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Intro to Business: A Primer Companion text to CapsimCore™ Business Simulation Edition 1

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Copyright © 2016 by Capsim Management Simulations, Inc.

Edited by Wendy Guest.

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Table of Contents

Introduction 1

Overview: what is a business? 7

Marketing: how do we identify, entice and add value for customers? 19

Production: how does a business create goods and services to sell? 34

Accounting: how do we keep track of the money? 47

Finance: how do we raise funds, reward shareholders, and manage our assets? 60

Strategy: how does it all work together? 83

Ethics: doing it right – social responsibility and ethical decision making 103

Selling your company and making brilliant business presentations 118

INTRODUCTION One way to learn about business is to read the textbooks, learn the definitions, dis­ cuss case studies, and pass the exam. With Intro to Business: A Primer, in conjunction with CapsimCore Business Simulation, we take a less theoretical and more hands-on approach.

We’re going to learn business by managing a business.

The approach makes sense for two reasons. First, business itself is practical. If there were a single true theory of business success, then every person who started a business and followed the theory would be able to create a profitable and sustainable enterprise. Unfortunately, it’s not that simple. Business requires the practical application of people, skills, ideas and money, and it requires some trial-and-error before you succeed. Sec ond, it is in that process of trial-and-error that mastery develops. If you want to master the basics of business, rather than learn only the theory, this program is for you.

CapsimCore is a basic business simulation designed to give you hands-on experience in running a company. It provides the opportunity to work with all the essential man agerial functions including marketing, production and finance, and to experience the interactions and interrelationships that businesses engage in – internally and externally – to succeed. Many of the concepts you’ll read about in this book, you can apply in the simulation.

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It starts with an idea . . .

Every business requires three basic resources to function and compete: ideas, people and money. In the world of business, those resources are configured and reconfigured over and over again to satisfy the needs and wants of the market.

Sometimes businesses are based on a brilliant idea that completely changes how we do something – such as the way smart phones revolutionized the way we find, man­ age, and communicate information. Sometimes businesses find a new way to make us want more of what we already have – like the fashion industry urging us to update our wardrobe every season. Some businesses continually improve on a basic product – whether it’s cars, light bulbs, fabricated steel or dishwasher detergent. Sometimes we’re being sold an emotion – by the entertainment industry, for example – or a service, like haircuts or gym memberships. Whatever the business, it begins with an idea.

. . . add some good management

Individual brilliance, great ideas, even revolutionary technologies however, are only parts of the equation. The real art of business is to take the basic resources – ideas, people and money – and get them working together as a growing, functional operation. Building a business requires the ability to understand and manage the network of inter­ relationships that delivering your product or service to the market requires.

2 | Intro to Business: A Primer

And to do that, every single business relies on some standard elements and practices. For example: accounting to keep track of the money; marketing to entice customers to buy; and production to get your product or service into the customers’ hands. Put simply, businesses need effective management.

The roots of the word manage come from the Latin word manus agere (to lead by hand) or mansionem agere (to run the house for the owner). The dictionary defines management as “the person or persons controlling and directing the affairs of a busi­ ness or institution.” It is the people who have their hands on the controls of the orga­ nization. In CapsimCore you will get your hands on some critical management tools and begin to build your skills using them. Those tools include accounting statements, forecasts, market data and more – all applied to the task of creating and managing a successful enterprise.

The forms that businesses take might be limitless, but the essence of how to run a company remains the same. The company you will run in this course designs, builds, and sells electronic sensors, but our goal is not to learn about sensors, it’s to build the skills you need to effectively manage a business – any business organization at all.

It starts with an idea…. Smart phones have stimulated many new business ideas. Jack Dorsey is responsible

for a few, and has created two start-ups offering products we didn’t know we needed or wanted until we had them. Twitter is one. Dorsey co-founded the social networking chat site in 2006. Twitter went public in 2013 but by 2016, while it had a market capitalization of around $12 billion, its stock had fallen 70% from its high soon after the IPO. With management instability and takeover rumors, Twitter struggles to turn its promise into profits.

