As demand for better-educated and more highly skilled workers begins to grow, troubling trends project a severe shortage of such workers. U.S. employers already struggling to find qualified workers will face an increasing shortage of such workers in coming years. To make matters worse, trends in U.S. secondary education suggest that even those future workers who stay in school to study math and science may not receive globally competitive educations. ### American Innovation Leadership at Risk A recently released report shows the United States is in danger of losing its global lead in science and innovation for the first time since World War II. The report was prepared by the Task Force on the Future of American Innovation, a coalition of leaders from industry, science, and higher education. Although the United States is still out front of the world’s innovation curve, competing countries are climbing the technology ladder quickly, and the only way the United States can continue to create high-wage, value-added jobs is to climb the innovation ladder faster than the rest of the world. The task force identified dwindling federal investment in science and research as a root cause of the problem. Federal research as a share of GDP has declined 40 percent over the past 40 years. The U.S. share of worldwide high-tech exports has been in a 10-year decline since 2008, after a dramatic rise from $77 billion in 1990 to $221 billion in 2008. The latest data has the U.S. high-tech exports at $153 billion. Similarly, graduate science and engineering enrollment is declining in the United States while on the rise in China, India, and elsewhere. In addition, retirements from science and engineering jobs here at home could lead to a critical shortage of U.S. talent in these fields in the near future. So what needs to be done to reverse this alarming trend? More robust investment is part of the solution because federally funded, peer-reviewed, and patented scientific advances are essential to innovation. Such basic research helped bring us lasers, the World Wide Web, magnetic resonance imaging (MRI), and fiber optics. National Association of Manufacturers President Jay Timmons noted that, “Modern manufacturing offers high-paying, long-term careers. It’s a high-tech, sleek industry. It’s time to close the skills gap and develop the next generation of the manufacturing workforce.” ### Business Process Management (BPM)—The Next Big Thing? The twenty-first century is the age of the scattered corporation. With an assortment of partners and an army of suppliers often spread across thousands of miles, many companies find themselves with global design, supply, and logistics chains stretched to the breaking point. Few firms these days can afford to go it alone with their own raw materials, in-house production processes, and exclusive distribution systems. “Business Process Management is the glue to bind it all together,” says Eric Austvold, research director at AMR Research. “It provides a unified system for business.” This technology has the power to integrate and optimize a company’s sprawling functions by automating much of what it does. The results speak for themselves. BPM has saved U.S. firms $117 billion a year on inventory costs alone. Defense contractor Lockheed Martin recently used a BPM system to resolve differences among the hundreds of businesses that it acquired, unifying them into a whole and saving $50 million per year by making better use of existing resources and data. BPM is the key to the success of such corporate high-flyers as Walmart and Dell, which collect, digest, and utilize all sorts of production, sales, and shipping data to continually hone their operations. So how does BPM actually work? When a Dell system is ordered online, rather than waiting for a person to get the ball rolling, a flurry of electronic traffic flows back and forth between suppliers so that every part arrives within a few hours and the computer’s assembly, as well as software loading and testing, are scheduled. Production runs like a well-oiled clock so customers get their computers quickly, and Dell can bill them on shipment. A well-thought-through BPM system can even reschedule production runs, reroute deliveries, or shift work to alternate plants. The key, says Byron Canady of Dell, is “to stay close to customers and the supply chain.” The amount of available data—business intelligence (BI), enterprise resource planning (ERP), customer relationship management (CRM), and other systems—is staggering. “Companies are flooded with information,” says Jeanne Baker, chair of the industry support group Business Process Management Initiative (BPMI) and vice president of technology at Sterling Commerce. “The challenge is to make sense of it all. How you leverage the value chain is the true competitive advantage of the 21st century.” According to Baker, “BPMI drives growth through the automation of business processes, particularly the processes that integrate organizations. These provide the best opportunities for growth. Studies have shown companies that have good collaborative processes experience 15 percent less inventory; 17 percent stronger order fulfillment; 35 percent shorter cash-to-cash cycles; 10 percent less stock outs; 7 to 8 percent increase in revenues from savings; and overall sales increases.” ### Summary of Learning Outcomes 1. What key trends are affecting the way companies manage production and operations? Data show the U.S. economy steaming steadily ahead, but dramatic advances in technology, predicted worker shortages, and global competition create challenges for the future. How will companies balance their technology and workforce needs? Will the United States maintain its lead in the ongoing war for leadership in innovation? And what should it be doing to convert today’s students into tomorrow’s innovators and scientists? Surveys indicate that finding qualified workers continues to be a major concern facing U.S. industry today. If the United States is to maintain its competitive edge, more private and federal investment is needed for science and research. And what of the increasingly crucial role of technology? These are some of the trends facing companies today. ### Preparing for Tomorrow’s Workplace Skills 1. Tom Lawrence and Sally Zickle are co-owners of L-Z Marketing, an advertising agency. Last week, they landed a major aerospace manufacturer as a client. The company wants the agency to create its annual report. Tom, who develops the art for the agency, needs about a week to develop the preliminary report design, another two weeks to set the type, and three weeks to get the report printed. Sally writes the material for the report and doesn’t need as much time: two days to meet with the client to review the company’s financial information and about three weeks to write the report copy. Of course, Tom can’t set type until Sally has finished writing the report. Sally will also need three days to proofread the report before it goes to the printer. Develop either a Gantt chart or a critical path diagram for Tom and Sally to use in scheduling the project. Explain why you chose the method you did. How long will it take Tom and Sally to finish the project if there are no unforeseen delays? (Resources, Systems) 2. Look for ways that technology and automation are used at your school, in the local supermarket, and at your doctor’s office. As a class, discuss how automation affects the service you receive from each of these organizations. Does one organization use any types of automation that might be effectively used by one of the others? Explain. (Interpersonal, Information) 3. Pick a small business in your community. Make a list of the resources critical to the firm’s production and operations. What would happen if the business suddenly couldn’t acquire any of these resources? Divide the class into small groups and discuss strategies that small businesses can use to manage their supply chain. (Resources, Information, Interpersonal) 4. Broadway Fashions is a manufacturer of women’s dresses. The company’s factory has 50 employees. Production begins when the fabric is cut according to specified patterns. After being cut, the pieces for each dress style are placed into bundles, which then move through the factory from worker to worker. Each worker opens each bundle and does one assembly task, such as sewing on collars, hemming dresses, or adding decorative items such as appliqués. Then, the worker puts the bundle back together and passes it on to the next person in the production process. Finished dresses are pressed and packaged for shipment. Draw a diagram showing the production process layout in Broadway Fashions’ factory. What type of factory layout and process is Broadway using? Discuss the pros and cons of this choice. Could Broadway improve production efficiency by using a different production process or factory layout? How? Draw a diagram to explain how this might look. (Resources, Systems) 5. As discussed in this chapter, many U.S. firms have moved their manufacturing operations to overseas locations