As you read this article, you will get about the business basics. I organized this article into several topics. In the beginning, I presented what business is about. Then, the next section discusses starting a business, choosing the type of business organization, and setting a vision and mission. Organizing a business and developing a culture is the next topic. Before the competitive strategy topic, you will also learn about business stakeholders and the business environment, which are important for formulating strategy. In the last section, I presented how to grow a business.
What is business?
Business refers to an organization or activity dealing in producing goods or providing services. They play a vital role in our lives. They exist to fulfill our needs and wants, which demand can come from individuals, companies, organizations, or governments. They may or may not be profit-oriented.
To produce goods and services, they combine inputs, process them into outputs. Thus, input quality is the key to producing quality output.
- Inputs – resources used by businesses to produce goods and services. Also called resources, factors of production, or input factors.
- Process – any activity involved in converting inputs into outputs.
- Output – what results from processing the input, it can be goods or services.
Guide to Business and Management
What inputs are used?
- Land – like where the business operates. It is usually defined broadly, which includes various natural resources for producing goods.
- Labor – individual physical and mental effort used in the production process. Its quality is improved through training, education, and experience.
- Capital – physical capital, i.e., man-made tools such as machines, tools, and vehicles. Businesses use financial capital such as cash, equity capital, and debt to purchase physical capital. In economics, financial capital is excluded because it does not contribute directly to the production process.
- Entrepreneurship – the courage to take risks to set up, invest and run a business, hoping to make a profit. The entrepreneur organizes the other three inputs to produce a product. They innovate by developing new ways of doing things and looking for new opportunities to launch and run businesses.
How does the business organize its activities?
There are many different activities within a company, and they are interrelated. Companies usually divide them into several business functions.
- Business functions – various activities to carry out business operations. We usually group them into several divisions or departments. The four main business functions are marketing, operations, finance, and human resources.
Marketing function is concerned with generating revenue by selling products. The marketing department selects target markets and acquires, retains, and grows customers by creating, delivering, and communicating superior customer value.
- It covers many activities and tasks, including promotion, sales, research, pricing, product service management, customer relationship management, and channel management.
Operations function is concerned with transforming inputs into outputs, resource utilization, research and development, logistics, and inventory management.
Human resources function deals with managing human resources within the company. Sometimes we call it personnel management.
- Its basic function is to recruit, motivate, develop and retain the right employees. It aims to ensure the company has the best talent to carry out value creation activities and achieve company goals.
Finance function manages the company’s money, including ensuring accurate financial recording and reporting, either for internal reporting or external reporting (financial reports).
Where does the business operate?
Businesses operate in various industries or markets. We can classify them into four sectors based on their activities, where each sector has similar activities.
- Business activity is about anything a business or company does to profitably satisfy consumers. It may involve manufacturing, distributing, or providing solutions to others (services).
The primary sector involves extracting, harvesting, and converting natural resources. This sector has little added value. Examples are agriculture, plantations, fisheries, animal husbandry, and mining.
The tertiary sector deals with providing services. Companies provide services to individuals, other businesses, or governments. Examples are retail, transportation, banking, insurance, hotels, restaurants, and tourism.
The quaternary sector provides services but is more specific to knowledge-based and intellectual activities. Examples are research and development, computing, information, and communication technology.
Sectors contribute to output, income, and employment in an economy. However, how important they are, it varies between countries. For example, the secondary sector may be more dominant in some countries. While in others, the tertiary sector dominates.
- Industrialization – the transition of the economy from agriculture-based to manufacturing-based. It creates higher added value in the economy.
- Deindustrialization – a long-term decline in the importance of the manufacturing sector in an economy. It may be the result of loss of competitiveness, loss of skilled labor, and capital flight.
Starting a business
Start-ups are new businesses with a focus on pioneering new products, production methods, or distribution. Recently, they have developed a new business model, which disrupts the conventional business model by adopting more reliable information technology.
Who started the business?
Business ideas can come from entrepreneurs or intrapreneurs. Who are they?
- Entrepreneurs – individuals who take risks to implement ideas and combine resources to solve problems. Some may seek to commercialize the idea by selling products and services for a profit. Meanwhile, others may be more interested in creating positive change in society through their initiatives.
- Intrapreneur – internal entrepreneur. They work in a company but have an entrepreneurial spirit. They launched new initiatives and developed new businesses to drive the company’s growth.
Intrapreneurs are different from entrepreneurs. For example, they are bound by company policies, while entrepreneurs are more flexible in commercializing ideas, integrating factors of production, and managing risk.
In addition, intrapreneurs work in the best interests of shareholders. Meanwhile, entrepreneurs work for their own interests and act as owners (shareholders) of the new business.
Why do entrepreneurs start businesses?
Various reasons inspire entrepreneurs to start a business. They may want:
- Make more money by maximizing business profits.
- Commercialize hobbies to earn extra money.
- Be their own boss and not just be a yes-man.
- Gain satisfaction by helping solve problems around them, either through the goods or services they launch.
- Bequeath wealth for a better future for their families.
How to start a business?
The general steps in starting a business include:
- Write a business plan on how to set up, run, and grow a new business.
