S

T
U
D
Y
OPERATIONAL
T

PAPER E1 E
X
T
ENTERPRISE OPERATIONS

Our text is designed to help you study effectively and efficiently.

In this edition we:
 Highlight the most important elements in the syllabus and the key skills you will need

 Signpost how each chapter links to the syllabus and the learning outcomes

 Provide lots of exam alerts explaining how what you're learning may be tested

 Include examples and questions to help you apply what you've learnt

 Emphasise key points in section summaries

 Test your knowledge of what you've studied in quick quizzes

 Examine your understanding in our exam question bank

 Reference all the important topics in the full index

SUITABLE FOR EXAMS UP TO SEPTEMBER 2014

ii

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 iii

Contents Page

Introduction
How our Study Text can help you pass iv
Features in our Study Text v
Streamlined studying vi
Syllabus and learning outcomes vii
Studying E1 xiii
The exam paper xviii

Part A The global business environment

1 The social, political and economic context 3
2 Governance and regulation 39

Part B Information systems

3 The role of information systems 65
4 Systems implementation and business strategy 95

Part C Operations management

5 Operations management and the organisation 131
6 Quality management 159
7 Managing capacity and inventory 191

Part D Marketing
8 Marketing and business strategy 215
9 Marketing plans, branding and communications 243
10 Developments in marketing 277

Part E Managing human capital

11 Human resource management 303
12 Human resource practices 341

Objective test question bank 381

Objective test answer bank 383

Exam question bank 387

Exam answer bank 393

Index 419
Review form
iv INTRODUCTION

How our Study Text can help you pass

Streamlined  We show you the best ways to study efficiently
studying
 Our Text has been designed to ensure you can easily and quickly navigate
through it
 The different features in our Text emphasise important knowledge and
techniques
Exam expertise  Studying E1 on page xiii introduces the key themes of the syllabus and
summarises how to pass
 We highlight throughout our Text how topics may be tested and what you’ll have
to do in the exam
 We help you see the complete picture of the syllabus, so that you can answer
questions that range across the whole syllabus
 Our Text covers the syllabus content – no more, no less
Regular review  We frequently summarise the key knowledge you need
 We test what you’ve learnt by providing questions and quizzes throughout our
Text

Our other products

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Practice and Providing lots more question practice and helpful guidance on how to pass the exam
Revision Kit
Passcards Summarising what you should know in visual, easy to remember, form
Success CDs Covering the vital elements of the E1 syllabus in less than 90 minutes and also
containing exam hints to help you fine tune your strategy
i-Pass Providing computer-based testing in a variety of formats, ideal for self-assessment
Interactive Allowing you to learn actively with a clear visual format summarising what you must
Passcards know

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 INTRODUCTION v

Features in our Study Text

Section Introductions explain how the section fits into the chapter

Key Terms are the core vocabulary you need to learn

KEY TERM

Key Points are points that you have to know, ideas or calculations that will be the
foundations of your answers
KEY POINT

Exam Alerts show you how subjects are likely to be tested

Exam Skills are the key skills you will need to demonstrate in the exam, linked to
question requirements

Formulae To Learn are formulae you must remember in the exam

Exam Formulae are formulae you will be given in the exam

Examples show how theory is put into practice

Questions give you the practice you need to test your understanding of what you’ve
learnt

Case Studies link what you’ve learnt with the real-world business environment

CASE STUDY

Links show how the syllabus overlaps with other parts of the qualification, including
Knowledge Brought Forward that you need to remember from previous exams

Website References link to material that will enhance your understanding of what
you’re studying

Further Reading will give you a wider perspective on the subjects you’re covering

Section Summaries allow you to review each section

vi INTRODUCTION

Streamlined studying
What you should do In order to
Read the Chapter and Section Introductions See why topics need to be studied and map your
way through the chapter
Go quickly through the explanations Gain the depth of knowledge and understanding
that you'll need
Highlight the Key Points, Key Terms and Formulae Make sure you know the basics that you can't do
To Learn without in the exam
Focus on the Exam Skills and Exam Alerts Know how you'll be tested and what you'll have to
do
Work through the Examples and Case Studies See how what you've learnt applies in practice
Prepare Answers to the Questions See if you can apply what you've learnt in
practice
Revisit the Section Summaries in the Chapter Remind you of, and reinforce, what you've learnt
Roundup
Answer the Quick Quiz Find out if there are any gaps in your knowledge
Answer the Question(s) in the Exam Question Bank Practise what you've learnt in depth

Should I take notes?

Brief notes may help you remember what you’re learning. You should use the notes format that’s most
helpful to you (lists, diagrams, mindmaps).

Further help
BPP Learning Media’s Learning to Learn Accountancy provides lots more helpful guidance on studying. It
is designed to be used both at the outset of your CIMA studies and throughout the process of learning
accountancy. It can help you focus your studies on the subject and exam, enabling you to acquire
knowledge, practise and revise efficiently and effectively.
 INTRODUCTION vii

Syllabus and learning outcomes

Paper E1 Enterprise Operations
The syllabus comprises:

Topic and Study Weighting

%
A The Global Business Environment 20
B Information Systems 20
C Operations Management 20
D Marketing 20
E Managing Human Capital 20

Learning Outcomes
Lead Component Syllabus content
A The Global Business Environment
1 Explain the (a) Explain the emergence of  Cross-cultural management and
social, political major economies in Asia different forms of business
and economic and Latin America organisation.
context of (b) Explain the emergence and  Emerging market multinationals.
business. importance of outsourcing
 Liberalisation and economic
and offshoring
nationalism.
(c) Explain the impact of
 Outsourcing and offshoring.
international
macroeconomic  Major economic systems including
developments (eg long- US, European and transition
term shifts in trade economies.
balances), on the  National account balances
organisation’s competitive (especially from international
environment. trade), monetary policy and their
impact on markets.
2 Analyse the (a) Explain the principles and  Corporate governance, including
relationship purpose of corporate social stakeholders and the role of
between the responsibility and the government.
internal principles of good
 Principles of corporate social
governance of corporate governance in an
responsibility and the scope for
the firm and international context
international variation, eg between
external (b) Analyse relationships developed and developing
sources of among business, society economies.
governance and government in
and regulation.  Business-government relations in
national and regional
developed and developing
contexts
economies.
(c) Apply tools of country and
 Regulation in the national and
political risk analysis
international context and its impact
(d) Discuss the nature of on the firm.
regulation and its impact
 Role of institutions and governance
on the firm.
in economic growth.
 Corporate political activity in
developed and developing markets.
 Country and political risk.
viii INTRODUCTION

Learning Outcomes
Lead Component Syllabus content
B Information Systems
1 Discuss the (a) Identify the value of  The role of information systems in
wider business information and organisations.
context within information systems
 Emerging information system
which organisations
trends in organisations (eg
information (b) Discuss the reasons for Enterprise-wide systems;
systems organisations’ increased knowledge management systems;
operate. dependence on information customer relationship management
systems systems, eg E-business, Web 2.0
(c) Discuss the transformation tools).
of organisations through  Information technology enabled
technology transformation; the emergence of
new forms of organisation.
 Geographically dispersed (virtual)
teams; role of information systems
in virtual teams and challenges for
virtual collaboration.
2 Analyse how (a) Discuss ways for  Assessing the costs and benefits of
information overcoming problems in information systems; criteria for
systems can information system evaluating information systems.
be implementation
 Privacy and security.
implemented (b) Discuss ways of organising
in support of  System changeover methods (ie
and managing information
the direct, parallel, pilot and phased).
system activities in the
organisation’s context of the wider  Information system implementation
strategy. organisation. as a change management process;
avoiding problems of non-usage
and resistance.
 Information system outsourcing
(different types of sourcing
strategies; client-vendor
relationships).
 Aligning information systems with
business strategy (eg strategic
importance of information systems;
information systems for
competitive advantage; information
systems for competitive necessity).
 INTRODUCTION ix

Learning Outcomes
Lead Component Syllabus content
C Operations management
1 Explain the (a) Explain the shift from  Supply chain management as a
relationship of price-based to relational strategic process.
operations procurement and
 An overview of operations strategy
management operations
and its importance to the firm.
to other (b) Explain the relationship of
aspects of the  Supply chains in competition with
operations and supply
organisation’s each other; role of supply
management to the
operations. networks; demand networks as an
competitiveness of the firm
evolution of supply chains.
(c) Explain the particular
 Design of products/services and
issues surrounding
processes and how this relates to
operations management in
operations and supply.
services
 The concept of sustainability in
(d) Explain the importance of
operations management.
sustainability in operations
management.
2 Apply tools (a) Apply contemporary  Different methods of quality
and thinking in quality measurement (eg Servqual).
techniques of management
 Approaches to quality
operations (b) Explain process design management, including Total
management.
(c) Apply tools and concepts Quality Management (TQM),
of lean management various British and European
Union systems as well as
(d) Illustrate a plan for the
statistical control processes.
implementation of a
quality programme  External quality standards.

(e) Describe ways to manage  Systems used in operations

relationships with management: Manufacturing
suppliers. Resource Planning II (MRPII);
Optimized Production Techniques
(OPT) and Enterprise Resource
Planning (ERP).
 Use of process maps to present the
flow of information and product
across supply chains and
networks.
 Methods for managing inventory,
including continuous inventory
systems (eg Economic Order
Quantity, EOQ), periodic inventory
systems and the ABC system
(Note: ABC is not an acronym; A
refers to high value, B to medium
and C to low value inventory).
 Methods of managing operational
capacity in product and service
delivery (eg use of queuing theory,
forecasting, flexible manufacturing
systems).
x INTRODUCTION

Learning Outcomes
Lead Component Syllabus content
 Application of lean techniques to
services.
 Practices of continuous
improvement (eg Quality circles,
Kaizen, 5S, 6 Sigma).
 The characteristics of lean
production.
 Criticisms and limitations of lean
production.
 Developing relationships with
suppliers, including the use of
supply portfolios.
D Marketing
1 Explain (a) Explain the marketing  The marketing concept as a business
developments concept, and the philosophy.
in marketing. alternatives to it
 The marketing environment,
(b) Describe the marketing including societal, economic,
environment of a range technological, political and legal
of organisations factors affecting marketing.
(c) Explain marketing in a  Marketing in not-for-profit
not-for-profit context organisations (ie charities, non-
(d) Explain the social context governmental organisations; the
of marketing behaviour public sector).
(e) Describe theories of  Theories of consumer behaviour (eg
consumer behaviour. social interaction theory), as well as
factors affecting buying decisions,
types of buying behaviour and stages
in the buying process.
 Social marketing and corporate
social responsibility.
2 Apply tools (a) Explain the relationships  Market research, including data
and between market gathering techniques and methods of
techniques research, market analysis.
used in segmentation, targeting  Segmentation and targeting of
support of the and positioning markets, and positioning of products
organisation’s (b) Apply tools within each within markets.
marketing. area of the marketing
 How business to business (B2B)
mix
marketing differs from business to
(c) Describe the business consumer (B2C) marketing in its
contexts within which different forms (ie consumer
marketing principles can marketing, services marketing, direct
be applied marketing, interactive marketing, e-
(d) Describe the market marketing, internal marketing).
planning process  Promotional tools and the promotion
(e) Explain the role of mix.
branding and brand  The ‘service extension’ to the
equity. marketing mix.
 INTRODUCTION xi

Learning Outcomes
Lead Component Syllabus content
 Devising and implementing a pricing
strategy.
 Experiential marketing.
 Marketing communications,
including viral, guerrilla and other
indirect forms of marketing.
 Distribution channels and methods
for marketing campaigns.
 The role of marketing in the business
plan of the organisation.
 Brand image and brand value.
 Product development and
product/service life-cycles.
 Internal marketing as the process of
training and motivating employees
so as to support the organisation’s
external marketing activities.
 The differences and similarities in
the marketing of products, services
and experiences.
 Product portfolios and the product
mix.
E Managing human capital
1 Explain the (a) Explain how HR theories  Theories of Human Resource
relationship of and activities can Management relating to ability,
Human contribute to the success motivation and opportunity.
Resources of the organisation
 The psychological contract and its
(HR) to the (b) Explain the importance of importance to retention.
organisation’s ethical behaviour in
operations.  The relationship of the employee to
business generally and for
other elements of the business.
the line manager and their
activities.  Personal business ethics and the
fundamental principles (Part A) of
the CIMA Code of Ethics for
Professional Accountants.
2 Discuss the (a) Explain the HR activities  Practices associated with recruiting
activities associated with developing and developing appropriate
associated the ability of employees abilities including recruitment and
with the (b) Discuss the HR activities selection of staff using different
management associated with the recruitment channels (ie
of human motivation of employees interviews, assessment centres,
capital. intelligence tests, aptitude tests,
(c) Describe the HR activities
psychometric tests).
associated with improving
the opportunities for  Issues relating to fair and legal
employees to contribute to employment practices (eg
the firm recruitment, dismissal,
redundancy, and ways of
managing these).
xii INTRODUCTION

Learning Outcomes
Lead Component Syllabus content
(d) Discuss the importance of  The distinction between
the line manager in the development and training and the
implementation of HR tools available to develop and train
practices staff.
(e) Prepare an HR plan  The design and implementation of
appropriate to a team. induction programmes.
 Practices related to motivation
including issues in the design of
reward systems (eg the role of
incentives, the utility of
performance-related pay,
arrangements for knowledge
workers, flexible work
arrangements).
 The importance of appraisals, their
conduct and their relationship to
the reward system.
 Practices related to the creation of
opportunities for employees to
contribute to the organisation
including job design,
communications, involvement
procedures and appropriate
elements of negotiating and
bargaining.
 Problems in implementing an HR
plan appropriate to a team and
ways to manage this.
 HR in different organisational
forms (eg project based, virtual or
networked firms) and different
organisational contexts.
 Preparation of an HR plan (eg
forecasting personnel
requirements; retention, absence
and leave, wastage).
 INTRODUCTION xiii

Studying E1
1 What's E1 about
E1 explores several discrete subjects which all affect how organisations operate. However, please note
that exam questions are likely to cover more than one of these subjects. You should therefore appreciate
the various links between them.

1.1 The global business environment

In Chapter 1 we introduce the setting within which all organisations compete – the global economy. We
begin by looking at the main influences on the international environment including the major economic
systems of the world, and how nations develop their economy and industry. Following on from this we
shall study the different types of businesses and the cultural considerations multinational companies
have to think about when managing business units in several countries.

The focus of Chapter 2 is on how governments affect their economies through economic policy and
regulation. The chapter also looks at non-legal regulation, in the form of corporate governance and
corporate social responsibility, which are becoming increasingly important to all business organisations.

1.2 Information systems

You are not expected to become an information systems (IS) expert, but the syllabus does require you to
appreciate the role IS plays in organisations. This includes the various types of system and the role
systems play in transforming how organisations operate and the types of business they do. These areas
are all covered in Chapter 3.

Chapter 4 is primarily concerned with how organisations implement new systems. However, you should
also understand the importance of organisations aligning their information systems with their overall
business strategy.

1.3 Operations management

Operations are the main activities of an organisation. They are ‘what it does’, and it is the subject of
Chapters 5, 6 and 7.

We begin by studying how operations develop around a value chain and how organisations join together
to form supply chains and networks. Quality is an important issue for all businesses, whether in terms of
products or services, and we shall see how quality can be measured and managed to ensure the
customer is satisfied. Finally, we shall find out how organisations can balance their inputs (inventory) and
outputs (products and services) with changing demand levels.

1.4 Marketing
Marketing is about communicating the organisation’s sales messages to the customer. It forms a major
part of its business strategy and is the subject of Chapters 8, 9 and 10. We shall firstly study the
marketing environment and see how a marketing strategy and plan are put together. Following on from
this, our study looks into how the marketing message is communicated to the customer and the
important issue of corporate branding.

The syllabus also covers several smaller areas of marketing. These include; consumer behaviour,
marketing not-for-profit organisations, marketing an organisation’s message to its employees (internal
marketing) and how corporate social responsibility affects how an organisation markets its products and
services. We shall cover all these areas in full as well.
xiv INTRODUCTION

1.5 Managing human capital

Many believe that an organisation’s employees are its main asset and they should be carefully managed
to get the best out of them. The E1 syllabus looks at all aspects of managing employees to maximise their
potential. Motivation, remuneration, appraisals and various types of working arrangement are all
important to this end and are covered in Chapters 11 and 12. We shall also look into what constitutes
good HR practice and the importance of employees acting ethically.

2 What's required
You will face a variety of questions in the E1 exam. Each type of question tests a different skill and you
must be confident in answering each of them.

20% of the marks are for objective test questions, such as those requiring a short written answer or the
selection of one correct answer from a choice of four. These questions test your ability to make quick
decisions and write succinctly.

When answering multiple choice questions try to eliminate any obviously wrong answers first before
considering the others.

A further 30% of the marks are available for answering five short answer questions which are based
around a single scenario. These test your ability to assimilate information quickly and either apply
theoretical knowledge or provide a brief analysis or evaluation.

It is always a good idea to list a few bullet points as a plan for each question, covering what you want to
say. This helps to focus your mind on the subject and your answers on the question.

The final 50% of the marks are awarded for answering one or two compulsory questions, each of which
may be related to a scenario. These scenarios will not necessarily be any longer than those in the short
answer questions, but your answers must be in more depth to earn the majority of the marks available.

Always produce an answer plan, including any models or theory that you need to mention. A good tip for
answering questions that require you to, for example,’ explain five advantages of…’ is to produce a bullet
list which you then use to provide the headings in your answer. Add some good explanation to this and
you’ll be well on your way to passing.

What the examiner means

The table below has been prepared by CIMA to help you interpret the syllabus and learning outcomes and
the meaning of exam questions.

You will see that there are 5 levels of Learning objective, ranging from Knowledge to Evaluation, reflecting
the level of skill you will be expected to demonstrate. CIMA Certificate subjects were constrained to levels
1 to 3, but in CIMA’s Professional qualification the entire hierarchy will be used.

At the start of each chapter in your study text is a topic list relating the coverage in the chapter to the
level of skill you may be called on to demonstrate in the exam.
 INTRODUCTION xv

Learning objectives Verbs used Definition

1 Knowledge
What you are expected to  List  Make a list of
know
 State  Express, fully or clearly, the details of/facts of
 Define  Give the exact meaning of
2 Comprehension
What you are expected to  Describe  Communicate the key features of
understand
 Distinguish  Highlight the differences between
 Explain  Make clear or intelligible/state the meaning of
 Identify  Recognise, establish or select after consideration
 Illustrate  Use an example to describe or explain
something
3 Application
How you are expected to  Apply  Put to practical use
apply your knowledge
 Calculate/  Ascertain or reckon mathematically
compute  Prove with certainty or to exhibit by practical
 Demonstrate means
 Prepare  Make or get ready for use
 Reconcile  Make or prove consistent/compatible
 Solve  Find an answer to
 Tabulate  Arrange in a table
4 Analysis
How you are expected to  Analyse  Examine in detail the structure of
analyse the detail of what
 Categorise  Place into a defined class or division
you have learned
 Compare and  Show the similarities and/or differences
contrast between
 Construct  Build up or compile
 Discuss  Examine in detail by argument
 Interpret  Translate into intelligible or familiar terms
 Prioritise  Place in order of priority or sequence for action
 Produce  Create or bring into existence
5 Evaluation
How you are expected to use  Advise  Counsel, inform or notify
your learning to evaluate,
 Evaluate  Appraise or assess the value of
make decisions or
recommendations  Recommend  Propose a course of action
xvi INTRODUCTION

3 How to pass
3.1 Study the whole syllabus
You need to be comfortable with all areas of the syllabus, as questions will often span a number of
syllabus areas. For example, question four in the Specimen Paper tested training (from the Managing
Human Capital syllabus area) in the context of systems implementation (from the Information Systems
syllabus area). A little wider reading will help you keep up to date with the global environment and new
technologies.

3.2 Lots of question practice

You can develop analysis and application skills by attempting questions in the Exam Question Bank and
later on questions in the BPP Practice and Revision Kit.

3.3 Analysing questions

For E1 it's particularly important to consider the question requirements carefully so that you understand
exactly what the question is asking. It is easy to misread multiple choice questions and therefore choose
the wrong answer.

Section C questions will often require you to produce an answer in the context of the scenario. Always
read the question carefully and answer the question set, not the question you hoped would be set!

3.4 Answering questions

Well-judged, clear recommendations grounded in the scenario will always score well as markers for this
paper look to reward good answers. Lists of points memorised from texts and reproduced without any
thought won't score well – you must always relate your knowledge to the specific question that you are
facing. Additionally, only include scenario information or detailed theory in your answer if it supports the
points you're making.

3.5 Exam technique

The following points of exam technique are particularly relevant to this paper.

 Answers with answer plans attached tend to score better and don't repeat the same material in
different question parts.

 You should consider in advance how you are going to use the 20 minute reading time as it can
help reduce time pressure. It is suggested that a good use of this time is to begin answering the
multiple choice questions by marking the question paper. Your answers can be transferred to your
answer book when writing time commences. Do not mark your answer book until you are
permitted to do so.

 Read the question carefully. A question that may appear on first glance to be about the product
lifecycle, may not require you to state the main stages of the cycle, but discuss how the model is
used or the principles behind it.

 Leave time to check your answers at the end to identify and correct any silly mistakes.
 INTRODUCTION xvii

4 Brought forward knowledge

CIMA has stated that syllabus material covered by any of the papers within the CIMA Certificate in
Business Accounting qualification may be relevant for assessment purposes in related subjects.

5 Links with other Operations level exams

The Operations level syllabus is wide and covers a number of different syllabus areas. The E1 syllabus
alone covers five significant syllabus areas, giving the examiner more than enough on which to base the
E1 exam. Therefore, it is unlikely that an E1 examination question would require knowledge from the
other operations level papers (F1 and P1).
xviii INTRODUCTION

The exam paper

Format of the paper

Number of
marks
Section A: Ten compulsory objective test questions, each worth 2 marks. Mini
scenarios may be given to which a group of questions relate. 20
Section B: Six compulsory short answer questions, each worth 5 marks. A short
scenario may be given, to which some questions relate. 30
Section C: Two compulsory written questions. Scenarios may be given, to which
questions relate 50
100

Time allowed: 3 hours, plus 20 minutes reading time

CIMA guidance
CIMA has stated that credit will be given for focusing on the right principles and making practical
evaluations and recommendations. Plausible alternative answers could be given to many questions, so
model answers should not be regarded as all-inclusive.

Numerical content
Questions in this paper usually require written answers. These involve applying theory or explaining key
concepts, so do not expect many calculations. However you should bring a calculator with you to the
exam just in case.

Breadth of question coverage

Questions in all sections of the paper may cover more than one syllabus area.

Knowledge from other syllabuses

Operations level papers can be taken independently and do not require knowledge from other syllabuses.

May 2013 exam paper

Section A
1 Ten multiple-choice questions covering the whole syllabus

Section B
2 Six short written questions covering a wide range of syllabus areas

Section C (two longer scenario questions worth 25 marks each)

3 Centralised IS activities, pay structures, flexible employment practices

4 Branding, marketing operations, development and training

 INTRODUCTION xix

March 2013 resit examination

Section A
1 Ten multiple-choice questions covering the whole syllabus

Section B
2 Six short written questions covering a wide range of syllabus areas

Section C (two longer scenario questions worth 25 marks each)

3 Lean production, recruitment and selection, employee retention

4 Role of Government, benefits of corporate social responsibility, corporate social responsibility

and HR policies

November 2012 exam paper

Section A
1 Ten multiple-choice questions covering the whole syllabus

Section B
2 Six short written questions covering a wide range of syllabus areas

Section C (two longer scenario questions worth 25 marks each)

3 Government policy, consumer buying behaviour and marketing, corporate social responsibility
and ethics
4 Roles of HR and line managers, lean management, Maslow/Herzberg and modular teams

September 2012 resit examination

Section A
1 Ten multiple-choice questions covering the whole syllabus

Section B
2 Six short written questions covering a wide range of syllabus areas

Section C (two longer scenario questions worth 25 marks each)

3 Market segmentation, ISO 9000, quality control

4 Offshoring, job rotation, training

xx INTRODUCTION

May 2012 exam paper

Section A
1 Ten multiple-choice questions covering the whole syllabus

Section B
2 Six short written questions covering a wide range of syllabus areas

Section C (two longer scenario questions worth 25 marks each)

3 Decentralised information systems, total outsourcing, principles of marketing

4 Total quality management (TQM), training, quality costs

March 2012 resit examination

Section A
1 Ten multiple-choice questions covering the whole syllabus

Section B
2 Six short written questions covering a wide range of syllabus areas

Section C (two longer scenario questions worth 25 marks each)

3 Strategic marketing, strategic marketing plans, bonus schemes
4 EPOS systems, resistance to change, HR issues

November 2011 exam paper

Section A
1 Ten multiple-choice questions covering the whole syllabus

Section B
2 Six short written questions covering a wide range of syllabus areas

Section C (two longer scenario questions worth 25 marks each)

3 Strategic marketing strategies, product portfolio management, sustainability
4 Geographically dispersed teams, home-working, role of an HR department
 INTRODUCTION xxi

September 2011 resit examination

Section A
1 Ten multiple-choice questions covering the whole syllabus

Section B
2 Six short written questions covering a wide range of syllabus areas

Section C (two longer scenario questions worth 25 marks each)

3 Brand management, total reward packages, internal marketing
4 People and payroll systems, approaches to quality, corporate websites

May 2011 exam paper

Section A
1 Ten multiple-choice questions covering the whole syllabus

Section B
2 Six short written questions covering a wide range of syllabus areas

Section C (two longer scenario questions worth 25 marks each)

3 ISO 9000, remuneration and reward packages, performance measures
4 Branding, product and place mix, HR activities

November 2010 exam paper

Section A
1 Ten multiple-choice questions covering the whole syllabus

Section B
2 Six short written questions covering a wide range of syllabus areas

Section C (two longer scenario questions worth 25 marks each)

3 HR Practices, HR \ workforce plan, e-HR

4 Ethics and CSR, marketing mix and branding, Internet marketing

xxii INTRODUCTION

May 2010 exam paper

Section A
1 Ten multiple-choice questions covering the whole syllabus

Section B
2 Six short written questions covering a wide range of syllabus areas

Section C (two longer scenario questions worth 25 marks each)

3 Emerging economies (BRIC), off-shoring; HR and redundancy

4 Supply chain management, process design, code of ethics

Specimen exam paper

Section A
1 Ten multiple-choice questions covering the whole syllabus

Section B
2 Six short written questions covering a wide range of syllabus areas

Section C (two longer scenario questions worth 25 marks each)

3 Marketing, market segmentation, promotional activity and ethics

4 Information system implementation problems and training provision

THE GLOBAL BUSINESS ENVIRONMENT

Part A

1
2
THE SOCIAL, POLITICAL AND
ECONOMIC CONTEXT

We start our E1 studies by looking at the develop and then apply our knowledge to the recently
wider environment that organisations operate emerging economies of Asia and Latin America.
in. This consists of the global economy and
Finally, we consider the different types of organisation
the nations which participate in it.
and the important cultural issues that face businesses
Once we have set the global context for business we who operate globally.
shall turn our attention to looking at how nations

topic list learning outcomes syllabus references ability required

1 The global business environment A1(a) A1(ii) comprehension
2 International environmental influences A1(a), A2(c) A1(ii) , A2(vi), application
A2(vii)
3 Economic context A1(a) A1(iii), A1(v) comprehension
4 Emerging economies A1(a), A1(b) A1(ii), A1(iv) comprehension
5 Different types of organisation A1(a) A1(i), A1(ii) comprehension
6 Culture and the global organisation A1(a) A1(i) comprehension

3
4 1: The social, political and economic context PART A THE GLOBAL BUSINESS ENVIRONMENT

1 The global business environment

Introduction
Today, international trade is truly global. In this section we consider the factors which led to the
globalisation of world trade.

1.1 Globalisation 05/11

GLOBALISATION refers to the growing interdependence of countries worldwide through increased trade,
increased capital flows and the rapid diffusion of technology.
KEY TERM Adapted from an IMF definition

Features of globalisation include:

(a) The ability of individuals to enter into transactions with individuals and organisations based in
other countries.

(b) The increased importance of global economic policy relative to domestic policy.

(c) The rise of globally linked and dependant financial markets.

(d) The reduction in importance of local manufacturing.

(e) Reduced transaction costs through developments in communications and transport.

(f) The rise of emerging, newly industrialised nations.

On an organisational level, global production implies that an organisation's production planning is

considered on a global scale.

(a) Global manufacture. A company can manufacture components for a product in a number of
different countries. China is becoming the workshop of the world.

(b) Global sourcing. Sub-components may be purchased from countries overseas.

1.2 Factors encouraging the globalisation of world trade

(a) Financial factors such as Third World debt. Often, lenders require the initiation of economic
reforms as a condition of the loan.

(b) Country/continent alliances, such as the European Union, which foster trade and other
phenomena such as tourism.

(c) Legal factors such as patents and trade marks, which encourage the development of technology
and design.

(d) Markets trading in international commodities. Commodities are not physically exchanged, only the
rights to ownership. A buyer can, thanks to efficient systems of trading and communications, buy a
commodity in its country of origin for delivery to a specific port.

1.3 Organisations involved in global trade.

A number of organisations are involved in developing and managing global trade. These include, the
World Trade Organisation (WTO), the G8, the International Monetary Fund (IMF), the World Bank and
the European Bank for Reconstruction and Development (EBRD).
PART A THE GLOBAL BUSINESS ENVIRONMENT 1: The social, political and economic context 5

1.3.1 The World Trade Organisation (WTO)

The World Trade Organisation (WTO) was formed in 1995 as successor to the General Agreement on
Tariffs and Trade (GATT) which was set up after World War II in 1948. It is an organisation that devotes
itself to international trade in goods, services, traded inventions, creations and intellectual property.

The WTO has over 150 members and these represent 97% of international trade. The organisation seeks
to promote the free flow of trade by removing obstacles to trade, and to make sure that individuals,
companies and governments know what these rules are.

The WTO:

 Administers trade agreements

 Is a forum for developing new trade agreements
 Settles trade disputes
 Reviews national trade policies
 Assists developing countries in trade policy issues (training/technical assistance)
 Co-operates with other international organisations

GATT is the WTO's main guidelines on international trade in goods. It is the result of negotiations
between nations and is subject to updating and revision. For example, when the WTO was set up, GATT
was extended to intellectual property, services, dispute settlement and other areas.

The WTO Agreements contain the principles of liberalisation of free trade. They include commitments by
each country to lower customs tariffs and other trade barriers, and to open and keep open services
markets. They also set procedures for settling disputes.

1.3.2 The G8
The G8, or Group of Eight, is a forum for eight of the main developed nations. Membership of the G8
includes France, Germany, Italy, Canada, Russia, Japan, the United Kingdom and the United States.

The forum, which has no official powers or resources, was originally established so that talks on
economics and trade can take place, however in recent years, politics has also been discussed and
agenda items have included global warming, AIDS and poverty. The group is seen to take a lead in world
affairs and often sets a direction for the international community to follow.

The group meets at an annual summit meeting. The members rotate the presidency of the forum and
responsibility for hosting the summit. Matters often discussed include:

 International trade generally

 Energy and pollution issues
 Developing nations
 Macroeconomic issues
 International crime
However, other issues that are often discussed include:

 Improved cooperation over trade and finance

 Strengthening the global economy
 Prevention and resolution of conflicts
 Promotion of peace and democracy

1.3.3 The International Monetary Fund (IMF)

The International Monetary Fund (IMF) was established at the Bretton Woods meeting in 1944 in the
US. Its initial role, after the Second World War, was in the rebuilding of national economies. The IMF
oversaw the international monetary system and took on the role of ensuring exchange rate stability and
encouraging members to eliminate exchange restrictions that hinder trade. Since then, the IMF has played
a major role in world affairs, for example in helping former communist nations transition into market
economies.
6 1: The social, political and economic context PART A THE GLOBAL BUSINESS ENVIRONMENT

In more recent times, the IMF has:

 Promoted financial cooperation

 Established stable exchange rates and easily convertible currencies
 Provided help and support for nations with trade deficits in order to help them overcome them
 Encouraged international liquidity

1.3.4 The World Bank

Like the IMF, the World Bank was founded at the Bretton Woods summit in 1944 and was initially
known as the International Bank for Reconstruction and Development (IBRD). Its role was to assist
nations reconstruct their economies after the Second World War but once that was achieved it refocused
its attention onto the developing world. The organisation (which is now known as the World Bank) is
made up of five main bodies.

The International Bank for Reconstruction and Development (IBRD) which provides loans to middle-
income and creditworthy low-income countries. Funds are raised by the IBRD and provided to nations at
a commercial (but low) rates of interest and on favourable terms.

The International Development Association (IDA) which provides interest-free (or low rate) loans, called
credits, and grants to the poorest countries. Funds are raised by subscription from donor countries and
distributed to borrowing countries.

The International Finance Corporation (IFC) which provides loans, equity and technical assistance to
stimulate private sector investment in developing countries.

The Multilateral Investment Guarantee Agency (MIGA) which provides guarantees against losses caused
by non-commercial risks to investors in developing countries.

The International Centre for Settlement of Investment Disputes (ICSID) which provides international
facilities for conciliation and arbitration of investment disputes.

1.3.5 The European Bank for Reconstruction and Development (EBRD)

The European Bank for Reconstruction and Development (EBRD) was established in 1991 as a response
to the political and economic changes in Central and Eastern Europe. The role of the Bank was to support
the development of market economies in the region following the widespread collapse of communist
regimes. In more recent times, the EBRD has embraced a role as the world’s only transition bank, and is
helping nations around the world to move from state controlled to market economies.

1.4 Impact of globalisation on firms

Globalisation has a number of impacts on firms, for example:

(a) Relocation. Firms may need to relocate their operations to reduce costs, avoid tariffs and quotas,
or to take advantage of areas of industrial excellence.

(b) Markets. New markets may emerge as closed markets (such as China) open up or as nations
become more developed. Consumer tastes change and products become more homogenised and
can therefore be sold in more countries.

(c) Competition. Reduced trade barriers and advances in communications greatly increases the
number of competitors that a firm faces.

(d) Alliances. The opportunities for forming alliances or merging/acquiring other firms will also
increase for the same reasons.

(e) Economic divisions. Wealthy countries with access to modern communications technology will
become more wealthy at the expense of poorer nations that cannot afford to make the necessary
investment. Such nations may also be pressured into producing goods for export rather than
ensuring the production of goods and services needed locally.
 PART A THE GLOBAL BUSINESS ENVIRONMENT 1: The social, political and economic context 7

Section summary
Global production involves manufacturing and sourcing on a global scale.

World trade has been encouraged by financial factors, trade alliances, legal factors, international
markets and various organisations.

2 International environmental influences

Introduction
The global business environment can be analysed against a number of factors, such as political,
economic, social/cultural and technological. This is known as PEST analysis. There will be differences
between different countries.

2.1 Political and legal

2.1.1 Political risk

Political risk is the risk of an organisation incurring losses due to non-market factors. These factors are
usually related to government policy, for example trade rules, investment incentives and the tax regime.
KEY POINTS
Political risk is also related to financial factors such as currency controls and the economy, and stability
factors such as rioting and civil war.

Some countries present a higher political risk than others. For example, less developed countries are
often viewed as more unstable than developed countries and therefore a higher risk in comparison.

Even in a developed country, there is significant political risk at the time a new government is elected.
This is particularly true where a previous opposition party is elected, as it may hold completely different
views about how the country should be run than the previous regime.

Some political risk directly affects a business (see the table below for examples). However, some political
risk indirectly affects a business (for example government economic policy that affects the general
business environment).

Examples of political risk

Changes to fiscal policy (taxation) Nationalisation of foreign-owned industries
Changes to regulations on paying dividends to Legislation changes (especially to
foreign shareholders corporate/employment law)
Changing/cancelling government contracts Pressure groups affecting government policy

2.1.2 Corporate political activity

Corporate Political Activity (CPA) refers to the involvement of companies in the political process with the
aim of influencing policies towards their preferences. Common activities include lobbying and donating to
KEY POINT political party campaigns.
8 1: The social, political and economic context PART A THE GLOBAL BUSINESS ENVIRONMENT

Corporate political activities are generally used by companies to attempt to gain competitive advantage
and can be classified into two types, buffering and bridging.

(a) Buffering refers to proactive actions such as warning the government about the impact of
legislation while it’s being considered, in an attempt to influence the content.

(b) Bridging is more reactive and focuses more on ensuring the firm is aware of and meets required
standards of behaviour, for example ensuring the company is aware of proposed new legislation
and complies with it when it is passed.

Organisations may need to deal with governments and make their policy preferences known in a number
of situations. Examples include:

(a) Multinational companies from developed countries may negotiate terms for their investment in that
country. For example finance, taxation and export agreements.

(b) Multinationals may lobby governments to provide conditions in the economy that benefit them.
For example reducing restrictions or controls over labour such as working hours and minimum
wages. The MNC may threaten to withdraw its investment if the government fails to agree.

(c) New industries in developing nations may seek protection from their government, for example
import restrictions.

(d) Developing industries may seek government support such as subsidies or tax breaks to help them
compete in the global market.

There is a difference in corporate political activity between businesses in developed and developing
nations.

In developed nations CPA is well-organised with large organisations nurturing close relationships with
relevant government departments. Businesses often have special government liaison departments to foster
their relationships. There are also organisations set up to lobby government on behalf of interested
parties. Examples of lobby groups in the UK include, Chambers of Commerce, the Confederation of British
Industry (CBI), the Institute of Directors (IOD) and the Federation of Small Businesses (FSB).