in the past decade. Although there can be sound financial benefits to this choice, moving production overseas can also raise new challenges for operations managers. Identify several of these challenges, and offer suggestions for how operations managers can use the concepts in this chapter to minimize or solve them. (Resources, Information) 6. Team Exercise Reliance Systems, headquartered in Oklahoma City, is a manufacturer of computer keyboards. The company plans to build a new factory and hopes to find a location with access to low-cost but skilled workers, national and international transportation, and favorable government incentives. Working in teams, assign tasks, and use the internet and your school library to research possible site locations, both domestic and international. Choose a location you feel would best meet the company’s needs. Make a group presentation to the class explaining why you have chosen this location. Include information about the location’s labor force, similar manufacturing facilities already located there, availability of resources and materials, possible local incentives, political and economic environment in the location, and any other factors you feel make this an attractive location. After all teams have presented their proposed locations, as a class rank all of the locations and decide the top two Reliance should investigate further. (Interpersonal, Information) 7. Your teacher has just announced a huge assignment, due in three weeks. Develop a Gantt chart to plan and schedule more effectively. After you complete and submit your assignment, compare your time estimates to the actual time each task took. How can these findings help you with future assignments? (Resources, Systems) ### Ethics Activity A recent spate of mine disasters that caused numerous fatalities refocused national attention on the question: is management doing enough to protect employees on the job? Recent serious Occupational Safety and Health Administration (OSHA) violations resulting in the deaths of two workers from falls due to the lack of harnesses or guardrails suggest there is still a long way to go. Companies are responsible for providing a safe workplace for employees. So why do accidents like these continue to happen? In a word—money. It takes money to purchase harnesses, install guardrails, and otherwise ensure a safe and healthy work environment. And even more is needed to employ the staff necessary to enforce company safety policies. It is often less costly for a company to just pay the fines that are levied for violations. As a supervisor at a company with frequent violations of OSHA regulations, you worry about your employees’ safety. But each time your company needs to implement a new safety feature, end-of-year employee bonuses get smaller. The money has to come from somewhere, management claims. Using a web search tool, locate articles about this topic, and then write responses to the following questions. Be sure to support your arguments and cite your sources. Ethical Dilemma: Do you report safety violations to management in the hope they will be corrected before someone gets hurt, or do you stage a total work stoppage to force management’s hand, knowing that either way you risk losing popularity at every level, and very possibly your job? Or, of course, you could say nothing and hope for the best. It is not a problem you created, and you’re just there to do a job, after all. Sources: George Avalos, “PG&E Violated Safety Rules, Was Late on Thousands of Wine Country Electricity Inspections and Work Orders,” The Mercury News, https://www.mercurynews.com, October 25, 2017; Barry Meier and Danielle Ivory, “Worker Safety Rules Are Among Those Under Fire in Trump Era,” The New York Times, https://www.nytimes.com, March 13, 2017; Kenneth Cheng, “Senior Managers Could Be Taken to Task for Workplace Safety Violations,” Today Online, http://www.todayonline.com, March 7, 2017. ### Working the Net 1. Use the Google search engine, http://www.google.com, to conduct a search for “supplier information,” and visit the websites of several firms (for example, Walmart, Northrop Grumman, Verizon, etc.). Compare the requirements companies set for their suppliers. How do they differ? How are they similar? 2. Visit Site Selection magazine, http://www.siteselection.com. Click on Area Spotlights for information about the manufacturing environment in various U.S. locations. Pick three to four areas to read about. Using this information, what locations would you recommend for firms in the following industries: general services, telecommunications, automotive manufacturing, and electronics manufacturing? Explain. 3. Manufacturers face many federal, state, and local regulations. Visit the National Association of Manufacturers at http://www.nam.org. Pick two or three legislative or regulatory issues discussed under their Policy sections, and use a search engine such as Yahoo! (http://www.yahoo.com) to find more information. 4. Using a search engine to search for information about technologies such as ERP, CAD/CAM systems, or robotics. Find at least three suppliers for one of these technologies. Visit their websites, and discuss how their clients are using their products to automate production. 5. Research either the Malcolm Baldrige National Quality Award or the ISO 9000 Quality Standards program on the internet. Write an executive summary that explains the basic requirements and costs of participating. What are the benefits of participating? Include a brief example of a company that has participated and their experiences. Include a list of relevant website links for further reading. ### Creative Thinking Case ### Innovation and E-mail Rules This chapter provides insights into how manufacturing and service organizations can implement processes and controls to increase efficiency, manage expenditures, and increase profits for the organization. For companies such as General Motors that need to manage suppliers and make sure that all components are procured on time and at the best costs to ensure the final assembly runs efficiently, and for service organizations such as Marriott, which wants to have clean rooms and an efficient check-in process when guests arrive, the main lessons of this chapter are readily apparent. All companies, however, need to innovate continuously to improve their products and services. Automobile companies such as General Motors have to constantly measure customer tastes and needs and provide products that meet and exceed their expectations. Likewise, Marriott needs to cater to the needs of business and leisure travelers in a variety of locations. Perhaps no company in recent years has captured the attention of the public more than Tesla and SpaceX, both headed by CEO Elon Musk. Tesla is named after the inventor Nicola Tesla, a contemporary of Thomas Edison, who designed the first electric engine. SpaceX is a company that is known for innovation such as reusing rocket launchers to reduce costs. While Tesla and SpaceX still manage their operations with all the processes covered in this chapter, their constant innovation requires new processes. Perhaps no aspect of modern business has had a bigger impact than the proliferation of e-mail. No longer confined to the desktop, e-mail messages are delivered via mobile devices, and managers must find ways to manage the proliferation of communication to keep on top of things. Elon Musk communicated the processes and rules for communicating at Tesla in this e-mail to all employees. Subject: Communication Within Tesla 2. Why would an e-mail rules memo like this work better at an innovation-driven company such as Tesla rather than at a manufacturing-driven company such as General Motors? 3. What are the potential problems that could arise out of this approach to e-mail? Sources: Justin Bariso, “This Email From Elon Musk to Tesla Employees Describes What Great Communication Looks Like,” Inc., https://www.inc.com, accessed February 20, 2018; John F. Wasik, “Tesla the Car Is a Household Name. Long Ago, So Was Nikola Tesla,” The New York Times, https://www.nytimes.com, December 30, 2017; Ken Costlow, “Ground Broken on New General Motors Supplier Park,” Arlington Voice, https://arlingtonvoice.com, June 19, 2017. ### Hot Links Address Book 1. See how American Leather brings it all together to create beautiful customized couches at https://www.americanleather.com. 2. What characteristics contribute to a city’s manufacturing climate? Find out by reading more at Industry Week’s website: http://www.industryweek.com. 3. How do companies decide whether to make or buy? Find out more at the Outsourcing Institute, a professional association where buyers and sellers network and connect: http://www.outsourcing.com. 4. Learn how to build your own Gantt chart at https://www.mindtools.com/pages/article/newPPM_03.htm. 5. What does it take to win the Malcolm Baldrige National Quality Award? Get the details at https://www.nist.gov/baldrige/baldrige-award. 6. Want to know more about how robots work? Find out at https://science.howstuffworks.com/robot.htm.