- Looking for initial capital and sources of financing, whether it comes from your own pocket, close people, or external funding such as bank loans.
- Manage resources, including business location, employees, business structure, fixed assets, and inputs.
- Registering a business to obtain a business license, legality, and protecting the name or brand owned, including obtaining a tax ID.
- Open a bank account for daily financial transaction needs.
- Marketing the product to the targeted market.
How to develop a business plan?
A business plan is a written strategic plan for commercializing an idea by running a business. It is important since serving as a blueprint for running a business smoothly and for securing funding by helping to convince investors or lenders.
A business plan usually outlines the following:
- Business and owner – about the business name, business type, intent, purpose, and owner details.
- Production – about what is sold, the price, the value proposition, how to produce, and the inputs used.
- Market preview – to whom the product is sold, market profile, competition, and competitive strategy.
- Finance – details start-up costs, potential sources of financing and revenue, expenses, cash flow forecast.
- Personnel – employees and skills, including how they are organized.
- Marketing – the strategies and marketing mix used by businesses.
Why do new businesses fail?
Business failure can occur due to external pressure or internal problems. As a result, new businesses don’t survive and have to stop or close their operations. A variety of reasons explain why new businesses fail, including:
- Marketing problems such as failure to attract customers
- Problems with funding and cash flow because it did not go as planned.
- Poor business location, increasing marketing or logistics costs.
- Competitive pressure from established companies.
- Human resource management issues, such as employee choices or poor leadership.
- Production problems, for example, due to man-made disasters or natural disasters.
- Deteriorating economic environment, such as a recession.
Choosing the type of organization
Businesses may operate in the private sector as well as the public sector. For example, they may be sole proprietorships and partnerships, for which the owner has unlimited liability. Or, they are a limited liability company, where the business is a separate legal entity from the owners.
Who is the ultimate owner of the business?
The private sector comprises various businesses in which the ultimate owner is an individual, either one person or several persons. Generally, they aim to generate profits. They may:
- Unincorporated business – there is no legal distinction between the business owner and the business itself. Sole proprietorships and partnerships are examples.
- Incorporated business – an entity whose existence is legally recognized as a separate entity from its owner. It can be a private limited company and a public limited company.
The public sector is the economic sector under the control of the government. It may be directly through government institutions or through state-owned entities. Goods or services may be free or for a small fee, e.g., public hospital services and museums.
- A public corporation is a state-owned business, which is fully or partially funded from the state budget. It is sometimes called a national industry because one company usually acts as a monopolist in a particular industry. It is common in strategic sectors such as electricity and railways. Also known as state-owned enterprises (SOEs).
A public-private partnership (PPP) is a participatory collaboration between the government and the private sector in public projects such as infrastructure. Such cooperation is usually a solution when the government’s fiscal capacity is limited, so it is necessary to involve the private sector.
PPP takes many models. Private companies may be involved in financing and building public facilities. Once done, they hand it over to the government, and they might as well operate the facility.
Privatization means transferring state-owned assets or companies to the private sector. It also includes when the government appoints a private company to provide certain public services previously provided by state-owned entities.
- A common way to privatize is with an initial public offering. State-owned companies issue their shares on the stock exchange to be owned and traded by the public.
Nationalization is the opposite of privatization. The government took over private companies and brought them under control.
How much responsibility should the owner be?
Unlimited liability – the business owner or partner has full legal liability for the business’s debts. They may have to sell personal assets to pay off debt. Two examples are:
- Sole proprietorship
A sole proprietorship is an unincorporated business and is owned and operated by one person. The owner has unlimited liability for the debts and obligations of the business. So, if the business’s money is not enough, they may have to sell personal assets to pay off the business debt. Also known as a sole trader.
A partnership is a business organization in which two or more partners form a business and operate it. Each partner contributes money and resources and shares responsibility for managing the business. Partners are generally responsible for operations and debt.
- General partnership – partners have unlimited liability for the debts of the business. They risk losing their personal savings and assets if the partnership is unable to pay its debts.
- Limited partnership – some partners have limited liability, according to their investment. The limited partner does not risk losing personal assets when the partnership is unable to pay its debts.
Limited liability – the business has a separate legal identity from the owners (shareholders), who have liability limited to the amount invested. So, they don’t have to sell their personal wealth to pay off the company’s debts. This business structure is divided into two categories:
- Private limited company – if its shares are not sold to the public through the stock exchange. Also known as a closed company or privately-held company.
- Public limited company – if its shares are sold to the general public through the stock exchange. Company shares are available for trading by the public through the stock exchange. Called a public company or listed company.
What is the orientation in producing products and services?
The for-profit businesses aim to generate profit. They seek to maximize profits by selling goods or providing services. They may operate as a sole proprietorship, partnership, or corporation (either a private limited liability company or a public limited liability company). Also called a commercial business or profit-oriented business.
For-profit social enterprises aim to generate profit but are socially oriented, not maximizing shareholder profits. Instead, they focus their business operations on social impact and maximize benefits to society and the environment. They share profits with members, give them to third parties, or use them to purchase resources to increase business reach.