This contrasts with developing nations where relationships are not so subtly managed. Businesses are
often more direct in approaching individual policy makers, government departments and politicians to put
across their needs. In some instances, those with the power to make government policy may be subjected
to bribery, corruption and threats.

2.1.3 Country risk

Country risk is similar to political risk, although it is usually wider in scope and includes all risks relevant
to the business environment (including market factors) in a specific country.
KEY POINT

It is important that organisations analyse the political and country risk of a nation before investing or
trading with it to minimise the risk of losses.

Examples of country risk

Political environment (stable/unstable) Level of interference of government in business
Structure of the society The economy
Feelings toward foreign business organisations Culture
PART A THE GLOBAL BUSINESS ENVIRONMENT 1: The social, political and economic context 9

2.1.4 Analysing political and country risk

Analysis of political and country risk is difficult. Some elements of risk, such as financial factors, can be
quantified, however some factors such as the risk of civil war are based on assumptions and judgements.

Macro-political risks are general risks that affect all foreign firms in the same way. The risk of the seizure
of all overseas owned business assets is an example of a macro political risk. Risks relevant to particular
organisations or sectors are referred to as micro-political risks. Industry specific regulation is an example
of a micro political risk.

Many organisations employ a third party to carry out a risk assessment for them.

Rugman and Hodgetts summarised different aspects of political risk as shown in the following tables.

Sources of political risk

Changing economic conditions Social unrest and upheaval
Religious competition and disputes Local business people vested interests
New international alliances Increased nationalism

Groups that generate political risk

The government and its agencies Foreign governments that have influence
International organisations (eg World Bank, United Terrorist groups
Nations)
Organised interest and protest groups (eg students) Political opposition groups

Effects of political risk

Expropriation (seizing) of assets, with or without Influence on government by non-government
compensation groups
Disruption and / or damage from terrorist activity Restrictions on ways of operating
Increased taxes and / or other financial penalties Cancellation or revision of contracts
Restrictions on foreign ownership and / or the favouring of local firms (indigenisation laws)

2.1.5 Weighing up political and country risk

Once the risks have been identified, the organisation needs to weigh up the probability of the risk
occurring and the consequences to the organisation should the event occur. Jennings and Wattam
(1998) devised the following model to weigh up political risk.

Impact of risk
Low High
Probability of risk

High A B

Low C D
10 1: The social, political and economic context PART A THE GLOBAL BUSINESS ENVIRONMENT

The model is used to classify the probability of the risk and impact of the risk as low or high. Four
possible situations will result:

(a) Situation A – High probability of risk, low impact. There is a good chance of the risk occurring,
although if it does it will not have a significant impact on the organisation. The company should
accept the risk but take action to manage it. If the cost of risk management is too high, the
organisation may decide to simply accept the risk (if it has a very low impact).

(b) Situation B – High probability of risk, high impact. Due to the high risk and potential impact on
the organisation, investing or dealing with the country should only go ahead if the risk can be
managed and contingency plans put in place. The potential benefits of the deal must outweigh the
costs of managing the risk.

(c) Situation C – Low probability of risk, low impact. The probability of the risk is low and the
potential impact on the organisation is also low. This is the ideal situation as the costs of
managing the risk will be low. The organisation may decide that risks classified in this quadrant
can be accepted with minimal or no additional risk management actions.

(d) Situation D – Low probability of risk, high impact. It can be difficult to decide what action is
appropriate in this situation because although the probability of risk is low, the damage it can
inflict on the organisation is high. If the organisation chooses to go ahead, then it must take action
to minimise the chance of the risk occurring and the potential impact it will have (for example, an
insurance policy). If this cannot be achieved in a cost-effective manner then the organisation
should consider abandoning its plans.

2.1.6 Managing country and political risk

RISK MANAGEMENT involves reducing the probability of the risk occurring and minimising the impact on
the organisation that it will cause.
KEY TERM
Managing political risk begins even before an investment is made as it is important for the organisation to
consider and understand it before making a commitment. At this stage the main issue is whether the
potential return from the investment outweighs the risk involved in making it.

Once the investment is made, the business should review the risks regularly. It should, in particular, look
out for the emergence of new risks or minor risks becoming more serious. These reviews ensure that the
risks can be addressed as soon as possible once they are detected.

Country risk can be analysed three ways – politically, financially and economically.

Political factors include the stability of the government and any tensions between groups (such as
religious or ethnic groups). Financial factors are usually macro-economic factors in relation to levels of
government debt, the exchange rate and balance of trade. Economic factors are key statistics relating to
economic activity – for example levels of GDP and inflation.

Once these factors are identified and analysed, the level of country risk can be assessed.

The following table contains general examples of how businesses can minimise the probability and
impact of both types of risk.

Minimising probability of risk Minimising impact of risk

Postponing/abandoning of project until the level of Continually monitor the environment and be
risk is reduced prepared to react quickly
Develop links with relevant government Develop contingency plans
departments to help shape policy
Abandon the project Take out country/political risk insurance

You will revisit risk management when you study P3.

PART A THE GLOBAL BUSINESS ENVIRONMENT 1: The social, political and economic context 11

2.1.7 Legal
The system of courts and the law will differ from country to country although many share similar
characteristics. The rule of law and independent judiciaries may be strong in one country but absent in
another. Rules relating to corporate status, property, the regulation of business and to financial reporting
may all be very different.

2.2 Economy and economic development

Various economic factors specific to a country may affect international trade:
 Is there growth or is the economy stagnating?
 Is the exchange rate stable?
 How does the interest rate compare with other countries? Is it stable?
 What is the rate of inflation? What is the government's policy? Is it realistic?

Economic factors affect the demand for, and the ability to acquire, goods and services. As countries
develop, demand increases for more and more sophisticated products and services. Countries generally
have larger agricultural sectors in the early stages of economic development. As the economy develops,
the manufacturing sector increases.

PEST analysis can also be used as a tool to identify the risks within an economy. In this case, potential
risks are generated for each of the four headings.

Factor Example of risk

Political Unstable government
Economic Economic slowdown
Social High crime rates, risk of civil war
Technological Lack of technological infrastructure – poor telecommunications network

2.2.1 Level of economic development

Generally each country can be classified under one of five headings. Note that gross domestic product
(GDP) is the value of the goods and services produced by an economy in a given period.

LESSER DEVELOPED COUNTRY (LDC). Relies heavily on primary industries (mining, agriculture, forestry,
fishing). Low GDP and poorly developed infrastructure.
KEY TERMS
EARLY DEVELOPED COUNTRY (EDC). Largely primary industry based but with developing secondary
(manufacturing) industrial sector. Low but growing GDP, developing infrastructure.

SEMI-DEVELOPED COUNTRY (SDC). Significant secondary sector still growing. Rising affluence and
education with the emergence of a 'middle class'. Developed infrastructure.

FULLY DEVELOPED COUNTRY (FDC). Primary sector accounts for little of the economy. Secondary sector
still dominates, but major growth in tertiary (service) sector. Sophisticated infrastructure.

TRANSITIONAL ECONOMIES (TES). These are countries which used to be part of the planned economy of
the Soviet Union but which are now in various stages of transition towards a market economy.

2.3 Social/cultural
A country's culture consists of a number of factors such as beliefs, morals and how citizens behave. A
nation's culture is very difficult to change and if change does occur it will take place very slowly.
National culture is important to businesses because it influences the perceptions and behaviour of
consumers as well as employees and managers. The national way of doing things pervades society.
Business practice is part of the structure of society and therefore subject to cultural influences.
12 1: The social, political and economic context PART A THE GLOBAL BUSINESS ENVIRONMENT

Language is another important aspect of culture. While English is fast becoming the international
language of business, there are many areas where it is not commonly understood, sometimes as a matter
of local pride. Mistaken use of a foreign language can have a detrimental affect on a business.

2.4 Technology
Technology is the key driver of global economic activity. It is an enabler, allowing new types of business
and organisational structure. It has had other impacts, such as:

(a) Protection of intellectual property. Patents, trademarks and copyright are particularly important in
international operations. Can they be protected? Similarly, in manufacturing, can trade secrets be
protected, perhaps by importing part-completed assemblies? Some countries require local
ownership of relevant patents before production can proceed in that country.

(b) If advanced technology is involved, it will be necessary to consider local standards of education
and technical infrastructure.

(c) Reliance on 'e' methods for marketing communications and product delivery (eg information or
music downloads) depends on potentially differing levels of infrastructure (eg availability of
broadband Internet connections) and adoption (eg mobile phone ownership).

(d) Ease of communication with overseas markets (eg via email and e-commerce) creating potential
fulfilment/delivery problems (given distance and infrastructure).

You can use PEST analysis to analyse many aspects of an organisation’s environment so
expect to apply it in your future exams, up to and including TOPCIMA.

We shall also apply PEST in connection with gathering information about an organisation’s environment,
and in relation to the marketing environment.

PEST analysis is also sometimes known as PESTEL analysis. This is the same as PEST, but considers
ecological factors and at legal factors separately from political factors.

Section summary
The global business environment can be analysed into political, economic, social and technological
factors, this is known as PEST analysis.

3 Economic context

Introduction
Free trade is not a new concept, but free trade on a global scale has grown massively in recent decades.
There are arguments for and against free trade.

In the global business environment a number of regional trading arrangements exist. These regional
trading groups take three forms, free trade areas, customs unions and economic unions/common
markets.

Another feature of the global environment is the increasing number of transition economies which are
becoming more outward looking and competitive.
PART A THE GLOBAL BUSINESS ENVIRONMENT 1: The social, political and economic context 13

3.1 Free trade v protectionism

FREE TRADE encourages easy movement of goods, services labour and capital between different countries.
Free trade involves an absence of quotas, tariffs, subsidies and discriminatory taxation or other barriers
KEY TERM that may hinder trade.

Free trade is sometimes referred to as liberalisation or liberal trade policies.

Arguments for free trade

Conflict is less likely between countries that trade and communicate with each other, and closer political
links should be formed
Facilitates specialisation by countries in the production of the goods and services they are best suited to
producing
Enables countries to develop and invest in resources leading to more efficient production
Encourages entrepreneurship and economic growth
Encourages all countries to export and competition is encouraged
Leads to better quality goods and a better quality of life as surpluses and deficits are removed
Internationalisation increases the size of markets which improves economies of scale
Competition lowers prices and improves consumer choice

Arguments against free trade

Countries become dependent upon a single product or type of product (eg the oil exporting countries of
the Middle East)
Less developed countries become dependent upon other countries for some products (eg high tech
products)
Can undermine local culture (eg the Americanisation of Europe)
Increases consumer expectations and encourages inefficiencies (eg air-freighting fruit to areas it is out of
season)
Free trade can prevent new industries developing and becoming established
Unfair competition is created as countries with excess goods can 'dump' their surplus cheaply into other
countries
Opening up of markets allows foreign monopolies to take over local industries
It allows potentially harmful products to be traded
Relaxed border controls reduce national security
Multi-national companies may have an unfair influence on a country's political system

PROTECTIONISM aims to restrict trade with one or more other country to protect home country producers
from overseas suppliers.
KEY TERM
Protectionism is sometimes referred to as economic nationalism.
14 1: The social, political and economic context PART A THE GLOBAL BUSINESS ENVIRONMENT

Protective trade measures

Quotas - restricting the quantity able to be imported (an embargo is a total ban on the import/export of a
particular good).
Tariffs and/or customs duty - effectively taxing imports making them more expensive
Subsidies - helping local producers giving them an advantage over overseas competitors
Campaigns – encouraging citizens to buy locally produced goods
Technical/administrative barriers - implementing strict quality, environmental, health and safety and / or
packaging regulations that effectively restrict imports

3.2 The move towards free trade

From the industrial revolution in the nineteenth century until the middle of the twentieth century, nations
held a nationalist view of their economy – in other words governments were only interested in protecting
and developing their own industries.

However, in the mid to late twentieth century economic liberalisation took place. Governments moved
away from the single minded view of looking after their own economies, towards working with others in
groups for the common good of all members.

Several forms of trading group have developed, including, free trade areas, customs unions, economic
unions/common markets and single markets.

Those in favour of such trading groups point out that by harmonising economic policies and removing
trade restrictions, trade is encouraged and prices are reduced.

However, critics of these trading groups point out that trade is encouraged within the group at the
expense of nations outside the group – even if their prices are lower.

The World Trade Organisation (WTO) opposes trading groups because they develop trade internally by
creating barriers to prevent external organisations entering their market. World trade may be affected as
each group seeks to promote trade within itself, this may create conflicts between different groups – for
example caused by import and export restrictions imposed. Protectionism may also be encouraged at the
time when the WTO is trying to free up world trade.

As an alternative to free trade or protectionism, countries may seek a policy of 'balanced trade'. The
objective of balanced trade is to manage the imports and exports between two nations so that neither
runs up a large trade deficit.

3.3 Free trade areas

Members in these arrangements agree to lower barriers to trade amongst themselves. They enable free
movement of goods and services, but not always the factors of production such as materials and labour.

3.4 Customs unions

Customs unions provide the advantages of free trade areas and agree a common policy on tariff and non-
tariff barriers to external countries. They attempt to harmonise tariffs, taxes and duties amongst
members.

3.5 Economic unions/common markets

In an economic union or common market, members become one for economic purposes. There is free
movement of the factors of production.
PART A THE GLOBAL BUSINESS ENVIRONMENT 1: The social, political and economic context 15

The European Union (EU) began as a single market and was created in 1957 by the Treaty of Rome.
This treaty had the goals of:

 Creating common policies on areas such as farming and transport that member countries should
abide by.

 Encouraging competition within the market by removing restrictive practices created by business.

 Removing duties and quotas on trade between member countries.

 Increasing trade with non-member countries.

 Allowing the free movement of goods, services, people and capital between member countries.

 Creating a customs union and common trade policies between members and non-members.

Since 1957, the EU has developed and now an economic union has been created. Some member states
have adopted a common currency, the Euro.

3.6 Single markets

A single market is a level playing field for all producers within an economic community. The community
creates common policies concerning the movement of goods, product specification and regulation so all
producers must meet the same requirements.

3.7 Other types of agreement

Bi-lateral and multi-lateral trade agreements eliminate protectionist policies such as quotas and tariffs on
goods traded between nations subject to the agreement. Bilateral agreements are between two nations
(for example the Closer Economic Relations agreement between Australia and New Zealand). Multi-lateral
agreements are between three or more nations and some examples are listed below.

3.8 Examples of trade agreements

The following are examples of the different types of trade agreements which are currently in operation.

Free movement of
Free trade eg EFTA
goods and services
area
between members

plus
Customs eg the EEC (the EU
Common external
union in earlier years)
tariffs

plus
Common eg the EU now
Free movement of
market
factors of production
16 1: The social, political and economic context PART A THE GLOBAL BUSINESS ENVIRONMENT

The major regional trade organisations are as follows.

(a) North American Free Trade Agreement (NAFTA) – A free trade area between the US, Canada and
Mexico.

(b) European Free Trade Association (EFTA) – Norway, Switzerland, Iceland, Liechtenstein.

(c) European Union (EU) – A single market / economic union between Ireland, United Kingdom,
France, Germany, Italy, Spain, Portugal, Finland, Sweden, Denmark, Luxembourg, Belgium, the
Netherlands, Austria, Greece, Bulgaria, Cyprus, Czech Republic, Estonia, Hungary, Latvia,
Lithuania, Malta, Poland, Romania, Slovakia, Slovenia.

Croatia is due to become a member in mid-2013.

(d) Asean Free Trade Area (AFTA) – Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the
Philippines, Singapore, Thailand, Vietnam.

(e) Asia-Pacific Economic Co-operation (APEC) – Australia, Brunei, Malaysia, Singapore, Thailand,
New Zealand, Papua New Guinea, Indonesia, the Philippines, Taiwan, Hong Kong, Japan, South
Korea, China, Canada, US, Mexico, Chile, Peru, Russia and Vietnam.

(f) Mercosur – A customs union between Brazil, Argentina, Paraguay, Uruguay and Venezuela
(Bolivia, Chile, Columbia, Ecuador and Peru are associates).

(g) Southern African Development Community (SADC); Angola, Botswana, Democratic Republic of the
Congo, Lesotho, Malawi, Mozambique, Mauritius, Namibia, South Africa, Seychelles, Swaziland,
Tanzania, Zambia, Zimbabwe.

(h) West African Economic and Monetary Union (UEMOA) – Ivory Cost, Burkina Faso, Niger, Togo,
Senegal, Benin, Mali and Guinea-Bissau.

(i) South Asian Association for Regional Co-operation (SAARC) – India, Pakistan, Sri Lanka,
Afghanistan, Bangladesh, the Maldives, Bhutan and Nepal.

(j) Andean Pact – Colombia, Ecuador, Peru and Bolivia.

(k) Association of Southeast Asian Nations (ASEAN) – A free trade area between Brunei, Indonesia,
Malaysia, Philippines, Singapore, Thailand, Vietnam, Laos, Myanmar and Cambodia.

(l) The Economic Community of West African States (ECOWAS) – A single market between Benin,
Burkina Faso, Cabo Verde, Ivory Coast, Gambia, Ghana, Guinee, Guinee-Bissau, Liberia, Mali,
Niger, Nigeria, Senegal, Sierra Leone and the Togolese Republic.

Section summary
Economic nationalism is a nation's view that it should protect its own economy and industries.

Economic liberalisation involves nations moving away from economic nationalism towards working with
others in a group to benefit all member economies and industries.

Free trade areas, customs unions and economic unions/common markets are all types of economic
system designed to provide members with a trade advantage.
PART A THE GLOBAL BUSINESS ENVIRONMENT 1: The social, political and economic context 17

4 Emerging economies 11/10

Introduction
Economies develop over time. Development begins with agriculture and moves to manufacturing and
services once demand for such goods is created and the economy is wealthy enough to afford them.

Traditionally the largest and most powerful economies of the world were those of the US, Japan and
Western Europe. These countries were the first to become developed and therefore they had a 'head start'
on the rest of the world. However, in recent years a number of other countries have begun to compete
with them.

4.1 Absolute advantage and comparative advantage

An early explanation for the success of different countries was Adam Smith’s theory of absolute
advantage. In The Wealth of Nations, way back in 1776, Smith proposed that each nation should
specialise in producing those goods that it could produce most efficiently. Some of these would be
exported to pay for the imports of goods that could be produced more efficiently elsewhere.

Smith’s theory of absolute advantage is based on the assumption that the nation is more efficient at
production of certain goods than are its trading partners, and that nations would gain from trade.

Smith’s theory was refined by David Ricardo (around 1817) and in the 1930s by Hecksher and Olin to
become the theory of comparative advantage. This held that relative opportunity costs were most relevant
when considering economic activities in relation to other countries. Even if a country is able to produce all
its goods at lower costs than another country can, trade would benefit both countries.

4.2 Competitive advantage - Porter's diamond

Michael Porter argues that comparative advantage is too general a concept to explain national sources of
competitive advantage. His The Competitive Advantage Of Nations (1992), suggests that some nations'
industries are more internationally competitive than others.

Porter believes the conditions within a country affects the ability of organisations and industries based in
that country to compete with organisations based in other countries. He identifies four principal factors,
that impact on the competitiveness of organisations as shown in the following diagram - the diamond.
Governments can intervene in their economy to support each factor and as a result can influence the
competitiveness of its organisations.

Porter’s diamond

Firm strategy,
structure, rivalry

Factor Demand
conditions conditions

Related and
supporting industries
18 1: The social, political and economic context PART A THE GLOBAL BUSINESS ENVIRONMENT

4.2.1 Factor conditions

Factor conditions relate to those factors used as inputs in the production of goods and services.

 Human resources (skills, price, motivation, industrial relations)

 Physical resources (land, minerals, climate, location relative to other nations)
 Knowledge (scientific and technical know-how, educational institutions)
 Capital (amounts available for investment, how it is deployed)
 Infrastructure (transport, communications, housing)

Porter distinguishes between basic and advanced factors.

(a) Basic factors are natural resources, climate, semiskilled and unskilled labour. They are inherent, or
at best their creation involves little investment. They are unsustainable as a source of national
competitive advantage, since they are widely available. For example, the wages of unskilled
workers in industrial countries are undermined by even lower wages elsewhere.

(b) Advanced factors are associated with a well-developed scientific and technological infrastructure
and include modern digital communications networks, highly educated people (eg computer
scientists), university research laboratories and so on. They are necessary to achieve high order
competitive advantages such as differentiated products and proprietary production technology.

An abundance of factors is not enough. It is the efficiency with which they are deployed that matters.
The former Soviet Union had an abundance of natural resources and a fairly well educated workforce, but
was an economic catastrophe.

Porter also notes that generalised factors, such as transport infrastructure are not significant in
establishing competitive advantage as specialised factors. Specialised factors are relevant to a limited
range of industries, such as knowledge bases in particular fields and logistic systems developed for
particular goods or raw materials. Such factors are integral to innovation and very difficult to move to
other countries.

4.2.2 Demand conditions: the home market

The home market determines how organisations perceive, interpret and respond to buyer needs. This
information puts pressure on organisations to innovate and provides a launch pad for global ambitions.

Important home market considerations include:

(a) There are no cultural impediments to communication.

(b) Segmentation of the home market shapes an organisation’s priorities. Companies will be
successful globally in segments which are similar to the home market.

(c) Sophisticated and demanding buyers at home encourage high quality standards.

(d) Anticipation of buyer needs. If consumer needs are expressed in the home market earlier than in
the world market, the organisation benefits from experience.

(e) The rate of growth. Slow growing home markets do not encourage the adoption of state of the art
technology.

(f) Early saturation of the home market will encourage an organisation to export.

4.2.3 Related and supporting industries

Competitive success in one industry is linked to success in related industries. Local suppliers may be
preferable to overseas suppliers if continuing close co-operation and co-ordination is important. The
process of innovation is also enhanced when innovative organisations in related industries are based close
to each other. For example, many innovative high-tech businesses are based in “Silicon Valley”,
California.
PART A THE GLOBAL BUSINESS ENVIRONMENT 1: The social, political and economic context 19

4.2.4 Firm strategy, structure and rivalry

Management style and industrial structure. Nations are likely to display competitive advantage in
industries that are culturally suited to their normal management practices and industrial structures. For
example, German managers tend to have a strong bias towards engineering and are best at products
demanding careful development and complex manufacturing processes. They are less successful in
industries based on intangibles such as fashion and entertainment.

Strategy. Industries in different countries have different time horizons, funding needs and so forth.

(a) National capital markets set different goals for performance. In Germany and Switzerland, banks
are the main source of capital, not equity shareholders. Short-term fluctuations in share prices are
not regarded as of great importance as funds are invested for the long term. In the USA, most
shares are held by financial institutions whose own performance indicators emphasise short-term
earnings growth.

(b) National attitudes to wealth are important. The egalitarian Swedes (as a generalisation) may be
less motivated to pursue success in industries that have the potential to create individual fortunes
but depend on new start-ups.

(c) National culture affects industrial priorities through the relative prestige it allots to various
industries and their leaders. Italy values fashion and furnishings, for instance, while in Israel the
most prestigious industries are agriculture and those related to defence.

Domestic rivalry is important for several reasons.

 All rivals are working under the same domestic conditions

 With little domestic rivalry, organisations may be happy to rely on the home market.
 Tough domestic rivals teach an organisation about competitive success.
 Domestic rivalry forces organisations to compete on grounds other than basic factors.
 Each rival can try a different strategic approach.

The promotion of one or two 'national champions' who can reap major economies of scale in the domestic
market is undermined by the vigorous domestic competition among high-performing companies. Examples
are the Swiss pharmaceutical industry and the US IT industry.

Porter’s diamond is a key theory which you will use again in the future, for example in paper
E2.

4.3 Influencing the diamond

A nation's competitive industries tend to be clustered. Porter believes clustering to be a key to national
competitive advantage. A cluster is a linking of industries through relationships which are either vertical
(buyer-supplier) or horizontal (common customers, technology, skills). For example, the UK financial
services industry is clustered in London.

Machinery that
produces the goods

Finished goods

Inputs, supplies

Related services
20 1: The social, political and economic context PART A THE GLOBAL BUSINESS ENVIRONMENT

4.3.1 Government intervention

How does a country create a diamond of competitive advantage? Governments cannot compete, only
organisations can do that. Governments can influence the context in which an industry operates and can
create opportunities and pressures for innovation.

(a) Factors of production provide the seeds for development. A large endowment of easily mined iron
ore would suggest metal-working industries.

(b) Related and supporting industries can also be a foundation, if the competences within them can
be configured in a new way.

(c) Government policy should support cluster development and promote high standards of education,
research and commercially relevant technologies.

(d) Extraordinary demand in the home market based on national peculiarities and conditions can set
the demand conditions determinant in the diamond.

It must be remembered that the creation of competitive advantage can take many years.

Individual organisations will be more likely to succeed internationally if there is a supporting cluster.
Businesses should be prepared to invest in co-operative ventures in such fields as training, infrastructure
and research. However, the cluster approach is not guaranteed to be successful.

4.4 Offshoring and outsourcing 11/10

Two relatively recent techniques organisations may decide to utilise are offshoring and outsourcing. Cost
reduction is often the primary reason for offshoring and outsourcing.

OFFSHORING is the relocation of some part of an organisation's activities to another country.

OUTSOURCING involves an organisation sub-contracting business activities to external providers. These
KEY TERMS
providers may be in the same country as the organisation, or based overseas.

SERVICE LEVEL AGREEMENTS are contracts between organisations and outsourcing partners that set out the
terms of the outsourcing agreement. It may include factors such as, details of the precise service to be
provided, targets and benchmarks that must be met, response times for technical issues and serious
problems, reporting procedures, complaints procedures and termination procedures.

Developments in technology have made offshoring and outsourcing feasible in many situations. These
technological advances permit business processes to be split up and performed in several locations.
Communication devices such as smartphones and computers allow people in various locations to work
together and to share information.

4.4.1 Offshoring 05/10, 09/12

Offshoring could involve locating a department or subsidiary in another country, or using an external
company based in another country (referred to as ‘offshore outsourcing’).

The most common motivation for offshoring is to make cost savings by taking advantage of lower labour
and / or other costs.

Managing operations based in another country involves a number of challenges:

 Risks associated with currency exchange rates and political and economic stability of the offshore
country
 Loss of skills and jobs in the home country
 Exercising control from a distance and security of sensitive information
 Cost savings and efficiency improvements may be slow to accrue or may not be realised at all
 Dealing with cultural, time zones and language differences
PART A THE GLOBAL BUSINESS ENVIRONMENT 1: The social, political and economic context 21

Offshoring has grown significantly in many developing countries in recent years. It is popular due to the
creation of new jobs and improvements in technological infrastructure and in education and skills that are
created. However, some nations have voiced concerns over wages, working hours and other issues
regarding the treatment of employees.

India is one popular offshoring country, for example many UK banks and other large companies now have
service centres based in India.

4.4.2 Outsourcing - what to outsource? 05/11

Generally speaking, outsourcing is appropriate for peripheral, non-core activities. To outsource strategic
or core competences could lead to loss of competitive advantage and risk the collapse of the whole
organisation.

Outsourcing of non-core activities is widely acknowledged as having the potential to achieve important
cost savings. However, it can be difficult to distinguish between core and non-core competences.

Threshold competencies are activities that an organisation must possess in order to be a realistic
competitor in a market. Outsourcing may be the only way for some organisations to obtain this type of
competence.

Cox categorises competences into three groups.

Cox’s types of competence

Core competences are those that result in competitive advantage. They should not be outsourced. Product
design is an example.
Complementary competences aren’t core themselves, but are connected or essential to core competences.
These may be outsourced, but only to trusted key suppliers with whom a strategic relationship is formed.
In many industries and organisations, the IT function is a complementary competence.
Residual competences aren’t in any way core and are suitable for outsourcing. The payroll function is an
example.

Quinn and Hilmer developed three tests that can be used to identify an organisation's core competences.

Quinn and Hilmer's core competence tests

Does the competence allow entry into a number of markets?
Does the competence make a substantial contribution to a customer's perceived benefits of a product?
Is the competence difficult for a competitor to copy?

If the answer to the questions is yes, then it is likely that the competence is core.

Quinn and Hilmer also identified three tests to establish whether an activity should be outsourced.

Quinn and Hilmer’s tests to establish whether an activity should be outsourced

Potential for competitive advantage. The lower the potential for competitive advantage, the more suitable
an activity is for outsourcing.
Strategic risk (or vulnerability) and the need for flexibility. Where strategic risk is high, or where an
organisation is vulnerable, the activity should be kept in-house. However, where strategic risk is low and
the need for flexibility is high, then the activity should be outsourced on a short-term contract.
Transaction costs. The level of transaction costs should be input into the decision.
22 1: The social, political and economic context PART A THE GLOBAL BUSINESS ENVIRONMENT

4.4.3 Transaction costs

A transaction cost is incurred by an organisation as a consequence of having a business activity
performed by a third party. Such costs arise from activities associated with the arrangement, for example
creating product specifications, managing quality and co-ordinating delivery and manufacturing
operations. Standard products which are mass produced may have low transaction costs due to the
standardisation of design. However, non-standard products may have high transaction costs which can
be classified as:

 Search and information costs. These are the result of determining which products are needed and
selecting a supplier at an appropriate cost and quality.

 Bargaining costs. These result from negotiating a deal with the supplier and completing any legal
formalities such as drawing up contracts.

 Policing and enforcement costs. These are the costs of monitoring whether the supplier adheres to
the terms of the contract and taking appropriate legal action if they do not.

4.4.4 Transaction cost theory

According to Williamson an organisation has a choice of whether to produce goods itself (by owning
assets and running the production process) or to buy-in the use of another organisation’s assets to
produce the goods for it. There are three aspects to the make or buy decision:

 Uncertainty - uncertainty in the business environment makes it difficult to arrange long-term

contracts and therefore it is more likely for a process to be undertaken in-house.

 Frequency – work is more likely to be outsourced if it is infrequent or unlikely to re-occur.

 Asset specificity – where the assets required are specific to the transaction then the process
should be taken on in-house as the corresponding transaction costs will be high.

Williamson suggests that the main concern in the decision is asset specificity which can be classified into
six main types.

Type of asset specificity Description

Site specificity Some sites, such as factories, are immobile and
therefore specific to a certain location.
Physical asset specificity Customised assets, or those with limited other
uses have lower alternative use values. This
means they are more specific to the task.
Human asset specificity Workers acquire knowledge or skills that are
specific to their role. This knowledge or skill has
a higher value within the activity (and therefore
within an organisation) rather then outside it.

Brand name capital specificity A brand name may become so associated with an
activity or process that it cannot be used in other
activities or for other customers.
Dedicated asset specificity This is similar to physical asset specificity but
relates to assets acquired solely for work
undertaken for a specific customer.
Temporal specificity Some activities, such as those involving
perishable goods, are so time specific that an
alternative processor is unlikely to be found in
time if the current supplier fails.
PART A THE GLOBAL BUSINESS ENVIRONMENT 1: The social, political and economic context 23

4.4.5 Advantages and disadvantages of outsourcing

The advantages of outsourcing are as follows.

(a) Outsourcing can remove uncertainty about cost, as there is often a long-term contract where
services are specified in advance for a fixed price.

(b) Long-term contracts (maybe up to ten years) encourage planning for the future. The organisation
can focus on its core business.

(c) It can save on costs by making use of a suppliers' economies of scale, reduced headcount, reduced
research and development costs and reduced capital spending on equipment.

(d) It can increase effectiveness and quality of output where the supplier deploys higher levels of
expertise.

(e) Access to specialist knowledge and innovations in technology is made possible, and easier, if the
organisation is experiencing a skills shortage. A specialist company can share staff with specific
expertise between several clients.

(f) Flexibility (contract permitting). Resources may be able to be scaled up or down depending upon
demand. In the long-term, the organisation may be able to switch suppliers to match cost and
quality requirements.

Some possible disadvantages are outlined below.

(a) Difficulties negotiating and managing a Service Level Agreement that meets the organisation’s
needs.

(b) There are cost implications to consider, for example, the supplier will need to make a profit, which
may result in outsourcing being more expensive than doing the work internally. Transaction costs
will also arise as a consequence of the outsourcing arrangement.

(c) It can lead to loss of control, particularly over quality and continuity of supply.

(d) It means giving up an area of threshold competence that may be difficult to reacquire. The
organisation may become out-of-touch with new developments resulting in a lack of in-house
knowledge.

(e) The same outsourcing service is likely to be available to competitors. There is a risk of confidential
information being leaked.

(f) Potential damage to employee morale due to redundancies and impact on corporate culture.

Question 1.1 Offshoring and outsourcing

Learning outcome A1(iv)

Explain the differences between offshoring and outsourcing. (4 marks)

4.5 Newly industrialising and emerging nations 05/10

Newly industrialising and emerging nations (NIEs) are countries which are grouped together by virtue of
the fact that their economies have grown significantly in recent years and they are becoming increasingly
important in the world economy.

NIEs are often (but not always) located in Asia and Latin America and include the BRIC nations (Brazil,
Russia, India and China – see below) and other countries such as Argentina, Mexico, South Korea,
Taiwan, and Singapore.
24 1: The social, political and economic context PART A THE GLOBAL BUSINESS ENVIRONMENT

4.5.1 The BRIC economies

Brazil, Russia, India and China have all experienced rapid economic growth in recent years, partly as a
consequence of globalisation. When combined, the BRICs have a bigger share of world trade than the
USA.

China has attracted most attention. China is now the second largest economy in the world (behind the
US), having recently overtaken Japan.

Key factors influencing the growth of the BRIC economies

Settled political system
Increased economic activity
Abundance of natural resources
Plentiful, cheap labour
Increased education standards
Free market philosophy encouraged
Foreign direct investment (FDI – although in the future the BRICs are likely to be investing overseas
themselves)

The BRICs have been affected by the global economic downturn since 2008. For example, inward FDI
and outsourcing arrangements have reduced, as has demand for exports. However, they are expected to
continue to see high growth, driven by strong national consumer demand and public spending, using
reserves built up from foreign trade.

4.5.2 Second tier emerging nations

Many other nations are often referred to as ‘emerging nations’. Examples include Vietnam, Indonesia,
Columbia and the Ukraine (which is also a transition economy). We now take a brief look at three other
emerging nations - South Korea, Taiwan and Mexico.

In South Korea since the 1980s the government has reduced the amount of control it held over industry
and allowed more foreign investment. Controls over the financial system were removed and the previously
controlled exchange rate was left to market forces.

This liberalisation saw the Korean government abandon many of the principles that had brought previous
economic growth, but was necessary for the country to integrate into the global economy – which is seen
as essential for long-term prosperity.

Taiwan's government initially focussed on the development of certain industries such as plastic, fibreglass
and textiles. Like South Korea, import-substitution policies were introduced for protection. This
development created an industrial base that could be built on.

The government was able to steer private investment away from industries which already produced a
surplus, or which operated in a non-growth market, into products that could be exported.

As a result of government intervention and operational efficiency, Taiwan has moved from a textiles based
economy to one which now produces hi-tech electrical goods.

Mexico suffered an economic crisis caused by its level of international debt and the oil price crash of
1981. After the economic crisis Mexico followed protectionist policies while it tried to stabilise itself. This
was followed by reform and more liberal trade and economic policies. The country formed an association
with the USA and Canada (NAFTA) and entered into a trade agreement with the European Union. These
measures led to an opening up of the economy to global business and helped to drive investment in the
economy to record levels.
PART A THE GLOBAL BUSINESS ENVIRONMENT 1: The social, political and economic context 25

4.6 Types of economic system

There are four main types of economic system in operation in the world - planned, free market, mixed and
transition.

A planned economy is one which is controlled by the government. This means that the state fixes the
price of goods and services and makes all the decisions regarding how resources are allocated in the
economy.

Free market economies are the opposite of planned economies. This means that prices and the allocation
of resources are not controlled by any individual or the state, but by market forces and the actions of
producers and suppliers.

In reality, there are no true free market economies in the world as governments tend to have some kind of
input into the economy and may intervene to influence the actions of private sector organisations. This
means that most economies are a halfway house between free market and planned economies – and are
known as mixed economies.

The term ‘transition economy’ has been applied to the countries that abandoned the Soviet-type political
and planned economic system at the end of the twentieth century. Often quoted examples include the
Russian Federation, Poland, Hungary, Romania, the Czech Republic, Ukraine, Kazakhstan, the Slovak
Republic, Bulgaria and Belarus. A number of these countries have completed their transition to a market
economy and have become members of the European Union.

The term is sometimes used with a wider meaning, referring to any country emerging from a socialist-type
economy towards a market-based economy (eg China). This means that in general usage, there is overlap
between transition economies and emerging economies.

4.7 Industrialisation strategies

Successful emerging nations follow three main strategies.

 Export of natural commodities

 Import-substitution
 Export-led industrialisation

4.7.1 Export of natural commodities

Countries are endowed with natural resources in various degrees. For example, oil, precious metals such
as gold, and fertile agricultural land. The first stage of industrialisation is to simply sell natural resources
to foreign countries. This generates income for the country which can be used to invest in infrastructure
(such as education and technology) and develop the economy. However the country must import products
that it cannot produce domestically.

4.7.2 Import-substitution
Once the economy has created wealth through exporting natural resources it begins to invest in new
industries which produce the more advanced products that it needs. Historically, to protect these
fledgling industries so that they can be developed and to reduce the country's dependence on foreign
imports, protectionist measures were used (eg import tariffs and quotas).