# Creating Products and Pricing Strategies to Meet Customers' Needs ## Introduction ### Learning Outcomes After reading this chapter, you should be able to answer these questions: 1. What is the marketing concept and relationship-building? 2. How do managers create a marketing strategy? 3. What is the marketing mix? 4. How do consumers and organizations make buying decisions? 5. What are the five basic forms of consumer and business market segmentation? 6. What is a product, and how is it classified? 7. How do organizations create new products? 8. What are the stages of the product life cycle? 9. What strategies are used for pricing products, and what are the future trends? 10. What trends are occurring in products and pricing? Marketing plays a key role in the success of businesses. It is the task of marketing to generate sales for the firm. Sales revenue, in turn, pays workers’ salaries, buys supplies, covers the costs of new buildings and equipment, and hopefully enables the company to earn a profit. This chapter looks at the nature of marketing and the creation of product and pricing strategies to meet customers’ needs. In this chapter, you will learn about the marketing concept, marketing strategies, and consumer and business buying decisions. You will also see how the marketing mix is used to create sales opportunities. We discuss how new products are created and how they go through periods of sales growth and then decline. Next you will discover how managers set prices to reach organizational goals.

# Creating Products and Pricing Strategies to Meet Customers' Needs ## The Marketing Concept 1. What is the marketing concept and relationship-building? Marketing is the process of getting the right goods or services or ideas to the right people at the right place, time, and price, using the right promotion techniques and utilizing the appropriate people to provide the customer service associated with those goods, services, or ideas. This concept is referred to as the “right” principle and is the basis of all marketing strategy. We can say that marketing is finding out the needs and wants of potential buyers (whether organizations or consumers) and then providing goods and services that meet or exceed the expectations of those buyers. Marketing is about creating exchanges. An exchange takes place when two parties give something of value to each other to satisfy their respective needs or wants. In a typical exchange, a consumer trades money for a good or service. In some exchanges, nonmonetary things are exchanged, such as when a person who volunteers for the company charity receives a T-shirt in exchange for time spent. One common misconception is that some people see no difference between marketing and sales. They are two different things that are both part of a company’s strategy. Sales incorporates actually selling the company’s products or service to its customers, while marketing is the process of communicating the value of a product or service to customers so that the product or service sells. To encourage exchanges, marketers follow the “right” principle. If a local Avon representative doesn’t have the right lipstick for a potential customer when the customer wants it, at the right price, the potential customer will not exchange money for a new lipstick from Avon. Think about the last exchange (purchase) you made: What if the price had been 30 percent higher? What if the store or other source had been less accessible? Would you have bought anything? The “right” principle tells us that marketers control many factors that determine marketing success. Most successful organizations have adopted the marketing concept. The marketing concept is based on the “right” principle. The marketing concept is the use of marketing data to focus on the needs and wants of customers in order to develop marketing strategies that not only satisfy the needs of the customers but also the accomplish the goals of the organization. An organization uses the marketing concept when it identifies the buyer’s needs and then produces the goods, services, or ideas that will satisfy them (using the “right” principle). The marketing concept is oriented toward pleasing customers (be those customers organizations or consumers) by offering value. Specifically, the marketing concept involves the following: 1. Focusing on the needs and wants of the customers so the organization can distinguish its product(s) from competitors’ offerings. Products can be goods, services, or ideas. 2. Integrating all of the organization’s activities, including production and promotion, to satisfy these wants and needs 3. Achieving long-term goals for the organization by satisfying customer wants and needs legally and responsibly Today, companies of every size in all industries are applying the marketing concept. Enterprise Rent-A-Car found that its customers didn’t want to have to drive to its offices. Therefore, Enterprise began delivering vehicles to customers’ homes or places of work. Disney found that some of its patrons really disliked waiting in lines. In response, Disney began offering FastPass at a premium price, which allows patrons to avoid standing in long lines waiting for attractions. One important key to understanding the marketing concept is to know that using the marketing concept means the product is created after market research is used to identify the needs and wants of the customers. Products are not just created by production departments and then marketing departments are expected to identify ways to sell them based on the research. An organization that truly utilizes the marketing concept uses the data about potential customers from the very inception of the product to create the best good, service, or idea possible, as well as other marketing strategies to support it. ### Customer Value Customer value is the ratio of benefits for the customer (organization or consumer) to the sacrifice necessary to obtain those benefits. The customer determines the value of both the benefits and the sacrifices. Creating customer value is a core business strategy of many successful firms. Customer value is rooted in the belief that price is not the only thing that matters. A business that focuses on the cost of production and price to the customer will be managed as though it were providing a commodity differentiated only by price. In contrast, businesses that provide customer value believe that many customers will pay a premium for superior customer service or accept fewer services for a value price. It is important not to base value on price (instead of service or quality) because customers who only value price will buy from the competition as soon as a competitor can offer a lower price. It is much better to use marketing strategies based on customer relationships and service, which are harder for the competition to replicate. Southwest Airlines doesn’t offer assigned seats, meals, or in-flight movies. Instead the budget carrier delivers what it promises: on-time departures. In “service value” surveys, Southwest routinely beats the full-service airlines such as American Airlines, which actually provide passengers with luxuries such as movies and food on selected long-haul flights. ### Customer Satisfaction Customer satisfaction is a theme stressed throughout this text. Customer satisfaction is the customer’s feeling that a product has met or exceeded expectations. Expectations are often the result of communication, especially promotion. Utilizing marketing research to identify specific expectations and then crafting marketing strategy to meet or exceed those expectations is a major contributor to success for an organization. Lexus consistently wins awards for its outstanding customer satisfaction. JD Powers surveys car owners two years after they make their purchase. Its Customer Satisfaction Survey is made up of four measures that each describe an element of overall ownership satisfaction at two years: vehicle quality/ reliability, vehicle appeal, ownership costs, and service satisfaction from a dealer. Lexus continues to lead the industry and has been America’s top-ranked vehicle for five years in a row. ### Building Relationships Relationship marketing is a strategy that focuses on forging long-term partnerships with customers. Companies build relationships with customers by offering value and providing customer satisfaction. Once relationships are built with customers, customers tend to continue to purchase from the same company, even if the prices of the competitors are less or if the competition offers sales promotions or incentives. Customers (both organizations and consumers) tend to buy products from suppliers whom they trust and feel a kinship with, regardless of offerings of unknown competitors. Companies benefit from repeat sales and referrals that lead to increases in sales, market share, and profits. Costs fall because it is less expensive to serve existing customers than to attract new ones. Focusing on customer retention can be a winning tactic; studies show that increasing customer retention rates by 5 percent increases profits by anywhere from 25 to 95 percent. Customers also benefit from stable relationships with suppliers. Business buyers have found that partnerships with their suppliers are essential to producing high-quality products while cutting costs. Customers remain loyal to firms that provide them greater value and satisfaction than they expect from competing firms. Frequent-buyer clubs are an excellent way to build long-term relationships. All major airlines have frequent-flyer programs. After you fly a certain number of miles, you become eligible for a free ticket. Now, cruise lines, hotels, car rental agencies, credit-card companies, and even mortgage companies give away “airline miles” with purchases. Consumers patronize the airline and its partners because they want the free tickets. Thus, the program helps to create a long-term relationship with (and ongoing benefits for) the customer. Southwest Airlines carries its loyalty program a bit further than most. Members get birthday cards, and some even get profiled in the airline’s in-flight magazine! ### Summary of Learning Outcomes 1. What is the marketing concept and relationship-building? Marketing includes those business activities that are designed to satisfy consumer needs and wants through the exchange process. Marketing managers use the “right” principle—getting the right goods or services to the right people at the right place, time, and price, using the right promotional techniques. Today, many firms have adopted the marketing concept. The marketing concept involves identifying consumer needs and wants and then producing products (which can be goods, services, or ideas) that will satisfy them while making a profit. Relationship marketing entails forging long-term relationships with customers, which can lead to repeat sales, reduced costs, and stable relationships.