- Cooperatives – owned and run jointly by members to meet common needs and goals. They join voluntarily and manage the cooperative under common ownership. Each has a voice in selecting the board.
- Social enterprise – a business whose main interest is not profit but also social goals. They operate commercially but reinvest most of their profits into society rather than maximizing profits for shareholders.
- Microfinance providers – offer financial services to those with limited access to financial institutions. In addition to loans, they may also provide micro-insurance and micro-savings.
Non-profit organizations are not profit-oriented and any money received does not go to the owner or organizer but to help fund the goals and objectives of the organization. Examples are charities and communities.
- Charities raise money for philanthropic and social welfare programs. They don’t make a profit. They are exempt from taxes.
- A non-governmental organization (NGO) is an independent organization without the participation or representation of any government. They usually aim to provide various humanitarian services and functions. They are often involved in social activities and voice specific issues such as sustainable development, emergency assistance, poverty alleviation, and child protection.
Setting the vision and mission
Vision describes the desired position for the company in the long term. It succinctly states the company’s ambitions and answers the question, “What do we want to be?”
- Vision statement – a written statement of the company’s vision. It should be short and, often, only one sentence long.
Mission states the business objectives and answers the question “What is our business?” and “Why do we exist?”. It provides a context within which strategy is formulated. It differentiates the company from competitors and identifies the scope of its operations, mainly related to the products offered, and markets served.
- Mission statement – a formal statement of the company’s mission. It supports the vision and serves to communicate goals and direction to stakeholders.
Organizational objectives cover the following three levels:
Strategic objectives – desired outcomes at the corporate level and describe what the company must do to fulfill its mission. Senior management establishes them, determines the necessary actions, and mobilizes resources for their implementation. An example is “to be number one in the industry.”
Tactical objectives – medium-term goals or targets to be achieved. The company breaks down its strategic goals into small, interrelated targets. It is at the departmental level. For example, increase market share by 10% in five years.
- A tactical plan is developed to implement parts of the strategic plan, outlining the steps.
Operational objectives – short-term goals or targets at the team level. Lower management develops day-to-day short-term action plans to achieve the company’s tactical goals as efficiently as possible. For example, developing a digital presence to increase sales.
Strategy vs. tactics
Strategy is the integrated choices taken to achieve the company’s mission and goals. It is not a specific goal and action, for example, to become a market leader through acquisitions. Rather, it represents the position chosen by the company, which is expected to lead to the vision and mission.
Tactics are carefully crafted short-term plans or actions to implement the chosen strategy. In other words, it is the path taken to realize positioning.
Corporate social responsibility
Corporate Social Responsibility (CSR) is a concept whereby businesses pursue profit and take responsibility for the impact of their activities on various stakeholders. For example, it may be through philanthropy, diversity and fair employment, legal compliance, and environmentally friendly operations.
Triple bottom line – the three goals of the company: profit, people, and planet. All three compromise economic, social and environmental objectives.
- In the conventional approach, the company only pursues profit. However, along with awareness about sustainability, companies must also pay attention to two other aspects.
- The reason is simple. Businesses need “people” as inputs and buyers and “planets” as inputs for raw materials in generating profits. Thus, when ignoring the other two aspects, there is no sustainable profit for the company.
An environmental audit is a systematic examination to measure a company’s performance and position concerning its environmental responsibilities. The audit answers questions such as: Has the company complied with environmental regulations and requirements? Are the implemented environmental responsibility policies and practices in line with the objectives?
A social audit refers to a systematic evaluation of corporate social responsibility. It reviews related company practices and policies and the company’s impact on society. It is useful for assessing how well the company is achieving its social responsibility goals.
Business ethics is a set of moral principles, especially those related to conducting business and management’s responsibilities to stakeholders, the environment, and society. These principles govern business behavior and human resources in it.
- Ethical principles – beliefs about what is good, acceptable, or obligatory behavior and what is bad, unacceptable, or prohibited behavior.
- Ethical responsibility – the responsibility to behave in a way that is generally considered right by society.
- Code of conduct – a set of guidelines for principles and standards of professional ethics and employee behavior. It serves as a general guideline on how employees should act, often sourced from a code of ethics.
- Code of ethics – a formal statement of the ethical or moral principles adopted by the company. It is different from the code of conduct. For example, the company prioritizes environmentally friendly ethics in its operations. The company then encourages employees to use less paper, except where they should. The first is a code of ethics, while the second is a code of conduct.
Organizing a business
Organizational structure is concerned with how elements within the company are organized to achieve efficient operational practices. It provides accountability by specifying who is responsible for a particular job and the chain of command, i.e., who is responsible for whom. The organizational structure is important to achieve stability, consistency, continuity, unity, and efficiency in operating the business.
- Organizational chart – shows the different functional departments, the chain of command, the span of control, and communication channels within a company. It visualizes the lines of communication, promotion, and roles in each position.
There are various organizational structures, including:
- Tall organizational structure – has many hierarchical levels, a long chain of command, but a narrow span of control. Decision-making is centralized with limited delegation. It is commonly adopted by established businesses.