Square is another of Dorsey’s ideas. Square is a small credit card reader that plugs into a smart phone or tablet, replacing card-processing equipment and making it simple for any small merchant to accept credit cards. Square went public in late 2015 but its IPO was labeled ‘lackluster’ and it was valued at $2.9 billion – less than half its private valuation a year before. Profits continue to be illusive.

Uber, another San Francisco start-up, launched the smart phone ride-on-demand app that streamlined personal transport. But it hasn’t been an easy ride. Traditional taxi unions, limo companies and city governments, the “rent seekers” in the market, have attempted to maintain the status quo through regulation and litigation. Unrest among Uber drivers protesting changes to their compensation has also plagued the company. However, Uber spread quickly to more than 60 countries and around 270 cities and, as it has raised around $10 billion since it started in 2010, it isn’t rushing to go public. But while Uber competitor SideCar has already come and gone, its major rival Lyft partnered with India’s Ola, China’s Didi Kuaidi and GrabTaxi in 2016, forming a ride share partnership now covering about half the world’s population.

Twitter, Square, Uber, Lyft and others are great ideas that were turned into businesses but still require excellent, fleet-footed management to become fully established firms that make a profit.

How many other businesses can you name that offered new products we didn’t know we needed until we saw them?

Introduction | 3

. . . and develop mastery.

The good news is that brilliant and successful business people – whether it’s Mukesh Ambani, Bill Gates, Rupert Murdoch, or Mark Zuckerberg – were not born with a “busi­ ness success” gene. Their success is not simply due to an inbuilt talent, and this means any one of us could be successful in business one day.

The bad news is that like all successful business people, we need to devote thousands and thousands of hours to our goal – trying and failing, learning from our mistakes, and trying again – because it turns out that while many of us have the right attributes to be successful in business, not all of us are willing to invest the time. To become expert in any field, we need to engage in what is called “deep practice”.

Deep practice

That’s not to say genetics is always irrelevant – if you want to be a world-class basket­ ball player, it helps to be tall – but few occupations require specialized characteristics such as height. Most require a combination of skills that can be developed and honed through practice, and this is especially true for business acumen.

Sensors: a fast-growing sector Electronic sensors – the product you will be designing, producing, marketing, and

selling during your simulation – exist in many applications.

One crucial sector is the fast-growing consumer electronics market. With “wearables” a hot trend in electronic devices, the health-conscious, tech-savvy buyers in the “quantified-self” market are being offered devices to measure their energy input and

output against personal fitness goals. Wearables all require sensors.

Jawbone (the industrial design company that first developed sleek, in-ear Bluetooth devices) launched its first fitness-tracking wrist band Up in late 2011. Up had early technical problems which Nike+ took advantage of by promoting its rival FuelBand. Four years later, however, neither product was a blip on the market share chart for wearables. By 2016 the market was dominated by Fitbit, Apple and Xiaomi. According to CCS Insight’s Wearable Forecast Worldwide 2015 – 2019, the market is set to grow from $15 billion to $25 billion, with smart watches accounting for more than half of the revenue.

At the All Things Digital Conference in May 2013, Apple CEO Tim Cook said there were problems to be solved in building wearable electronics – but the growing market would be good news for the sensor industry: “The whole sensor field is going to explode,” Cook said. “It’s already exploding. It’s a little all over the place right now, but with the arc of time, it will become clearer I think.”

By late 2015, the Worldwide Quarterly Wearable Device Tracker reported the number of devices shipped in 3rd quarter 2015 were up 197% over the same quarter 2014 – from 7.1 million units to 21 million units. And what about internal wearables? Nature Magazine reports skin surface and implanted sensors are being developed for monitoring the health of the human body. Sensors can, for example, warn of an impending heart attack or epileptic seizure.

The functionality of sensors will be expanded, refined and improved dramatically over the coming years.

4 | Intro to Business: A Primer

Success is often embedded in environmental influences. For example, the presence or absence of a great coach or mentor matters significantly. The presence of a role model in the culture also influences success. The opportunity to develop a skill matters most of all. You can’t become a pianist if there are no pianos!

After only 100 hours of deep practice, a person becomes noticeably better at a subject than others who haven’t done that work. At 1000 hours, he or she becomes highly skilled in that subject, and it doesn’t stop there. So “talent” becomes somewhat pre­ dictable and measurable. You can say a person with 100 hours of deep practice is less competent than a person with 1,000 hours of deep practice.