4.7.3 Export-led industrialisation

Protecting and developing new industries was the only perceived method of creating an industrial base up
until the 1960s. However, with the liberalisation of economic systems came an alternative – an export-
centred, outward looking strategy. Governments realised that the key to rapid economic growth was to
increase exports – and that by doing so the wealth of the country would be substantially improved.
26 1: The social, political and economic context PART A THE GLOBAL BUSINESS ENVIRONMENT

4.7.4 Foreign Direct Investment (FDI) 11/10

Many emerging and / or transition economies have benefited from Foreign Direct Investment (FDI). For
example, the growth of the Russian economy has been stimulated by multinational companies such as
Coca-Cola establishing bases in the country. In China, foreign investment has largely funded the growth in
the manufacturing sector.

FDI can take a number of forms but two of the most common is to acquire an existing organisation in the
local market or to develop new production facilities (known as greenfield investment).

FDI is now global in nature, with investment flows becoming more multi-directional. The BRIC nations are
now making and well as receiving foreign investments. For example, Ford sold its Jaguar and Land Rover
operations to India’s Tata Group in 2008.

Section summary
Porter identifies four principal factors that influence the competitiveness of an economy. These are factor
conditions, demand conditions, related and supporting industries and firm strategy, structure and
rivalry.

Governments can influence the context in which an industry operates and can create opportunities and
pressures for investment.

Offshoring is the relocation of an organisation's business activities (such as manufacturing) from one
country to another. Outsourcing involves an organisation sub-contracting business activities to external
providers.

Newly industrialising and emerging nations (NIEs) are countries which are grouped together by virtue of
the fact that their economies have grown significantly in recent years and they are becoming increasingly
important in world politics.

The term transition economy has been applied to the countries that abandoned the Soviet-type political
and economic system at the end of the twentieth century.

5 Different types of organisation

Introduction
Economies contain different types of organisation and the economy itself can be divided into the public
and private sectors.

In this section we consider the different types of organisation found in each sector.

5.1 The public and private sectors

The economy of a developed country can usually be divided into two sectors – public and private. Private
sector organisations, also called businesses, are owned and operated by private individuals or institutions,
while organisations in the public sector are usually owned by the state.

5.2 Private sector organisations

Private sector organisations are of two main types – those that seek profit for their owners and those that
have other objectives. The latter are known as non-profit making or not-for-profit organisations. However,
the majority of organisations in the private sector are businesses which aim to make profits for their
owners (shareholders).
PART A THE GLOBAL BUSINESS ENVIRONMENT 1: The social, political and economic context 27

5.2.1 Not-for-profit organisations

This terminology is a little misleading, in that 'not-for-profit' organisations often engage in profitable trade
and they are not able to run consistently at a loss. The essence of their status is not that they seek to
avoid generating a surplus of funds, but that the generation of wealth for their owners is not the purpose
of their existence.

Such organisations still aim to operate as efficiently as possible, but their primary objective is to provide a
service rather than to maximise profit. Not-for-profit organisations include co-operatives, charities and
unincorporated clubs, societies and associations.

Not-for-profit organisations use the surplus they generate to further their other objectives. Clubs and
associations exist to provide some kind of benefit to their members. Charities and voluntary organisations
generally exist to provide some kind of benefit to society at large.

Although not-for-profit organisations are not profit seekers, they still use economic factors of production to
produce goods or services. Therefore they need to be efficiently managed so that their resources are used
effectively to meet the objectives of the organisation whilst not making a financial loss.

5.2.2 Mutual organisations

Mutual organisations are a special type of non-for-profit organisation in the private sector. The essence of
their nature is that they are commercial operations owned by their customers, rather than having capital
and associated shareholders for whom they have to earn profit. This means that their customers benefit
both from the services the mutuals provide to them and from the trading surplus they make by doing so.

It is also possible for the managers of mutuals to pursue purposes other than maximise their trading
surplus. These can include a high level of charitable giving, the promotion of community interests and a high
quality of service. Mutuals therefore resemble both not-for-profit organisations and profit-seeking companies,
but as they don’t produce profit for shareholders, strictly speaking are not-for-profit organisations.

5.2.3 Profit seeking organisations

The economy is mostly driven by the profit-seeking part of the private sector. It is businesses that
undertake the most enterprising aspects of economic activity. They provide the bulk of employment
opportunities and tax revenue and create the growth needed to enhance economic welfare. Businesses are of
two main types, distinguished by the extent to which the owners are liable for the debts of the undertaking.

(a) An individual may set up business on their own account as a sole trader or in partnership with
others. In either case, the law will not distinguish between the private assets and liabilities of the
owners and those of the enterprise. The owners have unlimited liability for the debts of their
businesses.

(b) This degree of risk is unattractive to many potential investors, so to enable them to invest and
therefore release more funds for wealth-producing enterprise, the legal systems of most countries
provide for some form of limited liability enterprise. Such businesses are referred to as
corporations or companies.

In the UK, there are two forms of limited liability company. They both limit the liability of investors to the
nominal value of their share holdings but they differ in the extent to which they are permitted to solicit
investment from the general public.

Private limited companies may not offer their securities to the public – public limited companies (plcs) may.

KEY POINT When the shares of plcs are regularly bought and sold on a stock exchange, they may be referred to as
quoted companies, because the current price of their shares will be quoted in a journal of record.
28 1: The social, political and economic context PART A THE GLOBAL BUSINESS ENVIRONMENT

Exam skills
Remember that not all public limited companies are quoted companies.

5.2.4 Multinational corporations

Some businesses may develop into multinational corporations (MNC's). These organisations have the
capacity to produce in more than one country, either by owning or controlling a foreign subsidiary. They
are often large, well-known organisations such as petrol companies, but they may also be small in size.

There is no ‘typical’ multinational, some may operate in hundreds of countries, some in only a few. Many
types of businesses may be multinational – from large scale manufacturing operations to small scale
financial service companies. Finally, some may get the majority of their revenue from their foreign
operations, whereas others may only do a fraction of their trade overseas.

Advantages of becoming multinational

Production should increase as products are sold more widely. This means that costs (such as research
and development) can be spread over a greater amount of output.
Investment in new technology (also spread over higher output) can be made to take advantage of
economies of scale and improve productivity.
Multinationals may attract a higher calibre of staff in terms of experience or ability.
Operations can be located to take advantage of low cost materials, labour, transport and other operating
costs. High quality staff or government investment incentives may also be found.
The most appropriate business model can be used. For example, internalising costs of an overseas
subsidiary might be better in one country, but contracting with a supplier to produce the goods might be
better in another.

MNC's are estimated to account for a quarter of the world's economic output (Campbell and Craig, 2005;
Worthington and Britton, 2006).

The growth of MNCs can be attributed to

 Innovation in communications technology

 Improved transport and infrastructure
 Market homogenisation (eg the world's needs and wants have become increasingly similar)
 Political stability
 Increased merger activity

Due to these factors and especially Internet improvements and political changes such as the opening of
trading borders, some organisations, although they are still small, are actually 'born global' now .

MNC's have many opportunities because they are able to identify countries in which they are able to
maximise their competences and make the most of the variances in the business environment.

Many UK based IT companies are now retaining their sales divisions in the UK, but moving their system
development activities to India where there is a large pool of newly qualified system development
specialists who can be employed at a cheaper rate than in the UK. This is an example of offshoring that
we explained earlier.

MNC's also benefit from being able to spread their risk over many businesses in many countries.
Companies such as Proctor & Gamble, Pepsi co, Philips and Nestle for example, have large portfolio's of
businesses and brands which are located in many countries.

The legal and tax differences between countries in which they operate also means that MNC's, through the
process of internal transfer pricing, can reduce their overall tax burden and significantly increase profits.
PART A THE GLOBAL BUSINESS ENVIRONMENT 1: The social, political and economic context 29

Many emerging nations have made use of MNCs by attracting their investment through subsidies and low
labour costs. We have already seen that (for some organisations) it no longer really matters where an
organisation is based. This type of organisation has been the key to export-led industrialisation.

5.3 Public sector organisations

Public sector organisations used to be divided into two main groups – those that provide public services
(such as hospitals, schools, the police and the armed forces) and state owned industries. This distinction
has become less clear over the last quarter-century as governments have privatised state-owned industries
and sought to reform the public sector by involving private companies in the provision of public services.
The objective has been to curb waste of public money and improve efficiency by importing the
disciplined cost control found in the private sector.

In the UK, many providers of public services such as hospitals and schools, and formerly state owned
industries such as London Underground, are now involved in different forms of public-private partnership.
In such partnerships, the private sector provides funds for public sector purposes such as education. For
example the Private Funding Initiative (PFI) for schools seeks private partners to fund and manage school
buildings in return for an agreed fee. Some services in the UK such as the National Health Service (NHS)
are provided by self-governing trusts. These trusts sell their services to the NHS.

Public sector bodies are all, ultimately, responsible to government for their activities, and their purposes
are defined in the laws that establish them. They have a range aims and objectives but rarely will they set
out to trade at a profit. Nevertheless, their managers will be expected to exercise good stewardship and
prevent waste of resources. Public sector bodies' objectives will usually be defined in terms of the
provision of a service that is deemed to be beneficial to society.

An important feature of public sector bodies is that they have little control over their income. This is because
they depend upon government for the funds they need to operate. The funds they receive will be influenced
by a large number of factors, including current public opinion, government aspirations, the skill of their
leaders in negotiation, the current state of the public finances overall and the current economic climate.

5.3.1 Non-governmental organisations (NGOs)

Non-governmental organisations are defined by the World Bank as “private organisations that pursue activities
to relieve suffering, promote the interests of the poor, protect the environment, provide basic social services or
KEY POINT
undertake community development.” Many of the largest NGOs are charities such as Oxfam and the Red Cross.

There are two main types of NGO. The first seeks to influence government policy through lobbying and
generating public feeling in its favour – through marketing and public relations techniques. These are
known as campaigning NGOs. The second attempts to make a positive impact directly in the area it is
interested in. This might be through though specific projects or undertaking work to make a change.
These are known as operational NGOs.

Many NGOs have developed relationships with business organisations, for example where they share a
common goal. The benefits to each party of such an arrangement might include; the acquisition of skills
and knowledge that it might no otherwise obtain, the creation value (through reduced of duplication of
effort), to reduce their environmental impact, to develop corporate social responsibility and improve their
credibility in the eyes of their stakeholders.

Another type of NGO is the quasi autonomous non-governmental organisation (QUANGO). These share
similar objectives to public sector organisations, but are actually private organisations, independent of the
government, but to which the government has devolved the authority for running public services.
Examples of QUANGOs in the UK include ACAS (the independent employment relations mediator) and
Ofsted (the school inspection body).
30 1: The social, political and economic context PART A THE GLOBAL BUSINESS ENVIRONMENT

Section summary
The economy of a developed country can usually be divided into two sectors – public and private.

Private sector organisations are of two main types – those that seek profit for their owners and those that
have other objectives.

Examples of not-for-profit organisations include charities and voluntary or mutual organisations.

Examples of profit making organisations include sole traders, partnerships and companies.

Multinational companies have the capacity to produce in more than one country, usually with a centrally
located head office.

Public sector organisations provide services to the general public such as hospitals and schools.

6 Culture and the global organisation

Introduction
We have already discussed culture in a society as a factor of an organisation's environment. The issue of
corporate culture is important for multinational businesses because culture influences how things are
done.

CULTURE embodies the common set of values: 'the way things are done around here'.
Culture is embodied in rituals and behaviour.
KEY TERM
Culture is an important filter of information and an interpreter of it. For example, an organisation might
have a cultural predisposition against embarking on risky ventures. Existing behaviour patterns may make
a proposed strategy incompatible with the culture and so impossible to implement.

An organisation's culture is influenced by many factors.

(a) The organisation's founder. A strong set of values and assumptions may have been established by
the organisation's founder. Even after they have retired, these values have their own momentum.

(b) The organisation's history. The effect of history can be determined by stories, rituals and symbolic
behaviour. They legitimise behaviour and promote priorities.

(c) Leadership and management style. An organisation with a strong culture recruits managers who
naturally conform to it.

(d) Structure and systems affect culture as well as strategy.

(e) The industry (eg computer software organisations in the 'silicon valley' had a reputation for being
laid back on office dress).

(f) Location of head office – and its acquired culture

6.1 Management culture

A factor which has an impact on the culture of transnational organisations, or organisations competing in
global markets, is management culture. This is the view about managing held by managers, their shared
educational experiences, and the 'way business is done'. Obviously, this reflects wider cultural differences
between countries, but national cultures can sometimes be subordinated to the corporate culture of the
organisation (eg the efforts to ensure that staff of Euro Disney are as enthusiastic as their American
counterparts).
PART A THE GLOBAL BUSINESS ENVIRONMENT 1: The social, political and economic context 31

MANAGEMENT CULTURE is a part of overall organisational culture and relates to the prevailing view within
management about how to do its job.
KEY TERM

6.2 Managing across borders

There are often severe cultural differences as to what constitutes 'management' in the first place. Are
management principles universally applicable? Organisations need an awareness of effective management
approaches in different cultures.

6.2.1 Hofstede 05/11

Geert Hofstede analysed the role of national culture within organisations based on a large scale
investigation of the cultural attitudes of the employees of IBM in the 1960s and 70s. Hofstede identified
a number of dimensions that contributed to cross-cultural differences in beliefs and values.

Dimension Comment
Power – This refers to how far society and organisations tolerate an unequal distribution of power.
distance In high power-distance cultures (eg India) and organisations, power tends to be
concentrated at the top and managers exert their status and power over subordinates.
Uncertainty This measures the extent to which people are able to tolerate ambiguity and uncertainty.
avoidance For example whether individuals wait until they are completely sure of all details before
acting.
Individualism This measures the extent to which people see themselves in individual terms as opposed
versus to being members of a group – be it family, company, caste, class or even simply a
collectivism sporting club.
Masculinity This is about the degree to which a culture encourages one set of qualities (the
versus 'masculine' ones such as competitiveness and assertiveness) as opposed to another set
femininity (the so-called 'feminine' ones such as concern for others, attention to quality of life or to
the environment).
Long term This refers to whether people associate themselves with a long-term (forward looking)
orientation orientation (values such as thrift and perseverance – often associated with China) or a
(Confucian short-term (historical) orientation (values such as tradition, meeting social obligations
dynamism) and saving face – often associated with Germany).

Hofstede’s work has its critics. The following points must be considered.

(a) Hofstede's study is based on data that is now thirty years old. International attitudes have
changed significantly in that time – many people in the middle 1970s had hardly travelled
away from their home country. Today we have global organisations and markets, and the
consequent movement of people across the world.

(b) People's experience of other cultures has therefore changed, and so has their own self
image and behaviour.

The following table illustrates some consequences of Hofstede's categories on organisations.

Category Consequences
High power-distance Autocratic organisation
Many layers of management
Different work statuses of managers and sub-
ordinates
High uncertainty avoidance Rules and regulations prevail
Formal structures
Standardisation
High individualism Autonomy
Personal achievement
Self-reliance
32 1: The social, political and economic context PART A THE GLOBAL BUSINESS ENVIRONMENT

Category Consequences
High masculinity Achievement of challenge
High status sought
High earnings required
High long-term orientation Education and training respected
Strong ethic of work

Hofstede also found cultural differences in the following areas of employee attitude.

Motivation – Incentives used to motivate employees must match the culture. Not all cultures are
motivated by money.

Structure – In some cultures a bureaucracy works best, in others a more open and professional
approach is more effective.

Leadership – In some cultures a manager is expected to take a personal and social interest in their
subordinates, in other cultures this is discouraged.

McDonalds – national cultures and global organisations

The 'golden arches' logo of McDonalds is one of the most recognised symbols in the world. Alongside the
CASE STUDY
logo, McDonalds have developed a business format that is successful and established in 130 countries of
the world.

This success has occurred even in places where there has been 'cultural resistance', for example France
and Spain where there is a very distinctive (perceived and real) attitude to food as a key aspect of national
and regional culture.

Countries have absorbed the influences of McDonalds and have grown familiar with the nature of the
brand and what it has to offer. McDonalds have absorbed the influences of the communities in which
they locate, by offering differentiated and localised meals and foods according to location.

6.2.2 Other models

Trompenaars and Hampden Turner (1997) developed a Seven Dimensions of Culture model.

Five of their dimensions relate to how people deal with each other.

1 Universalism versus particularism. In universalistic cultures, rules are more important than
personal relationships. For example, high value is placed on written contracts.

2 Individualism versus collectivism (or communitarianism). Does the culture value and encourage
self-orientation and decision making or group orientation and decision making?

3 Neutral versus emotional (or effective). In neutral cultures, emotions aren’t expressed openly.

4 Specific versus diffuse. This refers to whether people change the way they act and relate to each
other in specific situations (specific) or whether behaviour and relationships are consistent
(diffuse). For example, in a culture that favoured specific behaviour people may relate to each
other differently outside the workplace than at work.

5 Achievement versus ascription. Is status based on achievement, or on other factors such as age
and years of experience?

The sixth dimension refers to how different societies view the concept of time.

6 Sequential versus synchronic. Do individuals work on one thing at a time (sequential) or on

several things at once (synchronic)?
PART A THE GLOBAL BUSINESS ENVIRONMENT 1: The social, political and economic context 33

The seventh and final dimension looks at how culture views the effect of the general environment.

7 Internal or high context versus external or low context. High context behaviour includes tradition
and ritual, the environment controls behaviour. Low context behaviour is controlled by individuals
rather than the environment.

Ronen and Shenkar (1985) identified four key characteristics of national culture.

 The importance placed on work goals

 The role of job satisfaction
 The impact of organisational and managerial factors
 The impact of work roles and interpersonal relationships

They identified groups of nations that displayed shared characteristics.

Models provide a framework that enables managers to consider what management structure and style
may work best in different countries. Managers need to be flexible enough to adapt to cultural differences
and are able to ride what Ronen and Shenkar refer to as ‘the waves of culture’.

6.3 Management structure

Local conditions and the scale of operations will influence the organisational structure of companies
operating internationally. Very large and complex companies may be organised as a heterarchy.

A heterarchy is a rather organic structure with significant local control.

(a) Some headquarters functions are diffused geographically. For example, R&D might be based in
the UK, marketing based in the US. Or certain products made in one country and others elsewhere
(motor manufacturers do not make every model of car at each factory.) Some central functions
might be split up – many organisations are experimenting with having several centres for R&D.

(b) Subsidiary managers have a strategic role for the corporation as a whole (eg through bargaining
and coalition forming).

(c) Co-ordination is achieved through corporate culture and shared values rather than a formal
hierarchy. Experienced employees might have worked in a number of different product divisions.

(d) Alliances can be formed with other parts of the company and with other businesses, perhaps in
joint ventures or consortia.

6.4 Influences on structure and methods

A variety of factors influence management methods in an international setting. These factors pull in
different directions and it may be that compromise is necessary. As always, a consideration of objectives
is a good starting point. A company merely seeking to expand sales volume while concentrating on its
home market will use very different methods from one seeking to operate in truly global markets such as
energy and telecommunications.

Central control may be appropriate if the volume of international business or the company's experience in
international operations is low. Centralisation is seen as promoting efficiency and prevents duplication of
effort between regions. Even when operations are on a limited scale, when conformity with demanding
technical standards is required, functional representation in international management may be necessary.
For example, a largely autonomous international subsidiary may have to accept supervision of its quality
assurance or financial reporting functions.

If business is done globally, a form of regional organisation may be appropriate if there is some measure
of social and economic integration within regions. The need for rapid response to local opportunities and
threats may be served by a significant measure of decentralisation. National political and cultural
sensitivities may reinforce this, but a shortage of local talent may limit it.
34 1: The social, political and economic context PART A THE GLOBAL BUSINESS ENVIRONMENT

As far as management processes and decision making are concerned, typical problems include:

(a) Poor information systems and communications. However, the rapidly falling costs of
telecommunications and the development of e-mail and video-conferencing facilities mean this is
now less likely to be a problem.

(b) Interpretation of information. Culture affects how information is interpreted and can also
determine the priorities of the planners. By failing to allow for diversity or to understand local
culture, planners based elsewhere can make marketing on the ground more difficult.

(i) Managing a local market in a large country with a rural population would be different from
marketing to a small country with most people living in cities.
(ii) High tech products may not be suitable for a country with a poorly developed educational
and technological infrastructure.
(iii) Consumers and managers in countries with very high rates of inflation will have different
priorities to those in countries with low inflation. Managers' may need to minimise holdings
of local currency, by converting it into a harder currency or into tangible assets.
(c) Meetings can be difficult when a company expands internationally. Air travel and hotel costs can
be significant. Video-conferencing is emerging as an alternative to face-to-face meetings.

You will study organisational culture further in paper E2.

6.5 Human resource management

The balance between local and expatriate staff must be managed. There are a number of influences.

 The availability of technical skills such as financial management

 The need for control
 The importance of product and company experience
 The need to provide promotion opportunities
 Costs associated with expatriates such as travel and higher salaries
 Cultural factors

6.5.1 Expatriates or locals?

International companies, which must think globally and act locally, have to consider a number of issues.

 Does it employ mainly expatriate staff to control local operations?

 Does it employ local managers with the possible loss of central control?
 Is there such a thing as the global manager, equally at home in different cultures?

Expatriate staff are sometimes favoured over local staff.

(a) Poor educational opportunities in the market may require the import of skilled technicians and
managers. For example, expatriates have been needed in many western business operations in
Russia and Eastern Europe, simply because they understand the importance of profit.

(b) Some senior managers believe that a business run by expatriates is easier to control than one run
by local staff.

(c) Expatriates might be better able than locals to communicate with the corporate centre.

(d) The expatriate may know more about the organisation overall, which is especially important if
they are fronting a sales office.
PART A THE GLOBAL BUSINESS ENVIRONMENT 1: The social, political and economic context 35

The use of expatriates in overseas markets has certain disadvantages.

(a) They cost more (eg subsidised housing, school fees).

(b) Culture shock. The expatriate may fail to adjust to the culture (eg by associating only with other
expatriates). This is likely to lead to poor management effectiveness, especially if the business
requires personal contact.

(c) A substantial training programme might be needed.

(i) Basic facts about the country will be given with basic language training and some briefings
about cultural differences.
(ii) Immersion training involves detailed language and cultural training and simulation of social
and business experiences. This is necessary to obtain an understanding and awareness of
the culture.

Employing local managers raises the following issues.

(a) A glass ceiling might exist in some companies. Local managers may not make it to board level if,
as in many Japanese organisations, most members of the board are drawn from one country.
(b) In some cases, it may be hard for locals to assimilate into the corporate culture, and this might lead
to communication problems.
(c) They will have greater local knowledge but may not be trained to understand the wider corporate
picture, but this is true of most management at operational level.

Question 1.2 Setting up overseas

Learning outcome A1(i)

Identify four issues which may affect an organisation that wishes to set up an overseas subsidiary.

(4 marks)

Section summary
Culture embodies the common set of values: 'the way things are done around here'.

Organisations need an awareness of effective management approaches in different cultures.

Local conditions and the scale of operations will influence the organisational structure of companies
trading internationally.

The balance between local and expatriate staff must be managed.

36 1: The social, political and economic context PART A THE GLOBAL BUSINESS ENVIRONMENT

Chapter Roundup
 Global production involves manufacturing and sourcing on a global scale.

 World trade has been encouraged by financial factors, trade alliances, legal factors, international
markets and various organisations.

 The global business environment can be analysed into political, economic, social and technological
factors, this is known as PEST analysis.

 Economic nationalism is a nation's view that it should protect its own economy and industries.

 Economic liberalisation involves nations moving away from economic nationalism towards working with
others in a group to benefit all member economies and industries.

 Free trade areas, customs unions and economic unions/common markets are all types of economic
system designed to provide members with a trade advantage.

 Porter identifies four principal factors that influence the competitiveness of an economy. These are factor
conditions, demand conditions, related and supporting industries and firm strategy, structure and
rivalry.

 Governments can influence the context in which an industry operates and can create opportunities and
pressures for investment.

 Offshoring is the relocation of an organisation's business activities (such as manufacturing) from one
country to another.

 Outsourcing involves an organisation sub-contracting business activities to external providers.

 Newly industrialising and emerging nations (NIEs) are countries which are grouped together by virtue of
the fact that their economies have grown significantly in recent years and they are becoming increasingly
important in world politics.

 The term transition economy has been applied to the countries that abandoned the Soviet-type political
and economic system at the end of the twentieth century.

 The economy of a developed country can usually be divided into two sectors – public and private.

 Private sector organisations are of two main types – those that seek profit for their owners and those that
have other objectives.

 Examples of not-for-profit organisations include charities and voluntary or mutual organisations.

 Examples of profit making organisations include sole traders, partnerships and companies.

 Multinational companies have the capacity to produce in more than one country, usually with a centrally
located head office.

 Public sector organisations provide services to the general public such as hospitals and schools.

 Culture embodies the common set of values: 'the way things are done around here'.

 Organisations need an awareness of effective management approaches in different cultures.

 Local conditions and the scale of operations will influence the organisational structure of companies
trading internationally.

 The balance between local and expatriate staff must be managed.

PART A THE GLOBAL BUSINESS ENVIRONMENT 1: The social, political and economic context 37

Quick Quiz
1 Which type of country is described below?

'Largely primary industry based, but with a developing secondary (manufacturing) industrial sector. Low
but growing GDP, developing infrastructure.'

A Lesser developed country

B Early developed country
C Semi-developed country
D Fully developed country

2 Which of the following is not classed as a transitional economy?

A Poland
B Romania
C Japan
D Belarus

3 Which of the following cannot be described as a newly industrialised emerging economy?

A China
B Singapore
C South Korea
D Hungary

4 Briefly explain the main reason why organisations choose to offshore or outsource their operations.

5 Which of the following is a public sector organisation?

A A school
B A charity
C A public limited company
D A partnership
38 1: The social, political and economic context PART A THE GLOBAL BUSINESS ENVIRONMENT

Answers to Quick Quiz

1 B The text describes an early developed country.

2 C Transitional economies include those countries which have recently emerged from the planned
economy of the Soviet Union and are moving towards a free market economy.

3 D NIEs are mainly located in Asia and Latin America and include nations such as Brazil, Argentina,
Mexico, India, South Korea, Taiwan, Singapore and China.

4 Cost reduction is the primary reason for offshoring and outsourcing. Organisations will locate
production units where production costs are lowest and then move completed units around the
world for sale.

5 A Public sector organisations provide services for the general public. Charities are part of the private
sector as not-for-profit organisations. Companies and partnerships are examples of profit seeking
organisations in the private sector.

Answers to Questions
1.1 Offshoring and outsourcing

Offshoring is the relocation of part of an organisation’s business activities from one country to another.

Outsourcing involves an organisation sub-contracting business activities to external providers.

Two key differences are:

Outsourcing often involves the activity remaining in the same country, using an outsourcing partner based in the
home country.
Offshoring always involves the relocation of some activity outside the home country, and usually means the
activity remains within the organisation.

1.2 Setting up overseas

Four issues which may affect an organisation that wishes to set up an overseas subsidiary include:

Educational constraints – poorly educated employees will result in poor management and decision making.

Sociological constraints – the employees of some countries may have a greater work ethic than others.

Legal and political constraints – legal or other regulations may restrict the subsidiary’s working practices.

Economic constraints – factors such as inflation will affect the subsidiary’s cost base and profitability.

Now try this question from Number Level Marks Time

the Exam Question Bank 1 Examination 25 45 mins
GOVERNANCE AND REGULATION

Governments have a key role to play in the Government influence is usually associated with economic
economy and development of a nation. policy, but as we shall see, governments also affect a
market through regulation.
The decisions they make and the policies they establish
Later in this chapter we consider the impact of two topical
all have an effect on an organisation's business
areas – corporate governance and corporate social
environment.
responsibility.

topic list learning outcomes syllabus references ability required

1 Government intervention in business A2(b) A2(iii), A2(iv) analysis
2 Government and the macroeconomic A1(c), A2(b) A1(vi), A2(iii), A2(v) analysis
environment
3 Market regulation A2(d) A2(iii), A2(iv), A2(v) analysis
4 Corporate governance A2(a) A2(i), A2(ii) comprehension
5 Corporate social responsibility A2(a) A2(i), A2(ii) comprehension

39
40 2: Governance and regulation PART A THE GLOBAL BUSINESS ENVIRONMENT

1 Government intervention in business

Introduction
In the previous chapter we focussed on the emergence of newly industrialised nations in the global
economy. In this chapter we consider how governments influence their economies and the competitive
environment of organisations.

A country's government has a major role to play in the success or failure of its economy. We have already
seen how it can influence a number of factors related to competitive advantage and foreign investment
but these are only part of the story. Governments can influence a number of other areas:

 The macroeconomic environment

 Legal and market regulation
 Corporate governance and social responsibility

Section summary
Government influence over business extends to the macroeconomic environment, legal and market
regulations, corporate governance and social responsibility.

2 Government and the macroeconomic environment

Introduction
The macroeconomic environment is concerned with factors in the overall economy, for example interest
rates, exchange rates and levels of demand and supply.

Microeconomics is concerned with economic circumstances of individual industries or companies.

A government will usually have four main objectives for its macroeconomic policy.

 Economic growth
 Controlled inflation
 Employment
 A controlled balance of trade and exchange rate

These objectives are affected by macroeconomic policy, and in particular, fiscal and monetary policy.

2.1 Growth, inflation and employment

Three key factors that indicate the strength of an economy are growth, inflation and employment.

2.1.1 Growth
Growth means the expansion of the economy and it is usually measured in percentage terms compared to
previous years. It is the product of a number of factors, the main factor being demand in the economy.
Demand from consumers and the Government for goods and services stimulates business organisations
to increase production and sell more.

Growth can be measured using two figures, GDP and GNP. Gross Domestic Product (GDP) is the total
value of a nation’s income produced by economic activity from within its borders. Gross National Product
(GNP) is a more complete figure than GDP because it also includes income earned overseas but
deducting income earned domestically by overseas residents.
PART A THE GLOBAL BUSINESS ENVIRONMENT 2: Governance and regulation 41

An effect of growth is that employment levels rise as more employees are required to produce the goods
and services, and those employed should enjoy increasing wages. This means the cycle of demand is
continued as consumer demand increases further. ‘Real’ growth is net of the nation’s inflation rate and
therefore growth must exceed inflation for any benefits to be created.

Despite the positive aspects of growth, it is not without issues. If demand for goods cannot be met by
what can be produced within the economy, then the amount of imported goods will rise to fill the gap,
worsening the nation’s balance of trade. Growth may also increase the gap between the rich and the
poor if its effects are unevenly distributed across the population. The environment and the poor may be
exploited by businesses taking advantage of commercial opportunities. For example, natural resources
may be increasingly used up in the production of goods and low paid workers may be forced to work
harder as production levels rise. Finally, growth may occur in unwelcome areas, such as in the trade of
illegal substances.

2.2.2 Inflation
Inflation is the increase in prices over time and, like growth, is measured in percentage terms compared
to previous years. Governments seek low, stable inflation for a number of reasons:

 Stable inflation creates certainty – the ideal condition for business investment.
 Low inflation levels are fairer to those on low or fixed incomes. If incomes increase at a lower rate
than the inflation rate then individuals will be worse off.
 If the inflation rate is greater than interest rates then savers will be worse off as they see the value
of their savings being eroded. Individuals are encouraged to spend rather than save.
 Higher prices reduce the amount of money individuals have to spend and therefore spending
within the economy falls. This may encourage savings to increase (the ‘real balance’ effect).
 Inflation acts to distort the price mechanism as prices are driven increasingly by cost rather than
true demand and supply factors.
 In extreme cases, soaring inflation rates, where prices rise on a daily basis, can create civil unrest.

2.2.3 Employment
Although some degree of unemployment within an economy is unavoidable (as some people are unable to
work and others will be between jobs), governments are keen to increase the overall level of employment
for a number of reasons.

 Large numbers of employment people can stifle economic growth because being on a low income
means an individual can afford to spend less and therefore demand within the economy falls.
 Welfare payments to those out of work have to be paid out of taxes collected from the working
population. High levels of unemployment increase the welfare bill, resulting in pressure to increase
taxes and cut back on other public services – both of which will harm economic growth.
 A number of societal problems, such as crime, poor health and the breakdown of family units are
linked to unemployment.

2.2 The balance of trade

A country's balance of trade is the difference, in financial terms between the value of its imports and
exports. If a country imports more than it exports there is a trade deficit, if it exports more than it imports
KEY POINT
there is a trade surplus.

National account balances measure the production, income and expenditure levels within an economy.
The balance of trade forms part of the current account of a nation's national account balances.
42 2: Governance and regulation PART A THE GLOBAL BUSINESS ENVIRONMENT

2.2.1 Factors affecting the balance of trade

A number of factors influence a country's balance of trade.

Factor Influence
Availability, price and If local producers are able to supply the home market with high-quality,
quality of goods competitively priced goods, it will be difficult for overseas producers to export to
produced by local that market.
producers
Inflation If a nation's inflation rate is higher than its competitors, producers in that
country will face higher costs which will cause the price of their products to
rise.
Exchange rates If a nation's currency weakens against those which export to it, then the goods
it imports become more expensive.
Trade agreements Trade agreements affect the volume of imports and exports between nations.
Nations are more likely to be able to export competitively to nations they are on
an ‘even playing field’ with.
Taxes, tariffs and trade Taxes and tariffs increase the price of imports, making them less attractive to
measures buy. Governments may attempt to help home producers with subsidies,
although free trade agreements mean this may be difficult (or lead to tit-for-tat
retaliation).
The business cycle Nations looking for export-led growth require sufficient demand in overseas
markets for their products.

If producers in one country are able to produce something cheaper than producers in other countries, it is
likely they will export it. This improves the balance of trade in the country in which the producers are
based.

On the other hand, if overseas suppliers are able to supply something cheaper than domestic producers
can, demand for imports will increase.

Most countries expect to import some goods and services and export others. For example New Zealand
produces lamb for export, far more is produced than the home market could consume. Many countries
import oil as they lack their own supply.

The volume of imports and exports, and the price levels of the products and services imported and
exported, affect the balance of trade.

A long-term trade surplus creates a positive national income because it represents the country making a
net inflow of funds. However, it may contribute to a rising inflation rate as demand within the economy
increases. This may contribute to reduced international competitiveness in the future, as firms face
increasing costs that must be passed on in their prices.

On the other hand, a long-term trade deficit is a major problem because the country experiences a net
outflow of funds. A deficit has to be financed through a reduced national income account (see below) and
this will impact on the nation’s production capacity and future growth prospects as demand in the
economy falls.
PART A THE GLOBAL BUSINESS ENVIRONMENT 2: Governance and regulation 43

2.2.2 National accounts

Like businesses, nations produce accounts that show their financial performance. The format of each
country's accounts will differ, however they are usually based around four elements.

(a) Current account. This is made up of three sub-accounts.

(i) Production accounts – the value of the nation's output less the value of the goods and
services used to create it. The difference is the nation's gross domestic product (GDP).

(ii) Income accounts – the total income generated by production less government redistribution
of tax and social security benefits. The difference is the nation's disposable income.

(iii) Expenditure accounts – this records how the nation's disposable income is either spent or
saved.

(b) Capital account. This records the total accumulation of the nation's non-financial assets and how
they were financed. The difference is the nation's net borrowing or lending.

(c) Financial account. This records the nation's net acquisition of financial assets and liabilities. The
difference between them is the change in the nation's financial position.

(d) Balance sheet. This records the nation's financial and non-financial assets and liabilities. The
difference between them is the nation's net worth.

2.2.3 Effect of balance of trade on national account balances

A nation's balance of trade forms part of its national account balance. National outputs and the resources
used to produce them will be reflected in the production account. A nation's income comes from its
exports which form the income account.

If a country imports more than it exports, the deficit will reduce the income account. This will also feed
to the financial account and balance sheet. If a nation’s income falls, it has less money to invest in assets
and it may have to increase its liabilities in order to support its industries.

2.3 Correcting a balance of payments deficit

A government may follow an expenditure-reducing or expenditure-switching strategy when attempting to
correct a balance of payments deficit.

2.3.1 Expenditure-reducing strategy

This strategy involves the government reducing overall demand within the local economy, usually by
increasing interest rates. By increasing interest rates, individuals and firms pay more on their borrowing
and therefore have less cash to spend on goods, therefore reducing demand.

Whilst reducing demand for local goods, it also may reduce demand imports and increase demand for
exports (high interest rates usually reduce inflation which makes exports cheaper).

However, this strategy may worsen the deficit as high interest rates can increase the value of a nation’s
currency, making exports more expensive and imports cheaper. It may also reduce investment in the
nation as the cost of borrowing is high. Unemployment may also increase as a consequence of this policy.

Demand in the home nation can also be reduced by contracting the money supply or increasing taxation.

2.3.2 Expenditure-switching strategy

This policy involves the government attempting to switch domestic expenditure from imports to locally
produced goods whilst increasing exports.
44 2: Governance and regulation PART A THE GLOBAL BUSINESS ENVIRONMENT

Policies that can be used to achieve this include:

 Import controls – such as tariffs and quotas on imports.

 Exchange controls – reducing the amount of foreign currency available to domestic consumers to
buy imports with.

 Currency devaluation/depreciation – to reduce demand for imports whilst making exports cheaper
to overseas countries.

 Subsidies – providing subsidies to exporters to help them compete in foreign markets.

 Export guarantees – reducing the risk to exporters seeking to sell their goods overseas.

2.4 Fiscal policy

FISCAL POLICY refers to government policy on taxation and government spending.
Fiscal policy is based on the theories of British economist John Maynard Keynes. Keynesian economics is
KEY TERM
based around the theory that governments can influence macroeconomic productivity levels by increasing
or decreasing tax levels and public spending.

The aim, generally, is to keep inflation relatively low (between 2% and 3%) while maintaining high
employment levels. This is a balancing act, as stimulating a stagnant economy to increase demand and
employment may result in a decrease in the value of money – inflation.