- Flat organizational structure – the opposite of tall structure. It has fewer hierarchical levels, a shorter chain of command, but a wide span of control. Decision-making is decentralized with more delegation than tall structures.
- Hierarchical organizational structure – the traditional model for representing business structures. It denotes the chain of command in a particular business. For example, senior managers at the top and bottom of the chain are middle managers, junior managers, and employees.
- Organizational structure by function – employees are grouped by marketing, finance, and human resources. Once the departments are formed, they are then sorted by seniority.
- Organizational structure by product – organizing human resources based on the different products made by the company.
- Organizational structure by region – organizing based on geographic or regional circumstances. It is a general international company with business activities in many countries.
Span of control
The span of control shows how many people are subordinate to a manager and to whom the manager is responsible. It affects whether the organizational structure is flat or tall. Factors considered include management style, manager’s experience and competence, nature of work, and adopted mode of operation/production.
- Tall organizational structure has many hierarchy levels. A flat organizational structure has few hierarchical levels.
Delegation is the extent to which superiors pass through the hierarchy to subordinates and give subordinates the authority to make certain decisions or carry out certain tasks. Even though some are delegated, the superior remains responsible for the outcome of the task or decision.
- Delegation can encourage subordinates to continue to learn, increase participation, and ultimately motivate employees. On the other hand, it saves time for the boss.
- However, it can cause confusion. It can also lead to failure if subordinates do not live up to expectations.
Levels of hierarchy
Levels of hierarchy describe the level of responsibility within the company. The organizational structure is arranged based on rank; there are seniors and juniors. It provides clear lines of communication but is often stiff and slow to respond to change.
Delayering means removing a layer in the business hierarchy/management layer. It aims to achieve a flatter structure and make the business less bureaucratic, allowing for more flexibility.
- Delayering reduces costs because there are fewer managers to hire. Apart from that, it also increases communication speed and encourages delegation.
- But, delayering is often accompanied by downsizing by reducing the number of employees. It can lead to job insecurity and a decrease in morale.
Chain of command
The chain of command is the way authority and responsibility are organized within the organization. It is a formal line of authority to be followed when making decisions.
Bureaucracy shows the relative importance of rules and procedures, which regulate detailed routines for carrying out certain activities. Bureaucratic companies mean they have a lot of regulations, rules, and established ways of doing things. Companies divide roles clearly in the form of a hierarchical system.
- Bureaucracy is important for standardizing processes and ensuring efficiency. It turns employees into specialists rather than generalists, making them more productive. In addition, authorities and responsibilities are clearly defined.
- However, bureaucracy often hinders creativity and reduces job satisfaction. It also makes decision-making slow. Lastly, it is thought to be responsible for the high turnover.
Centralization vs decentralization
Centralization and decentralization are the extents to which decision-making is devolved between different levels of the hierarchy. Factors considered whether to choose centralization or decentralization are usually the sizes of the organization, the scale of decision importance, corporate culture, and management attitudes and competencies.
Centralized organizational structure – all major decisions in the business are made by a minority, usually by senior management or the executive board.
- Centralization enables fast, controlled, and consistent decision-making.
- But, it can also demotivate employees and make the organization less flexible. Senior management is also stressed because they have to make a lot of decisions.
Decentralized organizational structure – top managers share decision-making. Senior managers make core strategic decisions; others are left to middle managers.
- Lower-level decisions are made faster, increase employee participation, and encourage them to be more enthusiastic.
- However, the chance of error is greater, and reducing it requires more intense communication. Decisions by top managers and middle managers can be inconsistent.
Developing corporate culture
Corporate culture is about beliefs and behavior within the company, which is defined as what is normal. It’s not only about interactions within the company but also about how to deal with stakeholders.
- Culture helps individuals, especially new employees, to adjust to the traditions and routines of the organization. It also increases togetherness, ownership, and security among employees, making them more cohesive and minimizing clashes.
- Various factors influence the culture formed, including the nature of the business, vision and mission, organizational structure, management style, rewards, and sanctions.
Four types of corporate culture:
- Power culture – centralized power, where decision-making authority lies with a dominant group of individuals. It is common in flat organizational structures with wide spans of control. Formal positions are underappreciated because real power is concentrated in a few people.
- Role culture – each individual’s job is clearly defined through a formal job description. Organizations within companies are usually structured and often bureaucratic.
- Task culture – focuses on getting work done with decentralized authority. The main focus is to complete the work according to the target. Individuals or teams have flexibility.
- Person culture – individuals are in similar positions, often with similar skills. They form groups to share skills and knowledge. This culture usually exists in large companies with many branches.
Dealing with stakeholders
Business stakeholders – various parties interested in, are influenced or influence the strategic decisions and operations of the company. They include shareholders, employees, management, customers, suppliers, creditors, governments, local communities, the general public, and special interest groups. Unfortunately, their interests are not always aligned, often even contradictory, giving rise to a conflict of interest.
- The stakeholder concept emphasizes responsibilities to various stakeholder groups, not just shareholders.
Stakeholders fall into two general categories:
- Internal stakeholders are within the organization.