Viewed in this way, talent becomes a choice. The choice is to trade off the time to de­ velop one talent, for time spent on something else. The more time spent focused on a single talent, the less time can be given to others.

Business acumen is a function of deep practice; talent has little to do with it.

Simulations and deep practice

Simulations are designed to offer focused opportunities for deep practice. That’s why they are often more effective than passive tools such as textbooks, videos, or lectures.

By the way, “deep practice” is very different from “ordinary practice.” After commuters who drive to school or work can accumulate thousands of hours of driving, but that doesn’t make them expert drivers. The key to deep practice is self-awareness. That is, paying attention to what you are doing well and not so well. This is so important to learning that scientists use a specific term for it: “metacognition,” or thinking about the way you think and learn.

Deep practice has these characteristics:

ƒ It is intentional. You are consciously seeking improvement as you practice.

ƒ It is at the limits of your present capability. ƒ You fail. Often. If you didn’t, you wouldn’t be at the limits of your

capability. You try again. ƒ You are seeking incremental improvement in each practice session,

not breakthroughs. ƒ You are practicing the right things, not the wrong things. This often

requires a coach. ƒ You have a feedback system in place, one that tells you when you are

right and when you are wrong. ƒ You spend between half an hour and three hours a day in deep

practice. If you spend more, you are getting diminishing returns. There is only so much you can accomplish in one day.

Overview | 5

Simulations work because they are hands-on experiences that mimic the real world. Well-designed simulations, such as CapsimCore Business Simulation present problems at the limits of your capabilities, offer positive and negative feedback, have a “coach,” and work your brain in a way that builds your business skills. Throughout the training, you can witness the incremental improvements in yourself over time.

Here’s a list of “do’s and don’ts” to enable you to use the simulation to develop your business acumen, in much the same way that you’d use a gym to build muscle.

Do’s:

ƒ Feedback is critically important to deep practice. The simulation delivers it via your online interface and in your reports. Both positive feedback and negative feedback are important. When the results come in, compare your expectations with the actual results. Why were you right? Why were you wrong? This applies when your results are both better than expected and worse than expected.

ƒ Focus on your portion of the company’s decisions each round. In sports, a player may spend a day of practice on only one skill. This same principle applies to business acumen and management skills.

ƒ Add a new skill each round such as pricing for products, sales forecasting, production analysis, financial modeling, and so forth.

ƒ Practice the old skills as well as the new skill. ƒ Use your coaches. These include your instructor, of course, but also

the auto- mated coaches that produce the end of round report available on your interface. If you encounter something you do not understand, the answer is probably in the online support system or you can contact support@Capsim.

Don’ts:

ƒ Don’t treat failure as a bad thing. Failure is a good thing. It means that you are practicing at the limits of your ability. It has been estimated that Olympic ice skaters fall 20,000 times on their way to a gold medal. The skaters practice at their limits, focusing on the movements that make them fall. Failure is also feedback. An emergency loan, a stock-out, a capacity shortage – simulations are designed to highlight mistakes such as these – but the important questions are, “What led to the failure?” and “How can I avoid this in the future?”

ƒ Don’t ask others to do it for you. Do the work yourself. Don’t seek help from past or present students. This is the equivalent of going to the gym to watch other people work out.

ƒ Don’t be concerned with the confusion you feel at the beginning of the simulation. Of course you’re confused – you’ve never run a multimillion-dollar company before. Trust the process. The confusion will fade.

ƒ Don’t focus on your mistakes. That angst locks you in place and prevents growth. As difficult as it is to accept, if you are not looking bad, you are not growing.

6 | Intro to Business: A Primer

So let’s begin.

This text can be read in conjunction with your CapsimCore simulation experience. It is designed to enlarge on the concepts you’ll come across in the simulation and introduce the way they work through examples in real, operating companies.

Remember, the best way to learn is to try, fail, try again and be persistent! Our hope is that you’ll find this a fun learning experience that will motivate you to continue to develop your business management skills.