2.4.1 Taxation 11/12

DIRECT TAXES are levied on earnings or profits, for example income tax for individuals and corporation tax
for companies. Taxes may also be raised on unearned income such as dividends, or special one-off taxes
KEY TERMS may be brought in for particular purposes. Direct tax is often viewed as progressive (as higher earners
tend to pay more tax), simple and easy to understand.

INDIRECT TAXES are levied on spending or expenditure. For example, Value Added Tax, specific sales taxes
such as those imposed on tobacco and petrol, import duties, road tax etc. Governments favour indirect
taxation as it is easy and cheap to collect. The tax is collected by sellers of goods and services and paid
over to the government. However, indirect taxes are often viewed by the public as regressive, unfair and
difficult to understand.

A key decision that governments need to make in their fiscal policy is what proportion of tax should be
paid by individuals rather than businesses.

By mainly taxing individuals the Government risks stopping the economy growing as people do not have
enough disposable income to spend on goods and services, this will also reduce company profits and
reduce the level of corporation tax collected.

If levels of corporation tax are too high then the country may become a less attractive place for foreign
companies to set up business and they may relocate their operations to other countries with a more
favourable tax regime. This may have an affect on the products and services available in the country as
well as on growth and unemployment levels.

The second key decision that is required is what proportion of tax should come from direct and indirect
taxes.

Indirect taxation is generally cheaper for the Government to administer as the cost of collecting and
paying the tax is a burden on business organisations, but it will increase inflation since it increases the
cost of goods and services. It is also generally more popular with the public than direct tax, as they feel
that they have a choice of whether to incur it (by deciding whether or not to buy goods subject to the tax).
It becomes unpopular where all goods and services are subject to indirect taxation and it is impossible to
avoid.
PART A THE GLOBAL BUSINESS ENVIRONMENT 2: Governance and regulation 45

Direct taxation is generally unpopular with the general population as they see that their income is
reduced. This reduction in income helps to reduce inflation by reducing demand but it is expensive for the
Government to administer and requires sometimes complex laws and regulations to be introduced.

2.5 Monetary policy

MONETARY POLICY refers to government policy on the money supply, the monetary system, interest rates,
exchange rates and the availability of credit.
KEY TERM
Monetary policy can be used as a means of achieving economic objectives for inflation, the balance of
trade and economic growth. Most economists believe that an increase in the money supply will increase
demand leading to increases in prices (inflation) and incomes.

Monetary policy focuses on three factors, interest rates, exchange rates and national income.

2.5.1 Interest rates

The government may change interest rates (the price of money) in an attempt to influence the level of
expenditure in the economy and/or the rate of inflation.

A rise in interest rates increases the price of borrowing for both companies and individuals. If companies
see the rise as relatively permanent, rates of return on investments will become less attractive and
investment plans may be curtailed. Corporate profits will fall as a result of higher interest payments.
Companies will reduce inventory levels as the cost of having money tied up in stocks rises. Individuals
should be expected to reduce or postpone consumption in order to reduce borrowings, and should become
less willing to borrow for house purchases.

Although it is generally accepted that there is likely to be a connection between interest rates and
investment (by companies) and consumer expenditure, the connection is not a stable and predictable
one. Interest rate changes are only likely to affect the level of expenditure after a considerable time lag.

The table below explains some impacts of a rise in interest rates.

Impact Comment
Spending falls Higher interest rates increase the cost of credit. The higher interest rate makes
it more attractive to hold money than to spend it.
Investment falls The higher rate will increase the opportunity cost of investment (for example in
new projects) and reduce the net present value of the investment. This will
discourage organisations from investing.
The increased interest rates will make borrowing more expensive.
Foreign funds are Interest rates are the reward for capital, so a rise in interest rates will encourage
attracted into the overseas currency investors because of the increased rate of return relative to
country other countries.
Exchange rate rises The inflow of foreign funds (above) increases the demand for the home currency
and therefore strengthens the exchange rate making exports more expensive and
imports cheaper.
Inflation rate falls This is often the main goal of an interest rate rise. The reduction in spending
and investment will reduce aggregate demand in the economy.
The stronger exchange rate means imported goods will be cheaper.

An increase in interest rates will have a deflationary impact on the economy.

Note, however, the potential conflicting objectives which monetary policy faces. A change in interest
rates will have effects on both the domestic economy and on a country's international trade position (for
example through exchange rate movements).
46 2: Governance and regulation PART A THE GLOBAL BUSINESS ENVIRONMENT

It may be the case that the interest rate movement required for the domestic economy conflicts with that
required to achieve a balance on the external current account.

2.5.2 Exchange rates

Exchange rates are often used in monetary policy for two reasons.

(a) If the exchange rate falls (or weakens), exports become cheaper to overseas buyers and so the
nation becomes more competitive in export markets. Imports will become more expensive and so
less competitive against goods produced by manufacturers at home. A fall in the exchange rate
might therefore be good for the domestic economy, by giving a stimulus to exports and reducing
demand for imports.

(b) An increase (or strengthening) in the exchange rate will have the opposite effect, with dearer
exports and cheaper imports. If the exchange rate rises and imports become cheaper, there should
be a reduction in the rate of domestic inflation. A fall in the exchange rate, on the other hand,
tends to increase the cost of imports and adds to the rate of domestic inflation.

When a country's economy is heavily dependent on overseas trade it might be appropriate for government
policy to establish a target exchange value for the domestic currency. However, the exchange rate is
dependent on both the domestic rate of inflation and the level of interest rates. Targets for the exchange
rate cannot be achieved unless the rate of inflation at home is first brought under control.

2.5.3 National income

The authorities might set targets for the level of national income. For example, the policy might be for the
growth in the national income to be X% per annum for Y years. However, it takes time to collect
information about national income.

For this reason, although a target growth rate in national income itself is, in theory, probably the most
suitable target of monetary policy, it is the least practical because the authorities would always be
working with out-of-date information.

Question 2.1 Exchange and inflation rates

Learning outcome A1(vi)

Briefly explain how a nation’s exchange and inflation rates may affect its national income. (4 marks)

Section summary
Key elements of the macroeconomy include, interest rates, exchange rates and levels of demand and
supply.

A number of factors influence a nation's balance of trade because they affect the price of domestic goods
compared to foreign imports.

A nation's balance of trade forms part of its national account balance.

Fiscal policy refers to government policy on taxation and government spending.

Monetary policy refers to government policy on money supply, the monetary system, interest rates,
exchange rates and the availability of credit. It can directly affect a nation's balance of trade.
PART A THE GLOBAL BUSINESS ENVIRONMENT 2: Governance and regulation 47

3 Market regulation 03/13

Introduction
Regulation can be defined as any form of state interference with the operation of the free market.
Efficient regulation is where the total cost of the regulation is less than the benefit it provides to society.
Regulation is effective if the function of business is not impeded and the end-product or service being
controlled is safe and works as it should.

3.1 Regulation and Competition Policy

Regulation could involve regulating demand, supply, price, profit, quantity, quality, entry, exit,
information, technology, or any other aspect of production and consumption in the market

In the UK, much regulation concerns competition. However the government also plays a part in regulating
externalities (costs or benefits that arise from industry which are experienced by wider society rather than
producers and consumers). The actions of business people may also be controlled – for example to
prevent insolvent companies trading and where market abuse, insider dealing and money laundering
occur.

3.1.1 The Competition Act 1998

In the UK, this Act sought to encourage competition by introducing the presumption that anti-competitive
arrangements are against the public interest and so should be illegal. Competition is thought to be in the
best interests of the consumer because the aim is to reduce prices, raise quality and encourage the
efficient use of resources. The Office of Fair Trading (OFT) has the power to investigate organisations
suspected of breaching the Act. Fines of up to 10% of revenue may be imposed.

3.1.2 Industry regulators

Most countries have specific industry regulators to monitor the activities of private companies in
‘essential’ industries. For example, the UK has OFCOM to regulate the telecommunications market, while
OFGEM regulates the gas industry.

The regulators aim to promote competition, for example by imposing price caps and performance
standards or removing barriers preventing new organisations entering the market.

3.2 The Competition Commission

In the UK, the Competition Commission's (CC's) role is to promote competition. For example, the CC may
investigate proposed mergers where the assets involved exceed a certain value and recommend whether
or not it should be allowed to proceed.

3.3 The Restrictive Practices Court

The UK Restrictive Practices Court (RTP) has jurisdiction to declare that certain agreements are contrary
to the public interest and to restrain parties from enforcing them.

The RTP considers applications made by the Director General of Fair Trading in respect of agreements
under which at least two parties are imposing restrictions on the price or supply of goods.
48 2: Governance and regulation PART A THE GLOBAL BUSINESS ENVIRONMENT

3.4 European Union competition policy

European Union competition policy is intended to ensure free and fair competition in the EU. The
Commission of the European Union has authority under the Treaty of Rome (Articles 81 to 89) to
prohibit price fixing and other uncompetitive arrangements, including limiting production or seeking to
exclude competitors from a market.

The Commission also has authority to prevent national governments within the EU offering subsidies or
other state aid to organisations in their countries which will distort competition across the wider market.

3.5 Self-regulation
In many markets, the participants may decide to maintain a system of voluntary self-regulation, possibly
in order to try to avert the imposition of government controls. Self-regulation often exists in the
professions.

3.6 Costs of regulation

The costs of regulation include:

(a) Enforcement costs. Direct costs of enforcement include the setting up and running of the
regulatory agencies. Indirect costs are those incurred by regulated organisations in conforming with
the regulations relevant to them.

(b) Regulatory capture. This refers to the process by which the regulator becomes dominated and
controlled by the regulated companies, such that it acts increasingly in the latter's interests, rather
than those of consumers. This is a phenomenon which has been observed in the USA.

(c) Unintended consequences of regulation. Organisations will not react passively to regulatory
constraints on their behaviour – instead they try to limit their effectiveness. In general, theory and
observation suggest that if it’s practical, businesses will move away from regulated activities
towards those which are less constrained or completely unregulated.

3.7 Deregulation
Deregulation can be defined as the removal or weakening of any form of statutory (or voluntary)
regulation of free market activity. Deregulation allows free market forces more scope to determine the
outcome.

There was a shift in policy in the 1980s in the UK and in the USA towards greater deregulation of
markets, in the belief that this would improve efficiency.

A rational assessment of deregulation should weigh the potential benefits against the costs. If there will
be a net gain to society, we can say that the deregulation should proceed. It would be simplistic to
contend that all regulation is detrimental to the economy.

3.7.1 Advantages and disadvantages of deregulation

Deregulation measures are also known as liberalisation.

Those who favour deregulation quote possible benefits such as:

(a) Increased incentive to find internal cost savings and efficiency. Increased competition should lead
to the most efficient organisations being the most successful.

(b) Improved allocative efficiency. Competition should result in prices closer to marginal cost and
therefore result in overall production that is closer to the socially optimal output level.
PART A THE GLOBAL BUSINESS ENVIRONMENT 2: Governance and regulation 49

In some industries, liberalisation could have certain disadvantages.

(a) Loss of economies of scale. If increased competition means that each organisation produces less
output on a smaller scale, unit costs will be higher.

(b) Lower quality or quantity of service. The need to reduce costs may lead organisations to reduce
quality or eliminate unprofitable but socially valuable services.

(c) Need to protect competition. It may be necessary to implement a regulatory regime to protect
competition where inherent forces have a tendency to eliminate it.

Section summary
Regulation can be defined as any form of state interference with the operation of the free market.

In the UK there have been various pieces of legislation enacted to maintain competition in the market
place and there are a number of industry regulators.

European Union competition policy is intended to ensure free and fair competition in the EU.

Deregulation can be defined as the removal or weakening of any form of statutory (or voluntary)
regulation of free market activity.

4 Corporate governance

Introduction
Although shareholders own a company, the responsibility for directing and controlling it rests largely with
the board of directors. In the UK, a series of high profile corporate scandals in the 1980s and 1990s led
to a range of corporate governance controls.

CORPORATE GOVERNANCE is the system by which companies and other entities are directed and
controlled.
KEY TERM (CIMA Official Terminology)

Corporate governance concerns shareholders (the owners) and directors (the management), as between
them they direct and control the company.

Sometimes, particularly in smaller businesses, companies are owned and managed by the same people.
This is the situation where people form a company to carry out their own business, buy the shares and
appoint themselves as directors.

In other, mainly bigger, companies, the directors and shareholders are different sets of people. Often in
larger companies quoted on stock exchanges, shareholders purchase shares as an investment and may
have very little personal contact with the company. Directors are employed for their management
expertise and have no other connection with the company.

There is a key difference between these two types organisation, which is known as the 'knowledge gap' or
‘agency problem’. In the owner-managed company, as the directors and shareholders are the same
people, they have access to the same information and are in a position to direct company policy. In the
other company, the shareholders do not have access to day-to-day company management information
and therefore have to rely on the directors to act in their interest.
50 2: Governance and regulation PART A THE GLOBAL BUSINESS ENVIRONMENT

4.1 Stakeholders
Stakeholders are persons or groups that have a legitimate interest in a business's conduct and whose
concerns should be addressed as a matter of principle. Many stakeholder groups have influence over the
way in which organisations are managed and operated. They can therefore be fundamental to corporate
governance.

STAKEHOLDERS are those persons and organisations that have an interest in the strategy of an
organisation.
KEY TERMS (CIMA Official Terminology)

STAKEHOLDER THEORY states that shareholders should not be the sole focus of an organisation’s attention,
but that it should be accountable to all stakeholders.

There are three broad types, or constituencies, of stakeholder in an organisation.

 Internal stakeholders such as employees and management

 Connected stakeholders such as shareholders, customers, suppliers and financiers
 External stakeholders such as the community, government, trade unions and pressure groups

Stakeholders

Connected Banks and

Shareholders Customers Suppliers
financiers

Internal INTERNAL, eg
Management
Employees

External Pressure
Community Government
groups

The extent to which external stakeholders are interested and recognised is linked in some ways to the size
of the organisation. For example the policies and actions of larger organisations are more likely to be of
interest to national governments and even international bodies than are those of smaller organisations.

Stakeholders may also be analysed into those who have a formal contractual relationship with the
organisation and those who do not. These two groups are called primary and secondary stakeholders.
Internal and connected stakeholders fall into the primary category, while external stakeholders are
secondary stakeholders.

It is important for management to consider stakeholders when determining corporate goals, objectives
and strategy for two reasons. Firstly, certain stakeholder groups, that hold power in the organisation,
might be able to disrupt or prevent certain policies being carried out. For example, staff may go on strike
and suppliers may choose not to supply the organisation if they do not agree with its activities. Secondly,
the organisation may legitimise its goals if it discusses them with those affected. In other words, the
organisation can demonstrate that its goals have been agreed upon by not just the senior management
team and therefore the decision may not be questioned by others.

You will use your understanding of the types of stakeholders in paper E3 when you study how
to manage them.
PART A THE GLOBAL BUSINESS ENVIRONMENT 2: Governance and regulation 51

4.1.1 Stakeholder conflict

Stakeholders are mostly interested in the success of the business, and this creates a common goal
between them. However, they may pursue their own interests in certain circumstances, and these
interests may be incompatible with the interests of other stakeholder groups, creating conflict between
them.

Examples of conflicting interests include:

 Shareholders demanding rising profits and customers wanting higher quality (more costly) products
 Employee demand for pay rises against the need for management to maximise profit (perhaps at
least in part to achieve their bonuses)
 The community wanting minimal environmental impact from the organisation but shareholders
want the least costly option for disposing of waste chosen
 Directors may recommend that the business is taken over by another but shareholders want to
remain independent

Directors usually give priority to those stakeholders which have the most power, but decisions are usually
a compromise between the various stakeholder groups.

Mendelow classifies stakeholders on a matrix whose axes are power (or influence) and degree of interest
in the organisation's activities. These factors help define the type of relationship the organisation should
seek with its stakeholders.
Level of interest
Low High

Low A B
Power/influence

High C D

(a) Key players are found in segment D. Any strategy must be acceptable to them, at least. An
example would be a major customer. These stakeholders may participate in decision-making.
(b) Stakeholders in segment C must be treated with care. While often passive, they may be capable of
moving to segment D. They should, therefore be kept satisfied. Large institutional shareholders
might fall into segment C.
(c) Stakeholders in segment B do not have great ability to influence strategy, but their views can be
important in influencing more powerful stakeholders, perhaps by lobbying. They should therefore
be kept informed. Community representatives and charities might fall into segment B.
(d) Minimal effort should be expended on segment A. An example might be a contractor's employees.
Internal stakeholder groups are likely to have both more influence and more interest than external groups.
Coalitions of stakeholder groups are likely to have more influence than single stakeholders or small
uniform groups.

Stakeholder mapping is also part of the syllabus for Paper E2.

52 2: Governance and regulation PART A THE GLOBAL BUSINESS ENVIRONMENT

4.2 Failures of corporate governance

Though mostly discussed in relation to quoted companies, governance is an issue for all organisations. An
increasing number of high profile corporate scandals and collapses, including Polly Peck International,
BCCI and Maxwell Communications Corporation prompted the development of governance codes in the
early 1990s. However, scandals since then, such as Parmalat and Enron, have raised questions about
further measures that may be necessary. These scandals have highlighted the need for guidance to tackle
the various risks and problems that can arise in organisations' systems of governance.

4.2.1 Domination by a single individual

A feature of many corporate governance scandals has been boards dominated by a single senior executive
with other board members merely acting as a rubber stamp. Sometimes the single individual may bypass
the board to action their own interests. The report on the UK Guinness case suggested that the Chief
Executive, Ernest Saunders paid himself a substantial reward without consulting the other directors. The
presence of non-executive directors on the board is felt to be an important safeguard against domination
by a single individual.

4.2.2 Lack of involvement of board

Boards that meet irregularly or fail to consider systematically the organisation's activities and risks are
clearly weak. Sometimes the failure to carry out proper oversight is due to a lack of information being
provided.

4.2.3 Lack of adequate control function

An obvious weakness is an ineffective internal audit function, since this is one of the most important
aspects of internal control. Another important weakness is a lack of adequate technical knowledge in key
roles, for example in the audit committee or in senior compliance positions. A rapid turnover of staff
involved in accounting or control may suggest inadequate resourcing and the constant change will make
control more difficult.

4.2.4 Lack of supervision

Employees who are not properly supervised can create large losses for the organisation through
incompetence, negligence or fraudulent activity. The behaviour of Nick Leeson, the employee who caused
the collapse of Barings bank was not challenged because he appeared to be successful, whereas he was
using unauthorised accounts to cover up his large trading losses. Leeson was able to do this because he
was in charge of both dealing and settlement, a systems weakness or lack of segregation of key roles
that has also featured in other financial frauds.

4.2.5 Lack of independent scrutiny

External auditors may not carry out the necessary questioning of senior management because of fears of
losing the audit and internal audit may avoid awkward questions because the chief financial officer
determines their employment prospects. Often corporate collapses are followed by criticisms of external
auditors; such as the Barlow Clowes affair where poorly planned and focused audit work failed to identify
illegal use of client monies.

4.2.6 Lack of contact with shareholders

Board members may be out of touch with the interests and views of shareholders. One possible symptom
of this is the payment of remuneration packages that do not appear to be warranted by results. Equally,
the directors may choose to pursue their own interests and ignore the requirements of the shareholders.
PART A THE GLOBAL BUSINESS ENVIRONMENT 2: Governance and regulation 53

4.2.7 Emphasis on short-term profitability

Emphasis on short-term results can lead to the concealment of problems or errors, or manipulation of
accounts to achieve desired results.

4.2.8 Misleading accounts and information

Often, misleading figures are symptomatic of other problems (or are designed to conceal them). In many
cases, poor quality accounting information is a major problem if markets are trying to make a fair
assessment of the company's value. Giving out misleading information was a major issue in the UK's
Equitable Life scandal where the company gave contradictory information to savers, independent
advisers, media and regulators.

4.3 Benefits of improving corporate governance

4.3.1 Risk reduction
Clearly, the ultimate risk is of the organisation making such large losses that bankruptcy becomes
inevitable. The organisation may also be closed down as a result of serious regulatory breaches, for
example misapplying investors' monies. Proper corporate governance reduces such risks by aligning
directors' interests with the company's strategic objectives and by providing for measures to reduce fraud.

4.3.2 Performance
Performance should improve if accountabilities are made clear and directors' motivation is enhanced by
performance-related remuneration. Also, the extra breadth of experience brought by non-executive
directors and measures to prevent domination by a single powerful figure should improve the quality of
decision-making at board level.

4.3.3 External support

External perceptions of the company should be enhanced. This can have wide-ranging benefits.

 Improved ability to raise finance

 Improved corporate image with public and government
 Improved relations with stakeholders such as customers and employees

4.4 The UK Corporate Governance Code (an example)

The UK Corporate Governance Code applies to listed companies in the UK. These companies must either
comply with the code or explain any departures from it in a note to their financial statements (‘comply or
explain’). The approach taken by the UK Corporate Governance Code is one based on a framework of
best practice principles.

The key principles of the code are explained briefly below.

4.4.1 Leadership
Every company should be headed by an effective board. The board consists of the chairman, chief
executive, executive directors and non-executive directors.

The roles of chairman and chief executive should not be exercised by the same individual. The chairman
runs the board and the chief executive runs the operations of the company. If the board decides that the
roles of chief executive and chairman should be held by the same individual, they should consult major
shareholders in advance, setting out their reasons.
54 2: Governance and regulation PART A THE GLOBAL BUSINESS ENVIRONMENT

Executive directors are involved in the day-to-day management of the company and may have titles that
describe their function – such as Finance Director. The main role of non-executive directors (NEDs) is to
attend board and board committee meetings and constructively challenge and help develop proposals on
strategy.

The board should include sufficient non-executive directors. What is ‘sufficient’ in terms of number of
NEDs depends on the company. In larger companies, NEDS should make up half the board (excluding the
Chairman), but in small companies on two NEDS are required.

A ‘senior independent director’ should be appointed out of the NEDs and act as a point of contact for
shareholders who wish to raise issues that concern them.

4.4.2 Effectiveness
The board should have an appropriate balance of skills, experience, independence and knowledge.

There should be a formal and transparent procedure for the appointment of new directors via a
nomination committee. This committee should ensure that appointments to the board are based on
finding the best person for the job (ie on merit).

The board should undertake a formal annual evaluation of its performance.

All directors should receive induction on joining the board and should regularly update and refresh their
skills and knowledge. Directors should be submitted for re-election at regular intervals.

The board should be supplied in a timely manner with information in a form and of a quality appropriate
to enable it to discharge its duties.

The board should include an appropriate combination of executive and non-executive directors such that
no individual or small group of individuals can dominate.

4.4.3 Accountability
The board should present a balanced and understandable assessment of the company’s position and
prospects.

The board is responsible for determining the nature and extent of risks it is willing to take to achieve
strategic objectives.

The board should establish an audit committee of at least three (or in the case of smaller companies
two), independent non-executive directors. At least one member of the audit committee should have
recent and relevant financial experience.

The main role and responsibilities of the audit committee should include monitoring the integrity of
accounting policies and financial statements, reviewing the company’s internal controls and risk
management, reviewing the work and effectiveness of the internal audit function, monitoring the external
auditor’s independence and objectivity, short-listing external audit firms when a change is needed and
being available for internal and external auditors to speak to.

4.4.4 Remuneration
Director remuneration should be sufficient to attract, retain and motivate directors of the quality
required, but should not be more than is necessary. A significant proportion of executive directors’
remuneration should be linked to corporate and individual performance.

There should be a formal and transparent procedure for developing policy on executive remuneration and
for fixing the remuneration of individual directors. No director should be involved in deciding his or her
own remuneration, rather a remuneration committee with a number of non-executive directors should set
director pay. The number of NEDs on the remuneration committee should be the same as the audit
committee.
PART A THE GLOBAL BUSINESS ENVIRONMENT 2: Governance and regulation 55

4.4.5 Relations with shareholders

There should be a dialogue with shareholders based on the mutual understanding of objectives. The
board as a whole has responsibility for ensuring that a satisfactory dialogue with shareholders takes
place. The Annual General Meeting (AGM) has a key role to play in this.

Exam skills
You may be asked to read a scenario and identify any corporate governance issues. Learn the principles
of good corporate governance rather than the specific requirements of the UK Corporate Governance
Code or any other country-specific regime.

Corporate governance is a popular topic – it appears on several syllabuses.

Further details of the UK Corporate Governance code are available on the web. Visit
www.frc.org.uk

4.5 Sarbanes-Oxley Act 2002

The US Sarbanes-Oxley Act 2002 (SOX) takes a different, rules-based approach, to corporate
governance. The objective is to prevent creative accounting. Examples of some SOX rules include:

 Restrictions on non-audit services provided by auditors

 Report on internal control systems to form part of the financial statements
 All off-balance sheet finance to be disclosed in the financial statements
 Companies to be prevent from trading if they do not have an audit committee

Question 2.2 Corporate governance and directors

Learning outcome A2(i)

Briefly explain what is meant by corporate governance and explain three measures concerning directors
recommended by the UK Corporate Governance Code. (4 marks)

Section summary
Corporate governance is the system by which companies and other entities are directed and controlled.

Stakeholders are persons or groups that have a legitimate interest in a business's conduct and whose
concerns should be addressed as a matter of principle.

Since their interests may be widely different, conflict between stakeholders can be quite common.

An increasing number of high profile corporate scandals and collapses prompted the development of
governance codes in the early 1990s.

The UK Corporate Governance Code sets out standards of best practice in relation to issues such as
board composition, remuneration and accountability.
56 2: Governance and regulation PART A THE GLOBAL BUSINESS ENVIRONMENT

5 Corporate social responsibility 11/10, 03/13

Introduction
Corporate social responsibility (CSR) refers to the expectation in society that companies are accountable
for the social and ethical effects of their actions. This expectation has grown since the 1970s and
organisations are expected to demonstrate a duty of care to society. If they fail in their duty to the public
then compensation may be sought from them.

In most countries, some CSR issues are covered by legal regulations (eg pollution and child labour).
Increasingly, consumers are demanding that producers of the products and services they use do more
than simply comply with laws - they expect companies to behave ethically and with moral responsibility.

The term Corporate Social Responsibility (CSR) is used to describe a wide range of obligations that an
organisation may feel it has towards its secondary or external stakeholders, including the society in which
KEY POINT
it operates.

The traditional view of business is that companies have the sole objective of maximising profits for
shareholders and that social responsibility has no part to play in business decision making. In recent
times, however, this view has shifted towards CSR related strategies that may offer a business a number
of advantages. The main benefits are to improve the organisation’s image in society and create a long-
term attachment with customers. Other advantages include the following:

Advantages of CSR strategies

Attractive to likeminded, high quality employees Differentiation from competitors
May reduce packaging costs and environmental Creates new markets for goods and services and
taxes attracts new, likeminded customers
Improves image of firm/brand Positive impact on profitability if sales increase and
costs fall

5.1 Caroll and Buchholtz's layers of corporate social responsibility

Caroll and Buchholtz argued that there are four main 'layers' of corporate social responsibility.

5.1.1 Economic responsibilities

Companies have economic responsibilities to shareholders demanding a good return, to employees
wanting fair employment conditions and to customers seeking good-quality products at a fair price.
Businesses are formed to be properly functioning economic units and so economic responsibilities form
the basis of all other responsibilities.

5.1.2 Legal responsibilities

Since laws codify society's moral views, obeying them must be the foundation of compliance with social
responsibilities. Although in all societies corporations will have some legal responsibilities, there is
perhaps more emphasis on them in continental Europe than in the Anglo-American economies. In Anglo-
American economies the focus of discussion has often been whether many legal responsibilities are
unnecessary burdens on business.
PART A THE GLOBAL BUSINESS ENVIRONMENT 2: Governance and regulation 57

5.1.3 Ethical responsibilities

These are responsibilities that require corporations to act in a fair and just way even if the law does not
compel them to do so. If customers demand this, acting ethically may be as much a business decision as
a moral one.

5.1.4 Philanthropic responsibilities

According to Carroll and Buchholtz, these are desired rather than being required of businesses. They
include charitable donations, contributions to local communities and providing employees with the
chances to improve their own lives.

Whilst CSR principles tend to be similar the world over, there are differences in application. For example,
in America, the approach of many businesses is to make charitable donations, but in Europe, the focus
tends to be on investing in communities and having responsible business practices. Although some
investment is needed when implementing a CSR policy, most firms see them as profitable in the long-
term as customers expect companies to be socially responsible, and if they’re not, they will spend their
money elsewhere.

5.2 Corporate citizenship

The concept of corporate citizenship provides a different perspective on organisations and society. It
seeks to explain what determines how much and in what ways organisations engage with society. Again
there are different views of how far it should extend.

5.2.1 Limited view

This is based on voluntary philanthropy undertaken in the organisations' interests. The main stakeholder
groups that the corporate citizen engages with are local communities and employees. Citizenship in action
takes the form of limited focus projects.

5.2.2 Equivalent view

This is based on a wider general definition of citizenship that is partly voluntary and partly imposed. The
organisation focuses on a broad range of stakeholders and responds to the demands of society. Self-
interest is not the primary motivation, instead the organisation is focused on legal requirements and
ethical fulfilment.

5.2.3 Extended view

This view is based on a partly voluntary and partly imposed view of active social and political citizenship.
Corporations must respect citizens' rights, particularly as governments have failed to provide some
necessary safeguards. Given this, corporations can make a big impact since they are the most powerful
institutions in society. Again the focus is on a wide range of stakeholders.

Under the extended view, organisations will promote:

 Social rights, by provision (for example decent working conditions)

 Civil rights, by intervening to promote citizens' individual rights themselves or to pressurise

governments to promote citizens' rights

 Political rights, by channelling (allowing individuals to promote their causes by using corporate
power)
58 2: Governance and regulation PART A THE GLOBAL BUSINESS ENVIRONMENT

5.3 Corporate social responsibility in developing nations

Developing economies face different challenges to corporate social responsibility than developed nations.

Key drivers for CSR in developing economies include:

(a) Culture. Many developing nations already have in their culture a tradition of ethics and
community. Often this has come about through religion. As businesses are part of a nation's
culture it is natural for such traditions to be followed.

(b) Politics. Political reform and the introduction of democracy is common in developing countries as
this is often the spark which drives economic development. Countries undergoing development
often follow examples of good practice, such as CSR, in developed nations.

(c) Socio-economic priorities. Developing countries often face a conflict of priorities. For example,
reducing pollution may be desirable to preserve the environment, but cleaner production methods
may be more expensive and hinder economic progress.

(d) Governance gaps. CSR can be used as a form of governance to 'plug the gaps' that result from
poor government services. For example, organisations can be used to provide healthcare or
education where the government cannot afford to.

(e) Market access. As developed nations have high public pressure for CSR, companies in developing
nations must follow the same principles if they are to sell in the same market.

(f) Multinational companies. Multinational companies strive for consistency across all their
international subsidiaries and production units. Where these are located in developing countries,
they will adopt the same policies as those in developed countries. Countries (or companies) that do
not adopt CSR are less likely to receive investment (or orders) from MNCs.

Exam skills
You may be asked to apply the concept of corporate social responsibility to a number of business areas.
For example in March 2013 a 5 mark question required candidates to link it to HR policies. Students
who understand the subject, rather than just rote learning facts, should be able to deal with such
situations successfully.

Section summary
Corporate social responsibility (CSR) is a recent development brought about by pressure on companies to
show an awareness of the social and ethical effects of their actions.

Developing economies face different corporate social responsibility challenges. For example, culture,
politics, socio-economic priorities, governance gaps, market access and the influence of multinational
companies all influence government, company and consumer attitudes towards corporate social
responsibility.
PART A THE GLOBAL BUSINESS ENVIRONMENT 2: Governance and regulation 59

Chapter Roundup
 Government influence over business extends to the macroeconomic environment, legal and market
regulations, corporate governance and social responsibility.

 Key elements of the macroeconomy include, interest rates, exchange rates and levels of demand and
supply.

 A number of factors influence a nation's balance of trade because they affect the price of domestic goods
compared to foreign imports.

 A nation's balance of trade forms part of its national account balance.

 Fiscal policy refers to government policy on taxation and government spending.

 Monetary policy refers to government policy on money supply, the monetary system, interest rates,
exchange rates and the availability of credit. It can directly affect a nation's balance of trade.

 Regulation can be defined as any form of state interference with the operation of the free market.

 In the UK there have been various pieces of legislation enacted to maintain competition in the market
place and there are a number of industry regulators.

 European Union competition policy is intended to ensure free and fair competition in the EU.

 Deregulation can be defined as the removal or weakening of any form of statutory (or voluntary)
regulation of free market activity.

 Corporate governance is the system by which companies and other entities are directed and controlled.

 Stakeholders are persons or groups that have a legitimate interest in a business's conduct and whose
concerns should be addressed as a matter of principle.

 Since their interests may be widely different, conflict between stakeholders can be quite common.

 An increasing number of high profile corporate scandals and collapses prompted the development of
governance codes in the early 1990s.

 The UK Corporate Governance Code sets out standards of best practice in relation to issues such as
board composition, remuneration and accountability.

 Corporate social responsibility (CSR) is a recent development brought about by pressure on companies to
show an awareness of the social and ethical effects of their actions.

 Developing economies face different corporate social responsibility challenges. For example, culture,
politics, socio-economic priorities, governance gaps, market access and the influence of multinational
companies all influence government, company and consumer attitudes towards corporate social
responsibility.
60 2: Governance and regulation PART A THE GLOBAL BUSINESS ENVIRONMENT

Quick Quiz
1 Briefly explain the impact a falling exchange rate will have on a nation's balance of trade.

2 The primary consequence of an increase in a nation's interest rates is:

A To make imports more expensive

B To make borrowing more expensive
C To make imports cheaper
D To make borrowing cheaper

3 Which of the following is an external stakeholder?

A Shareholders
B Customers
C Suppliers
D Pressure groups

4 Which of the following is not an example of a corporate governance failure?

A Domination by a single individual

B Lack of contact with shareholders
C Strong corporate finance controls
D Short-term profitability is pursued

5 Charitable donations are an example of which layer of corporate social responsibility according to Caroll
and Buchholtz?

A Economic
B Legal
C Ethical
D Philanthropic

Answers to Quick Quiz

1 If an exchange rate falls, exports become cheaper to overseas buyers and so the nation becomes more
competitive in export markets. Imports will become more expensive and so less competitive against goods
produced by manufacturers at home. A fall in the exchange rate might therefore be good for the balance
of trade, by giving a stimulus to exports and reducing demand for imports. However, if the demand for
imported goods remains constant at the higher price level (for example demand for oil-related products
such as petrol tends to be inelastic), the falling exchange rate may have an adverse effect on the balance
of trade.

2 B An increase in interest rates makes company and individual borrowing more expensive.

3 D Pressure groups are external stakeholders. The others are connected stakeholders.

4 C Strong corporate finance controls would be an example of good corporate governance.

5 D Charitable donations are an example of the philanthropic layer of corporate social responsibility
according to Caroll and Buchholtz.
PART A THE GLOBAL BUSINESS ENVIRONMENT 2: Governance and regulation 61

Answers to Questions
2.1 Exchange and inflation rates

Exchange rates affect the relative cost of a nation’s imports and exports. If its currency falls in value, imports
become more expensive and exports cheaper. This leads to an improvement in national income as the country
exports more than it imports.

Inflation rates affect the cost-base of organisations. If a nation experiences rising inflation, then the cost of
producing goods will rise. As a result, organisations have to raise their prices. This makes the price of goods
produced locally relatively more expensive compared to imports. Consequently, this will lead to a worsening
national income as the local demand for cheaper imports increases and overseas demand for expensive exports
decreases.

2.2 Corporate governance and directors

Corporate governance can be defined as the system by which an organisation is directed and controlled.

It is concerned with systems, processes, controls, accountability and decision making at the highest level of an
organisation. Therefore, it affects the way in which board members and senior managers execute their
responsibilities how they account for that authority to those who have entrusted them with assets and resources.

Three recommendations of the UK Corporate Governance Code concerning directors are:

(a) Companies should appoint non-executive directors to the board. They are intended to provide a check or
balance against the power of the chairman and chief executive.

(b) The posts of chairman and chief executive should not be held by the same person. This is to prevent
excessive executive power being held by one individual.

(c) Directors should not set their own remuneration. A remuneration committee consisting of non-executive
directors should set executive pay.

Note: These are just three possible examples, your answer may have included other examples.

Now try this question from Number Level Marks Time

the Exam Question Bank
2 Examination 20 36 mins
62 2: Governance and regulation PART A THE GLOBAL BUSINESS ENVIRONMENT
INFORMATION SYSTEMS

Part B

63
64
THE ROLE OF INFORMATION SYSTEMS

In this chapter we introduce information working and how IT enabled 'transformations' have led to
systems and explain their role within new forms of organisation both real and 'virtual'.
organisations.
Later, we consider two major issues concerning
In particular, we are interested in how developments in information systems – privacy and security.
technology have provided organisations new ways of

topic list learning outcomes syllabus references ability required

1 The role of information systems in organisations B1(a) B1(i) comprehension

2 Data and information B1(a) B1(i) comprehension

3 Types of information systems B1(a) B1(i) comprehension

4 Emerging trends in information systems B1(a) B1(ii) comprehension

5 IT enabled transformation B1(c) B1(iii) analysis

6 IT and new forms of organisation B1(b) B1(iii), B1(iv) analysis
7 Privacy and security B2(a) B2(ii) analysis

65
66 3: The role of information systems PART B INFORMATION SYSTEMS

1 The role of information systems in organisations 09/11

Introduction
In this section we look at the role information systems play in organisations. Two main roles can be
identified:

 Support operations through the processing and storing of transactions

 Support managerial activities such as decision making, planning, performance measurement and
control

These two purposes can be broken down into five elements.