# Creating Products and Pricing Strategies to Meet Customers' Needs ## Creating a Marketing Strategy 1. How do managers create a marketing strategy? ### What Is Marketing Strategy? Marketers use a number of different “tools” to develop the products or services that meet the needs and wants of their customers, provide excellent value for the customers, and satisfy those customers. Marketing strategy is really five different components of marketing. These components are traditionally called “the Four Ps” of marketing; however, this chapter includes an additional component "People" to create a new total of Five Ps. They are the methods, tools, and processes used by marketers to develop and market products. In Chapter 12, we will analyze an additional P, "Packaging" but will continue to refer to these components as "Five Ps." These five tools are also called “the marketing mix.” These are the 5Ps: 1. Product: Something offered in exchange and for which marketing actions are taken and marketing decisions made. Products can be goods (physical things such as smartphones) or services (such as the telecommunications that must be used for a smartphone to work) or ideas (such as the thought that being constantly connected through telecommunications is absolutely crucial in today’s society). All products have both tangible and intangible aspects. 2. Price: Something given in exchange for a product. Price may be monetary or nonmonetary (such as waiting in long lines for a restaurant or giving blood at the local blood bank). Price has many names, such as rent, fees, charges, and others. 3. Place: Some method of getting the product from the creator of the product to the customer. Place includes a myriad of important tasks: transportation, location, supply chain management (managing each entity that deals with the product in its route to the buyer), online presence, inventory, and atmospherics (how the office, store, or even the website looks). 4. Promotion: Methods for informing and influencing customers to buy the product. Promotion includes several different components – traditional advertising, sales promotion, public relations, personal selling, social media, and e-commerce. Promotion is often mistaken for marketing because it is the most visible part of marketing; however, marketing encompasses much more than just promotion. 5. People: Methods of utilizing organization employees to support the marketing strategies of the company. All products have both tangible and intangible aspects. People (as a marketing strategy) are crucial to the development of the product’s intangible aspects. Marketers utilize the tools of marketing strategy to develop new products and sell them in the marketplace. But marketers cannot create products in isolation. Marketers must understand and consider all aspects of the external environment in order to create marketing programs (plans) that will be successful in the current market and in future markets. Thus, many organizations assemble a team of specialists to continually collect and evaluate environmental information, a process called environmental scanning. The goal in gathering the environmental data is to identify current and future market opportunities and threats. Computer manufacturers understand the importance of environmental scanning to monitor rapidly changing consumer interests. Since the invention of the personal computer (PC), computer technicians and other enthusiasts have taken two things for granted: processor speeds will grow exponentially, and PCs will become indistinguishable from televisions. The result of this will be “convergence,” which means that the digital industry (manufacturers of computers, smartphones, and other mobile devices) will merge together with entertainment (such as television, radio, streaming video, and the internet). This convergence is already creating great opportunities for new products—watches that have both computers and cell phones in them, cell phones used to download videos not available except by independent entertainment producers (who are not affiliated with traditional media) such as Amazon and Google. One clear winner in this new world so far is Apple, which has leveraged its computer platform to make it easy and fashionable for consumers to become experts in the digital age. Apple has capitalized on this through the development of iTunes, the iPhone and iPads, and the iWatch. Apple sells almost as many iPads per quarter as it does Macintosh computers, and it certainly sells a massive number of iPhones. Microsoft wants in on this business badly, but Hewlett-Packard decided to shift its loyalty to Apple, so Microsoft doesn’t have much leverage just now. The other company to watch over the next few years is Samsung, which has doubled its efforts to make its consumer electronics offerings strong competition to Apple products. Finally, the device-free streaming services such as Amazon Music, Pandora, and Spotify have provided competition to Apple while restoring profitability to the music industry. In general, six categories of environmental data shape most marketing decisions: 1. Cultural/social forces: Includes such factors as the buying behaviors of specific cultures and subcultures, the values of potential customers, the changing roles of families, and other societal trends such as employees working from home and flexible work hours 2. Demographic forces: Includes such factors as changes in the ages of potential customers (e.g., baby boomers, millennials), birth and death rates, and locations of various groups of people 3. Economic forces: Includes such factors as changing incomes, unemployment levels, inflation, and recession 4. Technological forces: Includes such factors as advances in telecommunications and computer technology 5. Political and legal forces: Includes such factors as changes in laws, regulatory agency activities, and political movements 6. Competitive forces: Includes such factors as new and shifting competition from domestic and foreign-based firms ### Defining the Target Market Marketers develop the information about the environment to get a clear picture of the total market for the product, including environmental factors. Once the marketers understand the various environmental factors, specific target markets must then be chosen from the total market. Marketers focus on providing value for a well-defined target market or target markets. The target market is the specific group of customers (which could be organizations or individual consumers) toward which a firm directs its marketing efforts. Quaker Oats targets its grits to blue-collar consumers in the South. Williams Sonoma has several different types of stores, each geared toward a distinct target market: Pottery Barn for upscale home furnishings; its specialty stores, West Elm, Mark and Graham, and Rejuvenation, that specialize in jewelry and other accessories; and home improvement and furnishings that are affordable and sustainable. These target markets are all part of the overall retail market for housewares and lifestyle. Identifying a target market helps a company focus its marketing efforts on those who are most likely to buy its products or services. Concentrating on potential customers lets the firm use its resources efficiently. Examples of the target markets for Marriott Hotel Brands’ lodging alternatives are shown in . ### Creating a Competitive Advantage A competitive advantage, also called a differential advantage, is a set of unique features of a company and its products that are perceived by the target market(s) as significant and superior to those of the competition. Competitive advantage is the factor that causes customers to patronize a specific firm and not the competition. There are four types of competitive advantage: cost, product differentiation, service differentiation, and niche. ### Cost Competitive Advantage A firm that has a cost competitive advantage can produce a product or service at a lower cost than all its competitors while maintaining satisfactory profit margins. Firms become cost leaders by obtaining inexpensive raw materials, making plant operations more efficient, designing products for ease of manufacture, controlling overhead costs, and avoiding marginal customers. Over time, the cost competitive advantage may fail. Typically, if one firm is using an innovative technology to reduce its costs, then other firms in the industry will adopt this technology and reduce their costs as well. For example, Bell Labs invented fiber-optic cables that reduced the cost of voice and data transmission by dramatically increasing the number of calls that could be transmitted simultaneously through a two-inch cable. Within five years, however, fiber-optic technology had spread through the industry, and Bell Labs lost its cost competitive advantage. Firms may also lose their cost competitive advantage if competing firms match their low costs