- External stakeholders are outside the organization.
Internal stakeholders represent stakeholders within a company. Their income depends on the company’s performance. On the other hand, they either own shares or work in the company. Thus, their performance and decisions affect the company’s performance.
- Owners or shareholders hold company shares. They can be individuals or institutions. They have an interest in business performance and have decision-making power. The company’s performance affects the dividends and capital gains they earn. If there is no reward, they don’t bother investing in the company.
Employees work under the direction of others in exchange for wages or salaries. As a result, the company’s performance affects their income and job security, which is also determined by the quality of their work.
- Staff typically refers to full-time white-collar workers, whose working conditions, pay grades, and additional benefits are typically higher than those of blue-collar workers.
Management is responsible for planning, organizing, leading, and controlling the resources within the company.
- Their importance to the company is relatively similar to employees, salaries, and job security. However, they occupy a higher hierarchy. The company’s performance depends not only on the quality of their work but also on their decisions.
Management can span multiple layers, including:
- Managers are responsible for setting goals, managing resources, and motivating staff to achieve company goals.
- Director is the highest person in charge of the overall performance and operations of the company. They may fill positions as chief executive, finance director, marketing director, operations director, and human resources director. They are often referred to as senior management – managers at the top of the hierarchy.
External stakeholders are outside the company. They may have a claim against or interest in the operations and performance of the company. Examples are suppliers, customers, governments, banks, bondholders, trade unions, local communities, and the general public.
Suppliers provide goods and services to the company. They like it when the company pays faster and orders more frequently and in large volumes.
Customers surrender money to acquire company products. They buy maybe for their own consumption or for the consumption of others. They are the most important stakeholders. Without them, the business cannot continue to exist because it cannot make money. On the other side, they have an interest in getting a product that is, at least, worth the money they pay.
Pressure groups are interested in the company and try to influence the company’s policies and behavior for certain purposes. For example, they may lobby the government to change a company’s policies or practices by issuing petitions or writing letters to members of parliament.
Governments are concerned with business performance primarily because they affect tax revenues, job and income creation in the economy, and business impact on society and the environment. On the other hand, the government has also launched various regulations and policies regarding business, including employment practices, product safety, minimum wages, and economic policies.
Competitors aim to beat the company to make more money. They serve the same basic customer needs as the company. They are happy if the company fails. Their strategy affects the company’s success.
Creditors provide loans to the company. They may be banks or bondholders. They are interested in their money back plus interest and paid on time. If the company fails to pay, they may file for bankruptcy against the company in court.
Why do stakeholder conflicts arise?
- Take the example between shareholders and employees. Shareholders do not like high employee salary increases because it reduces the profits distributed to them.
- Another example is between shareholders and customers. Customers want cheaper and higher-quality products. That increases costs, reducing the profits available to shareholders.
- Such conflicts require companies to make priorities.
How to handle conflicts of interest?
Satisfying all stakeholders all the time is impossible.
- Stakeholder analysis identifies and evaluates how strategic each stakeholder is to the company. It is important to assist management in making decisions, prioritizing policies and strategies for dealing with them.
- The stakeholder map classifies stakeholders based on two variables: how strategic they are and how significant their influence is. The greatest priority should be allocated to strategic stakeholders to the company’s success and significantly affect the company.
Solutions for dealing with conflicts of interest:
- Arbitration – to resolve industrial disputes between employees and management.
- Workforce participation – to reduce potential conflicts between employees and managers by improving communication, decision-making roles, and motivation.
- Profit-sharing schemes – reduce conflicts between employees and shareholders by sharing profits, not only for shareholders but also for employees and management.
- Share-ownership scheme – to reduce conflict between employees, managers, and shareholders where employees and managers have the opportunity to own company shares.
Scanning business environment
Business environments affect business success. They fall into two categories:
- Internal environment – is within the organization and under management control. They bring out strengths and weaknesses.
- External environment – is outside the organization and beyond the control of management. They present opportunities and threats.
Internal environment includes internal stakeholders (such as employees and management), organizational structure, and corporate culture. They influence activity, competitive capacity, and decision-making within the firm.
Business structure – the legal form as stated in its charter. The three types are sole proprietorship, partnership, and corporation. Corporations have a higher capacity to compete because they have more significant capital compared to the other two.
Organizational structure – about how the company organizes tasks, responsibilities, decision making, workflows, communication channels, and hierarchies. It determines the mode in which the company operates and works.
- There are various organizational structures, including flat, functional, divisional, and matrix structures. Each determines how flexible the company is in responding to external opportunities and threats, which are often dynamic and constantly changing.
Corporate culture – a set of beliefs, norms of behavior, and values inherent in the company. It characterizes the company and the way it operates. Culture is learned, shared, and transmitted to new individuals in the company.
External environment exposes opportunities and threats for the company even though they are outside the company’s control. Companies can only adapt. They fall into the following three categories:
- Natural physical environment – such as physical resources, climate, and wildlife. They represent the outermost environment in which the change exposes the other two environments (social environment and task environment).
- Societal environment – including the political, economic, socio-cultural, and technological environment.