Organisations require information for a range of purposes.

KEY POINT  Recording transactions

 Decision making
 Planning
 Performance measurement
 Control

1.1 Recording transactions

Information about each business transaction or event is required for a number of reasons. Documentation
of transactions can be used as evidence in a case of dispute. There may be a legal requirement to record
transactions, for example for accounting and audit purposes. Detailed information on production costs can
be built up allowing a better assessment of profitability.

1.2 Decision making

Information is also required to make informed decisions. Information and information systems enable
informed decisions to be made.

Information used by information systems may be classified as internal and external.

1.3 Planning
Planning requires a knowledge of, among other things, available resources, possible time-scales for
implementation and the likely outcome under alternative scenarios. Information systems can provide a
number of planning tools.

1.4 Performance measurement

Just as individual operations need to be controlled, so overall performance must be measured in order to
enable comparisons against budget or plan to be made. This may involve the collection of information
on, for example, costs, revenues, volumes, time-scale and profitability. The collection, analysis and
presentation of such data can be performed by information systems.

1.5 Control
Once a plan is implemented, its actual performance must be controlled. Information is required to assess
whether it is proceeding as expected or whether there is some unexpected deviation from the plan. It
may consequently be necessary to take some form of corrective action. Information systems can be used
to monitor and control the outcomes of plans.
PART B INFORMATION SYSTEMS 3: The role of information systems 67

2 Data and information

Introduction
When discussing information systems the terms data and information often crop up. It is worth defining
these terms.

 Data consists of raw, unprocessed facts and figures.

 Information is data that has been processed in a way that makes it meaningful for planning or
decision making.

The process of turning data into information involves a number of stages.

Data collection
Data gathering from internal and external sources.

Data evaluation
The data collected is examined and filtered. Irrelevant data may be deleted or ignored.

Data analysis
Data collected is compared against benchmarks or yardsticks, for example actual versus
budget..

Interpretation
Data is considered, interpreted and meaning added. For example an explanation as to why
actual differs from budget.

Reporting
Information is distributed to those who require it, for example as a report sent out as an
email attachment.

There are costs associated with developing and running the system required to convert data into
information. For example costs associated with system design, purchasing, housing and testing
equipment, and operating costs such as electricity and staff salaries.

It is important that such costs do not exceed the value of the information created by the system.
Information may have an intrinsic value and may be sold, but it may also have a value to the organisation
in terms of creating competitive advantage, cost control and reduction, improving corporate decision
making and strategy (such as marketing decisions).

2.1 Internal data and information

This is data and information that is held within the organisation’s own files. The following are examples of
internal information.

2.1.1 Accounting records

Accounts receivable ledgers, accounts payable ledgers, general ledgers and cash books etc hold
information that may be of great value outside the accounts department, for example, sales information
for the marketing function.
68 3: The role of information systems PART B INFORMATION SYSTEMS

2.1.2 Personnel records

Information about personnel will be held, possibly linked to the payroll system. Additional information
may be obtained from this source if, say, a project is being costed and it is necessary to ascertain the
availability and rate of pay of different levels of staff, or the need for and cost of recruiting staff from
outside the organisation.

2.1.3 Production data

Much information will be produced by a production department about machine capacity, fuel
consumption, movement of people, materials, work in progress, set up times, maintenance requirements
and so on.

2.1.4 Timesheets
Many service businesses, notably accountants and solicitors, need to keep detailed records of the time
spent on various activities, both to justify fees to clients and to assess the efficiency and profitability of
operations.

2.2 External data and information

Organisations often need to collect information concerning environmental factors. The following table
describes some of these factors using PEST analysis.

Factor Comment
Political/legal National or local politics may affect how an organisation operates. Changes in legislation
may put new responsibilities or liabilities on an organisation.
Economic Economic factors affect an organisation’s finances such as the availability of loans or
sales levels.
Social Society’s views may put pressure on how the organisation is run, for example pressure to
reduce environmental pollution.
Technological Technological advances may affect an organisation’s production and/or management
processes. Technology may also allow the development of new products and services
which were not previously possible.

Organisations may also require external information relating to:

(a) Competitors – how successful are they, are they developing new products?

(b) Customers – what are their needs, how large is the potential market, are there any new market
segments?

(c) Suppliers – what are their prices, what is the quality of their products like, are there any new
potential suppliers in the market?

Formal collection of data from outside sources includes the following.

(a) A company's tax specialists will be expected to gather information about changes in tax law and
how this will affect the company.

(b) The company's legal expert or company secretary would collect relevant information relating to
any new legislation on health and safety at work, or employment regulations.

(c) Research and development (R & D) work often relies on information about other R & D work being
done by another company or by government institutions.

(d) Marketing managers need to know about the opinions and buying attitudes of potential customers.
To obtain this information, they might carry out market research exercises.
PART B INFORMATION SYSTEMS 3: The role of information systems 69

The phrase ENVIRONMENTAL SCANNING is often used to describe the process of gathering external
information from a wide range of sources.
KEY TERM Sometimes additional external information is needed, requiring an active search outside the organisation.

The following additional external sources may be identified; the Government, advice or information
bureaux, consultancies, newspaper and magazine publishers, specific reference works which are used in a
particular line of work, libraries and information services, customer or supplier systems can be a source of
information, for instance via electronic data interchange (EDI) and web-based sources of information are
becoming ever more important.

2.2.1 Informal data and information gathering

Informal gathering of data and information from the environment goes on all the time, when employees
learn what is going on in the world around them – perhaps from trade magazines, newspapers, websites,
television reports or meetings with business associates. Knowledge, skills and experience developed by
members of staff is collectively known as the organisation’s human capital. This contrasts with structural
capital with comprises assets such as patents and client-lists that the business owns.

2.3 The qualities of information

To be useful, information requires a number of specific qualities. The mnemonic ACCURATE, shown in
the following table, is a useful way of remembering them. Information systems should aim to produce
information that possesses these qualities.

Quality Example
Figures in a report should add up, the degree of rounding should be appropriate,
Accurate there should be no typos, items should be allocated to the correct category,
assumptions should be stated for uncertain information. Must be reliable.
Information should include everything relevant to the decision being considered. if
relevant, comparative information should be included. Information should be
Complete consistent, for example it should be collected on the same basis each time, to
allow for meaningful comparison. Excessive information should be avoided.
It should not cost more to obtain the information than the benefit derived from its
Cost-effective use. Information collection and analysis should be efficient. Presentation should be
clear, such that users do not waste time working out what the information means.
The needs of the user are paramount. The information must be easy to read and
Understandable well presented.
Information that is not needed for a decision should be omitted. All significant
Relevant information that is relevant to the decision being considered should be included.
The choice of medium to provide the information should appropriate (face-to-
Accessible face, email, letter, written report) and consider the needs of the user.
The information should be available when it is needed and in time for required
Timely action to be effective.
As well as being understandable (clear and well presented) and accessible
Easy to use (correct choice of medium) the information should be presented in a manner that
the user can easily use or pass on as required.
70 3: The role of information systems PART B INFORMATION SYSTEMS

Section summary
Information systems play a key role within organisations. In particular they are used in planning,
controlling, recording transactions, performance measurement and decision making.

Data consists of raw, unprocessed facts and figures. Information is data that has been processed in a way
that makes it meaningful for planning or decision making.

Information used by organisations comes from a variety of internal and external sources.

Information systems should provide information that possesses certain specific qualities (ACCURATE).

3 Types of information systems

Introduction
There are a large range of information systems available to an organisation, with different purposes. In
this section we shall look at common forms of information system, and later, some recent trends and
developments in information systems.

3.1 Information systems at different organisational levels

The term ‘information system’ is a general concept that refers to the people, data and activities, both
computer-based and manual, that effectively gather, process, store and disseminate information. Most
information systems utilised in a business context today rely on information and communications
technologies (ICT).

Exam alert
You must be aware of the difference between information systems and information technology.
Information systems provide management information and assist with business operations. Information
technology is the underlying hardware equipment that the system is built on.

Organisations require different types of information system to provide information at different levels of the
organisation, and in a range of functional areas.

System level System purpose and features Examples

Strategic Purpose: To help senior managers with long-term planning. Key ratios and
Time focus: Long term performance
indicators
Coverage: Whole organisation
Uncertainty and subjectivity: High Ad hoc market
analysis
Accuracy: Less critical than at other levels
Strategic plans
Management Purpose: To help middle managers monitor and control. Variance analyses
or Time focus: Short to medium term Exception reports
tactical
Coverage: Department(s) or function(s)
Uncertainty and subjectivity: Moderate
Accuracy: Moderate level, not as detailed as operational level
PART B INFORMATION SYSTEMS 3: The role of information systems 71

System level System purpose and features Examples

Operational Purpose: To process transactions and help operational Transaction listings
managers track the organisation's day-to-day operational Daily receipts and
activities. payments
Time focus: Immediate
Real-time production
Coverage: Specific activities data
Uncertainty and subjectivity: Low Debtors and creditors
Accuracy: A high level of accuracy is required listings

Different types of information systems exist with different characteristics – reflecting the different roles
they perform. The most common are described below.

3.1.1 Centralised and decentralised systems and departments 05/12, 05/13

An information system or department may be centralised or decentralised.

KEY POINTS
A centralised information system or department involves all functions being based out of a single central
location, such as head office.

A decentralised information system or department involves functions being spread out throughout the
organisation’s locations.

There is no single 'best' structure, so an organisation should consider the merits of each.

3.1.2 Advantages of centralisation

Advantages of a centralised system or department include the following.

(a) Assuming centralised processing is used, there is only one set of files. Everyone uses the same
data and information.

(b) It gives better security/control over data and files. It is easier to enforce standards.

(c) Head office is in a better position to know what is going on.

(d) There may be economies of scale available in purchasing computer equipment and supplies.

(e) Computer staff are in a single location, and more expert staff are likely to be employed. Career
paths may be more clearly defined.

3.1.3 Disadvantages of centralisation

Disadvantages of a centralised system or department include the following.

(a) Local offices might have to wait for IS/IT services and assistance.

(b) Reliance on head office. Local offices are less self-sufficient.

(c) A system fault at head office will impact across the organisation.

3.1.4 Advantages of decentralisation

Advantages of a decentralised system or department include the following.

(a) Each office can introduce an information system specially tailored for its individual needs. Local
changes in business requirements can be taken into account.

(b) Each office is more self-sufficient.

(c) Offices are likely to have quicker access to IS/IT support/advice.

(d) A decentralised structure is more likely to facilitate accurate cost/overhead allocations.

72 3: The role of information systems PART B INFORMATION SYSTEMS

3.1.5 Disadvantages of decentralisation

The disadvantages of a decentralised system or department include the following.

(a) Control may be difficult – as uncoordinated information systems may be introduced.

(b) Self-sufficiency may encourage a lack of co-ordination between departments.

(c) Increased risk of data duplication, with different offices holding the same data on their own
separate files.

Exam skills
The advantages and disadvantages described above are a good starting point for an exam answer, but it is
important to think widely and apply your knowledge to the scenario you are presented with.

For example, in May 2012 a 10 mark question was set requiring a discussion of the advantages of a
decentralised system. Given the scenario, other advantages included being a boost to moral and job
satisfaction, empowering the workforce and reducing red tape.

3.2 Transaction Processing Systems (TPS)

A TRANSACTION PROCESSING SYSTEM (TPS) performs and records routine transactions.

TPS are used for routine tasks in which data items or transactions must be processed so that operations
KEY TERM
can continue. TPS support most business functions in most types of organisation. Transaction Processing
Systems are sometimes referred to as Data Processing Systems (DPS).

The following table shows a range of TPS applications.

Transaction processing systems

Sales/ Manufacturing/ Finance/ Human

marketing production accounting resources Other types
systems systems systems systems (eg university)
Major  Sales  Scheduling  Budgeting  Personnel  Admissions
functions management records
 Purchasing  General  Student
of system
 Market Shipping/ ledger  Benefits academic
research receiving  Billing  Salaries records
 Promotion  Engineering  Management  Labour  Course
pricing  Operations accounting relations records
 New products  Training  Graduates
PART B INFORMATION SYSTEMS 3: The role of information systems 73

Transaction processing systems

Sales/ Manufacturing/ Finance/ Human

marketing production accounting resources Other types
systems systems systems systems (eg university)
Major  Sales order  Materials  General  Payroll  Registration
application information resource ledger  Employee  Student record
systems system planning  Accounts records  Curriculum/
 Market  Purchase receivable  Employee class control
research order control /payable benefits systems
system  Engineering  Budgeting  Career path  Benefactor
 Pricing  Quality  Funds systems information
system control management system

3.3 Management Information Systems (MIS)

MANAGEMENT INFORMATION SYSTEMS (MIS) convert data from mainly internal sources into information
(eg summary reports, exception reports). This information enables managers to make timely and effective
KEY TERM decisions for planning, directing and controlling the activities for which they are responsible.

An MIS provides regular reports and access to the organisation's current and historical performance.

MIS usually transform data from underlying transaction processing systems (TPS) into summarised files
that are used as the basis for management reports.

MIS have the following characteristics:

 Support structured decisions at operational and management control levels
 Designed to report on existing operations
 Have little analytical capability
 Relatively inflexible
 Have an internal focus

3.4 Executive Information Systems (EIS) 05/11

An EXECUTIVE INFORMATION SYSTEM (EIS) pools data from internal and external sources and makes
information available to senior managers in an easy-to-use form. EIS help senior managers make
KEY TERM strategic, unstructured decisions.

An EIS should provide senior managers with easy access to key internal and external information. The
system summarises and tracks strategically critical information, possibly drawn from internal MIS and
DSS (see below), but also including data from external sources eg competitors, legislation and external
databases such as Reuters.

Executive Information Systems are sometimes referred to as Executive Support Systems (ESS). An
ESS/EIS is likely to have the following features.

 Flexibility
 Quick response time
 Sophisticated data analysis and modelling tools
74 3: The role of information systems PART B INFORMATION SYSTEMS

A model of a typical EIS follows.

An Executive Information System (EIS)

EIS
workstation

Menus
Graphics
Communications
Local processing
EIS EIS
workstation workstation

.. Internal data
TPS/MIS data .. External data
Share prices

.. ..
Financial data Market research
Menus Office systems Legislation Menus
Graphics Modelling/analysis Competitors Graphics
Communications Communications
Local processing Local processing

Exam alert
Exam questions may require you to explain the value of a good MIS or EIS. To gain good marks you must
think about the benefits these systems bring to an organisation.

3.5 Decision Support Systems (DSS) 05/11

DECISION SUPPORT SYSTEMS (DSS) combine data and analytical models or data analysis tools to support
semi-structured and unstructured decision making.
KEY TERM
DSS are used by management to assist in making decisions on issues which are subject to high levels of
uncertainty. They are intended to provide a wide range of alternative information gathering and analytical
tools with a major emphasis upon flexibility and user-friendliness.

DSS have more analytical power than other systems, enabling them to analyse and condense large
volumes of data into a form that aids managers' decision making. The objective is to allow the manager to
consider a number of alternatives and evaluate them under a variety of potential conditions.

3.6 Knowledge Work Systems (KWS)

KNOWLEDGE WORK SYSTEMS (KWS) are information systems that facilitate the creation and integration of
new knowledge into an organisation.
KEY TERMS
KNOWLEDGE WORKERS are people whose jobs primarily involve creating new information and knowledge.
They are often members of a profession such as doctors, engineers, lawyers and scientists.

KWS help knowledge workers create new knowledge and expertise. Examples include:

 Computer Aided Design (CAD)

 Computer Aided Manufacturing (CAM)
 Specialised financial software that analyses trading situations

3.7 Office Automation Systems (OAS)

OFFICE AUTOMATION SYSTEMS (OAS) are computer systems designed to increase the productivity of data
and information workers.
KEY TERM
PART B INFORMATION SYSTEMS 3: The role of information systems 75

OAS support the major activities performed in a typical office such as document management, facilitating
communication and managing data. Examples include:

 Word processing, desktop publishing, presentation software

 Digital filing systems
 E-mail, voice mail, videoconferencing (or teleconferencing)
 Groupware (calendars, address books and journals), intranets, extranets, schedulers
 Spreadsheets, desktop databases

3.8 Expert systems

EXPERT SYSTEMS are a form of DSS that allow users to benefit from expert knowledge and information.
Such systems consist of a database holding specialised data and rules about what to do in, or how to
KEY TERM interpret, a given set of circumstances.

For example, many financial institutions now use expert systems to process straightforward loan
applications. The user enters certain key facts into the system such as the loan applicant's name, their
most recent addresses, their income, monthly outgoings and details of other loans. The system will then:

(a) Check the facts given against its database to see whether the applicant has a good credit record.

(b) Perform calculations to see whether the applicant can afford to repay the loan.

(c) Match up other criteria such as whether the security offered for the loan or the purpose for which
the loan is wanted is acceptable and the applicant’s is risk profile. The system makes these
judgements based on previous experience (as represented within the system).

A decision is then suggested, based on the results of this processing. This is why it is now often possible
to get a loan or arrange insurance over the telephone, whereas in the past it would have been necessary
to go and speak to a bank manager or send details to an actuary and then wait for them to come to a
decision.

Exam skills
Do not just learn what these systems are – you need to understand which levels of an organisation's
hierarchy would use them and how they support its operations.

There are many other business applications of expert systems.

(a) Legal advice.

(b) Tax advice.

(c) Forecasting of economic or financial developments, or of market and customer behaviour.

(d) Surveillance, for example of the number of customers entering a supermarket to decide when more
checkouts need to be opened – or of machines in a factory, to determine when they need
maintenance.

(e) Diagnostic systems to identify causes of problems, for example in production control in a factory,
or in healthcare.

(f) Project management.

(g) Education and training, diagnosing a student's or worker's weaknesses and providing or
recommending extra instruction as appropriate.
76 3: The role of information systems PART B INFORMATION SYSTEMS

An organisation can use an expert system when a number of conditions are met.

(a) The problem is reasonably well-defined.

(b) The expert can define some rules by which the problem can be solved.

(c) The problem cannot be solved by conventional transaction processing or data handling.

(d) The expert could be released to more difficult problems. Experts are often highly paid, meaning
the value of even small time savings is likely to be significant.

(e) The investment in an expert system is cost-justified.

Question 3.1 Expert systems

Learning outcome B1(ii)

Explain why organisations use expert systems for decision-making tasks which humans are naturally
better able to perform than computers? (5 marks)

3.9 Intranets and Extranets

Organisations are increasingly using intranets and extranets to disseminate information.

(a) An intranet is like a mini version of the Internet. Organisation members use networked computers
to access information held on a server. The user interface is a browser – similar to those used on
the Internet. The intranet offers access to information on a wide variety of topics.

(b) An extranet is an intranet that is accessible to authorised outsiders, using a valid username and
password. The username will have access rights attached – determining which parts of the
extranet can be viewed. Extranets are becoming a very popular means for business partners to
exchange information.

An INTRANET is a private network inside a company or organisation accessed through web-browser like
software. Intranets are for the use of staff only, they are not accessible by the public. Intranets are used to
KEY TERMS provide and distribute information.

An EXTRANET allows customers and suppliers to gain limited access to an intranet in order to enhance the
speed and efficiency of their business relationship. Put another way, it is an intranet that allows some
access by authorised outsiders.

3.10 Databases
A DATABASE is a collection of data organised to service many applications. The database provides
convenient access to data for a wide variety of users.
KEY TERMS
A DATABASE MANAGEMENT SYSTEM (DBMS) is the software that centralises data and manages access to
the database. It enables numerous applications to utilise the same files

The term 'database system' is used to describe a wide range of systems that utilise a central pool of data.
PART B INFORMATION SYSTEMS 3: The role of information systems 77

Example of a database system

INPUT DATA

DATABASE
MANAGEMENT DATABASE
SYSTEM

APPLICATION
PROGRAMS

SALES BRANCH AND

APPLICATIONS PERSONNEL STAFF PAYROLL OTHER
STATISTICS ETC STATISTICS ETC ANALYSIS ETC APPLICATIONS

3.10.1 The characteristics of a database system

The way in which data is held on a system affects the ease with which the data is able to be accessed
and manipulated. A database system has the following characteristics:

(a) Shared. Different users are able to access the same data for their own processing applications.
This removes the need to hold the same data in different files.

(b) Controls to preserve the integrity of the database.

(c) Flexibility. The database system should provide for the needs of different users, who each have
their own processing requirements and data access methods. The database should be capable of
evolving to meet future needs.

3.10.2 Database queries

A database can be interrogated by a query language. A query language is a formalised method of
constructing queries in a database system. The language provides a way of asking a database for data.
Some query languages are also able to make changes within the database. SQL, short for Structured
Query Language, is a popular language.

Databases connected to a web server are able to be accessed by people outside the organisation through
their web browser. Microsoft ADO is an example of a database connectivity component that enables this
functionality. Potential customers are able to view product and service information, and if the site is
enabled for e-commerce, make a purchase.

3.10.3 Advantages of database systems

The advantages of a database system include the following:

(a) Avoidance of unnecessary duplication of data (data redundancy) brings time and efficiency savings
and reduced storage costs.

(b) Data is looked upon as serving the organisation as a whole, not just for individual departments.
The database concept encourages management to regard data as a resource that must be properly
managed.
78 3: The role of information systems PART B INFORMATION SYSTEMS

(c) The installation of a database system encourages management to analyse data, relationships
between data items, and how data is used in different applications.

(d) Consistency (data integrity) – because data is only held once, the possibility of departments
holding conflicting data on the same subject is reduced.

(e) Data on file is independent of the user programs that access the data. This allows greater
flexibility in the ways that data can be used. New programs can be easily introduced to make use
of existing data in a different way. More than one user can use the information at any one time.

(f) Developing new application programs with a database system is easier because the programmer is
not responsible for the file organisation.

3.10.4 Disadvantages of database systems

The disadvantages of database systems relate mainly to security and control:

(a) There are problems of data security and data privacy. There is potential for unauthorised access to
data. Administrative procedures for data security must supplement software controls. Staff training
may be required.

(b) Since there is only one set of data, it is essential that the data should be accurate and free from
corruption. This process is known as data cleansing.

(c) There may be disputes over who ‘owns’ the data so has the right to decide how it is maintained.

(d) Since data is held once, but its use is widespread, the impact of system failure would be greater.
A contingency plan in case of data loss is required.

(e) If an organisation develops its own database system from scratch, initial development costs will be
high.

Section summary
Different types of information system exist with different characteristics – reflecting the different roles
they perform.

Organisations are increasingly using intranets, extranets and database systems to manage and provide
access to data and information.

4 Emerging trends in information systems

Introduction
In recent years information systems and technology have continued to develop rapidly. Three trends in
information system have emerged as being popular with many types of organisation. These are enterprise-
wide systems, knowledge management systems and customer relationship management systems.

4.1 Enterprise-wide systems

ENTERPRISE-WIDE SYSTEMS are designed to co-ordinate all business functions, resources and
information, wherever they are geographically.
KEY TERM
Under an enterprise-wide system, each business area (such as accounts, HR, production and sales) is
provided with a system that fulfils its needs, however each module shares a common database that is the
basis of all the information within the organisation.
PART B INFORMATION SYSTEMS 3: The role of information systems 79

The central database allows each business area to access and update information in real-time and this
means that information is easy to share, available to all business areas, and above all, reliable.

In some enterprises, even though the system spans the whole organisation individual locations have their
own specific data processing capability, via a direct link to the central database. This is known as
Distributed Data Processing (DDP). The link is provided a network – a connection between devices that
allows them to communicate. The two main types of network are Local Area Networks (LANs) and Wide
Area Networks (WANs).

The difference between the two is where the networked devices are located. Local Area Networks are
often found within an office and are often used to connect printers and other peripherals to computers.
Wide Area Networks are used when the devices are dispersed geographically – even around the world.

Enterprise resource planning (ERP) software is an example of an enterprise-wide system. A relatively

recent development has been the development of web-based enterprise-wide software. To access these
systems requires only a computer with an Internet connection and a web browser. The application is web-
based, so the distance between the user and the data is irrelevant. The use of web-based software is
sometimes referred to as cloud computing.

4.2 Knowledge management systems

KNOWLEDGE MANAGEMENT SYSTEMS (KMS) record and store the knowledge held within an organisation.
Information held on a KMS is easily accessed and shared by employees. Examples of information held in
KEY TERM
a KMS include facts, solutions to problems, relevant legislation and intellectual property.

A KMS is primarily of benefit to knowledge based organisations, such as those involved in research and
development or providing services such as legal advice. This is because their information is best suited to
storing and sharing by a database.

We have already seen examples of knowledge management systems. These include, extranets and
intranets, groupware and LANs and WANs.

Benefits of a KMS include:

(a) Valuable data is preserved for the future and not lost, for example, where an employee leaves

(b) The data is easily shared

(c) Data duplication (or data redundancy) is avoided

(d) It allows employees to 'get up to speed' on knowledge quickly and easily and this may reduce the
time they need to spend training

4.3 Customer relationship management systems

CUSTOMER RELATIONSHIP MANAGEMENT (CRM) systems are software applications which specialise in
providing information concerning an organisation's products, services and customers.
KEY TERM
Most CRM systems are based on a database which stores data about customers such as their order
history and personal information such as address, age and any marketing feedback they have provided.
These systems allow a personalised service to be provided to the customer as well as a swift reply to their
queries.

CRM systems are often used by customer facing staff who handle customer enquiries, orders or
complaints and who need to understand the customer's immediate needs and provide an appropriate
response.

4.4 Web 2.0 and e-commerce

Two other trends are increased business use of web 2.0 applications and increased use of e-commerce.
80 3: The role of information systems PART B INFORMATION SYSTEMS

4.4.1 Web 2.0

WEB 2.0 APPLICATIONS are ‘second generation’ Internet-based services. These sites usually include tools
that let people collaborate and share information online. These may be used as part of a CRM system.
KEY TERM
Examples of web 2.0 applications include blogs (short for web log), RSS feeds, wikis, and You Tube
(although there is some debate as to whether You Tube qualifies as web 2.0 as although users upload to
it, and access content from it, they don’t download from it).

Social networking sites such as Facebook are Twitter are also part of the web 2.0 movement, and are
increasingly being used by businesses. They are frequently used to monitor customer feedback and to
influence sales by providing online content.

4.4.2 E-commerce
E-commerce (the selling of goods or services over the Internet) has developed alongside CRM systems.
The trend is towards providing the customer with a unique shopping experience that is tailored to their
needs. The view and products presented to a customer is geared to their individual tastes, based on their
profile and past behaviour on the site.

Most organisations have e-commerce capability on their website. Many have gone further, for example
Amazon suggests potential purchases for customers when they log-on. These suggestions are driven by
the customer's previous orders and their history of viewing products.

Berens (2006) identifies the following points to consider when building a website with e-commerce
capability.

(a) Ensure transactions are secure, and tell customers they are. Customer trust is essential.

(b) Comply with all applicable consumer, privacy and data protection legislation.

(c) Have clear terms of use for the site.

(d) Don’t require customers to provide excessive amounts of information as this may deter them.

(e) Maintain on-going communication with willing customers, for example by e-mail.

The term e-business refers to conducting business on the Internet. It has a wider meaning than e-
commerce, because it covers not only buying and selling but also servicing customers and collaborating
with suppliers.

Benefits to a business of using e-commerce include; improved marketing and decision making though the
collection of sales and customer data, increased sales as customers increasingly look to the Internet to
purchase goods, and reduced costs as it is cheaper to operate a website than a physical shop.

Despite the benefits of e-commerce, some organisations face a number challenges when adopting it. For
example, they may lack the necessary in-house skills to develop the website, it may be expensive to set-
up and maintain the trading platform, it may be difficult to integrate back-office and fulfilment systems,
there may be security concerns and certain staff may be unhappy or unwilling to work with the new
system.

Business use of Twitter

Stuart Lynn, Head of R&D, Sage Mid Market Division, http://twitter.com/_stuartlynn

CASE STUDY
27% of UK SME’s use Twitter. 27% of the 1.4 million businesses registered for VAT equals 460,000
businesses. This number rises to well over 1 million if you include businesses who are not VAT registered.

Twitter provides a ready made network to share information about your business, to set up a trading
network and to build your brand. What’s more, Twitter is global.

As a social networking tool Twitter has had a meteoric rise to fame with between 3 and 6 million users.
When I first tried it, I was unimpressed. How can I make use of it? How do I know who to follow? How do
I get followers? How could I say it in only 140 characters?
PART B INFORMATION SYSTEMS 3: The role of information systems 81

Today, I’m a convert, I use Twitter every day. It’s an excellent source of news and information on just
about any topic. It allows me to keep my finger on the pulse of IT and business information and to share
information about Sage, as well as my other passions, with people who have chosen to follow me.

The Twitter network means if one of my follower’s re-tweet’s my tweet, then all of their followers see my
tweet, and so on. I tweeted a link to my last blog ‘The secret to successful innovation’ and watched what
happened.

Although I only have a few hundred followers myself, within the first hour, my original tweet had an
audience of over 30,000 people. Within a couple of days my blog had turned up on other sites such as
Innovation America. Others had reused parts of my blog in their own innovation blogs, a way to keep the
message alive and a complement indeed. One piece of information, seen by a huge audience across the
globe and recycled a second and third time.

What’s more, it significantly increased traffic on sage.co.uk - all from a single tweet. The power of social
networking is amazing. Remember though, Twitter is a tool to build your network, headline key
information and lead people to your business. When they get there they need to find a website, or a blog,
with more meaningful and relevant information, and the ability to make a purchase.

Give it a try, other than a little of your time and effort, it’s free, and you might be as amazed with the
results as I was.

Section summary
Enterprise-wide systems are designed to co-ordinate all business functions, resources and information.

The purpose of knowledge management systems (KMS) is to record and store the knowledge held within
an organisation.

Customer relationship management (CRM) systems are software applications which specialise in
providing information concerning an organisation's products, services and customers.

Web 2.0 applications are second generation’ Internet-based services. These sites usually include tools
that let people collaborate and share information online.

E-commerce (the selling of goods or services over the Internet) continues to grow rapidly.

5 IT enabled transformation 11/10, 03/12

Introduction
Information technology and information systems allow an organisation to transform how it does business.
A dependence on IT commits an organisation to continual change. The pace of technological change is
rapid. Computer systems – both hardware and software – are likely to be superseded after a few years.

In this section we consider how IT enables an organisation to transform itself.

5.1 Information technology as an enabler of change

Information technology may be the driving force or trigger of organisational change. Even when IT is not
a significant factor in the actual change, it can play an important part in the change management
process.
82 3: The role of information systems PART B INFORMATION SYSTEMS

The benefits an IT Strategy can bring to an organisation are numerous. For example it may:

 Develop business opportunities

 Improve operational productivity and performance
 Create competitive advantage
 Enable structural change (such as employees working at home)
 Bring congruency to corporate goals

The table below indicates the numerous ways in which IT may enable change within an organisation.

IT's possible role in Comment

organisational change
The type of products For example, companies like Sony manufacture home computers, Virgin have
or services that are an Internet Service Provider business. Technological changes affect many
made and sold products, for example the introduction of tennis and squash rackets with
graphite frames.
The way in which There is a continuing trend towards computer aided design and manufacture.
products are made Computer-Aided Design (CAD) can be used to create designs which can be
quickly amended.
Computer-Aided Manufacturing (CAM) involves the use of software to control
machine tools and related machinery.
Computer-Integrated Manufacturing (CIM) involves using computers to control
the production process. CAD and CAM are integrated and the flow of data, and
processing of material is controlled.
CAD and CAM have changed the methods and cost profiles of many
manufacturing processes as they increase the organisation’s flexibility to meet
customer requirements and reduce mistakes and therefore wastage.
The techniques used to measure and record costs have also adapted to the use
of IT.
The way in which The use of IT encourages de-layering of organisational hierarchies and greater
employees are workforce empowerment and skills. Using technology frequently requires
mobilised changes in working methods.
The way in which High-street banks encourage customers to use 'hole-in-the-wall' cash
services are provided dispensers, or telephone or Internet banking. Most larger shops now use
computerised Point of Sale terminals at cash desks. Many organisations use e-
commerce – selling products and services over the Internet.
To enable change IT can produce dramatic changes in individual businesses and whole industries.
For example, competition in the airline industry has intensified due to
information systems that allow easy fare comparison and booking. IT can be
both a cause of major changes in doing business and a response to them.
To aid communication Co-ordination is essential when introducing change. IT can facilitate this
and co-ordination through the use of e-mail, project management software, an intranet, and
groupware (such as Microsoft Outlook).
As a source of unity In times of restructuring, information systems can be a visible sign of the new
and structure situation. For example, an organisation-wide network, perhaps with an intranet,
provides evidence of and encourages acceptance of the new situation.
PART B INFORMATION SYSTEMS 3: The role of information systems 83

5.2 Degrees of transformation

The diagram below illustrates five different degrees of IT-enabled change.

High
5

Degree of 3
business
transformation Revolution level
Evolution level
2

Low
Low High
Range of potential benefits

Level Name Description

1 Localised exploitation Existing IT is used to reengineer high value
(automation) business areas.

2 Internal integration Integrate business operations into a smooth

process using IT capabilities.
3 Business process reengineering Use IT to enable the redesign of key business
processes to provide future capabilities.
4 Business network redesign The business network and IT are used to develop
new products and services.
5 Business scope redefinition Organisational scope, and that of business
partners, is redefined by what is possible using
IT.

Question 3.2 IT transformation

Learning outcome B1(iii)

Velospeed designs, manufactures and distributes bicycles.
Designs are drawn by hand. These are passed to skilled workers who construct the bicycle frame by hand
using traditional materials such as steel. Some customers have reported quality problems with frames.
The frame is the only part that Velospeed builds itself. Wheels, gears, brakes and pedals are each sourced
from individual suppliers.
Orders for these parts are made over the telephone, recorded on paper and filed in a storage cabinet. The
company has problems in retrieving and analysing cost data for management reports.
Required
Advise Velospeed as to how information technology could transform its business. (9 marks)
84 3: The role of information systems PART B INFORMATION SYSTEMS

Section summary
IT may enable an organisation to transform how it does business. In particular:
 The type of products or services that are made and sold
 The way in which products are made
 The way in which employees are mobilised
 The way in which services are provided
 To enable change
 To aid communication and co-ordination
 As a source of unity and structure

6 IT and new forms of organisation

Introduction
As we have seen, information technology can affect an organisation in many ways including changing the
way it does its business. As a consequence IT has allowed different types of organisation to emerge.
Some examples of emerging types of organisation are described below.

6.1 Virtual organisations

The global explosion of information technology has led to the creation of virtual teams, virtual companies
and virtual supply chains.

6.1.1 Virtual teams

Virtual teams are groups of people who aren’t based in the same office or organisation (and may even be
in different areas of the world) but who:

 Share information and tasks (eg technical support provided by a supplier)

 Make joint decisions (eg on quality assurance or staff training)
 Fulfil the collaborative (working together) function of a team

Technology has facilitated this kind of collaboration, simulating team working through the use of
teleconferencing, video-conferencing, networked computers and the Internet.

(a) Dispersed individuals and units can use such technology to access and share product, customer,
inventory and delivery information (eg using web-based databases and data tracking systems).

(b) Electronic meeting sites and systems allow virtual meeting participants to talk and listen to each
other while sharing data and using electronic 'white boards' on their PCs.

This has enabled organisations to:

(a) Outsource areas of organisational activity to other organisations and freelance workers (even 'off-
shore' in countries where skilled labour is cheaper) without losing control or co-ordination.

(b) Organise 'territorially' without the overhead costs of local offices and without the difficulties of
supervision, communication and control. Dispersed centres are linked to a 'virtual office' by
communications technology and can share data freely.

(c) Centralise shared functions and services (such as data storage and retrieval) without the
disadvantages of 'geographical' centralisation, and with the advantages of decentralised authority.
Databases and communications (email) create genuine sharing of, and access to, common data.

(d) Adopt flexible cross-functional and multi-skilled working by making expertise available across the
organisation. A 'virtual team' co-opts the best people for the task – regardless of location.
PART B INFORMATION SYSTEMS 3: The role of information systems 85

Forming a virtual team is different to forming a team based in a single location. The main issue is the
lack of face-to-face contact. This makes it difficult for team members to bond and build trust, share
knowledge, establish a hierarchy and team processes, and support morale. Cultural differences between
team members may create misunderstandings that damage working relationships.

Skyrme (1997) developed a number of principles regarding virtual teams. These principles suggest that:

 The team should develop a sense of purpose, support members and build high levels of trust
 Team members should give back what they get in terms of support, information and knowledge
 Teams should be small and multi-disciplined
 Communication – there should be frequent communication, where emails are used they should
only have one topic per email, emails should be used to summarise face-to-face meetings and
should be informal

6.1.2 Virtual companies and virtual supply chains

A VIRTUAL COMPANY is a collection of separate companies, each with a specific expertise, who work
together, sharing their expertise to compete for bigger contracts/projects than would be possible if they
KEY TERMS worked alone.

A traditional SUPPLY CHAIN is made up of the physical entities linked together to facilitate the supply of
goods and services to the final consumer.

A VIRTUAL SUPPLY CHAIN (VSC) is a supply chain that is enabled through e-business links, for example
the web and extranets.

A relatively recent development is the virtual company. This is created out of a network of alliances and
subcontracting arrangements. It is as if most of the activities in a particular value chain are conducted by
different organisations, even though the process is loosely co-ordinated. For example, assume an
organisation produces small toys. It could in theory outsource:

 The design to a consultancy

 Manufacturing to a subcontractor
 Delivery arrangements to a specialist logistics organisation
 Debt collection to a bank
 Filing, tax returns, bookkeeping to an accountancy firm

The virtual company relies on technology such as remote networking, the Internet and extranets. Many
companies have become, or are becoming, more 'virtual'. They are developing into looser affiliations of
companies, organised as a supply network.