by using the same lower-cost suppliers. Therefore, a cost competitive advantage may not offer a long-term competitive advantage. ### Product Differentiation Competitive Advantage Because cost competitive advantages are subject to continual erosion, other types of competitive advantage tend to provide a longer-lasting competitive advantage. The durability of a differential competitive advantage can be more successful for the long-term viability of the company. Common differential advantages are brand names (Tide detergent), a strong dealer network (Caterpillar for construction equipment), product reliability (Lexus vehicles), image (Neiman Marcus in retailing), and service (Federal Express). Brand names such as Chanel, BMW, and Cartier stand for quality the world over. Through continual product and marketing innovations and attention to quality and value, marketers at these organizations have created enduring competitive advantages. ### Service Differentiation Competitive Advantage In today’s world of instant connection and social media, services are crucial for both tangible and nontangible products. Almost every day, the media report the consequences of poor service that went “viral” on social media because the service interaction was videotaped and uploaded to the internet. Customers now demand a higher level of service for all kinds of products, and if the service level does not meet customer expectations, it is likely that the customer will post negative comments on a review site or upload the interaction to various social media platforms. Some small companies have had to close their doors on the basis of one poor service interaction that went viral. Service levels that delight customers are even more important for intangible products such as engineering and accounting. More than 80 percent of the U.S. GDP is based on services. The ability to create the service product, continually refine the service process, and interact with customers (co-creators of the service) is crucial. Higher-level services require more planning, better execution, and constant evolution through the relationships with the customers. The use of service differentiation as a competitive advantage can be one of the most enduring and viable types of advantage. ### Niche Competitive Advantage A company with a niche competitive advantage targets and effectively serves a single segment of the market. For small companies with limited resources that potentially face giant competitors, utilizing a niche competitive advantage may be the only viable option. A market segment that has good growth potential but is not crucial to the success of major competitors is a good candidate for a niche strategy. Once a potential segment has been identified, the firm needs to make certain it can defend against challengers through its superior ability to serve buyers in the segment. For example, Regions Bank–Music Row Private Bank follows a niche strategy with its concentration on country music stars and entertainment industry professionals in Nashville. Its office is in the heart of Nashville’s music district. Music Row Private Bank has decided to expand its niche strategy to Miami, the “epicenter” of Latin music, and to Atlanta. The latter is a longtime rhythm-and-blues capital and now is the center of contemporary “urban” music. Both new markets have the kinds of music professionals—entertainers, record executives, producers, agents, and others—that have made Regions Bank–Music Row Private Bank so successful in Nashville. ### Summary of Learning Outcomes 1. How do managers create a marketing strategy? A firm creates a marketing strategy by understanding the external environment, defining the target market, determining a competitive advantage, and developing a marketing mix. Environmental scanning enables companies to understand the external environment. The target market is the specific group of consumers toward which a firm directs its marketing efforts. A competitive advantage is a set of unique features of a company and its products that are perceived by the target market as significant and superior to those of the competition.

# Creating Products and Pricing Strategies to Meet Customers' Needs ## Developing a Marketing Mix 1. What is the marketing mix? Once a firm has defined its target market and identified its competitive advantage, it can create the marketing mix, which is based on the 5Ps discussed earlier, that brings a specific group of consumers a product with superior value. Every target market requires a unique marketing mix to satisfy the needs of the target customers and meet the firm’s goals. A strategy must be constructed for each of the 5Ps, and all strategies must be blended with the strategies of the other elements. Thus, the marketing mix is only as good as its weakest part. For example, an excellent product with a poor distribution system could be doomed to failure. An excellent product with an excellent distribution system but an inappropriate price is also doomed to failure. A successful marketing mix requires careful tailoring. For instance, at first glance you might think that McDonald’s and Wendy’s have roughly the same marketing mix. After all, they are both in the fast-food business. But McDonald’s targets parents with young children through Ronald McDonald, heavily promoted children’s Happy Meals, and in-store playgrounds. Wendy’s is targeted to a more adult crowd. Wendy’s has no playgrounds, but it does have flat-screen TVs, digital menu boards, and comfy leather seating by a fireplace in many stores (a more adult atmosphere), and it has expanded its menu to include more items for adult tastes. ### Product Strategy Marketing strategy typically starts with the product. Marketers can’t plan a distribution system or set a price if they don’t know exactly what product will be offered to the market. Marketers use the term product to refer to goods, services, or even ideas. Examples of goods would include tires, MP3 players, and clothing. Goods can be divided into business goods (commercial or industrial) or consumer goods. Examples of services would be hotels, hair salons, airlines, and engineering and accounting firms. Services can be divided into consumer services, such as lawn care and hair styling, or professional services, such as engineering, accounting, or consultancy. In addition, marketing is often used to “market” ideas that benefit companies or industries, such as the idea to “go green” or to “give blood.” Businesses often use marketing to improve the long-term viability of their industries, such as the avocado industry or the milk industry, which run advertising spots and post social media messages to encourage consumers to view their industries favorably. Thus, the heart of the marketing mix is the good, service, or idea. Creating a product strategy involves choosing a brand name, packaging, colors, a warranty, accessories, and a service program. Marketers view products in a much larger context than is often thought. They include not only the item itself but also the brand name and the company image. The names Ralph Lauren and Gucci, for instance, create extra value for everything from cosmetics to bath towels. That is, products with those names sell at higher prices than identical products without the names. Consumers buy things not only for what they do, but also for what they mean. ### Pricing Strategy Pricing strategy is based on demand for the product and the cost of producing that product. However, price can have a major impact on the success of a product if the price is not in balance with the other components of the 5Ps. For some products (especially service products), having a price that is too low may actually hurt sales. In services, a higher price is often equated with higher value. For some types of specialty products, a high price is expected, such as prices for designer clothes or luxury cars. Even costume jewelry is often marked up more than 1000 percent over the cost to produce it because of the image factor of a higher price. Special considerations can also influence the price. Sometimes an introductory price is used to get people to try a new product. Some firms enter the market with low prices and keep them low, such as Carnival Cruise Lines and Suzuki cars. Others enter a market with very high prices and then lower them over time, such as producers of high-definition televisions and personal computers. ### Place (Distribution) Strategy Place (distribution) strategy is creating the means (the channel) by which a product flows from the producer to the consumer. Place includes many parts of the marketing endeavor. It includes the physical location and physical attributes of the business, as well as inventory and control systems, transportation, supply chain management, and even presence on the web. One aspect of distribution strategy is deciding how many stores and which specific wholesalers and retailers