OVERVIEW: what is a business? 1

Learning Goals

After reading this chapter you will be able to:

ƒ Define what a business represents and why businesses exist. ƒ Define essential business concepts including products,

services,profits, and stakeholders.

ƒ Describe the major functions of business. ƒ Discuss the role of management in business success. ƒ Differentiate between performance effectiveness and efficiency. ƒ Describe the enterprise system and how it relates to business. ƒ Differentiate between internal and external stakeholders. ƒ Discuss key market concepts such as specialization, uncertainty, and

risk. ƒ Compare and contrast economic and opportunity costs. ƒ Describe the differences between financial and managerial

accounting.

What is a business? A business can be defined as any organization that provides products, services or both to individual consumers or to other organizations. The essential role of a business is to create products or offer services that satisfy customer needs or wants. Whether is it creating smart phones or offering home delivery of groceries, businesses could not exist without someone desiring their products or services.

Let us start with some basic definitions of essential concepts:

PRODUCT: a good that has tangible characteristics and that provides sat­ isfaction or benefits (e.g., an automobile). SERVICE: an activity that has intangible characteristics and that provides satisfaction or benefits (e.g., a mechanic per- forming automotive repair). PROFIT: the basic goal of most businesses. Profit is the difference be­ tween what it costs to make and sell a product or service and what the customer pays for it. STAKEHOLDERS: groups of people who have a vested interest (a “stake”) in the actions a business might take. There are four major groups of stake­ holders: (1) owners, (2) employees, (3) customers, and (4) society. The specific interests of each of these stakeholder groups may sometimes conflict with each other.

8 | Intro to Business: A Primer

To summarize, a business sells products or services with the specific goal of making a profit, and in the process has an impact on various stakeholders.

Business, however, is much more interesting than its definitions. As described in the introduction, every business requires three basic resources – people, ideas, and mon­ ey – that are configured and reconfigured over and over again to satisfy the needs and wants of customers. In that process there may be winners and losers, there may be cheaters, heroes, hard work, laughter, tears – the theory of business may be straightfor­ ward, but the experience of business is an exciting, ever-changing story, as you will dis­ cover in the CapsimCore Business Simulation. Let’s look at the way businesses deploy their three important resources.

Business functions and functioning

Each business must employ people to entice customers, produce its products or ser­ vices, organize workflow, plan to fund or pay for its operations, and more. Whatever type of business it is, the work that has to be done will typically fall into four basic “business functions.”

MARKETING is all the activities designed to provide the goods and ser­ vices that satisfy customers. These activities include market research, de­ velopment of products, pricing, promotion, and distribution. PRODUCTION refers to the activities and processes used in making prod­ ucts or delivering services. These activities involve designing the produc­ tion processes (investments in facilities and equipment) and the efficient management and operation of those processes. ACCOUNTING is the process that tracks, summarizes, and analyzes a company’s financial position. FINANCE refers to the activities concerned with funding a company and using resources effectively.

There is no one simple formula for successful business functioning or performance. Put simply, ideas (innovation + product development) + people (marketing + operations + leadership) + money (finance + accounting) does not equal a well-functioning busi­ ness. Business is all about complex interactions – external interactions with customers, competitors, communities, and regulators – and internal interactions between all the people who operate the functions of the business itself. Engineers, computing wizards, accountants, human resource professionals, creative designers, marketers, and sales people – they may all be necessary to a business, but they are not sufficient to guaran­ tee success.

To be successful, businesses need good managers who are able to see the big picture and understand how all the individual business functions work together. Fortunately, we know a lot about what goes into good management.

Overview | 9

To summarize, a business sells products or services with the specific goal of making a profit, and in the process has an impact on various stakeholders.

Business, however, is much more interesting than its definitions. As described in the introduction, every business requires three basic resources – people, ideas, and mon- ey – that are configured and reconfigured over and over again to satisfy the needs and wants of customers. In that process there may be winners and losers, there may be cheaters, heroes, hard work, laughter, tears – the theory of business may be straightfor- ward, but the experience of business is an exciting, ever-changing story, as you will dis- cover in the CapsimCore Business Simulation. Let’s look at the way businesses deploy their three important resources.