Virtual Supply Chain networks have two types of organisation: producers and integrators.

(a) Producers produce goods and services. Producers must focus on delivery to schedule and within
cost. The sales driver within these companies is on ensuring that their capacity is fully sold.
Producers are often servicing multiple chains, so managing and avoiding capacity and commercial
conflicts becomes key.

(b) Integrators manage the supply network and effectively 'own' the end customer contact. The focus
of the integrating organisation is on managing the end customer relationship. This includes
synchronising the responses and performance of network functions and members.

Many of the most popular Internet companies are integrators in virtual companies, for example
Amazon.com and Lastminute.com. These organisations 'own' customer contact and manage customer
relationships for a range of producers.
86 3: The role of information systems PART B INFORMATION SYSTEMS

6.2 Advantages of virtual operations

Virtual operations have various advantages.

 Flexibility and speed of operation

 Low investment in assets and hence less risk involved
 Injection of market forces into all the linkages in the value chain

6.3 Disadvantages of virtual operations

But there are some disadvantages.

 Organisations must complement each other and form close relationships if the venture is to
succeed

 Quality may be a problem owing to a loss of control

 The suppliers/resources may also be available to rival operations

 Customers may recognise the virtual characteristics and this might negatively affect customer
perceptions of the service or product

First Virtual Corporation, one of the few truly virtual organisations in existence, was set up in 1993 by
Ralph Ungermann and it generates multi-million dollar sales of its multimedia networking equipment.
CASE STUDY Everything except the crucial design and development work is outsourced. The company has two 'core
competences' according to Ungermann: technical development and forging alliances with large
companies.

Section summary
The global explosion of information technology has led to the creation of virtual teams, companies and
supply chains.

Virtual teams are interconnected groups of people who may not be present in the same office or
organisation.

A virtual company is a collection of separate companies, each with a specific expertise, who work
together, to compete for bigger contracts/projects than would be possible if they worked alone.

A Virtual Supply Chain (VSC) is a supply chain that is enabled through e-business links, for example the
web or extranets.

7 Privacy and security 05/11

Introduction
Most of the advances in technology and information systems that we have seen in this chapter rely on the
Internet as a means of communication. However, establishing Internet links makes organisations
vulnerable to privacy and security risks. Therefore suitable systems, policies and procedures should be
implemented to minimise them.
PART B INFORMATION SYSTEMS 3: The role of information systems 87

Computer systems are exposed to privacy and security risks. Some of the main risks are explained below.

Privacy and security risks

Risk Explanation
Hackers and Hackers attempt to gain unauthorised access to computer systems. They may
eavesdroppers attempt to damage a system or steal information. Hackers use tools like electronic
password generators which enable rapid multiple password attempts.
Data that is transmitted across telecommunications links is exposed to the risk of
being intercepted or examined during transmission (eavesdropping).
Viruses A virus is a small piece of software which performs unauthorised actions and which
replicates itself. Viruses may cause damage to files or attempt to destroy files and
damage hard disks. When transmitted over a network such as the Internet, into a
'clean' system, the virus reproduces and infects that system.
Types of virus:
E-mail viruses spread using e-mail messages and replicate by mailing themselves to
addresses held in the user's contacts book.
Worms copy themselves from machine to machine on a network.
Trojans or Trojan horses are hidden inside a 'valid' program but perform an
unexpected act. Trojans therefore act like a virus, but aren't classified as a virus as
they don't replicate themselves.
Trap doors are undocumented access points to a system allowing controls to be
bypassed.
Logic bombs are triggered by the occurrence of a certain event.
Time bombs are triggered by a certain date.
Hoaxes An associated problem is that of hoax virus warnings. There are a vast number of
common hoaxes, most of which circulate via e-mail. Many are a variation of one of
the most 'popular' early hoaxes – the Good Times hoax. This hoax takes the form of a
warning about viruses contained in e-mail. People pass along the warning trying to
be helpful, but they are in fact wasting the time of all concerned.

Denial of service Another threat, to websites is the 'denial of service attack'. This involves an organised
attack campaign to bombard a site with excessive volumes of traffic at a given time, with
the aim of overloading the site.
Natural disasters Fires, floods and other natural events may damage the place where the system is
stored. It is important for the organisation to protect the system by selecting a
suitable location and environment to house it. Backups should be taken regularly
and be stored in a separate location so that the system can be restored if necessary.
Steps should be taken to prevent risks as far as possible, for example by installing
sprinkler systems and locating the system on a high floor to avoid flooding.
Hardware and Systems may malfunction for a number of reasons. This risk can be minimised by
software failure designing them to cope with extreme volumes of demand. Backups will enable the
system to be restored if it does fail.
Human error Operators may accidently damage or delete information held on the system. This risk
can be minimised by staff training and in-built protections, such as only allowing
certain individuals to alter or amend information.
Operator injury Repetitive strain injury (RSI) is a risk faced by computer operators. This risk can be
minimised through the design of workstations and the office environment.
88 3: The role of information systems PART B INFORMATION SYSTEMS

A number of websites provide information on hoaxes and 'real' viruses – for example
www.sophos.com. If you receive a warning of a virus or the promise of rewards for forwarding
an e-mail to a number of others, this is a good place to look to establish if the warning is a
hoax or not.

7.1 Minimising privacy and security risks

The risks concerned with hackers, eavesdroppers and viruses can be minimised through a variety of
controls that provide network and communications security.

7.1.1 Anti-virus software

The main protection against viruses is anti-virus software. Anti-virus software, such as McAfee or Norton
search systems for viruses and remove them. Anti-virus programs include an auto-update feature that
downloads profiles of new viruses, enabling the software to check for all known or existing viruses. Very
new viruses may go undetected by anti-virus software (until the anti-virus software vendor updates their
package – and the organisation installs the update).

Additional precautions include disabling external media to prevent viruses entering an organisation via
external storage devices. However, this can disrupt work processes. At the very least, organisations should
ensure all files received via external media and e-mail are virus checked.

7.1.2 A firewall
External e-mail links can be protected by way of a firewall that may be configured to virus check all
messages, and may also prevent files of a certain type being sent via e-mail (eg .exe files, as these are the
most common means of transporting a virus). Firewalls can be implemented in both hardware and
software, or a combination of both. A firewall disables part of the telecoms technology to prevent
unauthorised intrusions. However, a determined hacker may well be able to bypass this.

7.1.3 Encryption
Data that is transmitted across telecommunications links is exposed to the risk of being intercepted or
read during transmission (known as 'eavesdropping'). Encryption is used to reduce this risk and involves
scrambling the data at one end of the line, transmitting the scrambled data, and unscrambling it at the
receiver's end of the line. A person intercepting the scrambled data is unable to make sense of it.

7.1.4 Electronic signatures

One way of providing electronic signatures is to make use of what is known as public key (or
asymmetric) cryptography signatures. Public key cryptography uses two keys – public and private. The
private key is only known to its owner and is used to scramble the data contained in a file. The received
'scrambled' data is checked against the original file using the public key of the person who signed it. This
check confirms the file could only have been signed by someone with access to the private key. If a third
party altered the message the fact that they had done so would be easily detectable.

An alternative is the use of encryption products which support key recovery, also known as key
encapsulation. These products incorporate a Key Recovery Agent (KRA) which allows the authorised user
to unscramble data by approaching the KRA with an encrypted portion of the message.

7.1.5 Authentication
Authentication is a technique of making sure that a message has come from an authorised sender.
Authentication involves adding extra data in a form previously agreed between sender and recipient.
PART B INFORMATION SYSTEMS 3: The role of information systems 89

7.1.6 Dial-back security

Dial-back security operates by requiring the person wanting access to dial into the network and identify
themselves first. The system then dials the person back on their authorised number before allowing
access.

7.2 General and application controls

There are two main types of control designed to safeguard information stored in a system, ensure it is
processed accurately and only used by those who are authorised.

7.2.1 General controls

General controls are often physical restrictions on who can access and use information held in the
system. There may be personnel controls, such as Internet use policies, segregation of duties and levels of
access based on seniority which may be protected by passwords and lock-outs. Equipment may also be
physically protected by locks, doors and cages,

7.2.2 Application controls

These are controls to ensure the accuracy and validity of data. For example, there may be checks on who
can access and amend the data, completeness checks built into the system to ensure all expected
information is provided and validity checks to ensure the data being entered is in the expected form (eg to
stop words being entered where numbers are expected).

7.3 Data Protection Act (DPA) 1998

An individual’s privacy relates to their right to control how personal information held about them is
disseminated and used by others. In the UK, the relevant legislation is the Data Protection Act 1998.
This is an attempt to protect the individual. The terms of the Act cover data about individuals – not data
about corporate bodies.

7.3.1 Definitions of terms used in the Act

In order to understand the Act it is necessary to know some of the technical terms used in it.

Personal data is information about a living individual, including expressions of opinion about him or her.
Data about organisations is not personal data.

Data users are organisations or individuals who control personal data and the use of personal data.

A data subject is an individual who is the subject of personal data.

90 3: The role of information systems PART B INFORMATION SYSTEMS

7.3.2 The data protection principles

The UK Data Protection Act includes eight Data Protection Principles with which data users must
comply.

DATA PROTECTION PRINCIPLES

Schedule 1 of the Act contains the data protection principles.

1 Personal data shall be processed fairly and lawfully in accordance with the Act.

2 Personal data shall be obtained only for one or more specified and lawful purposes, and shall not
be further processed in any manner incompatible with that purpose or those purposes.

3 Personal data shall be adequate, relevant and not excessive in relation to the purpose or purposes
for which they are processed.

4 Personal data shall be accurate and, where necessary, kept up to date.

5 Personal data processed for any purpose or purposes shall not be kept for longer than is necessary
for that purpose or those purposes.

6 Personal data shall be processed in accordance with the rights of data subjects under this Act.

7 Appropriate technical and organisational measures shall be taken against unauthorised or unlawful
processing of personal data and against accidental loss or destruction of, or damage to, personal
data.

8 Personal data shall not be transferred to a country or territory outside the European Economic Area
unless that country or territory ensures an adequate level of protection for the rights and freedoms
of data subjects in relation to the processing of personal data.

The Act has two main aims:

(a) To protect individual privacy. Previous UK law only applied to computer-based information. The
1998 Act applies to all personal data, in any form.

(b) To harmonise data protection legislation so that, in the interests of improving the operation of the
single European market, there can be a free flow of personal data between the member states of
the EU.

7.3.3 The rights of data subjects

The Act establishes the following rights for data subjects.

(a) A data subject may seek compensation through the courts for damage and any associated distress
caused by the loss, destruction or unauthorised disclosure of data about himself or herself or by
inaccurate data about himself or herself.

(b) A data subject may apply to the courts for inaccurate data to be put right or even wiped off the
data user's files altogether. Such applications may also be made to the Registrar.

(c) A data subject may obtain access to personal data of which he or she is the subject. (This is
known as the 'subject access' provision.) In other words, a data subject can ask to see his or her
personal data that the data user is holding.

(d) A data subject can sue a data user for any damage or distress caused to him by personal data
about him which is incorrect or misleading as to matter of fact (rather than opinion).
PART B INFORMATION SYSTEMS 3: The role of information systems 91

7.3.4 The Privacy and Electronic Communications (EC directives) Regulations

2003
These regulations are derived from EC directives with the intention of protecting individuals and
organisations from receiving spam (unsolicited electronic communications).

Most e-marketing activities are covered (such as email and SMS messages) and such communications
are only permitted if the recipient has ‘opted-in’ to receive them. For the sender, this means having to
obtain consent from the recipient before contacting them for the first time. The sender must also identify
themselves in any direct marketing communication and provide a valid reply email address.

Permission is also deemed granted where a person is an existing customer (and has already provided
their contact details) or where they have emailed or sent a text enquiry directly to the organisation.

All communications must provide a free ‘unsubscribe’ service and a fine of £5,000 may be imposed on
the sender of any unlawful communications.

The regulations also impose certain controls on the use of cookies which are used to store information
about website visitors.

Section summary
Computer systems with links to other systems such as the Internet are exposed to privacy and security
risks.

The key privacy and security risks come from hackers and eavesdroppers, viruses, hoaxes and denial of
service attacks.

Organisations can take various measures against privacy and security risks, including anti-virus software,
firewalls, encryption, electronic signatures, authentication and dial-back security.

The Data Protection Act 1998 provides individuals with some protection regarding how data held about
them is used.
92 3: The role of information systems PART B INFORMATION SYSTEMS

Chapter Roundup
 Information systems support operations and management activities within organisations. In particular
they are used in recording transactions, decision making, planning, performance measurement and
control.
 Data consists of raw, unprocessed facts and figures. Information is data that has been processed in a way
that makes it meaningful for planning or decision making.
 Information used by organisations comes from a variety of internal and external sources.
 Information systems should provide information that possesses certain specific qualities (ACCURATE).
 Different types of information system exist with different characteristics – reflecting the different roles
they perform.
 Organisations are increasingly using intranets, extranets and database systems to manage and provide
access to data and information.
 Enterprise-wide systems are designed to co-ordinate all business functions, resources and information.
 The purpose of knowledge management systems (KMS) is to record and store the knowledge held within
an organisation.
 Customer relationship management (CRM) systems are software applications which specialise in
providing information concerning an organisation's products, services and customers.
 Web 2.0 applications are second generation’ Internet-based services. These sites usually include tools
that let people collaborate and share information online.
 E-commerce (the selling of goods or services over the Internet) continues to grow rapidly.
 IT may enable an organisation to transform how it does business. In particular:
– The type of products or services that are made and sold
– The way in which products are made
– The way in which employees are mobilised
– The way in which services are provided
– To enable change
– To aid communication and co-ordination
– As a source of unity and structure

 The global explosion of information technology has led to the creation of virtual teams, companies and
supply chains.
 Virtual teams are interconnected groups of people who may not be present in the same office or
organisation.
 A virtual company is a collection of separate companies, each with a specific expertise, who work
together, to compete for bigger contracts/projects than would be possible if they worked alone.
 A Virtual Supply Chain (VSC) is a supply chain that is enabled through e-business links, for example the
web or extranets.
 Computer systems with links to other systems such as the Internet are exposed to privacy and security
risks.
 The key privacy and security risks come from hackers and eavesdroppers, viruses, hoaxes and denial of
service attacks.
 Organisations can take various measures against privacy and security risks, including anti-virus software,
firewalls, encryption, electronic signatures, authentication and dial-back security.
 The Data Protection Act 1998 provides individuals with some protection regarding how data held about
them is used.
PART B INFORMATION SYSTEMS 3: The role of information systems 93

Quick Quiz
1 Which of the following is not a type of information system?

A EIS
B MIS
C DSL
D OAS

2 A private network inside an organisation that is accessed through web-browser like software is known as:

A Internet
B Extranet
C Intranet
D Privatenet

3 Which type of system is designed to co-ordinate all an organisation's functions, resources and
information?

A A knowledge management system

B A customer relationship system
C An expert system
D An enterprise-wide system

4 Web 2.0 applications have what purpose?

A To engage the customer in the organisation

B To reduce the number of customer complaints
C To increase an organisation's sales
D To collect information about the customer

5 Briefly explain what a virtual company is.

Answers to Quick Quiz

1 C DSL (Digital Subscriber Line) is a communications technology. The others are: Executive
Information System, Management Information System and Office Automation System.

2 C A private network inside an organisation that is accessed through web-browser like software is
known as an intranet.

3 D An enterprise-wide system is designed to co-ordinate all an organisation's functions, resources and

information.

4 A Web 2.0 applications allow the customer to interact with the organisation with the purpose of
engaging them in the organisation.

5 A virtual company is a collection of separate companies, each with a specific expertise, who work
together to compete for bigger contracts/projects than would be possible if they worked alone.
94 3: The role of information systems PART B INFORMATION SYSTEMS

Answers to Questions
3.1 Expert systems

The primary reason has to do with the relative costs. A 'human' expert is likely to be more expensive either to
employ or to use on a consultancy basis.

Secondly, enshrining an expert's accumulated wisdom in a computer system means that this wisdom can be
accessed by more people. Therefore, the delivery of complicated services to customers, decisions whether or not
to extend credit and so forth, can be made by less experienced members of staff. If a manufacturing company
has a complicated mixture of plant and machinery, then the repair engineer may accumulate a lot of knowledge
over a period of time about the way it behaves. If a problem occurs, the engineer will be able to make a
reasoned guess as to where the likely cause is to be found. If this accumulated expert information is made
available to less experienced staff, it means that some of their learning curve is avoided.

An expert system is advantageous because it saves time, like all computer systems (in theory at least) but it is
particularly useful as it possesses both knowledge and limited reasoning ability.

3.2 IT transformation

IT could transform Velospeed in three main areas.

The way in which bicycles are made

The current labour-intensive process of manufacture can be made more efficient. Computer Aided Design (CAD)
can be used to allow efficient and accurate design, rather than relying on hand drawings which may contain
inaccuracies or be unclear.

Computer Integrated Manufacturing (CIM) could be used to change the manufacturing process of the bike
frames. Data from the design can be fed into an automated system that cuts and forms the metal into frames.
This will ensure consistent standards of production and will reduce labour costs.

The types of bicycle which are made

The use of modern production methods will facilitate a move to new types of material in the bicycle frame.
Materials not suitable for use under manual methods, such as carbon-fibre, may be used.

The combination of state-of-the-art design technology and modern materials permit new types of product to be
made. For example, professional race bikes, that need to be aerodynamic and extremely light, could be
produced.

To aid communication and co-ordination

Velospeed could change its paper-based ordering and filing system to one which is based on an enterprise-wide
system. Orders could be made electronically over the Internet and invoices posted to an accounting system,
perhaps using EDI.

Data could be stored in a database, and reports extracted. This will result in more accurate and consistent
reports, as all systems will use the same source information.

Now try this question from Number Level Marks Time

the Exam Question Bank
3 Examination 30 54 mins
SYSTEMS IMPLEMENTATION AND
BUSINESS STRATEGY

In this chapter we move on from looking at system failure is user resistance – we look at a number of
the role of information systems to looking at ways to overcome or prevent this.
their implementation and alignment with
Later we consider how aligning a new information system
business strategy.
with the organisation's overall business strategy can help
Implementing a system involves a number of stages, make the system a success and even be a source of
each of which is vital if the completed system is to be a competitive advantage.
success. We shall see that a key cause information

topic list learning outcomes syllabus references ability required

1 System implementation B2(a) B2(iii), B2(iv) analysis
2 Information technology and change management B2(a) B2(iv) analysis
3 Introducing the change B2(a) B2(iv) analysis
4 System evaluation B2(a) B2(i) analysis
5 System maintenance B2(a) B2(iv) analysis
6 System outsourcing B2(b) B2(v) analysis
7 Aligning systems with business strategy B2(b) B2(vi) analysis

95
96 4: Systems implementation and business strategy PART B INFORMATION SYSTEMS

1 System implementation 11/10

Introduction
Implementation is part of the systems development cycle, or systems development life cycle (SDLC). The
main stages of the SDLC are Planning, Analysis, Design, Development and Implementation (PADDI).

The planning stage includes a feasibility study into relevant technical, operational, economic and social
factors. A cost-benefit analysis may be used to check that the costs of the new system do not exceed the
benefits. At this stage, the costs and benefits are estimated.

Costs of a new system can be divided into initial costs and running costs, these include: System design,
purchase of equipment, purchase or development of software, testing and implementation, training, staff
costs to operate and maintain the system, consumables associated with the system and support costs for
the developers or in-house IT team.

Benefits of a new system include: Better quality of information, efficient operations, increased capacity,
cost savings (labour), improved access to information across the organisation, better communications,
improved customer service, and potential competitive advantage.

System analysis determines the system’s purpose and the features and procedures required in it. The future
users of the new system should have the opportunity to provide their input, to ensure the new system
satisfies their needs.

After system requirements have been documented, work can begin on system design. Here the
component parts of the system (its hardware and software) are decided upon and purchased. The
systems development stage follows and involves writing software and integrating it with hardware.

Implementation comes next. This is the process the E1 syllabus focuses on – we cover this in detail in
this chapter.

Following implementation comes system review and maintenance. Where appropriate, the outcomes of
both feedback into the planning stage and the cycle starts again.

The main steps in the implementation of an information system are as follows.

(a) Installation of the hardware and software.

(b) Testing.
(c) Staff training and production of documentation.
(d) File conversion.
(e) Changeover.

The items in the list above do not necessarily happen in a set chronological order and some may be done
at the same time – for example staff training and system testing can be part of the same operation. The
requirements for implementation vary from system to system.

1.1 Installation
Installing a mainframe computer or a large network is a major operation that is carried out by the
manufacturer/supplier. If just a few PCs are being installed in a small network, this may be able to be
performed by non-specialists.

Most new software is provided on CD-ROM or DVD and may be able to be installed by non-specialists,
depending upon the complexity of the system and the checks required to ensure it is operating correctly.
PART B INFORMATION SYSTEMS 4: Systems implementation and business strategy 97

1.2 Testing
A system must be thoroughly tested before implementation, to prevent the system ‘going live’ with faults
that might prove costly. The scope of tests and trials will vary with the size and complexity of the system.
To ensure a coherent, effective approach to testing, a testing strategy should be developed.

A testing strategy should cover the following areas.

Testing strategy area Comment

Strategy approach A testing strategy should be formulated that details the approach that will be
taken to testing, including the tests to be conducted and the testing
tools/techniques that will be used.
Test plan A test plan should be developed that states what will be tested, when it will be
tested (sequence), and the test environment.
Test design The logic and reasoning behind the design of the tests should be explained.
Performing tests Detailed procedures should be provided for all tests. This explanation should
ensure tests are carried out consistently, even if different people carry out the
tests.
Documentation It must be clear how the results of tests are to be documented. This provides a
record of errors, and a starting point for error correction procedures.
Re-testing The re-test procedure should be explained. In many cases, after correction, all
aspects of the software should be re-tested to ensure the corrections have not
affected other aspects of the software.

Four stages of testing can be identified as:

 System logic
 Program testing
 System testing
 User acceptance testing

1.2.1 Testing system logic

Before any programs are written, the logic devised by the systems analyst should be checked. This
process often involves the use of flow charts or data flow diagrams. Both tools involve the manual plotting
of different types of data and transactions through the system. The object is to ensure that all possibilities
have been catered for and that the processing logic is correct. When all results are as expected, programs
can be written.

1.2.2 Program testing

Program testing involves processing test data through all system programs. Test data should be of the
type that the program will be required to process and should include invalid/exceptional items to test
whether the program reacts as it should.

Program testing should cover the following areas.

 Input validity checks

 Program logic and functioning
 Interfaces with related modules/systems
 Output format and validity

The testing process should be fully documented – recording data used, expected results, actual results
and action taken. This documentation may be referred to at a later date, for example if program
modifications are required. Two types of program testing are unit testing and unit integration testing.
98 4: Systems implementation and business strategy PART B INFORMATION SYSTEMS

1.2.3 Unit testing and unit integration testing

UNIT TESTING means testing one function or part of a program to ensure it operates as intended.
UNIT INTEGRATION TESTING involves testing two or more software units to ensure they work together as
KEY TERMS
intended. The output from unit integration testing is a debugged module.

Unit testing involves detailed testing of part of a program. If it is established that a program is not
operating as intended, the cause of the error must be established and corrected. Automated diagnostic
routines, that step through the program line by line may be used to help this process.

Test cases should be developed that include test data (inputs), test procedures, expected results and
evaluation criteria. Sets of data should be developed for both unit testing and integration testing. Cases
should be developed for all aspects of the software.

1.2.4 System testing (overall system testing)

When it has been established that individual programs and interfaces are operating as intended, overall
system testing should begin. System testing has a wider focus than program testing. System testing
should extend beyond areas already tested, to cover:

 Input documentation and the practicalities of input eg time taken

 Flexibility of the system to allow amendments to the 'normal' processing cycle
 Ability to produce information on time
 Ability to cope with peak resource requirements eg transaction volumes
 Viability of operating procedures
 Ability to produce information on time

System testing will involve testing both before installation (known as off-line testing) and after
implementation (on-line testing). As many problems as possible should be identified before
implementation, but it is likely that some problems will only become apparent when the system goes live.

1.2.5 User acceptance testing

USER ACCEPTANCE TESTING is carried out by those who will use the system to determine whether the
system meets their needs. These needs should have previously been stated as acceptance criteria.
KEY TERM
The purpose of user acceptance testing is to establish whether users are satisfied that the system meets
the system specification when used in the actual operating environment. Users process test data, system
performance is closely monitored and users report whether they feel the system meets their needs. Test
data may include some historical data, because it is then possible to check results against the 'actual'
output from the old system.

It is vital that users are involved in system testing to ensure the system operates as intended when used
by the people expected to utilise it. Any problems identified should be corrected – this will improve
system efficiency and should also encourage users to accept the new system.

1.2.6 Types of test

To ensure as many scenarios as possible are tested, testing should include the following types of test.

(a) Realistic tests. These involve using the system in the way it will be used in reality – ie the actual
environment, users and types of data.

(b) Contrived tests. These are designed to present the system with unusual events to ensure these are
handled correctly, for example that invalid data is rejected.

(c) Volume tests present the system with large numbers of transactions to see how the system copes.

(d) Acceptance tests are undertaken by users to ensure the system meets user needs.
PART B INFORMATION SYSTEMS 4: Systems implementation and business strategy 99

1.2.7 Limitations of testing

The presence of 'bugs' or errors in the vast majority of software/systems demonstrates that even the most
rigorous testing plan is unlikely to identify all errors.

The limitations of software testing are outlined in the following table.

Limitation Comment
Poor testing process The test plan may not cover all areas of system functionality. Testers
may not be adequately trained. The testing process may not be
adequately documented.
Inadequate time Software and systems are inevitably produced under significant time
pressures. Testing time is often 'squeezed' to compensate for project
over-runs in other areas.
Future requirements not The test data used may have been fine at the time of testing, but
anticipated future demands may be outside the range of values tested. Testing
should allow for future expansion of the system.
Inadequate test data Test data should test 'positively' – checking that the software does
what it should do, and test 'negatively' – that it doesn't do what it
shouldn't. It is difficult to include the complete range of possible input
errors in test data.
Software changes inadequately System/software changes made as a result of testing findings or for
tested other reasons may not be adequately tested as they were not in the
original test plan.

1.3 Training
Staff training in the use of a new system is essential if the system is to meet its full potential. Training
should be provided to all staff who will use the system. Training should focus on the specific tasks the
user is required to perform such as entering an invoice or answering a query. There are a range of options
available to deliver training, as shown below.

Training method Comment

Individual tuition 'at desk' A trainer could work with an employee observing how they use a
system and suggesting possible alternatives.
Classroom course The software could be used in a classroom environment, using
'dummy' data.
Computer-based training (CBT) Training can be provided using CDs, DVDs, over an intranet or via an
interactive website.
Case studies and exercises Regardless of how training is delivered, it is likely that material will be
based around a realistic case study relevant to the user.
Software reference material Users may find on-line help, built-in tutorials and reference manuals useful.

The training method applicable in a given situation will depend on the following factors:

 Time available
 Software complexity
 User skill levels
 Facilities available
 Budget

User documentation may be used to explain the system to users. Much of this information may be
available online using context-sensitive help eg 'Push F1 for help'.
100 4: Systems implementation and business strategy PART B INFORMATION SYSTEMS

1.4 File conversion

FILE CONVERSION, means converting existing files into a format suitable for the new system.
Most computer systems are based around files containing data. When a new system is introduced, files
KEY TERM
must be created that conform to the requirements of that system.

The various scenarios that file conversion could involve are outlined in the following table.

Existing data Comment

Held in manual (ie paper) files Data will be keyed into the new system – probably via input forms, so
that data entry operators have all the data they require in one
document. This is likely to be a time-consuming process.
Held in existing computer files How complex the process is in converting the files to a format
compatible with the new system will depend on technical issues and
the coding systems used. It may be possible to automate much of the
conversion process.
Held in both manual and Two separate conversion procedures are required.
computer files
Existing data is incomplete If the missing data is crucial, it must be researched and made
available in a format suitable for the new system – or suitable for the
file conversion process.

The file conversion process is shown in the following diagram, which assumes the original data is held in
manual files.

It is essential that the 'new' converted files are accurate. Various controls can be utilised during the
conversion process.

(a) One-to-one checking between records on the old and new systems.

(b) Sample checking. Selecting and checking a sample of records. This is used if there are too many
records to check individually.

(c) Built-in data validation routines in automated conversion processes.

(d) Control totals and reconciliations. These checks could include checking the total number of
records, and the value of transactions.
PART B INFORMATION SYSTEMS 4: Systems implementation and business strategy 101

Exam alert
You may find it useful to remember the main system implementation stages as FITT. File conversion,
Installation, Testing, Training and documentation.

1.5 Changeover
Once the new system has been fully and satisfactorily tested, the final stage of implementation,
changeover, can begin. There are four approaches to system changeover, each varies in terms of time
required, cost and risk.

 Direct ('Big Bang') changeover

 Parallel running
 Pilot operation
 Phased or modular implementation

1.5.1 Direct ('Big Bang') changeover

The old system is completely replaced by the new system in one move. This may be unavoidable where
the two systems are substantially different, or where the costs of parallel running are too great.

While this method is comparatively cheap and convenient, it is risky (system or program corrections are
difficult while the system has to remain operational). The new system should be introduced during a
quiet period, for example over a bank holiday weekend or during an office closure.

A direct changeover is often used where there is:

 Complete confidence in the new system

 A need to overcome a reluctance to ‘let the old system go’
 A need to implement the system before staff have a chance to object
 A need on cost or convenience grounds to avoid running two systems

1.5.2 Parallel running

The old and new systems are run in parallel for a period of time. They both process current data which
enables cross checking to be made. This method provides a degree of safety should there be problems
with the new system. However, if there are differences between the two systems, cross-checking may be
difficult or impossible.

Parallel running delays the actual implementation of the new system, which may be perceived as a lack
of confidence in the system. Also, more staff are required to cope with systems running concurrently.
This cautious approach, if adopted, should be properly planned, and the plan should include:

(a) A firm time limit on parallel running.

(b) Details of cross-checking procedures.
(c) Instructions on how errors in the old system are to be dealt with.
(d) Instructions on how to report and act on any major problems in the new system.

1.5.3 Pilot operation

Pilot operation involves selecting part or parts of an organisation (eg a department or branch) to operate
the new system in parallel with the existing system. When the branch or department piloting the system
is satisfied with it, they cease to use the old system. The new system is then piloted in another area of
the organisation.

Pilot operation is cheaper and easier to control than running the whole system in parallel, and provides a
greater degree of safety than a direct changeover.
102 4: Systems implementation and business strategy PART B INFORMATION SYSTEMS

1.5.4 Phased or modular changeover

Phased or modular changeover involves selecting a complete section of the system for a direct
changeover, eg in an accounting system the payables ledger. When this part is running satisfactorily,
another part is switched – until eventually the whole system has been changed. A phased series of direct
changeovers is less risky than a single direct changeover, as any problems and disruption experienced
should be isolated in an area of operations.

1.5.5 Advantages and disadvantages

The advantages and disadvantages of the various changeover methods are outlined below.

Method Advantages Disadvantages

Direct ('Big Bang') Quick Risky
changeover Minimal cost Could disrupt operations
Minimises workload If fails, will be costly
Parallel running Safe, built-in safety Costly, two systems need to be operated
Provides a way of verifying results of Time-consuming
the new system Additional workload

Pilot operation Less risky than direct changeover Can take a long time to achieve total
Less costly than complete parallel changeover
running Not as safe as complete parallel running
Phased or modular Less risky than a single direct Can take a long time to achieve total
changeover changeover changeover
Any problems should be in one area – Interfaces between parts of the system
other operations unaffected may make this impractical

Facing frequent outages in the DSL (Digital Subscriber Line) network serving 50-plus corporate-owned
gyms, Gold's Gyms management knew it was time for a significant upgrade. After looking into the various
CASE STUDY options they opted to replace DSL with a carrier-provided voice VoIP (Voice over Internet Protocol)
service.

If they had to this again, however, they would take a more phased approach. 'We tried the big-bang
theory, doing everything at once,' a spokesman said. That decision was driven by business needs,
because the DSL network was so unreliable, and because the supplier was urging Gold's to sign a contract
that included every gym. 'I think we should've done two or three gyms first, and made sure they worked
OK, before we did the rest.' This would have reduced system downtime.
Adapted from Case study: VoIP implementation The problems of the 'big bang' approach
Paul Desmond, PC Advisor

Section summary
The main stages in the implementation of a computer system are:

 Installation of the hardware and software.

 Testing.
 Staff training and production of documentation.
 File conversion.
 Changeover.
PART B INFORMATION SYSTEMS 4: Systems implementation and business strategy 103

2 Information technology and change management

Introduction
Any change, such as the introduction of a new information system, involves structural and behavioural
factors which may result in resistance from individuals to that change. Many new systems fail, not
because of hardware or software problems, but because the users themselves are against it.

This section considers what causes user resistance and how it can be overcome or prevented by
management action.

2.1 How change affects individuals

Before looking at the causes of user resistance we must first consider how change affects individuals.
Change may affect individuals in several areas.
(a) There may be physiological changes in a person's life, both as the natural product of development,
maturation and ageing, and as the result of external factors. For example, a change in the pattern
of shift-working may temporarily throw the individual's eating, waking and sleeping routine out of
synchronisation with the body's sense of time.
(b) Circumstantial changes – living in a new house, establishing new relationships, working to new
routines – will involve letting go of things, perhaps 'unlearning' old knowledge, and learning new
ways of doing things.
Above all, change affects individuals psychologically.
(a) It may create feelings of disorientation before new circumstances have been assimilated.
(b) Uncertainty may lead to insecurity. This is especially acute in changes involving work, where
there can be very great pressures for continuity and fast acclimatisation.
(c) The secure basis of warm, accepting relationships may be up-rooted – the business of forging new
relationships can be fraught with personal insecurity.

2.1.1 Types of change experience

Four types of change experience have been identified (Torrington and Weightman (1994)).

Type Comment Reaction

Imposition Initiated and driven by someone else Resistance
Adaptation A change in attitude or behaviour as a result of changes by others Uncertainty
Growth A response to opportunities Delight
Creativity The individual instigates and controls the change process Excitement

2.1.2 Reactions to proposed change

There are a range of other possible reactions to a proposed change.

(a) Acceptance – whether enthusiastic espousal, co-operation, grudging co-operation or resignation

(b) Indifference – usually where the change does not directly affect the individual: apathy, lack of
interest, inaction

(c) Passive resistance – refusal to learn, working to rule

(d) Active resistance – deliberate 'spoiling', go-slows, deliberate errors, sabotage, absenteeism or
strikes
104 4: Systems implementation and business strategy PART B INFORMATION SYSTEMS

John Hunt highlights a number of responses that may not look like resistance on the face of things, but
are behaviours aimed at reinforcing the status quo. There are a number of responses that the manager
should learn to recognise.

(a) Pleas of ignorance: ('I need more information').

(b) Delayed judgement: ('let's wait and see ...'), perhaps stalling for time with comparisons ('there are
other ways ...').

(c) Defensive stances: ('This isn't going to work', 'It'd be too expensive', 'It's the wrong time to ...').

(d) The display of various personal insecurities: ('I won't be able to cope', 'I won't see my team
anymore', 'We won't have control over our planning any more', 'Why can't we just go on as we
are?'); fear, anxiety, resentment at the manner of change, frustration at perceived losses.

(e) Withdrawal, or disowning of the change: ('Oh well. On their heads be it', 'I'm not interested in
flexitime anyway').

2.2 Problems in the design stage

One common cause of dissatisfaction with new information systems is insufficient user involvement when
establishing requirements for the new system.

Other common causes of dissatisfaction with information systems include:

(a) IS project managers are often technicians, not managers. Technical ability for IS staff is no
guarantee of management skill – an individual might be a highly proficient analyst or programmer,
but not a good manager.

(b) The project manager may accept an unrealistic deadline where the timescale is fixed early in the
planning process. User demands may be accepted as deadlines before sufficient consideration is
given to the realism of this.

(c) Poor or non-existent planning is a recipe for disaster. Unrealistic deadlines would be identified
much earlier if a proper planning process was undertaken.

(d) A lack of monitoring and control.

(e) Users change their requirements, resulting in changes to the system as it is being developed.

(f) Poor timetabling and resourcing. It is no use being presented on Day 1 with a team of
programmers, when there is still systems analysis and design work to do. The development and
implementation of a computer project may take a considerable length of time (perhaps two years
for a relatively large installation). Major projects require formal planning and scheduling.

2.3 Problems in the development process

Problems that occur when implementing a new information system can usually be traced to deficiencies
in the development process. The table that follows outlines some common mistakes that adversely affect
the implementation process – and the systems development stage or activity they relate to.