will handle the product in a geographic area. Cosmetics, for instance, are distributed in many different ways. Avon has a sales force of several hundred thousand representatives who call directly on consumers. Clinique and Estée Lauder are distributed through selected department stores. Cover Girl and Coty use mostly chain drugstores and other mass merchandisers. Redken products sell through hair salons. Revlon uses several of these distribution channels. For services, place often becomes synonymous with both physical location (and attributes of that location such as atmospherics) and online presence. Place strategy for services also includes such items as supply chain management. An example would be that an engineering firm would develop offices with lush interiors (to denote success) and would also have to manage the supplies for ongoing operations such as the purchase of computers for computer-aided drafting. ### Promotion Strategy Many people feel that promotion is the most exciting part of the marketing mix. Promotion strategy covers personal selling, traditional advertising, public relations, sales promotion, social media, and e-commerce. These elements are called the promotional mix. Each element is coordinated with the others to create a promotional blend. An advertisement, for instance, helps a buyer get to know the company and paves the way for a sales call. A good promotional strategy can dramatically increase a firm’s sales. Public relations plays a special role in promotion. It is used to create a good image of the company and its products. Bad publicity costs nothing to send out, but it can cost a firm a great deal in lost business. Public relations uses many tools, such as publicity, crisis management strategy, and in-house communication to employees. Good publicity, such as a television or magazine story about a firm’s new product, may be the result of much time, money, and effort spent by a public-relations department. Public-relations activities always cost money—in salaries and supplies. Public-relations efforts are the least “controllable” of all the tools of promotion, and a great deal of effort and relationship-building is required to develop the ongoing goodwill and networking that is needed to enhance the image of a company. Sales promotion directly stimulates sales. It includes trade shows, catalogs, contests, games, premiums, coupons, and special offers. It is a direct incentive for the customer to purchase the product immediately. It takes many forms and must adhere to strict laws and regulations. For example, some types of contests and giveaways are not allowed in all the states within the United States. McDonald’s discount coupons and contests offering money and food prizes are examples of sales promotions. Social media is a major element of the promotion mix in today’s world. Most businesses have a corporate website, as well as pages on different social media sites such as Facebook, Pinterest, and Twitter. Social media is more powerful as a channel for getting the company’s message out to the target market (or general public) than traditional advertising, especially for some target markets. Companies (and even individuals) can use social media to create instant branding. E-commerce is the use of the company website to support and expand the marketing strategies of the 5Ps. It can include actual “order online” capabilities, create online communities, and be used to collect data from both existing and potential customers. Some e-commerce websites offer free games and other interactive options for their customers. All of this activity helps to build and strengthen the long-term relationships of customers with the company. ### Not-for-Profit Marketing Profit-oriented companies are not the only ones that analyze the marketing environment, find a competitive advantage, and create a marketing mix. The application of marketing principles and techniques is also vital to not-for-profit organizations. Marketing helps not-for-profit groups identify target markets and develop effective marketing mixes. In some cases, marketing has kept symphonies, museums, and other cultural groups from having to close their doors. In other organizations, such as the American Heart Association, marketing ideas and techniques have helped managers do their jobs better. In the private sector, the profit motive is both an objective for guiding decisions and a criterion for evaluating results. Not-for-profit organizations do not seek to make a profit for redistribution to owners or shareholders. Rather, their focus is often on generating enough funds to cover expenses or generating enough funds to expand their services to assist more people. For example, the Methodist Church does not gauge its success by the amount of money left in offering plates. The Museum of Science and Industry does not base its performance evaluations on the dollar value of tokens put into the turnstile. An organization such as the American Red Cross raises funds to provide basic services, but if enough funds are raised (beyond just the amount to cover expenses), those funds are used to expand services or improve current services. ### Summary of Learning Outcomes 1. What is the marketing mix? To carry out the marketing strategy, firms create a marketing mix—a blend of products, distribution (place) systems, prices, promotion, and people. Marketing managers use this mix to satisfy target consumers. The mix can be applied to nonbusiness as well as business situations.

# Creating Products and Pricing Strategies to Meet Customers' Needs ## Buyer Behavior 1. How do consumers and organizations make buying decisions? An organization that wants to be successful must consider buyer behavior when developing the marketing mix. Buyer behavior is the actions people take with regard to buying and using products. Marketers must understand buyer behavior, such as how raising or lowering a price will affect the buyer’s perception of the product and therefore create a fluctuation in sales, or how a specific review on social media can create an entirely new direction for the marketing mix based on the comments (buyer behavior/input) of the target market. To understand buyer behavior, marketers must understand how customers make buying decisions. Consumers and businesses have processes for making decisions about purchases. These decision-making processes are affected by cultural, social, individual, and psychological factors. The consumer decision-making process has several steps, which are shown in . The process starts with need recognition. Need recognition could be as simple as running out of coffee. Need recognition could also take place over several months, such as when repeated car repairs influence a consumer to make a decision to buy a new car. (Step 1 in ). Next, the buyer gathers information. If the consumer is making a decision to purchase a house, they might research information about financing, available homes, styles, locations, and so forth (Step 2). Once the consumer has gathered the information, he or she must evaluate alternatives (Step 3). For example, a consumer might eliminate all homes that cost over $150,000 or are more than a 30-minute drive to work. After evaluating the alternatives, the consumer will make a decision based on those alternatives. Then the consumer makes the purchase decision, the decision to buy or not to buy (Step 4). Finally, the consumer assesses the decision itself and his or her satisfaction with the purchase, which would include not only the home, but the buying experience as well (Step 5). ### Influences on Consumer Decision-Making Cultural, social, individual, and psychological factors have an impact on consumer decision-making from the time a person recognizes a need through post-purchase behavior. We will examine each of these factors in more detail. It is important to understand the relevance of these influences on consumer decision-making. ### Culture Purchase roles within the family are influenced by culture. Culture is the set of values, ideas, attitudes, and symbols created to shape human behavior. Culture is the part of customs and traditions of a group of people that is transformed into its art, food, costumes/clothing, architecture, and language, as well as other unique manifestations of a specific group of related individuals. Culture is environmentally oriented. For example, the nomads of Finland have developed a culture for Arctic survival. Similarly, the natives of the Brazilian jungle have created a culture suitable for jungle living. Culture by definition is social in nature. It is human interaction that creates values and prescribes acceptable behavior. Culture gives order to society by creating common expectations. Sometimes these expectations are codified into law; for example, if you come to a red light, you stop the car. In some cultures, a young man undergoes a special rite of passage