- Task environment – formed from the interaction between the company and its stakeholders. Sometimes it is also called the industry environment.
Environmental factors – such as weather, climate, air, water, soil, natural resources, flora, fauna, and so forth. They expose businesses, but their impact varies across industries.
- Insurance, for example, has direct exposure to environmental changes. Climate change increases natural disasters and catastrophic risks, giving rise to significant losses and claims.
Political factors – government or public affairs. It affects the company through the policies and regulations made. For example, when the head of government changes, the policies adopted by the new one may be different from the previous one. Another example is the riots due to dissatisfaction with the election results.
Economic factors – the economic conditions surrounding the business. They include economic growth, inflation, interest rates, and exchange rates. Their changes can affect aspects such as operating costs and consumer spending attitudes.
Socio-cultural factors – institutions and elements in society such as demographic structure, lifestyle, attitudes, culture, and tastes. They can change, which affects the company’s products, business activities, strategies, and the way they market their products.
Technological factors – technological developments and changes. It affects the product and various other business aspects, including business models, production techniques, and marketing and communication channels.
- Information technology includes computer systems, the internet, software, wireless telephones, and networks to support information systems. They contribute to reducing operating costs and time, operating efficiency, and becoming a key managerial tool in business decision-making.
Legal factors – laws and regulations passed by the government such as company laws, trade union laws, environmental standards, and product safety. Their changes may force businesses to change the way they operate to comply with new laws or regulations.
Task environment – various factors in the market in which the company operates. It may be related to market structure, industry cycles, the extent to which forces such as competitors, buyers, suppliers, new entrants, and substitutes affect a firm’s profitability and competitive advantage in the market. Changes in these factors only have an impact on companies in the industry, not in other industries.
- Market structure – the composition and relationship between elements in the market. It includes the number of companies and consumers, company size, differentiation, barriers to entry and exit, competitive strategy (price or non-price competition), and market power. The five market structures often cited are perfect competition, monopolistic competition, oligopoly, and monopoly.
- Porter’s Five Forces – five factors to explain competition and answer why certain industries have higher profitability than others. They are rivalry among existing companies, barriers to entry, the threat of substitution, bargaining power of suppliers, and bargaining power of buyers.
- Industry life cycle – a pattern showing how an industry/market evolves from embryo to decline. It is divided into five phases: embryo, growth, shakeout, maturity, and decline. Such evolution affects profitability and competition in the market.
How to analyze the external environment?
Companies analyze the internal and external environment as they affect the business. The tools used by management are:
PESTEL analysis provides a framework for examining the company’s external environmental conditions. PESTEL stands for political, economic, social, technological, environmental, and legal. It is useful to sort out which factors are relevant and significantly affect the company.
SWOT analysis – stands for Strengths – Weaknesses – Opportunities – Threats. It is useful to map which external environmental factors are the most significant, considering its internal environment. The results serve as a management guide for developing strategy.
- Companies map the opportunities and threats in their external environment. Then, they map out their strengths and weaknesses, which come from their internal environment.
- Ideally, companies should effectively manage external opportunities and threats considering the company’s internal strengths and weaknesses. Companies should exploit external opportunities with their internal strengths and minimize the impact of external threats on their weaknesses.
- Strengths – advantages over competitors and are the foundation on which to build competitive advantage. For example, the company has a flexible organizational structure, a culture of innovation, and strong brand equity.
- Weaknesses – negative factors within the company, which can lead to a competitive disadvantage. Examples are limited capacity, outdated production machines, or high levels of financial leverage.
- Opportunities – potential areas to be exploited to grow the business and increase future profits. For example, lower interest rates and increased consumer spending.
- Threats – negative factors, which hinder or jeopardize the company’s future success. Examples are intense market competition and rapid technological changes.
A stakeholder map is important to address whose interests should be considered when developing or implementing a strategy. Therefore, companies must systematically collect and analyze information about who the company’s stakeholders are, how they affect the company, and how significant their influence is.
- Stakeholder maps are made into a two-dimensional matrix: how strategic they are to the company and how significant their influence to the company. Then, each stakeholder is assigned to a matrix.
Strategic groups help companies identify who is their most direct competitors. Through this analysis, companies will also know on what basis they are competing.
- Like stakeholder maps, companies map strategic groups into a matrix using two main variables. Then, they identify and place competing firms into the matrix.
Building a competitive strategy
Competitive strategy is about how companies outperform competitors in serving consumer needs more profitably. It sometimes works, resulting in a competitive advantage and above-average returns. But, not a few also failed.
- Strategic analysis examines the business environment with an emphasis on its implications for corporate success. It scans current conditions and considers future possibilities, taking into account the significance of each factor.
Strategic competitiveness – when companies successfully formulate and implement a value creation strategy, which enables them to outperform competitors and deliver superior performance. In other words, it generates a competitive advantage.
Competitive advantage – when a company generates higher profits than companies in the industry, usually measured by the return on invested capital (ROIC). Companies do business better than their competitors, perhaps through cost leadership or differentiation.
- Sustainable competitive advantage – when its strategy allows it to maintain above-average profitability over time.