Stage/activity Problems
Analysis The problem the system is intended to solve is not fully understood.
Investigation of the situation is hindered by insufficient resources.
User input is inadequate through either lack of consultation or lack of user
interest.
The project team is unable to dedicate the time required or insufficient time
spent planning the project.
PART B INFORMATION SYSTEMS 4: Systems implementation and business strategy 105

Stage/activity Problems
Design Insufficient user input.
Lack of flexibility. The organisation's future needs are neglected.
The system requires unforeseen changes in working patterns.
Failure to perform organisation impact analysis. An organisational impact
analysis studies the way a proposed system will affect organisation structure,
attitudes, decision making and operations. The analysis aims to ensure the
system is designed to best ensure integration with the organisation.
Organisational factors sometimes overlooked include:
 Ergonomics (including equipment, work environment and user interfaces)
 Health and safety
 Compliance with legislation
 Job design
 Employee involvement
Programming Insufficient time and money allocated to programming.
Programmers supplied with incomplete or inaccurate specifications.
The logic of the program is misunderstood.
Poor programming technique results in programs that are hard to modify.
Programs are not adequately documented.
Testing Insufficient time and money allocated to testing.
Failure to develop an organised testing plan.
Insufficient user involvement.
User management do not review and sign-off the results of testing.
Conversion Insufficient time and money allocated to data conversion.
Insufficient checking between old and new files.
The process is rushed to compensate for time overruns elsewhere.
Final implementation Insufficient time, money and/or appropriate staff mean the process has to be
rushed.
Lack of user training increases the risk of system under-utilisation and rejection.
Poor system and user documentation.
Lack of performance standards to assess system performance against.
System maintenance provisions are inadequate.

2.4 Dealing with user resistance 03/12

We now look at two models relevant to dealing with user resistance.

2.4.1 Lewin/Schein: Unfreeze, Move, Refreeze

In the words of John Hunt (Managing People at Work): 'Learning also involves re-learning – not merely
learning something new but trying to unlearn what is already known.' This is the thinking behind
Lewin/Schein's three stage approach to changing human behaviour, which may be depicted as follows.

UNFREEZE MOVE REFREEZE

 
existing behaviour attitudinal/behavioural change new behaviour
106 4: Systems implementation and business strategy PART B INFORMATION SYSTEMS

Unfreeze is the most difficult (and in many cases neglected) stage of the process, concerned
mainly with selling the change, with giving individuals or groups a motive for changing their
attitudes, values, behaviour, systems or structures. If the need for change is immediate,
clear and perceived to be associated with the survival of the individual or group (for example
change in reaction to an organisation crisis), the unfreeze stage will be greatly accelerated.
Routine changes may be harder to sell than transformational ones, if they are perceived to
be unimportant and not survival-based.

Changing organisational culture is perhaps hardest of all, especially if it involves changes to

long-held cultural values.

Unfreezing processes require four things. These are: a trigger, someone to challenge and
expose the existing behaviour pattern, the involvement of outsiders and alterations to the
power structure.
Move is the second stage. It is mainly concerned with identifying what the new, desirable
behaviour or norm should be, communicating it and encouraging individuals and groups to
'own' the new attitude or behaviour. This might involve the adoption of a new culture. To be
successful, the new ideas must be shown to work.

Refreeze is the final stage, implying consolidation or reinforcement of the new behaviour.
Positive reinforcement (praise and reward) or negative reinforcement (sanctions applied to
those who deviate from the new behaviour) may be used.

This model is based on the view that change is capable of being planned. You should note that this is not
always possible.

2.4.2 Lewin’s Force Field Analysis

Force field analysis consists of identifying the factors that promote or hinder change. In order for change
to be successfully implemented, driving forces need to be exploited and the effect of restraining forces
need to be reduced, such that the driving forces for change outweigh those forces resisting change.

Examples of driving forces

Perceived improvements to organisational performance
Necessary in order to keep up with competitors
Improved profitability and employee bonuses
Dislike of old system
Better information and work processes
New challenges and improved motivation

Examples of restraining forces

Job security fears
Happy with old system
Lack of understanding of need for change
Fears over poor implementation process
Employee loss of control over how they work
Lack of training and fears over difficulty of using new system
PART B INFORMATION SYSTEMS 4: Systems implementation and business strategy 107

2.4.3 Dealing with resistance

Kotter and Schlesinger (1979) identified six methods of dealing with resistance to change and
restraining forces. They are:

(a) Education and communication. This method is effective where the cause of the resistance is lack
of information about the change.

(b) Participation and involvement. Where those affected by the change have the power to resist it,
this method reduces the resistance by taking their views into account.

(c) Facilitation and support. Where the cause of the resistance is anxiety and insecurity, support such
as training is effective.

(d) Negotiation and agreement. Compensating those who lose out (for example redundancy packages)
may be appropriate in some instances.

(e) Manipulation and co-optation. This method involves the presentation of partial or misleading
information to those resisting change or 'buying-off' the main individuals who are at the heart of the
resistance.

(f) Explicit and implicit coercion. This involves the use or threat of force to push through the change.
A very last resort if parties are operating from fixed positions and are unwilling to move.

The final two options raise ethical and legal issues. They also risk alienating people, making the change
even less likely to be accepted.

The six approaches are not intended to be used separately in isolation – a combination of them is likely to
be required. Remember that people may disguise their real reason for opposing change (such as possible
loss of influence or status) with technical objections.

Exam alert
Exam questions may require you to discuss potential strategies for overcoming resistance to change and
identify which would be most suitable for the organisation in the scenario.

You may also be asked for an analysis of how an organisation has managed resistance to a change.

Question 4.1 Resistance to change

Learning outcome B2(iv)

Which of Kotter and Schlesinger’s six methods of dealing with resistance to change is best suited to a
situation where resistance is caused by a lack of information about the change?

A Education and communication.

B Negotiation and agreement.

C Manipulation and co-optation.

D Explicit and implicit coercion.

(2 marks)
108 4: Systems implementation and business strategy PART B INFORMATION SYSTEMS

Section summary
User resistance is a key cause of information systems failure.

Theories that may help when considering how to overcome user resistance include:
 Lewin/Schein's unfreeze, move, refreeze
 Kotter and Schlesingers' six methods of dealing with resistance

3 Introducing the change

Introduction
Rather than dealing with resistance to change after it has occurred, a better approach is to try and
prevent resistance before it occurs.

Several theories have been developed that aim to help managers deal with change more effectively so that
resistance is prevented or at least minimised.

3.1 Pace, Manner and Scope

There are three important factors for managers to consider when introducing change.

 The pace of change

 The manner of change
 The scope of change

3.1.1 Pace
The more gradual the change, the more time is available for questions to be asked, reassurances to be
given and retraining (where necessary) embarked upon. People can get used to the idea of new methods
and become acclimatised at each stage.

(a) Presenting the individuals concerned with change as a fait accompli may avoid resistance at the
planning stage, but may result in resistance surfacing later – probably strengthened by resentment.

(b) Timing will also be crucial. Those responsible for change should be sensitive to incidents and
attitudes that might indicate that 'now is not the time'.

3.1.2 Manner
The manner in which a change is put across (communicated) is very important. The need for change
must made clear, fears soothed, and if possible the individuals concerned positively motivated to embrace
the changes as their own.
(a) Resistance should be welcomed and confronted, not swept under the carpet. Talking thorough
areas of conflict may lead to useful insights and the adaption of the programme of change to the
company’s advantage. Repressing resistance will only send it underground.
(b) There should be free circulation of information about the reasons for the change, its expected
results and likely consequences. That information should appear sensible, clear, consistent and
realistic. There is no point issuing information which will be seen as a blatant misrepresentation of
the situation.
PART B INFORMATION SYSTEMS 4: Systems implementation and business strategy 109

(c) The change must be sold to the people concerned. Objections must be overcome, but it is also
possible to get people behind the change in a positive way. If those involved understand that there
is a real problem, which poses a threat to the organisation and themselves, and that the solution is
a sensible one and will solve the problem, there will be a firm rational basis, for implementing
change. It may even be possible to get staff excited by the change, by emphasising the challenge
and opportunity and perhaps by offering rewards and incentives.
(d) Individuals must be helped to learn, that is, to change their attitudes and behaviours. Few
individuals will really be able to see the big picture in a proposed programmed of change. In order
to put across the overall objective, the organisation should use visual aids to help conceptualise.
Learning programmes for any new skills or systems necessary will have to be designed according
to the abilities of the individuals concerned.
(e) The effects of insecurity and resentment may be lessened if people are involved in the planning
and implementation of the change, so that it is not perceived to have been imposed from above.

3.1.3 Scope
The scope or extent of the change is important and should be reviewed. Total transformation will create
greater insecurity – but also provides the opportunity for greater excitement – than moderate innovation.
There may be hidden changes to take into account. For example, a change in technology may necessitate
changes in work methods, which may in turn result in the breaking up of work groups. Management
should be aware of how many various aspects of their employees' lives they are proposing to alter – and
therefore on how many fronts they are likely to encounter resistance.

3.2 Commitment, co-ordination and communication

Commitment, co-ordination and communication are often cited as playing an important role in the
context of introducing any form of change.
(a) Commitment. Commitment to the change must be universal. Senior management must ensure
adequate resources are provided (people, money, time etc) to achieve change.
(b) Co-ordination. To implement change successfully requires co-ordination. This involves ensuring
those involved in the process work in an efficient and effective way towards an agreed common
goal. This requires planning and control.
(c) Communication. Successful change requires good communication. The right people must
communicate the right things at the right time and in the right way. Good communication early in
the process should ensure all are aware of what the process hopes to achieve. Communication
during the process should aid co-ordination and to maintain momentum. Upon completion,
communication is likely to focus on ensuring there is no return to the previous behaviour – and a
review of the process itself to see if any lessons may be learnt.

3.3 Successful implementation of information systems

A recurring theme when examining the reasons for information system failure is user resistance. Three
types of theory explain the causes user resistance against new information systems together with how
they are overcome (Markus 1983 and David and Olsen 1985).
110 4: Systems implementation and business strategy PART B INFORMATION SYSTEMS

Theory Description Overcoming the resistance

People-oriented User-resistance is caused by factors User training.
internal to users as individuals or as a Organisation policies.
group.
Find ‘change champions’ who already
For example, users may not wish to see the benefits of the system and can
disrupt their current work practices and persuade others who are resisting.
social groupings.
User involvement in system
development.
System-oriented User-resistance is caused by factors User training and education.
inherent in the new system design, Improve the user-interface.
relating to ease of use and functionality.
Ensure users contribute to the system
For example, a poorly designed user- design process.
interface will generate user-resistance.
Ensure the system 'fits' with the
organisation.
Interaction User-resistance is caused by the Re-organise the organisation before
interaction of people and the system. implementing the system.
For example, the system may be well- Redesign any affected incentive
designed but its implementation will schemes to incorporate the new system.
cause organisational changes that users Promote user participation and
resist eg reduced chance of bonuses, encourage organisation-wide teamwork.
redundancies, monotonous work.
Emphasise the benefits the system
brings.

Section summary
It is better for the organisation to prevent or minimise resistance occurring in the first place. Theories
aimed at achieving this include:

 Pace, manner and scope

 Commitment, co-ordination and communication

4 System evaluation

Introduction
A system should be reviewed after implementation, and periodically when in operation, so that any
unforeseen problems may be resolved and to confirm that it is achieving the desired results. The system
should have been designed with clear, specified objectives, and justification in terms of cost-benefit
analysis or other performance criteria.

4.1 Cost-benefit review

A cost-benefit review is similar to a cost-benefit analysis, except that actual data can be used. For
instance when a large project is completed, techniques such as DCF appraisal can be performed again,
with actual figures being available for much of the expenditure.
PART B INFORMATION SYSTEMS 4: Systems implementation and business strategy 111

Question 4.2 Cost-benefit review

Learning outcome B2(i)

A cost-benefit review might categorise items under the five headings of direct benefits, indirect benefits,
development costs, implementation costs and running costs.

Required

Give two examples of items which could fall to be evaluated under each heading. (5 marks)

4.2 Measuring system performance

METRICS are quantified measurements used to measure system performance.
The use of metrics enables some aspects of system quality to be measured. Metrics may also allow the
KEY TERM
early identification of problems – for example, by highlighting instances of system failure, the causes of
which may then be investigated.

Metrics should be carefully thought out, objective and stated clearly. They must measure significant
aspects of the system, be used consistently and agreed with users. Examples of metrics include system
response time, the number of transactions that can be processed per minute, the number of bugs per
hundred lines of code and the number of system crashes per week.

Many facets of system quality are not easy to measure statistically (eg user-friendliness). Indirect
measurements such as the number of calls to the help-desk per month can be used as an indication of
overall quality/performance.

4.3 Performance reviews

Performance reviews can be carried out to look at a wide range of systems functions and characteristics.
They will vary in content from organisation to organisation, but may include the following.

(a) The growth rates in file sizes and the number of transactions processed by the system. Trends
should be analysed and projected to assess whether there are likely to be problems with lengthy
processing time or an inefficient file structure due to the volume of processing.

(b) The staffing requirements of the system, and whether they are more or less than anticipated.

(c) The identification of any delays in processing and an assessment of their consequences.

(d) An assessment of the efficiency of security procedures, in terms of number of breaches, or number
of viruses encountered.

(e) A check of the error rates for input data. High error rates may indicate inefficient preparation of
input documents, an inappropriate method of data capture or poor design of input media.

(f) An examination of whether output from the computer is being used for a good purpose. (Is it used?
Is it timely? Does it go to the right people?)

(g) Operational running costs can be examined to discover any inefficient programs or processes. This
examination may reveal excessive costs for certain items although in total, costs may be
acceptable.
112 4: Systems implementation and business strategy PART B INFORMATION SYSTEMS

4.4 Post-implementation review

A post-implementation review establishes whether the objectives and targeted performance criteria have
been met, and if not, why not, and what should be done about it. In appraising the operation of the new
system immediately after the changeover, comparison should be made between actual and predicted
performance.

This will include:

(a) Consideration of throughput speed (time between input and output).

(b) Use of computer storage (both internal and external).
(c) The number and type of errors/queries.
(d) The cost of processing (data capture, preparation, storage and output media, etc).

A special steering committee may be set up to ensure that post-implementation reviews are carried out,
although the internal audit department may be required to do the work of carrying out the reviews.

The post-implementation measurements should not be made too soon after the system goes live, or else
results will be abnormally affected by 'teething' problems, lack of user familiarity and resistance to
change. A suitable period is likely to be between one month and one year after completion (the
appropriate length of time will depend upon the role of the system, and how complex it is).

Post-implementation audits are on the paper E2 syllabus in connection with project

management.

4.4.1 The post-implementation review report

The findings of a post-implementation review team should be formalised in a report.

(a) A summary of their findings should be provided, emphasising any areas where the system has
been found to be unsatisfactory so the organisation can learn from its mistakes.

(b) A review of system performance should be provided. This will address the matters outlined above,
such as run times and error rates and whether it meets users' needs.

(c) A cost-benefit review should be included, comparing the forecast costs and benefits identified at
the time of the feasibility study with actual costs and benefits.

(d) Recommendations should be made as to any further action or steps which should be taken to
improve performance. It will also make recommendations on how the project was managed to help
future initiatives.

4.5 Reasons for system failure

The performance review may conclude that the project has failed. Common causes often cited include:

 Poor planning and coordination

 Unrealistic schedules and deadlines
 Poor project control
 Lack of user involvement
 Project complexity
 Lack of support from senior management
 Insufficient skills within the workforce to deliver a successful project.
PART B INFORMATION SYSTEMS 4: Systems implementation and business strategy 113

Section summary
After implementation the system should be evaluated to see if it is a success and whether there are any
lessons to be learned.

Evaluation often takes the form of a cost-benefit review or performance measurement using metrics or
other measurable features of the system.

A post-implementation review compares actual and expected performance levels and is a formal report
that should be compiled after a suitable period of time following implementation.

5 System maintenance

Introduction
After implementation, the system will require regular maintenance if it is to continue operating as
expected and to develop with the organisation.

There are three types of systems maintenance.

CORRECTIVE MAINTENANCE is carried out when there is a systems failure of some kind, for example a
defect in processing or in an implementation procedure. Its objective is to ensure that systems remain
KEY TERMS operational.

PERFECTIVE MAINTENANCE is carried out in order to perfect the software, or to improve it so that
processing inefficiencies are eliminated and performance is enhanced.

ADAPTIVE MAINTENANCE is carried out to take account of anticipated changes in the processing
environment. For example new taxation legislation might require changes to be made to payroll software.

Corrective maintenance usually consists of action in response to a problem.

Perfective maintenance consists of making enhancements requested by users to improve or extend the
facilities available. The user interface may be amended to make software more user friendly.

There are many examples of adaptive maintenance, for example:

(a) The system needs minor modifications to cope with changes in the computer user's procedures or
volume of business.

(b) The system can benefit from advances in computer hardware technology without having to switch
to another system altogether.

5.1 The causes of system maintenance

Besides environmental changes, three factors contribute to the need for maintenance.

Factor Comment
Errors However diligently a system is tested, it is likely that bugs will exist in a
newly implemented system. These require fixing.
Poor documentation If old systems are accompanied by poor documentation, or even a complete
lack of documentation, they may be difficult to understand. It is difficult to
update or maintain these systems. Programmers may opt instead to patch up
the system with new applications using newer technology.
114 4: Systems implementation and business strategy PART B INFORMATION SYSTEMS

Factor Comment
Changes in requirements Although users should be consulted at all stages of systems development,
problems may arise after implementation, for example users may have found
it difficult to express their requirements, or not participated fully in
development.
Cost constraints may have meant that certain requested features were not
incorporated. Time constraints may have meant that requirements suggested
during development were ignored in the interest of prompt completion.

5.1.1 Testing the effect of changes

A problem with systems development and maintenance is that it is hard to predict all the effects of a
change to the system. A 'simple' software change in one area of the system may have unpredicted effects
elsewhere. It is important therefore to carry out regression testing.
REGRESSION TESTING involves the retesting of software that has been modified to fix 'bugs'. It aims to
ensure that the bugs have been fixed and that no other previously working functions have failed as a
KEY TERM result of the changes.

Regression testing involves repeating system tests that had been executed correctly before the recent
changes were made. Only the changes expected as a result of the system maintenance should occur
under the regression test – other changes could be due to errors caused by the recent change.

Problems with regression testing include deciding on the extent of testing required, envisaging all areas
possibly affected, and convincing users and programmers that the tests are necessary.

5.2 Hardware maintenance

Provision must also be made to ensure computer hardware is maintained. A hardware maintenance
contract should specify service response times in the event of a breakdown, and include provision for
temporary replacement equipment if necessary. Maintenance services may be provided by the computer
manufacturers or suppliers, or by a third-party maintenance company.

Section summary
Corrective Maintenance is carried out when there is a systems failure of some kind, for example a defect
in processing or in an implementation procedure. Its objective is to ensure that systems remain
operational.

Perfective Maintenance is carried out in order to perfect the software, or to improve it so that processing
inefficiencies are eliminated and performance is enhanced.

Adaptive Maintenance is carried out to take account of anticipated changes in the processing
environment. For example new taxation legislation might require changes to be made to payroll software.

6 System outsourcing 05/10, 05/12

Introduction
We shall now consider the application of outsourcing to information systems.
 PART B INFORMATION SYSTEMS 4: Systems implementation and business strategy 115

There are four broad classifications of IT outsourcing.

Classification Comment
Ad-hoc The organisation has a short-term requirement for increased IT skills. An
example would be employing programmers on a short-term contract to help
with the programming of bespoke software.
Project management The development and installation of a particular project is outsourced. For
example, a new accounting system. This approach is sometimes referred to as
systems integration.
Partial Some services are outsourced. Examples include hardware maintenance,
network management or ongoing website management.
Total An external supplier provides the vast majority of an organisation's IS services.
For example, a third party owns or is responsible for IT equipment, software
and possibly staff.

6.1 Levels of service provision

The degree to which the provision and management of IS services are transferred to the third party varies
according to the situation and the skills of both organisations.

(a) Timeshare. The vendor charges for access to an external processing system on a time-used basis.
Software ownership may be with either the vendor or the client organisation.

(b) Service bureaux usually focus on a specific function. Traditionally bureaux would provide the same
type of service to many organisations, eg payroll processing. As organisations have developed their
own IT infrastructure, the use of bureaux has decreased.

(c) Facilities management (FM) . The terms 'outsourcing' and 'facilities management' are sometimes
confused. Facilities management traditionally involved contracts for premises-related services such
as cleaning or site security.

In the context of IS, facilities management involves an outside agency managing the organisation's
IS facilities. All equipment usually remains with the client, but the responsibility for providing and
managing the specified services rests with the FM company. FM companies operating in the UK
include Accenture, Cap Gemini, EDS and CFM.

The retailer Sears outsourced the management of its vast information technology and accounting functions
to Accenture. First year savings were estimated to be £5 million per annum, growing to £14 million in the
CASE STUDY following year, and thereafter. This is clearly considerable, although re-organisation costs relating to
redundancies, relocation and asset write-offs are thought to be in the region of £35 million. About 900
staff were involved: under the transfer of undertakings regulations (which protect employees when part or
all of a company changes hands), Accenture was obliged to take on the existing Sears staff. This provided
new opportunities for the staff who moved, while those who remained at Sears were free to concentrate
on strategy development and management direction.

6.2 Developments in outsourcing

Outsourcing arrangements are becoming increasingly flexible to cope with the ever-changing nature of the
modern business environment.
116 4: Systems implementation and business strategy PART B INFORMATION SYSTEMS

Examples of outsourcing arrangements include:

(a) Multiple sourcing. This involves outsourcing different areas of the IS function to a range of
suppliers. Some suppliers may form alliances to present a stronger case for selection.

(b) Incremental approach. Organisations progressively outsource selected areas of their IS function.
Possible problems with outsourced services are solved before progressing to the next stage.

(c) Joint venture sourcing. This term is used to describe an organisation entering into a joint venture
with a supplier. The costs (risks) and possible rewards are split on an agreed basis. Such an
arrangement may be suitable when developing software that could be sold to other organisations.

(d) Application Service Providers (ASP). ASPs are third parties that manage and distribute software
services and solutions to customers across a Wide Area Network. ASPs could be considered the
modern equivalent of the traditional computer bureaux.

6.3 Managing outsourcing arrangements

Managing outsourcing arrangements involves deciding what will be outsourced, choosing and negotiating
with suppliers and managing the client-vendor relationship.

6.3.1 Deciding what to outsource

When considering whether to outsource a particular service the following issues are relevant.

(a) Strategic importance of system. If the decision relates to an information system, strategic
information systems are generally not suited to outsourcing as they require a high degree of
specific business knowledge that a third party IT specialist cannot be expected to possess.

(b) Is the function and/or system relatively isolated? Functions that have only limited interfaces are
most easily outsourced, eg payroll.

(c) Is there enough in-house system knowledge to manage the outsourced service agreement? If an
organisation knows very little about a particular technology it may be difficult to know what
constitutes good service and value for money. It may be necessary to recruit additional expertise to
manage the relationship with the other party.

(d) Are the organisation’s requirements likely to change? Organisations should avoid tying themselves
into a long-term outsourcing agreement if requirements are likely to change.

(e) Communication with employees. Once the decision to outsource has been taken it is important for
employees to be kept informed of the reasons behind the decision and how it may impact on
them. If redundancies are planned then this should be managed sensitively.

6.3.2 Choosing and negotiating with suppliers

The organisation should draw up a short-list of potential suppliers and invite them to bid for the outsource
contract by an invitation to tender. The choice of outsource supplier should be made based on clearly
defined criteria and the organisation should also make background checks into the supplier’s finances,
seek references from its other clients and check its legal history for any litigation against it. Any potential
supplier should be sympathetic to the organisations’ culture and ethics and be willing to put mechanisms
in place to ensure the satisfaction of the organisation’s customers.

A contract, known as a Service Level Contract (SLC) or Service Level Agreement (SLA) should be drawn
up that sets out the terms and conditions of the arrangement.
PART B INFORMATION SYSTEMS 4: Systems implementation and business strategy 117

The key elements of the contract are described below.

Contract element Comment

Service level The contract should clearly specify minimum levels of service to be provided.
Penalties should be specified for failure to meet these standards. Relevant
factors will vary depending on the nature of the services outsourced but could
include:
 Response time to requests for assistance/information
 System 'uptime' percentage
 Deadlines for performing relevant tasks
Exit route Arrangements for an exit route, addressing how the transfer to another
supplier, or the move back in-house would be conducted.
Timescale When does the contract expire? Is the timescale suitable for the organisation's
needs or should it be renegotiated?
Software ownership Relevant factors include:
 Software licensing and security
 If the arrangement includes the development of new software who owns
the copyright?
Dependencies If related services are outsourced, the level of service quality agreed should
group these services together.
Employment issues If the arrangement includes provision for the organisation's IT staff to move to
the third party, employer responsibilities must be specified clearly.

Once the arrangement has been established, handover should take place at an appropriate time either
directly or be phased in stages.

6.3.3 Managing the client-vendor relationship

It is important for the organisation to build a strong relationship with its outsource supplier, perhaps
through the use of a relationship manager responsible for monitoring the costs of the agreement and
checking that the terms and conditions of the SLA are adhered to. Any issues arising should be dealt with
appropriately. The closeness of the relationship would depend on the nature of the function being
outsourced

If full facilities management is involved and almost all management responsibility for IS lies with the
entity providing the service, then a close relationship between the parties is necessary (a 'partnership').
Factors such as organisation culture need to be considered when entering into such a close and critical
relationship.

On the other hand, if a relatively simple function such as payroll were outsourced, such a close
relationship with the supplier would not be necessary. A 'typical' supplier – customer relationship is all
that is required.
118 4: Systems implementation and business strategy PART B INFORMATION SYSTEMS

6.4 Advantages of outsourcing arrangements

The advantages of outsourcing are as follows.

(a) Outsourcing can remove uncertainty about cost, as there is often a long-term contract where
services are specified in advance for a fixed price. If computing services are inefficient, the costs
will be borne by the outsourcing company. This is also an incentive to the third party to provide a
high quality service.

(b) Long-term contracts (maybe up to ten years) encourage planning for the future.

(c) Outsourcing can bring the benefits of economies of scale. For example, an outsourcing company
may conduct research into new technologies that benefits a number of their clients.

(d) A specialist organisation is able to retain skills and knowledge. Many organisations would not have
a sufficiently well-developed IS department to offer IS staff opportunities for career development.
Talented staff would leave to pursue their careers elsewhere.

(e) New skills and knowledge become available. A specialist company can share staff with specific
expertise (such as programming in HTML to produce Web pages) between several clients. This
allows the outsourcing company to take advantage of new developments without the need to
recruit new people or re-train existing staff, and without the cost.

(f) Flexibility (contract permitting). Resources may be able to be scaled up or down depending upon
demand. For instance, during a major changeover from one system to another the number of IT
staff needed may be twice as large as it will be once the new system is working satisfactorily.

An outsourcing organisation is more able to arrange its work on a project basis, whereby some
staff will expect to be moved periodically from one project to the next.

6.5 Disadvantages of outsourcing arrangements

Some possible drawbacks are outlined below.

(a) It is arguable that information and its provision is an inherent part of the business and of
management. Unlike office cleaning, or catering, an organisation's IS services may be too
important to be contracted out. Information is at the heart of management.

(b) A company may have highly confidential information and to let outsiders handle it could be seen
as risky in commercial and/or legal terms.

(c) Information strategy can be used to gain competitive advantage. Opportunities may be missed if a
third party is handling IS services, because there is no onus upon internal management to keep up
with new developments and have new ideas. Any new technology or application devised by the
third party is likely to be available to competitors.

(d) An organisation may find itself locked in to an unsatisfactory contract. The decision may be very
difficult to reverse. If the outsourcing company supplies unsatisfactory levels of service, the effort
and expense the organisation would incur to rebuild its own computing function or to move to
another provider could be substantial.

(e) The use of outsourcing does not encourage awareness of the potential costs and benefits of IS
within the organisation. If managers cannot manage in-house IS resources effectively, then it could
be argued that they will not be able to manage an arrangement to outsource effectively either.
PART B INFORMATION SYSTEMS 4: Systems implementation and business strategy 119

6.6 Information systems and broader management operations

The information systems within an organisation should complement and support other functional areas
such as finance, human resources and marketing. For example, an intranet facilitates the sharing of
information.

Effective information systems and information management contribute towards the attainment of
organisational goals. To best achieve this, a cohesive IS strategy should be developed that supports the
organisation's overall strategy.

As with any expenditure, the benefits of information systems should be greater than their costs.

Section summary
Four broad types of information systems outsourcing are ad-hoc, project management, partial and total.

Examples of outsourcing arrangements include multiple sourcing, incremental approach, joint venture
sourcing, Application Service Providers (ASP).

7 Aligning systems with business strategy

Introduction
An organisation's information systems (IS) should support the overall strategy of the business.
A firm's strategy is built in three layers
 Corporate (what products to make or markets to be in).
 Business (how to increase sales or profitability of a product).
 Functional (the strategy of a business function such as HR or Marketing).
Therefore a firm's IT strategy is a functional strategy, although due to its revolutionary nature, it can also
become a business strategy. For example where IT can improve efficiency or sales (such as through
e-commerce).

The identification of business needs and the information technology framework to satisfy them is at the
heart of a strategy for information systems. However, this is not always feasible, especially if an
organisation's use of technology has grown in a haphazard fashion. The purpose of the strategy in this
situation may be to impose some sort of order on a disorganised situation.

We shall begin by looking at the effect information systems have on an industry.

7.1 The effect of IS on an industry

Porter and Millar state that IS has the potential to change the nature of competition within an industry.

The ways in which IS can impact an industry according to Porter and Millar are:

 Change the industry structure

 Create new businesses and industries
 Be used to create competitive advantage
120 4: Systems implementation and business strategy PART B INFORMATION SYSTEMS

7.2 Changing the industry structure

Porter's five forces model can be used to analyse the effect of IS on an industry.

Porter identified five competitive forces operating in a competitive environment.

(a) The threat of new entrants.

(b) The bargaining power of suppliers.
(c) The bargaining power of customers.
(d) The threat of substitute products/services.
(e) The existing competitive rivalry in the industry.

Potential
entrants

Threat of
new entrants
Bargaining Bargaining
power of Industry competitors power of
suppliers customers
Suppliers Rivalry among Customers
existing firms

Threat of substitute
products or services

Substitutes

7.2.1 New entrants

IS can have two possible roles in relation to barriers to entry

(a) Defensively. IS can increase economies of scale, raise the capital cost of entry (by requiring an
investment in IS) or effectively colonising distribution channels by tying customers and suppliers
into the supply chain.

(b) Offensively. IS can leap over entry barriers. An example is the use of telephone banking, which
sometimes obviates the need to establish a branch network.

7.2.2 Suppliers
Supplier power can derive from various factors such as geographical proximity and the fact that the
organisation requires goods of a certain standard in a certain time.

The bargaining power of suppliers can be eroded by IS in three ways.

(a) By increasing competition between suppliers. IS can provide a purchases database, which enables
easy scanning of prices from a number of suppliers.

(b) Suppliers' power can be shared. An example is using CAD to design components in tandem with
suppliers. Such relationships might be developed with a few key suppliers. The supplier and the
organisation both benefit from performance improvement.

(c) Suppliers can be integrated, in purely administrative terms, by a system of electronic data
interchange (EDI). This involves the creation of standardised electronic documents (such as order
forms) that can be transmitted between supplier and customer to save duplication of effort in terms
of getting the information into each computer system.
PART B INFORMATION SYSTEMS 4: Systems implementation and business strategy 121

7.2.3 Customers
The bargaining power of customers can be affected by using IS to 'lock them in'.

(a) IS can raise switching costs in both cash terms, and in terms of operational inconvenience). An
example is where IS provides a distribution channel for certain services (eg airline tickets). Another
example comes from the computer industry itself. Until the advent of the PC, most computers were
run with proprietary software in other words, you could not run ICL software, say, on IBM
mainframes. This made any switch in supplier (of hardware or software) too much trouble to
contemplate.

(b) Customer information systems can enable a thorough analysis of marketing information so that
products and services can be tailored to the needs of certain market segments.

7.2.4 Substitutes
IS has the following relationships to existing and substitute products and services.

(a) In some cases IS itself is the 'substitute'. PC-based word processing packages were originally
a substitute for typewriters, e-commerce is a substitute for a high street shop.
(b) Technology is the basis for new leisure activities (eg computer games. Alternatively, IT based
systems can imitate existing goods (eg electronic keyboards imitating pianos).
(c) Technology can add value to existing services by allowing more detailed analysis, by generating
cost advantages, or by extending the market.

7.2.5 Rivalry
IS can be used to compete – as a source of competitive advantage (see below).

Porter’s five forces is another important strategy for analysing an organisation’s environment.
Be prepared to use it again as it is part of the syllabus for Paper E2.

7.3 Using IS for competitive advantage

As the importance of information has increased, organisations have realised that information systems can
be used as a source of competitive advantage.

Where the majority of organisations in an industry use IS for competitive advantage, or the industry is
based on IS to a large extent, there may be a competitive necessity to use it.

COMPETITIVE ADVANTAGE is a profitable and sustainable position. It exists in the minds of customers, who
believe the value they will receive from a product or service is greater than both the price they will pay
KEY TERM and the value offered by competitors.

7.3.1 Generic strategies for competitive advantage

Porter proposes three generic strategies for achieving competitive advantage.

(a) Cost leadership means being the lowest-cost producer in the industry as a whole. A cost
leadership strategy seeks to achieve the position of lowest-cost producer in the industry.
(b) Differentiation is the exploitation of a product or service which the industry as a whole believes to
be unique. A differentiation strategy assumes that competitive advantage can be gained through
particular characteristics of a product or service.
(c) Focus involves a restriction of activities to only part of the market (a segment or niche) through:
(i) Providing goods and/or services at lower cost to that segment (cost-focus).
(ii) Providing a differentiated product or service to that segment (differentiation-focus).
122 4: Systems implementation and business strategy PART B INFORMATION SYSTEMS

Cost leadership and differentiation are industry-wide strategies. Focus involves segmentation – pursuing
within the segment a strategy of cost leadership or differentiation. Examples of how IS can support each
of these strategies are shown in the following table.

Strategy How IS can support the strategy

Cost-leadership By facilitating reductions in cost levels, for example by reducing the number of
administration staff required.
Allowing better resource utilisation, for example by providing accurate stock
information allowing lower 'buffer' inventories to be held.
Using IS to support just-in-time and advanced manufacturing systems.
Differentiation Differentiation can be suggested by IS, perhaps in the product itself or in the way it
is marketed. For example moving away from paper-based products to electronic.
Focus IS may enable a more customised or specialised product/service to be produced.
IS also facilitates the collection of sales and customer information that identifies
targetable market segments.

7.4 Porter's value chain

Porter analyses the various activities of an organisation into a value chain. This is a model of value
activities (which procure inputs, process them and add value to them in some way, to generate outputs
for customers) and the relationships between them.

The value chain is usually applied in relation to operations management. We are considering it briefly
here as it can be applied to IS strategy as well.

Value chain analysis can be used to assess the impact of IS, and to identify processes where it could be
used to add value. The activities and how IS can benefit them are described below.

7.4.1 Logistics
In both inbound logistics and outbound logistics IS can have an impact.

(a) Inbound logistics. The use of inventory control systems such as MRP, MRPII, ERP and JIT.

(b) Warehousing. The use of barcodes facilitates accurate inventory data.

(c) It is possible to create computer models, or virtual warehouses of inventory held at different
locations.

7.4.2 Marketing
Marketing and services can be made more effective by customer databases enabling market segmentation.

(a) Buying and analysing a mailing list is a more precise method of targeting particular groups of
consumers than television advertising.

(b) A variety of market research companies use IS to monitor consumers' buying habits.

(c) Supermarkets can use automated EPOS systems to have a precise hour-by-hour idea of how
products are selling to enable speedy ordering and replenishments.

Customer relationship management (CRM) systems can encourage closer customer relationships.
PART B INFORMATION SYSTEMS 4: Systems implementation and business strategy 123

7.4.3 Support activities

As far as support activities are concerned IS has some impact.

(a) Procurement. IS can automate some purchasing decisions. Paperwork can be saved if the
organisation's purchase systems are linked directly to the sales order systems of some suppliers (eg
by electronic data interchange).

(b) Technology development. Computer Aided Design (CAD) is, in a number of areas, an important
influence.

(i) Drafting. CAD produces engineer's drawings, component design, layout (eg of stores, wiring
and piping) and electronic circuit diagrams in complex systems.

(ii) Updating. It is easy to change design in CAD systems and to assess ramifications of any
changes. Some CAD systems have archive data (eg for reference).

(iii) CAD enables modelling to be checked without the necessity of producing working
prototypes. Some 'stress testing' can be carried out on the model.

(c) There is perhaps less impact on human resources. However, HR applications include the
maintenance of a skills database, staff planning, computer based training, time attendance
systems, payroll systems, pension systems.

7.5 IS and strategy – other writers

7.5.1 Ward and Griffiths

Ward and Griffiths suggested four ways that IS could be used for competitive advantage:

(a) Linking the organisation to customers or suppliers.

(b) Creating effective integration of the use of information in a value-adding process.
(c) Enabling the organisation to develop, produce, market and distribute new products or services.
(d) Giving senior management information to help develop and implement strategy.

7.5.2 Clegg
Clegg (2003) stated that an organisation’s information strategy is a plan for ensuring that information is
appropriate, accurate, available, timely and effective. A starting point for achieving this could be the
organisation reviewing its information for duplication or errors, or taking a ‘blank page’ approach and
simply deciding its information requirements from scratch.

He emphasised that information strategy should not be left in the hands of IT experts. It’s the managers
within the organisation that know what information they require.

7.5.3 Boomer
Boomer (2007) identified a number of issues relevant when planning information systems.

Strategic issues relevant when planning information systems:

 The corporate plan and the organisation’s priorities expressed in it

 How technology could be used to meet corporate objectives
 Trends in the use of IT in the organisations industry and in other industries

Tactical issues relevant when planning information systems:

 What skills and abilities do people within the organisation possess?