from youth into adulthood (such as a bar mitzvah in Jewish culture). In other cultures, young women have a rite of passage but young men do not (such as a quinceañera in Hispanic culture). As long as a value or belief meets the needs of society, it will remain part of the culture. If it is no longer functional, the value or belief fades away. For example, the value that very large families are “good” is no longer held by a majority of Americans. This is because most Americans live in an urban rather than a rural environment, and children are no longer needed to perform farm chores. ### Social Factors Most consumers are likely to seek out the opinions of others to reduce their search and evaluation effort or uncertainty, especially as the perceived risk of the decision increases. Consumers may also seek out others’ opinions for guidance on new products or services, products with image-related attributes, or products where attribute information is lacking or uninformative. Specifically, consumers interact socially with reference groups, opinion leaders, and family members to obtain product information and decision approval. All the formal and informal groups that influence the buying behavior of an individual are considered that person’s reference groups. Consumers may use products or brands to identify with or become a member of a group. They learn from observing how members of their reference groups consume, and they use the same criteria to make their own consumer decisions. A reference group might be a fraternity or sorority, a group you work with, or a club to which you belong. ### Individual Influences A person’s buying decisions are also influenced by personal characteristics unique to each individual, such as gender and personality. Individual characteristics are generally stable over the course of one’s life. For instance, most people do not change their gender, and the act of changing personality requires a complete reorientation of one’s life. Physiological differences between men and women result in different needs, such as health and beauty products. Just as important are the distinct cultural, social, and economic roles played by men and women and the effects that these have on their decision-making processes. Men and women also shop differently. Studies show that men and women share similar motivations in terms of where to shop—that is, seeking reasonable prices, merchandise quality, and a friendly, low-pressure environment—but they don’t necessarily feel the same about shopping in general. Most women enjoy shopping; their male counterparts claim to dislike the experience and shop only out of necessity. Furthermore, men desire simple shopping experiences, stores with less variety, and convenience. When it comes to online shopping, gender differences continue. According to recent research, women tend to shop based on their future needs, while men tend to shop when their need is immediate. In addition, women tend to make impulse buys more frequently than men, who tend to think logically when making purchase decisions. Each consumer has a unique personality. Personality is a broad concept that can be thought of as a way of organizing and grouping how an individual typically reacts to situations. Thus, personality combines psychological makeup and environmental forces. It includes people’s underlying dispositions, especially their most dominant characteristics. Although personality is one of the least useful concepts in the study of consumer behavior, some marketers believe that personality influences the types and brands of products purchased. For instance, the type of car, clothes, or jewelry a consumer buys may reflect one or more personality traits. ### Psychological Influences An individual’s buying decisions are further influenced by psychological factors such as perception, beliefs, and attitudes. These factors are what consumers use to interact with their world. They are the tools consumers use to recognize their feelings, gather and analyze information, formulate thoughts and opinions, and take action. Unlike the other three influences on consumer behavior, psychological influences can be affected by a person’s environment because they are applied on specific occasions. For example, individuals will perceive different stimuli and process these stimuli in different ways depending on whether the individual is sitting in class concentrating on an instructor’s lecture, sitting outside of class talking to friends, or sitting at home watching television. ### B2B Purchase Decision-Making Business-to-business (B2B) buyer behavior and business markets are different from consumer markets. Business markets include institutions such as hospitals and schools, manufacturers, wholesalers and retailers, and various branches of government. The key difference between a consumer product and a business product is the intended use. For example, if a consumer purchases a certain brand of computer for use at home, it is considered a consumer good. If a purchasing agent for Netflix buys exactly the same computer for Netflix scriptwriter, it is considered a business good. Why? The reason is that Netflix is a business, so the computer will be used in a business environment. ### The Decision-Making Process The purchases that organizations make often involve greater risk than purchases made by individual consumers. For this reason, businesses (and other organizations) tend to base purchase decisions on more data and make purchase decisions based on rational decision-making so purchases will optimize value for the organization and minimize risk. For this reason, the business purchase decision-making process differs from the consumer process. The steps are similar: need recognition, setting specifications, information search (including identification of suppliers), evaluation (including evaluation of suppliers), purchase (“go or no-go”), and post-purchase evaluation. The major difference between the two processes is that businesses decide beforehand what exactly is needed on the purchase (setting specifications) and then seek information regarding products that meet those specifications. In this way, the purchases are more likely to satisfy the needs of the overall organization, thus reducing the risk. ### Characteristics of the B2B Market The main differences between consumer markets and business markets include the following: 1. Purchase volume: Business customers buy in much larger quantities than consumers. Mars must purchase many truckloads of sugar to make one day’s output of M&Ms. Home Depot buys thousands of batteries each day for resale to consumers. The federal government must use (and purchase) millions of pens each day. 2. Number of customers: Business marketers usually have far fewer customers than consumer marketers. As a result, it is much easier to identify prospective buyers and monitor current needs. For example, there are far fewer customers for airplanes or industrial crane companies than there are for consumer goods companies since there are more than 125 million consumer households in the United States. 3. Location of buyers: Business customers tend to be much more geographically concentrated than consumers. The computer industry is concentrated in Silicon Valley and a few other areas. Aircraft manufacturing is found in Seattle, Washington; St. Louis, Missouri; and Dallas/Fort Worth, Texas. Suppliers to these manufacturers often locate close to the manufacturers to lower distribution costs and facilitate communication. 4. Direct distribution: Business sales tend to be made directly to the buyer because such sales frequently involve large quantities or custom-made items such as heavy machinery. Consumer goods are more likely to be sold through intermediaries such as wholesalers and retailers. ### Summary of Learning Outcomes 1. How do consumers and organizations make buying decisions? Buyer behavior is what consumers and businesses do in order to buy and use products. The consumer purchase decision-making process consists of the following steps: recognizing a need, seeking information, evaluating alternatives, purchasing the product, judging the purchase outcome, and engaging in post-purchase behavior. A number of factors influence the process. Cultural, social, individual, and psychological factors have an impact on consumer decision-making. The business purchase decision-making model includes the following steps: need recognition, setting specifications, information search, evaluation of alternatives against specifications, purchase, and post-purchase behavior. The main differences between consumer and business markets are purchase volume, number of customers, location of buyers, direct distribution, and rational purchase decisions. Companies learn more about their target markets by conducting marketing research—the process of planning, collecting, and analyzing data relevant to a marketing decision.