Business functions and functioning

Each business must employ people to entice customers, produce its products or ser- vices, organize workflow, plan to fund or pay for its operations, and more. Whatever type of business it is, the work that has to be done will typically fall into four basic “business functions.”

MARKETING is all the activities designed to provide the goods and ser- vices that satisfy customers. These activities include market research, de- velopment of products, pricing, promotion, and distribution. PRODUCTION refers to the activities and processes used in making prod- ucts or delivering services. These activities involve designing the produc- tion processes (investments in facilities and equipment) and the efficient management and operation of those processes. ACCOUNTING is the process that tracks, summarizes, and analyzes a company’s financial position. FINANCE refers to the activities concerned with funding a company and using resources effectively.

There is no one simple formula for successful business functioning or performance. Put simply, ideas (innovation + product development) + people (marketing + operations + leadership) + money (finance + accounting) does not equal a well-functioning busi- ness. Business is all about complex interactions – external interactions with customers, competitors, communities, and regulators – and internal interactions between all the people who operate the functions of the business itself. Engineers, computing wizards, accountants, human resource professionals, creative designers, marketers, and sales people – they may all be necessary to a business, but they are not sufficient to guaran- tee success.

To be successful, businesses need good managers who are able to see the big picture and understand how all the individual business functions work together. Fortunately, we know a lot about what goes into good management.

Managing a Business As we discussed earlier, without customers a business would not be sustainable. This fact also applies to managers – without managers a business would wither and die. Successful management requires individuals who juggle the trade-offs and compro­ mises necessary to keep a complex business moving along a clear strategic track. These individuals must also display intellectual flexibility to adjust to changing customer de­ mands, and be able to harness the impact of creative abrasion that results from dealing with various business stakeholders who often have colliding agendas that must be met in the drive for success, profitability, and sustainability.

When we say “success,” however, what do we really mean? One useful way to think about success in management is that it entails the two “E’s” of performance: effective­ ness and efficiency. Performance effectiveness means doing the right thing. Perfor­ mance efficiency means doing things right.

Being effective involves committing to a course of action that allows you to accomplish your goals. It is a measure of how appropriately and successfully your actions achieve your goal. Being efficient refers to employing the right processes to achieve the goal. Ef­ ficiency is measured by comparing the resources invested with the outcomes achieved.

Decisions that shape the marketing, production, and financial functions of a business are often made in environments that are specialized, complex, uncertain, and risky. Managing these functions requires planning, organizing, leading, and controlling all the important variables.

10 | Intro to Business: A Primer

PLANNING: Determining what the organization needs to do and how to get it done. ORGANIZING: Arranging the organization’s resources and activities in such a way as to make it possible to accomplish the plan. LEADING: Enacting the plan, including guiding and motivating employ­ ees to work toward accomplishing the necessary tasks. CONTROLLING: Measuring and comparing performance to expectations established in the planning process and adjusting either the performance or the plan.

Regardless of the business functions or the types of managerial decisions to be made, effective and efficient management cannot be achieved without leadership. At higher levels of responsibility, people who may be referred to as chief executives or senior managers fill leadership roles. Of course, the more people, functions, and processes a company has, the more its senior management will need to align and coordinate management activities. You will have the opportunity to experience a plethora of man­ agement challenges in your simulated company, particularly if you are operating in a

Innovation sparks growth He has been called the “Steve Jobs of yogurt”. Hamdi Ulukaya, a Turkish

immigrant to the U.S., built the Chobani yogurt company that made him a billionaire in six years on an obsession for brewing the perfect cup of yogurt.

In 2005 Ulukaya bought a defunct yogurt factory from Kraft in New Berlin, N.Y., with a U.S. Government-backed small business loan - and went on to shake up an industry owned by the major food companies. In 2007 he launched an innovation into the already crowded yogurt market: low-fat, sugar-free, Greek-style yogurt with a taste customers loved.

As Ulukaya told USA Today: “I literally lived in the plant for 18 months to make that perfect cup. And then five years after, it just exploded. I did not have all the ideas right from the beginning. I just jumped in and learned the swimming right in there.”