 How are information systems and IT resources managed? Is outsourcing used – and should it be?
 What is the budget and timescale?
124 4: Systems implementation and business strategy PART B INFORMATION SYSTEMS

Question 4.3 Five forces

Learning outcome B2(vi)

Using each of Porter’s five forces, identify and briefly explain five ways that information systems could be
used to create a competitive advantage for an organisation that manufactures wooden furniture for sale
through a chain of its shops. (10 marks)

Section summary
The ways in which IS can impact an industry according to Porter and Millar are, change the industry
structure, create new businesses and industries and be used to create competitive advantage.

Porter identified five competitive forces operating in a competitive environment.

Porter proposes three generic strategies for achieving competitive advantage, cost leadership,
differentiation and focus.

Value chain analysis can be used to assess the impact of IS, and to identify processes where it could be
used to add value.
PART B INFORMATION SYSTEMS 4: Systems implementation and business strategy 125

Chapter Roundup
 The main stages in the implementation of a computer system are:

 Installation of the hardware and software.

 Testing.
 Staff training and production of documentation.
 File conversion.
 Changeover.

 User resistance is a key cause of information systems failure.

 Theories to overcome user resistance include:

 Lewin/Schein's unfreeze, move, refreeze

 Kotter and Schlesingers' six methods of dealing with resistance

 It is better for the organisation to prevent or minimise resistance occurring in the first place. Theories
aimed at achieving this include:

 Pace, manner and scope

 Commitment, co-ordination and communication

 After implementation the system should be evaluated to see if it is a success and whether there are any
lessons to be learned.

 Evaluation often takes the form of a cost-benefit review or performance measurement using metrics or
other measurable features of the system.

 A post-implementation review compares actual and expected performance levels and is a formal report
that should be compiled after a suitable period of time following implementation.

 Corrective Maintenance is carried out when there is a systems failure of some kind, for example a defect
in processing or in an implementation procedure. Its objective is to ensure that systems remain
operational.

 Perfective Maintenance is carried out in order to perfect the software, or to improve it so that processing
inefficiencies are eliminated and performance is enhanced.

 Adaptive Maintenance is carried out to take account of anticipated changes in the processing
environment. For example new taxation legislation might require changes to be made to payroll software.

 Four broad types of information systems outsourcing are ad-hoc, project management, partial and total.

 Examples of outsourcing arrangements include multiple sourcing, incremental approach, joint venture
sourcing, Application Service Providers (ASP).

 The ways in which IS can impact an industry according to Porter and Millar are, change the industry
structure, create new businesses and industries and be used to create competitive advantage.

 Porter identified five competitive forces operating in a competitive environment.

 Porter proposes three generic strategies for achieving competitive advantage, cost leadership,
differentiation and focus.

 Value chain analysis can be used to assess the impact of IS, and to identify processes where it could be
used to add value.
126 4: Systems implementation and business strategy PART B INFORMATION SYSTEMS

Quick Quiz
1 Which of the following is the final step in Lewin and Schien's three stage model of change?

A Refreeze
B Move
C Unfreeze
D Fix

2 Which of the following describes corrective maintenance?

A Maintenance carried out when there is a systems failure

B Maintenance carried out to perfect the system
C Maintenance carried out to adjust the system for changes in the processing environment
D Maintenance carried out to improve user-friendliness

3 How does a cost-benefit review differ from a cost-benefit analysis?

4 Which level of service provision by an IS outsourcing organisation is described below?

‘The vendor charges for access to an external processing system on a time-used basis.’

A Service bureaux
B Timeshare
C Facilities management
D Processing rental

5 Who developed value chain analysis?

A Lewin
B Schein
C Porter
D Clegg
PART B INFORMATION SYSTEMS 4: Systems implementation and business strategy 127

Answers to Quick Quiz

1 A The final stage in Lewin and Schien's three stage model of change is refreeze.

2 A Option B is perfective maintenance, C is adaptive maintenance, D is also perfective maintenance

3 The review uses actual data. The analysis relies on estimates.

4 B Timeshare is where the vendor charges for access to an external processing system on a time-used
basis.

5 C Porter developed value chain analysis.

Answers to Questions
4.1 Resistance to change

A Education and communication is effective where the cause of the resistance is lack of information about
the change.

4.2 Cost-benefit review

Direct benefits might include reduced operating costs, for example lower overtime payments.

Indirect benefits might include better decision-making and the freeing of human 'brainpower' from routine tasks
so that it can be used for more creative work.

Development costs include systems analysts' costs and the cost of time spent by users in assisting with fact-
finding.

Implementation costs would include costs of site preparation and costs of training.

Running costs include maintenance costs, software leasing costs and on-going user support.

4.3 Five forces

The following are just some ideas that are possible, you may have thought of others.

Potential entrants
Technology can reduce the labour cost of manufacturing and speed up the production process so that substantial
economies of scale are created. This may mean that new entrants cannot compete with the organisation on cost.

Suppliers
The organisation can store price, and other data, regarding suppliers on a database. This will allow it to quickly
scan which suppliers provide the best deal, increasing the competition between them and therefore reducing
their bargaining power.

Customers
The organisation can store marketing data that it collects from its customers on a database. This information can
be analysed and used to improve the targeting of the marketing effort, therefore reducing customer bargaining
power.

Substitutes
The organisation can develop a website and an in-store product database that allows customers to analyse and
compare the products that are on offer. For example by colour, size and style. Such value-added activities can
help reduce the threat of substitutes.
128 4: Systems implementation and business strategy PART B INFORMATION SYSTEMS

Industry rivalry

Porter proposed three strategies for competitive advantage. Cost leadership, differentiation and focus.

We have already seen how IS can help the organisation compete on cost. Differentiation can be achieved
through the provision of the website and in-store database – not all of the organisation’s competitors will provide
this.

IS can also help focus the organisation’s activities by allowing it to trade under two different brands on the
Internet. For example one brand could compete on cost – this would sell cheaper products. Another brand could
compete on product differentiation such as stylish or luxury products. Each brand could have a separate website
and be marketed differently, even though the organisation that manufactures their products is the same.

Now try this question from Number Level Marks Time

the Exam Question Bank 4 Examination 25 45 mins
OPERATIONS MANAGEMENT

Part C

129
130
OPERATIONS MANAGEMENT AND
THE ORGANISATION

In this chapter we begin our study of organisation structures itself and its relations with
operations management by discussing what it suppliers, to meet the needs of the customer.
is and the important role it plays in
Finally, we look at the issue of sustainability in operations
organisations.
management. This is a recent development that many
We then continue by considering an organisation's broad organisations are under pressure from customers to
operations strategy. This is concerned with how the address.

topic list learning outcomes syllabus references ability required

1 Operations management C1(a), C1(c) C1(i), C1(iii), C1(iv) comprehension
2 Operations strategy C1(a), C1(b), C2(b), C1(i), C1(ii), C1(iii), comprehension
C2(e) C2(v), C2(xii)
3 Sustainability in operations management C1(d) C1(v) comprehension

131
132 5: Operations management and the organisation PART C OPERATIONS MANAGEMENT

1 Operations management

Introduction
The overall objective of operations is to use a transformation process to add value and create competitive
advantage. It involves taking input resources and transforming them into outputs of products or services
for customers. Operations management involves the design, implementation and control of these
processes.

OPERATIONS MANAGEMENT is concerned with the transformation of 'inputs' into 'outputs' that meet the
needs of the customer.
KEY TERM

1.1 The operations function

Organisations will invariably have an operations function. The operations function might be considered as
one of the three traditional 'core functions'.

(a) Operations. This is responsible for fulfilling customer orders and requests through production of the
goods or services, and for delivery of products or services to the customer.

(b) Marketing and sales. This is responsible for identifying customer needs and perhaps more
significantly, for communicating information about the organisation's products or services to
customers so as to procure sales orders.

(c) Product and service development. This is responsible for designing new products and services that
will meet customer needs, to generate sales orders.

There are also support functions within an organisation that help the core functions to operate effectively.
Traditionally, support functions might include accounting, HR and IT. However, what is actually a core
function or a support function will depend on the particular organisation. For example, organisations that
rely heavily on technology (eg the use of computer-aided manufacturing) may consider IT a core function.

The functions within an organisation overlap, and for any particular task or process, input is often
required from more than one core function or support function.

The core functions: examples

Publishing company Hotel
Operations Editing Reservations
Printing Housekeeping
Distribution Building maintenance
Catering
Marketing and Advertise through trade magazines Advertise across media
sales Book fairs Liaise with tour operators, travel agents and
Negotiate sale of rights booking agents
Sell into bookshops and other outlets
Product/ Commission new titles Develop accommodation offerings, creative
service Vet submitted scripts ambience, catering and ancillary facilities
development such as gym, business centre, conference
Develop new media forms, eg Internet
facilities, entertainment etc
delivery
Devise new packages
Identify new locations

At its simplest, operations management tries to ensure that organisations are run as efficiently as possible.
PART C OPERATIONS MANAGEMENT 5: Operations management and the organisation 133

1.2 Mintzberg's operating core

Henry Mintzberg suggested one way of looking at organisations. His theory published in 1983 suggested
organisations are made up of five parts.

Five parts of an organisation (Mintzberg)

Strategic
Apex

Support
Technostructure Staff
Middle
Line

Operating Core

Mintzberg's five basic parts of an organisation

Part Comment
Operating core People involved producing products and services by transforming inputs such
as stock using operations such as manufacturing.
Middle line The hierarchy linking the strategic apex to the operating core. Usually
comprises first line supervisors up to senior managers.
Strategic apex Formulates and implements strategy – and if applicable links the organisation
to those who own or control it.
Technostructure Co-ordinates work through standardising processes, outputs and skills, eg HR
managers includes expert advice, research and work study.
Support staff Provide services and assistance outside the work flow, eg catering, cleaning,
PR.
134 5: Operations management and the organisation PART C OPERATIONS MANAGEMENT

1.3 The transformation process model

An operation takes input resources and, through one or more processes, transforms these into outputs.
Input resources are transformed in the process into a product or service that satisfies customer needs.
This generalised concept of the transformation process model applies to all processes and may be
depicted as follows.

Transformation processes

The transformation process could be a physical transformation, a change in nature or form (for example,
a transformation of data into information), a change in location, a change in ownership, or, in the case of
customers, a psychological change (eg giving enjoyment).

Inputs to the transformation process can be categorised as either transformed resources or transforming
resources.

(a) Transformed resources are manipulated and formed into a different condition by the process.
These resources can be materials, information or customers themselves.

(b) Transforming resources are the resources that are used to alter the condition of the transformed
resources. These consist of the work force of the organisation and facilities such as buildings,
equipment and vehicles.

Here are some practical examples of the transformation process.

(a) In a manufacturing process, inputs of raw materials and components are manipulated into a
finished product. The output is the product. This is then distributed to the customer.

(b) In the legal profession, a client seeks clarification about a legal problem. A lawyer holds a meeting
with the client and provides the necessary advice. The output is an informed client.

(c) In the rail industry, rail service providers take customers, and use their work force and facilities (eg
trains) to deliver the customers from one location to another. The output is a re-located customer.

(d) In banking, instructions from a customer (information) are processed using the facilities of the
bank, and the instructions are carried out, for example by the transfer of money. The output is the
completed transfer.

(e) In the entertainment industry, the customer might be provided with entertainment input such as a
comedian telling a joke. The output is an entertained customer.
PART C OPERATIONS MANAGEMENT 5: Operations management and the organisation 135

1.3.1 Product and service outputs

Many operations produce a mixture of product and service outputs. Remember also that in many
countries the service economy may be more significant than the manufacturing economy. Here are some
examples of the close interrelationships between service and manufacturing operations.

(a) The manufacture of machine tools is primarily concerned with the output of products. However,
the organisation will also provide training and technical support services to customers.

(b) An education and training organisation might provide lectures, tutorials and workshops. The
service may include the provision of products in the form of study notes or books. It might also
provide an online helpline.

(c) A restaurant provides products in the form of food and drink. However, for the customer an
essential ingredient of going to a restaurant is usually the overall dining experience that includes
the enjoyment obtained from the service style, entertainment and general ambience.

1.3.2 The Four Vs of operations

Another method of analysing the differences between transformational processes is by using the four Vs.

V Description
Volume The volume of units produced. High volume usually means capital intensive, low
volume usually means labour intensive.
Variety Whether the operation handles a number of different inputs or produces a range
of different outputs.
Variation in Demand for same operations may be seasonal or regular peaks and dips in
demand demand may be experienced.
Visibility The degree to which business operations are visible to the customer.

Section summary
Operations is a core part of any organisation.

The transformational process model describes how inputs are converted through processes into outputs.

2 Operations strategy

Introduction
Organisations may employ one or more of a number of operations strategies to improve their processes
and as a source of competitive advantage over competitors. Common strategies involve what is known as
the value chain and supply chain management. This is the view that an organisation is one link in a
chain that aims to turn raw materials into what the customer wants. As a result all links in the chain
benefit.
136 5: Operations management and the organisation PART C OPERATIONS MANAGEMENT

2.1 The value chain

VALUE CHAIN. 'Sequence of business activities by which, in the perspective of the end-user, value is added
to the products or services produced by an entity.' (CIMA Official Terminology)
KEY TERM
In Porter's analysis, business activities are not the same as business functions.

(a) Functions are the familiar departments of a business (eg production function, the finance function)
and reflect the formal organisation structure and the distribution of labour.

(b) Activities are what actually goes on, the work that is done. Activities are the means by which an
organisation creates value in its products – sometimes referred to as value activities. Activities
incur costs and provide a product or service which earns revenue.

An example should make this clear. An organisation needs many inputs of resources to function. It needs
to secure resources from the environment. This activity can be called procurement. However,
procurement will involve more departments than purchasing, for example the accounts department will
certainly be involved and possibly production and quality assurance.

Organisations create value for their buyers by performing these activities. The ultimate value a firm
creates is measured by the amount customers are willing to pay for its products or services above the cost
of carrying out value activities. A business is profitable if the realised value to customers exceeds the
collective cost of performing the activities.

There are two points to note here.

(a) Customers purchase value, which they measure by comparing an organisation's products and
services with similar offerings from competitors.

(b) The business creates value by carrying out its activities either more efficiently than other
businesses, or combined in such a way as to provide a unique product or service.

Porter’s value chain is a model of value activities (which procure inputs, process them and add value to
them in some way, to generate outputs for customers) and the relationships between them.

Porter’s Value Chain

PART C OPERATIONS MANAGEMENT 5: Operations management and the organisation 137

2.1.1 Primary activities

Porter distinguished between primary activities and support activities.

Primary activities are those directly related with production, sales, marketing, delivery and services.

The diagram shows five primary activities.

(a) Inbound logistics are those activities involved with receiving, handling and storing inputs to the
production system.

(b) Operations are those activities which convert resource inputs into a final product. In a
manufacturing business, this is relatively easy to identify as the factory. In a service company,
operations include those activities which make up the basic service.

(c) Outbound logistics are those activities relating to storing the product and its distribution to
customers.

(d) Marketing and sales are those activities that relate to informing customers about the product,
persuading them to buy it, and enabling them to do so.

(e) After-sales service includes activities such as installing products, repairing them and providing
spare parts.

2.1.2 Support activities

Support activities are those which provide purchased inputs, human resources, technology and
infrastructural functions to support the primary activities.

(a) Procurement consists of those activities which acquire the resource inputs to the primary activities
(eg purchase of materials, subcomponents, equipment).

(b) Technology development (in the sense of apparatus, techniques and work organisation). These
activities are related to both product design and to improving processes and/or resource utilisation.

(c) Human resource management is the activities of recruiting, training, developing and rewarding
people.

(d) Firm infrastructure. The systems of planning, finance, quality control and management are
activities which Porter believes are crucially important to an organisation's strategic capability in all
primary activities.

2.1.3 Other elements

Furthermore, in addition to the categories described above, Porter identifies three further types of activity.

(a) Direct activities are concerned with adding value to inputs.

(b) Indirect activities enable direct activities to be performed (eg maintenance, sales force
administration).

(c) Quality assurance. This type of activity monitors the quality of other activities, and includes:
inspection, review and audit (eg the quality of the financial records).

Linkages connect the interdependent elements of the value chain together. They occur when one element
of the value chain affects the costs or effectiveness of another. They require co-ordination.

(a) More costly product design, or better quality production, might reduce the need for after-sales
service.

(b) To deliver goods on time requires smooth functioning of operations, outbound logistics and service
activities such as installation.
138 5: Operations management and the organisation PART C OPERATIONS MANAGEMENT

Porter’s Value Chain is a key theory which will crop up in other papers, for example E3 and
P2.

Question 5.1 Activities

Learning outcome C1(i)

Which of the following is a support activity in the value chain?

A Inbound logistics
B Human resource management
C Marketing and sales
D Service (2 marks)

2.2 The value system

Activities that add value do not stop at the organisation's boundaries. For example, when a restaurant
serves a meal, the quality of the ingredients – although they are chosen by the cook – is determined by
the grower. The grower has also added value, and the grower's success in growing produce of good
quality is as important to the customer's ultimate satisfaction as the skills of the chef. Consequently, a
company's value chain is connected to what Porter describes as a value system.

Distributor/retailer
value chain

Organisation's Customer
value value
chain chain
Supplier
value
chain

As well as managing its own value chain, a business can secure competitive advantage by managing the
linkages with its suppliers and customers. A company can create competitive advantage by making best
use of these links. An example is a Just-in-Time system where close integration of the organisation's
operations with those of its suppliers is essential.

2.3 Purchasing and supply chain management 05/10

SUPPLY CHAIN MANAGEMENT is concerned with the flow of goods and services through the organisation
with the aim of making the firm more competitive. (Cousins)
KEY TERM
The nature of purchasing has changed dramatically over recent years. Historically, it was viewed as a
clerical function related to the day-to-day purchase of goods. High importance was placed on price,
quality and timely delivery. However, this has changed in recent years.

Purchasing today, in most organisations, is viewed as a strategically important function that impacts
significantly on organisational performance. A degree of control is sought over the supply process and
businesses actively manage the number of suppliers they use, implement outsourcing arrangements as
necessary and consider developing strategic partnerships where appropriate.
PART C OPERATIONS MANAGEMENT 5: Operations management and the organisation 139

2.3.1 What caused the need for closer supply chain links?
Christopher (2005) identified a number of factors.

 Shorter product life cycles requiring more efficient supply pipelines

 Increasingly global supply chains requiring greater coordination
 A move towards more flexible organisations that partner with others (organisational integration)
 More demanding customer service standards

2.3.2 Effective supply chain management

Supply chain management is concerned with the flow of goods and services through the organisation.
Ultimately, the goal is to contribute to customer satisfaction.

Porter recognised that management of the supply chain and supply network could be a source of
competitive advantage. He referred to the position of firms in supply chains and networks in relation to
their proximity to the customer. If a firm is closer to the customer than another, it is ‘downstream’ of it. If
a firm is further away from the customer than another, it is ‘upstream’ of it.

Supply chains today must be responsive and reliable. The relationships between members must
demonstrate a high degree of mutual understanding. Integration between the organisation and other
chain members, both upstream and downstream, should be facilitated by integrated information systems.

2.3.3 Reck and Long 05/11

Reck and Long (1988) devised a model that aimed to provide an insight into the evolution of the
purchasing function. Their strategic positioning tool identified a four-phase development of purchasing
within organisations.

The phases of Reck and Long's strategic positioning tool

Phase Comment
1 Passive  Purchasing reacts to requests from other departments.
 The focus is on efficient transaction processing.
2 Independent  A more professional approach to purchasing is taken.
 During this phase, the importance of negotiation with suppliers to securing
the best prices for individual products/services purchased is recognised.
 Often includes IT improvements and the creation of a purchasing manager
position to manage supplier negotiations.
3 Supportive  The potential for purchasing to support wider organisational goals is
recognised.
 This phase is often characterised by a centralised purchasing department
with organisation-wide buying policies and systems.
 The emphasis is co-ordination and compliance with centrally negotiated
contracts.
 The importance of careful supplier selection is recognised.
 Policies and procedures for supplier management are developed.
140 5: Operations management and the organisation PART C OPERATIONS MANAGEMENT

The phases of Reck and Long's strategic positioning tool

Phase Comment
4 Integrative  Purchasing is now fully integrated in the major business activities of the
organisation.
 Pro-active purchasing strategies are developed and followed.
 Purchasing is part of the firm's strategic planning process and purchasing
strategy is aligned with corporate goals and strategy.
 The alignment of purchasing strategy with overall organisational goals and
strategy often leads to new requirements in suppliers' performance and
capabilities.
 Suppliers are viewed as partners and supplier management is viewed as
relationship management.
 Today, closely linked or joint communication and information systems
would facilitate this relationship.

2.3.4 Cousins
Cousins (2000) conducted a 12-month research project to investigate the level of strategic maturity in
the purchasing function of UK/European companies. In particular, the research aimed to establish the
level of collaboration between leading UK companies (ie suppliers) and their major customers. The
research looked at a range of inter-connected aspects considered important when looking at how an
organisation deals with relationships relevant to overall strategy and supply strategy.

These aspects are shown in the diagram below.

Cousin's Strategic Supply Wheel

The research revealed that all of the aspects identified and shown in the Strategic Supply Wheel are
inter-connected. Cousins stated that it was clear that a focus on anyone area (eg relationship
development) would be to the detriment of another area (eg performance measures). Organisations need
to balance these resources and issues.

The research also examined the 'relationship type', using a simple classification of 'opportunistic' (low
level of co-operation with the supplier) versus 'collaborative' (high level of co-operation). The results
showed that the more collaborative the relationship the greater the degree of strategic alignment required
(between overall strategy and purchasing strategy).
PART C OPERATIONS MANAGEMENT 5: Operations management and the organisation 141

An ‘opportunistic’ (or ‘competitive’) approach is one where suppliers are selected on price and is based
on the power and threat of the purchasing organisation to switch suppliers and insist of heavy penalty
clauses in supply contracts. There is little trust between the parties and very little information passes
between them (as the buyer seeks to retain as much power in the relationship as possible). This means
that the true potential of the arrangement can never be exploited.

A ‘collaborative’ approach is based on the customer and supplier working together to provide the a
package that best meets the needs of the market. The end-result should be that both parties increase
their market share. Such relationships are long-term partnerships where both parties work together when
designing products and overcoming problems. In this regard, the purchasing organisation may offer sole
supply contracts in return for the supplier’s commitment.

2.4 Supply chain networks

A SUPPLY CHAIN NETWORK is an interconnecting group of organisations which relate to each other through
linkages between the different processes and activities involved in producing products/services to the
KEY TERM ultimate consumer.

Increasingly, organisations are recognising the need for and benefits of establishing close links with
companies in the supply chain. Historically, businesses in the supply chain have operated relatively
independently of one another to create value for an ultimate customer. Independence was maintained
through holding buffer stocks and managing lead-times. There was very little control over other channel
members, and no wider perspective on the system as a whole.

Market and competitive demands are now, however, compressing lead times and businesses are reducing
inventories and excess capacity. Linkages between businesses in the supply chain must therefore become
much tighter. This new condition is shown in the 'Integrated supply chain' model (the second model in
the following diagram).

There seems to be increasing recognition that, in the future, it will be whole supply chains which will
compete and not just individual organisations – we saw earlier how Porter's value chain achieves this.

Traditional and integrated supply chain models

142 5: Operations management and the organisation PART C OPERATIONS MANAGEMENT

The aim is to co-ordinate the whole chain, from raw material suppliers to end customers. The chain
should be considered as a network rather than a pipeline - a network of vendors support a network of
customers, with third parties such as transport businesses helping to link the companies. In marketing
channels, organisations have to manage the trade-off between the desire to remain independent and
autonomous, and the need to be interdependent and co-operative.

INDEPENDENCE: each channel member operates in isolation and is not affected by others, so maintaining
a greater degree of control.
KEY TERMS
INTERDEPENDENCE: each channel member can affect the performance of others in the channel.

If the supplier 'knows' what its customers want, it does not necessarily have to guess, or wait until the
customer places an order. It will be able to better plan its own delivery systems. The potential for using
the Internet to allow customers and suppliers to acquire up-to-date information about forecasted needs
and delivery schedules is a recent development, but one which is being used by an increasing number of
companies. Some supply chain relationships are strengthened and communication facilitated through the
use of extranets (intranets accessible to authorised outsiders).

2.4.1 Implications for supply chain management

Supply chain management involves optimising the activities of companies working together to produce
goods and services. The trend towards closer links with suppliers and the development of supply chain
networks has implications for supply chain management.

 Reduction in customers served. For the sake of focus, companies might concentrate resources on
customers of high potential value.
 Price and inventory co-ordination. Businesses co-ordinate their price and inventory policies to
avoid problems and bottlenecks caused by short-term surges in demand, such as promotions.
 Linked computer systems. Closer links may be facilitated through the use of Electronic Data
Interchange (EDI), for example to allow paperless communication, billing and payment and
through the use of a computer extranet.
 Early supplier involvement in product development and component design.
 Logistics design. Hewlett-Packard restructured its distribution system by enabling certain product
components to be added at the distribution warehouse rather than at the central factory. For
example user-manuals which are specific to the French market would be added at the French
distribution centre.
 Joint problem-solving.
 Supplier representative on site.

The business case for supply chain management is the benefit to all the participants in terms of the
performance objectives of speed, dependability and cost.
PART C OPERATIONS MANAGEMENT 5: Operations management and the organisation 143

Performance objective Example

Speed Plumbers need to manage their supply chains to ensure they are able to get
hold of parts such as water tanks, boilers, valves etc so they can respond
quickly to customer emergencies.
Dependability A mail order business promises delivery within 10 days of receipt of order. It
will need to ensure good supply chain management to fulfil its promise.
Cost A company providing mortgages will need to manage its supply chain with
great skill with one of its objectives being to obtain the cheapest sources of
finance in keeping with the profile and risks of their mortgage lending.

Businesses that are perceived by customers and potential customers to excel at delivering the desired
performance objectives are likely to derive a competitive advantage.

2.5 Demand networks

Demand networks are a recent evolution of supply chains. The key difference between them is how they
are formed.

In a traditional supply chain, producers form links between themselves in order to produce a product that
the customer wants at an appropriate selling price and cost to the producer. The chain is formed to 'push'
KEY POINT
the product out into the market.

By contrast, products produced by demand networks are 'pulled' into existence in response to demand
signals. Organisations within a demand network share information and collaborate to produce a product
or service the market is demanding.

A demand network is the result of companies evolving internally (or within their departments) and
externally (with their partners). This evolution is a four-stage process.

Reacting
Departments optimise their operations to meet demand. Reacting organisations cannot
sense demand or tie it into corporate strategy – they simply react to market conditions.

Anticipating
Anticipating companies have developed internally to respond to long and short-term
demand. They often use lean production or six sigma (see later) to bring order to their
operations. They can anticipate upstream demand (the demand which is coming to them)
but not downstream demand.

Collaborating
Collaborating organisations have established external relationships with business partners
that allow intelligence to be gathered on downstream demand. This allows better
forecasting and adjustment of plans.

Orchestrating
Supply and demand have evolved into a flow of information throughout the network.
Companies plan new products and product life cycles, and can begin to influence demand
patterns. Production decisions are based on costs and profitability.
144 5: Operations management and the organisation PART C OPERATIONS MANAGEMENT

Demand network evolution

To create competitive advantage, organisations within a demand network have to manage three factors:

 Alignment – of shared incentives

 Agility – to respond to demand quickly
 Adaptability – to adjust the structure of the supply chain to meet demand

Exam alert
Exam questions may require you to consider a range of operations strategies and decide which is the most
suitable in a given scenario.
PART C OPERATIONS MANAGEMENT 5: Operations management and the organisation 145

2.6 Supply portfolios and sourcing strategies

Organisations may use a number of suppliers for their raw materials, and there are a range of possible
strategies open to an organisation when deciding who they will purchase their supplies from. For example

 Certain suppliers may produce a better quality of product.

 Some suppliers may be cheaper on price.

 Suppliers may also be selected from a number of countries to guard against the risk of supplies
from one country being affected by circumstances such as bad weather.

 Suppliers are of different sizes so buyers can match order sizes to appropriate suppliers (ie small
suppliers may not be suitable for larger orders).

 Expertise varies between suppliers so building relationships with a number of them can help the
buyer make more informed choices.

The mix of suppliers should be optimised so that the organisation maximises the benefits they offer and
minimises any risks involved in supply – the result is a supply portfolio.

The following strategies may be followed when deciding on a supply strategy.

Supply sourcing strategies

Option Comment
Single Description
 The buyer chooses one source of supply.
Advantages
 Stronger relationship with the supplier.
 Possible source of superior quality due to increased opportunity for a supplier quality
assurance programme.
 Facilitates better communication.
 Economies of scale.
 Facilitates confidentiality.
 Possible source of competitive advantage.
Disadvantages
 Vulnerable to any disruption in supply.
 The buyer is dependent on the supplier.
 Supplier power may increase if no alternative supplier.
 The supplier is vulnerable to shifts in order levels.
Multiple Description
 The buyer chooses several sources of supply.
Advantages
 Access to a wide range of knowledge and expertise.
 Competition among suppliers may drive the price down.
 Supply failure by one supplier will cause minimal disruption – it is easy to switch
between suppliers.
Disadvantages
 Not easy to develop an effective quality assurance programme.
 Suppliers may display less commitment.
 Economies of scale are neglected.
146 5: Operations management and the organisation PART C OPERATIONS MANAGEMENT

Supply sourcing strategies

Option Comment
Delegated Description
 A supplier is given responsibility for the delivery of a complete sub-assembly. For
example, rather than dealing with several suppliers a 'first-tier' supplier would be
appointed to deliver a complete sub-assembly (eg a PC manufacturer may delegate the
production of keyboards).
Advantages
 Allows the utilisation of specialist external expertise.
 Frees-up internal staff for other tasks.
 The purchasing entity may be able to negotiate economies of scale.
Disadvantages
 Quality control is difficult to maintain.
 Loss of confidentiality if products use trade secrets.
 Competitors may utilise the same external organisation so it is unlikely to be a source of
competitive advantage.
Parallel Description
 Parallel sourcing involves mixing/combining the other three approaches to maximise the
benefits of each.
Advantages
 If used correctly should provide an efficient/effective strategy.
 Supplier failure will not halt production.
 Price competition is created between suppliers.
Disadvantages
 Can be complicated to manage.
 Quality control is difficult to maintain.

Strategic supply chain management is also part of the Paper E3 syllabus.

Question 5.2 Sourcing and supplier performance

Learning outcome C2(xii)

(a) List four methods organisations use to source materials. (4 marks)

(b) Which method would you recommend to an organisation whose product is based upon a trade
secret and relies on quality for competitive advantage? (1 mark)

(c) List four criteria that could be used to assess supplier performance. (Hint: Come up with these
yourself based on what you have read and your own experience when you order a product or
service.) (4 marks)

2.7 Information flows across supply chains and networks

For supply chains and networks to operate successfully information must flow smoothly between all
participating organisations. One way of analysing and representing information flows is with the use of
process maps. Process maps are a diagrammatic representation of a process. A number of techniques or
notations may be used to produce a process map.
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2.8 Process mapping

Process mapping aims to identify and represent the steps and decisions involved in a process, in
diagrammatic form.

Process maps:

 Describe the flow of materials, information and documents

 Display the tasks contained within the process
 Show that the tasks transform inputs into outputs
 Indicate the decisions that need to be made
 Demonstrate the relationships and dependencies between the process steps

There are many types of process maps (also known as process charts) and many charting conventions.
Two common types of process map are:

 A ‘basic’ flowchart – which provides a basic 'birds eye' view

 A deployment chart – which provides an overview and also indicates where or by whom actions
are performed

Process maps should be simple enough for the process under review to be understood by almost anyone,
even someone unfamiliar with the process.

2.8.1 Why process map?

Process maps are important for several reasons.

(a) Changing systems and working methods without understanding the underlying processes can lead
to costly mistakes. It can also create conditions that make it difficult for staff to work effectively.

(b) If organisations don’t understand a process they will not be able to manage it effectively – and if
they cannot manage a process they cannot improve it.

(c) Process mapping enables businesses to clearly define current processes, identifying problem areas
such as bottlenecks, delays or waste. This knowledge provides a solid basis from which to develop
solutions and plan new improved processes.

(d) Process mapping enables an organisation to:

 Establish what is currently happening and why

 Measure how efficiently the process is working

 Gather information to understand where waste and inefficiencies exist and their impact on
employees, customers and/or partners

 Develop new improved processes to reduce or eliminate inefficiency.

2.8.2 Process map types and symbols

Two common types of process map are a basic flowchart and a deployment flowchart.

(a) Basic process map flowchart

Process map flowcharts set out the sequence of activities and decision points. They illustrate the
main steps and decisions in the process. Labels showing the type and level of staff doing each step
can be added if required.

(b) Deployment process map flowchart

Deployment process map flowcharts are similar to basic process maps, but also show who does
what, including interactions between the parties involved. This type of chart is sometimes referred
to as a ‘swim lane’ chart – as the page is divided into vertical lanes for each person or party
involved.
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2.8.3 Process map flowcharting symbols

Below are examples of commonly used flowcharting symbols. You should remember though that different
people and organisations may use different symbols, or may use only some of the symbols below. Factors
such as the complexity of the process being modelled and simple personal preference play a part.

Flowcharting symbols

Start/End

This symbol marks the starting or ending point of the system.

Action or
process

A box can represent a single step (‘add two cups of flour’), or an entire sub-process
(‘make bread’) within a larger process.
Document

A printed document or report. This symbol is not always used – it depends upon the level
of detail required in the model.

Decision

A decision or branching point. Lines representing different decisions emerge from

different points of the diamond.
Input/
Output

Represents material or information entering or leaving the system, such as customer

order (input) or a product (output). Again, the use of this symbol is not consistent – some
people may identify a customer placing an order at a retail counter as an action – others
may identify it as Input.
Flow

This arrow indicate the sequence of steps and the direction of flow.
PART C OPERATIONS MANAGEMENT 5: Operations management and the organisation 149

2.8.4 Constructing a process flowchart

Maps are most-easily produced using relatively specialised software, for example Microsoft Visio. General
purpose software packages such as Word, Excel and PowerPoint can also be used.

Organise the sequence out by working down rather than across.

Having thought through the main 'steps' of the process, flowchart them in the sequence they
are performed.

Use rectangles for 'tasks' and diamonds for ‘decisions’. Use connecting arrows between
boxes to represent the direction of the sequence.

Concisely describe each task or decision in its own box. Boxes may be numbered and a key
provided where the activity is described in more detail.

If the process includes decision points, this will normally imply some 'return-routing' causing
some boxes to have more than one input. ‘Return routing’ or ‘loops’ often indicate an
inefficiency or waste.

Decisions usually (but not always) pose questions answerable by ‘Yes’ or ‘No’. Structure
questions so that the preferred answer is 'Yes'.

Conventions include drawing the 'Yes' route out of the bottom of the diamond (ie normal
flow downward through the chart) and the 'No' route as a line to the side of the box).
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2.8.5 A simple process flowchart

2.8.6 Constructing a deployment flowchart

Deployment flowcharts include a ‘department’ or ‘unit’ dimension along the top of the chart. They may
include individuals, groups, departments, agencies, organisations, functions etc – whatever 'units' involved
in the process.

The following should be considered when constructing deployment flowcharts:

 Draw vertical lines to separate the functional boundaries.

 When the flow moves from one function to another, this is ideally denoted by a horizontal line.

 Apart from the horizontal moves between functions, aim when possible to sequence activities from
top to bottom.

 Always connect symbols with arrows indicating the direction of flow.

PART C OPERATIONS MANAGEMENT 5: Operations management and the organisation 151

2.8.7 A simple deployment flowchart

It may be useful to also use the D symbol to indicate any delays in the process, particularly at the
boundaries between agencies or sections.

2.9 Process design

Process mapping is also often used to build a prototype model when designing organisational processes.

Bowhill (2008) saw process design as a way of highlighting inefficiencies and designing improved
processes that ultimately lead to increased customer satisfaction.

An important technique that an organisation can use to identify inefficiencies is through benchmarking.

2.9.1 Benchmarking
Benchmarking is the analysis of performance compared with a similar activity elsewhere. Types of
benchmarking include:

 Internal benchmarking – comparison against the best elsewhere in the organisation

 Competitive benchmarking – comparison against the best elsewhere in the industry
 Inter-industry benchmarking – comparison against the best functional area in any industry

Other management techniques covered elsewhere in this book could be used to improve processes, for
example supply chain management, TQM, Kaizen and Business Process Re-engineering.
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2.10 Operations strategy – Brown

Brown (2001) identified six items to consider when devising an organisation's operations strategy.

Item Comment
Capability required What is it that the organisation wants to 'do' or produce?
Range and location of operations How big and/or widespread does the organisation want to be?
Investment in technology How will processes and production be performed?
Strategic buyer-supplier relationships Who will be key strategic partners?
New products/services How long will the business be able to keep doing what it
does? What are the expected product life-cycles?
Structure of operations How will staff be organised and managed?

2.11 General points

Operations strategy theories are simply illustrations of approaches to operations strategy formulation. In
broad terms, strategy formulation in practice will include many of the following concepts.

(a) Setting operational objectives that are consistent with the organisation‘s overall business strategy.

(b) Translating business strategy or marketing strategy into operations strategy, by means of
identifying key competitive factors.

(c) Assessing the relative importance of different competitive factors.

(d) Assessing current operational performance by comparison with the performance of competitors.

(e) Using the idea of a clean-slate or 'green-field' approach to strategy selection. Managers are asked
to consider how they would ideally design operations if they could start again from scratch. The
ideal operations design is then compared with actual operations, and important differences
identified. Strategy decisions are then taken to move actual performance closer towards the ideal.

(f) Formulating strategy could be based on other types of gap analysis, such as comparing what the
market wants with what the operation is actually achieving, and taking decisions aimed