# Creating Products and Pricing Strategies to Meet Customers' Needs ## Market Segmentation 1. What are the five basic forms of consumer and business market segmentation? Most organizations cannot target the total market for a specific product. For each separate part of the market that an organization wants to target, a marketing mix (a set of 5Ps) must be created. It would be very expensive to try to create a marketing mix for every part of the target market. Instead, companies cut up those targets into specific “segments” of the market that the organization is more strategically positioned to be successful in targeting. Segmentation also varies based on the target market being a consumer market or a business market. The study of buyer behavior helps marketing managers better understand why people make purchases. To identify the target markets that may be most profitable for the firm, marketers use market segmentation, which is the process of separating, identifying, and evaluating the layers of a market to identify a target market. For instance, a target market might be segmented into two groups: families with children and families without children. Families with young children are likely to buy hot cereals and presweetened cereals. Families with no children are more likely to buy health-oriented cereals. Cereal companies plan their marketing mixes with this difference in mind. A business market may be segmented by large customers and small customers or by geographic area. The five basic forms of consumer market segmentation are demographic, geographic, psychographic, benefit, and volume. Their characteristics are summarized in and discussed in the following sections. ### Demographic Segmentation Demographic segmentation uses categories such as age, education, gender, income, and household size to differentiate among markets. This form of market segmentation is the most common because demographic information is easy to obtain. The U.S. Census Bureau provides a great deal of demographic data, especially about metropolitan areas. For example, marketing researchers can use census data to find areas within cities that contain high concentrations of high-income consumers, singles, blue-collar workers, and so forth. However, even though demographic information is easier to obtain than other types of information, it may not always be the best approach to segmentation because it is limited on what it can reveal about consumers. Many products are targeted to various age groups. Most music CDs, Pepsi, Coke, many movies, the Honda Fit, and thousands of other products are targeted toward teenagers and persons under 25 years old. In contrast, most cruises, medical products, fine jewelry, vacation homes, Teslas, and denture products are targeted toward people 50 years old and up. An example of how Frito Lay targets various age groups for three of its most popular products is shown in . Income is another popular way to segment markets. Income level influences consumers’ wants and determines their buying power. Housing, clothing, automobiles, and alcoholic beverages are among the many markets segmented by income. Budget Gourmet frozen dinners are targeted to lower-income groups, whereas the Stouffer’s line and California Pizza Kitchen frozen pizzas are aimed at higher-income consumers. ### Geographic Segmentation Geographic segmentation means segmenting markets by region of the country, city or county size, market density, or climate. Market density is the number of people or businesses within a certain area. Many companies segment their markets geographically to meet regional preferences and buying habits. Pizza Hut, for instance, gives easterners extra cheese, westerners more ingredients, and midwesterners both. Both Ford and Chevrolet sell more pickup trucks and truck parts in the middle of the country than on either coast. The well-defined “pickup truck belt” runs from the upper Midwest south through Texas and the Gulf states. Ford “owns” the northern half of this truck belt and Chevrolet the southern half. ### Psychographic Segmentation Race, income, occupation, and other demographic variables help in developing strategies but often do not paint the entire picture of consumer needs. Demographics provide basic data that can be observed about individuals, but psychographics provide vital information that is often much more useful in crafting the marketing message. Demographics provide the skeleton, but psychographics add meat to the bones. Psychographic segmentation is market segmentation by personality or lifestyle. People with common activities, interests, and opinions are grouped together and given a “lifestyle name.” For example, Harley-Davidson divides its customers into seven lifestyle segments, from “cocky misfits” who are most likely to be arrogant troublemakers, to “laid-back camper types” committed to cycling and nature, to “classy capitalists” who have wealth and privilege. Two different managers could be described by demographics as male, managers, 35 years old, with $80,000 per year income. A marketer who just saw the demographics might create one advertisement to reach both of them. However, if the marketer knew that one of the managers was president of his homeowner’s association and captain of a rugby league team and the other manager was a holder of opera season tickets and president of the Friends of the Public Library, the messages might be designed very differently in order to be more successful. ### Benefit Segmentation Benefit segmentation is based on what a product will do rather than on consumer characteristics. For years Crest toothpaste was targeted toward consumers concerned with preventing cavities. Recently, Crest subdivided its market. It now offers regular Crest, Crest Tartar Control for people who want to prevent cavities and tartar buildup, Crest for kids with sparkles that taste like bubble gum, and another Crest that prevents gum disease. Another toothpaste, Topol, targets people who want whiter teeth—teeth without coffee, tea, or tobacco stains. Sensodyne toothpaste is aimed at people with highly sensitive teeth. ### Volume Segmentation The fifth main type of segmentation is volume segmentation, which is based on the amount of the product purchased. Just about every product has heavy, moderate, and light users, as well as nonusers. Heavy users often account for a very large portion of a product’s sales. Thus, a firm might want to target its marketing mix to the heavy-user segment. For example, in the fast-food industry, the heavy user (a young, single male) accounts for only one in five fast-food patrons. Yet this heavy user makes over 60 percent of all visits to fast-food restaurants. Retailers are aware that heavy shoppers not only spend more, but also visit each outlet more frequently than other shoppers. Heavy shoppers visit the grocery store 122 times per year, compared with 93 annual visits for the medium shopper. They visit discount stores more than twice as often as medium shoppers, and they visit convenience/gas stores more than five times as often. On each trip, they consistently spend more than their medium-shopping counterparts. ### Business Market Segmentation Business markets are segmented differently than consumer markets. Business markets may segment based on geography, volume, and benefits, just as consumer markets are. However, organizations might also segment based on use of the product (such as a petrochemical company having one market segment for purchasers who use polyethylene for instrumentation panels and one for purchasers who use polyethylene for car seats), characteristics of purchasing function (such as purchasing committees, purchasing managers, or purchasing departments), size of the client (one segment for large customers who have different needs than smaller customers), or industry (such as segmenting food systems into restaurants or government agencies such as schools or military bases), as well as other considerations related to characteristics of business customers. ### Using Marketing Research to Serve Existing Customers and Find New Customers How do successful companies learn what their customers value? Through marketing research, companies can be sure they are listening to the voice of the customer. Marketing research is the process of planning, collecting, and analyzing data relevant to a marketing decision. The results of this analysis are then communicated to management. The information collected through marketing research includes the preferences of customers, the perceived benefits of products, and consumer lifestyles. Research helps companies make better use of their marketing budgets. Marketing research has a range of uses, from fine-tuning existing products to discovering whole new marketing concepts. For example, everything at the Olive Garden restaurant chain, from the décor to the wine list, is based on marketing research. Each new menu item is put through a series of consumer taste tests before being added to the menu. Hallmark Cards uses marketing research to test messages, cover designs, and even the size of the cards. Hallmark’s experts know which kinds of cards will sell best in which places. Engagement cards, for instance, sell best in the Northeast, where engagement parties are popular. Birthday cards for “Daddy” sell best in the South because even adult southerners tend to call their fathers Daddy. Marketing research can use either primary data (where the organization actually gets the data and analyzes it) or secondary data (where the organization uses data that has already been developed and published by another entity and the organization is able to utilize the data for its own purposes). There are three basic research methods used for gathering primary data: survey, observation, and experiment. With survey research, data is gathered from respondents—in person, through the internet, by telephone, or by mail—to obtain facts, opinions, and attitudes. A questionnaire is used to provide an orderly and structured approach to data-gathering. Face-to-face interviews may take place at the respondent’s home, in a shopping mall, or at a place of business. Observation research is research that monitors respondents’ actions without direct interaction. In the fastest-growing form of observation research, researchers use cash registers with scanners that read tags with bar codes to identify the item being purchased. Technological advances are rapidly expanding the future of observation research. Arbitron research has developed a portable people meter (PPM) about the size of a cell phone that research participants clip to their belts or any article of clothing. They agree to wear it during all waking hours. Before the study participants go to sleep, they put the PPM in a cradle that automatically sends data back to Arbitron (now Nielsen Audio). The PPM will tell the marketing research company exactly which television programs the person watched and for how long. It also records radio programs listened to, any web streaming, supermarket piped-in music, or any other electronic media that the research participant encountered during the day. In the third research method, experiment, the investigator changes one or more variables—price, package, design, shelf space, advertising theme, or advertising expenditures—while observing the effects of those changes on another variable (usually sales). The objective of experiments is to measure causality. For example, an experiment may reveal the impact that a change in package design has on sales. ### Summary of Learning Outcomes 1. What are the five basic forms of consumer and business market segmentation? Success in marketing depends on understanding the target market. One technique used to identify a target market is market segmentation. The five basic forms of segmentation are demographic (population statistics), geographic (location), psychographic (personality or lifestyle), benefit (product features), and volume (amount purchased). Business markets may segment based on geography, volume, and benefits, just as consumer markets are. However, organizations might also segment based on use of the product, characteristics of purchasing function, and size of the client or industry, as well as other considerations related to characteristics of business customers.