Porter’s generic strategy
Porter’s generic strategy provides the foundation on which to build a competitive advantage. Porter divides them into three categories:
- Cost leadership – creates value to satisfy customers in the same way as competitors, but more efficiently. The company offers relatively standard products and sells products at industry average prices. But, it has a lower cost structure than the average competitor. So, its profit is high because even though the revenue is average, it saves more costs.
- Differentiation – creating value by providing a unique offering. It makes customers willing to pay a premium price. The margin per unit is high, and therefore the company’s profits as well.
- Focus – instead of applying the above two strategies to the main market, the company targets a narrower market (niche market). Customers in a niche market have more specific needs to satisfy. Large companies do not want to enter, probably due to low economies of scale.
Competitive advantage is rooted in the company’s resources and capabilities. Both are decisive factors for creating superior value.
- Resources – unique company-specific assets, little or no competitors have, such as patents, intellectual property, brand equity, and company reputation. Companies exploit them to create cost or differentiation advantages.
- Capabilities – the company’s ability to use its resources effectively. Examples are leadership style, innovation culture, and organizational agility. They are more difficult to imitate than resources because they are embedded in organizational routines. They are not documented as procedures.
- Core competencies – unique resources and capabilities act to differentiate the company from its competitors. It generates a competitive advantage if it contributes to value creation, is rare and non-substitutable.
How do companies develop competitive strategies?
Strategic management is the foundation for creating value and achieving sustainable competitive advantage. It is formulating, implementing, and evaluating context-relevant strategies. If it successfully leads to value creation, the company has strategic competitiveness.
Companies build competitive advantage by empowering internal resources and capabilities to face external opportunities and threats. Both are the basis for building core competencies, as discussed earlier. Building a competitive strategy typically involves the following processes:
- Internal and external environment analysis – scan for external opportunities and threats and internal strengths and weaknesses. It should lead to strategic plans and objectives to maximize opportunities using internal strengths and minimize the impact of external threats on company weaknesses.
- Strategy formulation – formulating overall long-term goals for the company and developing policies and tactics to achieve these goals.
- Strategy implementation – executing policies and plans across business functions. It requires synergy between them to achieve company goals.
- Evaluation – establishes a mechanism for reviewing individual policies and the overall strategy itself to keep it relevant to the external environment, which often changes over time.
Business growth is about increasing the size or scale of a company’s operations. It is important to support a better market position and profit. When companies grow faster than their competitors, they can dominate the market. They can sell more output, achieve higher economies of scale and earn higher profits.
- Business expansion – an attempt to grow the size of the business. It can be through internal growth strategies or external growth.
As companies get bigger, they gain economies of scale and make more profits.
Economies of scale are when the long-run average cost decreases as the volume produced increases. By lowering costs, the company earns higher profits.
- Technical economies of scale – larger firms can use more efficient production techniques and production specialization.
- Managerial economies of scale – when operations are larger, companies can hire specialist staff to oversee production, thereby cutting managerial costs per unit. The company also spreads the administrative costs associated with business functions such as finance and human resources to more output.
- Financial economies of scale – large companies are considered more established and less risky than small companies. Thus, they can raise capital, such as borrowing a bank or issuing bonds, at a lower cost.
- Marketing economies of scale – firms spread marketing costs over more output, making marketing costs per unit lower. For example, the company incurs one-time advertising costs for its output. If it produces more output, then advertising costs per unit of output fall.
- Purchasing economies of scale – firms get discounts when buying inputs in large quantities.
External economies of scale – cost reduction occurs across all firms in an industry. The examples above are internal economies of scale, where the reduction in costs occurs only in one company. External economies of scale occur beyond the control of individual companies and apply to all companies in the market. For example, when the government provides tax breaks, it applies to all companies in an industry.
Diseconomies of scale – costs increase when companies increase output. It occurs when production has passed the minimum efficient scale where the long-run average cost is lowest. Thus, an increase in output further increases the cost per unit. Bureaucracy and management complexity are among the causes.
Economies of scope – cost savings when a company produces two or more products using existing resources. It shares production machinery, distribution systems, and skilled labor for different activities and outputs. Thus, it optimizes their use, minimizes idle resources, and finally, reduces costs.
Business size is about how big the company is, measured from variables such as the number of employees, total production, revenue, total assets, sales volume, or even market capitalization.
Size affects the company’s capacity to compete in the market.
- Small business – small operation size. Definitions vary between countries. Some definitions might say they have fewer than 100 employees. They are usually privately owned by a single individual or a small group of individuals. For production, usually, they only rely on one factory and target the local market. Although relatively easy to manage, the competitive capacity is low.
- Large business – large operating size and high economies of scale. They target national or even international markets. They may own several factories and rely on advanced production technology and techniques. They also have more access to financial capital and are easy to attract specialists or professionals.
The Ansoff Matrix offers a framework for explaining how companies grow concerning their products and target markets. It classifies growth strategies into four: market penetration, market development, product development, diversification.
- Market penetration focuses on existing products and markets, for example, by increasing promotions to reach more consumers or adjusting prices to attract more people to buy.
- Market development means marketing existing products to new markets, for example exporting them abroad or attracting new market segments.
- Product development focuses on the current market with new products, for example, by launching new variants or complementary products to existing ones.
- Diversification focuses on products to new markets. It could be concentric diversification, where the company targets markets that are related to the current market. Or, it’s conglomerate diversification where they are completely different from what they already are.
Two ways to grow a business: internally or externally. Both have different risk exposures and opportunities for success.
- Internal growth – increasing the business size by relying on internal resources and competencies. For example, a company may choose to open a new factory, increase advertising and promotion, or establish a subsidiary. Also known as organic growth.
- External growth – integrating external and internal resources and competencies. It could be through acquisitions, mergers, and joint ventures. Also known as inorganic growth.
Merger – when two companies are combined into one. There is only one surviving entity, maybe one of them or forming a new entity. That’s different from acquisitions, where the two companies still survive and operate independently. One company acts as the parent company, while the other acts as a subsidiary.
Acquisition – when a company buys a controlling stake in another company. After this corporate action, the target company becomes a subsidiary and operates independently (unlike a merger). It could be:
- Friendly acquisition – the target company’s management agrees to be acquired.
- Unfriendly acquisition – the target company’s management opposes the acquisition. Known as a hostile acquisition. Also, the term takeover is usually used to refer to it.
Joint venture – an arrangement between two or more companies to work together on a particular project or business for the common good. It is a type of formal strategic alliance in which the companies involved set up separate new companies.
Strategic alliance – when two or more work together, share resources and expertise to achieve common business goals. Such cooperation can be joint ventures, co-production arrangements, marketing alliances, and technology transfers. It is an important way to gain market access, competence collaboration, technology exchange, capital, and risk-sharing.
Franchising – granting another party the right to use a company’s name, reputation, and skills in a specific location or area in exchange for royalties or fees. Franchisees often receive technical expertise, financing, and inventory assistance from the franchisor. They also agree to abide by the franchisor’s strict rules on how to do business.
Licensing – granting another party the right to use a patented technology, manufacturing process, or design in a specific market or geographic area for compensation of fees and royalties. The licensee then uses it to make money.
Business integration is a strategy to unite or combine various businesses to be under the company’s control. For example, a company may take over a controlling stake in its supplier and make it a subsidiary. It could be through acquisitions or mergers.
Horizontal integration increases control in its current supply chain. For example, it is possible by merging with competitors, making the company size bigger. Or, it is by acquiring competitors and making them subsidiaries and under the control of the company.
Vertical integration joins businesses in a vertical supply chain. Companies can do this by acquiring other companies, establishing subsidiaries, or joint ventures. It can be:
- Backward vertical integration – entering the upstream business to gain control over inputs such as raw materials and components. For example, an automobile company acquires a tire manufacturer.
- Forward vertical integration – entering the downstream business to increase control over distribution and retail. For example, a car company takes over a car distributor.
Conglomerate integration – integrating diverse unrelated businesses under one control. The company enters other businesses outside its current supply chain. It usually aims to diversify and reduce concentration risk where the profits of one business can compensate for the losses in the other.
- Lateral integration – integrating several companies where they sell related goods or services but do not compete directly with each other.
Expansion to the international market
International business is involved in international trade or investment. There are various reasons why domestic companies are going global. They choose foreign markets because the market size is more significant than the domestic market. Technological advances also contribute to reducing production costs and information exchange. Trade liberalization and deregulation reduce trade barriers.
Globalization – an integration process in which countries are interconnected through international trade, international migration, investment, capital flows, and the spread of technology. That will eventually lead to the homogenization of the worldwide market.
- Globalization opens opportunities as well as challenges for businesses. Companies can more easily access the international market, which is much more significant than the domestic market. But, they also have to compete with companies from other countries, which might have better resources.
Multinational companies are involved in business in more than one country. They control or manage production and distribution facilities in several countries. They usually have a head office in their home country to coordinate and manage their global activities.
- Transnational corporations combine the features of multinational and global strategies. Companies compete through product standardization worldwide but remain open to adapting through adaptation to local conditions. In other words, they pursue a strategy of low cost and differentiation through the various subsidiaries under their control. In addition, they also encourage synergies through the transfer of skills between subsidiaries.
How to enter the international market?
Exporting – the company sells products abroad. This strategy is relatively fast with low risk. But the company has low local control and knowledge. In addition, companies are also vulnerable to changes in trade policies by governments in destination countries.
Licensing or franchising – granting license or franchise rights to parties abroad with royalty or fee compensation. This entry strategy is relatively fast, low cost, and low risk. However, the company has less control, and third parties may become competitors in the future.
Strategic partnerships and alliances – cooperating with established companies in the target country. It reduces risk by sharing costs, knowledge, and resources with partners.
Acquisition – taking over an established company abroad. This strategy is relatively quick to achieve an established position in the destination country. But, it also carries a high risk and cost.
Greenfield investment – the company establishes a new wholly-owned subsidiary. This strategy is slow to achieve an established market position and the highest risk compared to other market entry strategies.