Chobani went from six employees to 3,000 in five years and added a second plant in Twin Falls, Idaho, in 2012. When Ulukaya launched Chobani, Greek yogurt was 1% of the market in the U.S. Within five years it was almost 60%. “So we take quite a bit of credit for that,” he said. “What we did was make it for everyone, and we made it delicious. And when people tasted it for the first time, this wow effect came in.”

Sales of Chobani yoghurt hit a billion dollars in 2013, but a product recall that same year proved costly. By 2015 competition was intense and sales growth slower. Along with private equity funds and management assistance from TPG Capital, the company started looking to more innovation to stimulate growth. Chobani launched its “flip” range including Mango and Sriracha, or Chipotle Pineapple, mixing yoghurt with crunchy, savory toppings for all-day snacking. Innovation surrounding Chobani, however, has not been restricted to yogurt. As Ulukaya told USA Today: “That old plant that we turned back to life opened four different other factories somewhere else because of the butterfly effect. So you open the Greek yogurt factory. Then somebody has to make a cup factory. Somebody has to make a foil factory. Somebody has to make a fruit factory. Then the farmers have to add more cows. Then the people have to work on the farms. Then the trucks have to go up to those factories. All of that contributes to billions and billions of dollars invested and thousands of jobs created.”

Overview | 11

team where each team member, depending on his or her business function, will pursue different interests.

The Big Picture: The Enterprise System

Now that we’ve discussed some basics about business, business functions, and manage­ ment, let’s look a little closer at the economic forces that impact business functioning.

Businesses operate within an overall economic system. There are at least three key terms to understand when thinking about overall economic systems.

MARKET: a mechanism that facilitates the exchange of goods and ser­ vices between buyers and sellers. DEMAND: the quantity of goods and services that consumers are willing to buy at different prices. SUPPLY: the quantity of goods and services that businesses are willing to provide at those prices.

The terms of a sales transaction, or the quantity of goods traded and the trading price, are determined by the supply of and demand for any particular good or service.

Economic systems are typically, but not always, embedded in a framework of activities that are carried out by mostly democratic elected representatives (the government) of a society within its geographic boundaries. Activities that serve the society by fulfilling basic needs (e.g. roads, defense, security) or needs that no other business can serve (e.g. judicial branches) are performed by public enterprises.

Unlike public enterprises, the simulated company you will run in the CapsimCore Sim­ ulation is a private enterprise. In private enterprise systems individual citizens (rather than governments) own and operate the majority of businesses. Private enterprise sys­ tems require four essential conditions:

1. Private property 2. Freedom of choice 3. The right to keep profits 4. An environment where fair competition can occur

The theory underlying the private enterprise system is that competition among busi­ nesses will produce an efficient allocation of resources across the economy. Goods and services are desired where they produce the greatest benefit or are used most produc­ tively. Throughout this economic process, pressure is exerted from several areas. For example, there is pressure to lower prices and pressure to innovate through technolog­ ical and procedural improvements.

When businesses compete in a private enterprise system, value is created for con­ sumers. Customers are offered additional choices because businesses are motivated to innovate often through technological advancements to improve their offerings and

12 | Intro to Business: A Primer

make them more attractive. Innovation of processes, products, and services also mo­ tivates businesses to price their offerings attractively to position themselves for future and sustainable success.

Internal and External Stakeholders

Within an economic system are various groups with a stake in the way businesses oper­ ate. Earlier, we defined these different groups as business “stakeholders”. All businesses will have stakeholders from the four categories we discussed. One way to think of these stakeholders is in terms of their being either internal or external to a business.

The key internal stakeholders are owners (stockholders/shareholders), who derive eco­ nomic benefits when the business makes a profit, and whose investments lose value when it doesn’t, and employees, who also derive economic benefits through wages but can experience additional benefits (such as training and experience) or disadvantages (exposure to toxins/accidents). The key external stakeholders are customers, who want the best product or service possible for the lowest possible price, and the society at

Stakeholders’ changing needs and demands The Easy-Bake Oven may have been a favorite toy of American children for more

than 50 years, but in recent years Hasbro, its manufacturer, has had to respond dramatically to stakeholders including both customers and government regulators.

The toy, launched in 1963, is a working oven in which mini-portions of cake mix and other treats are fed on small trays into a slot and emerge cooked. In 2003 it was voted

Parenting magazine’s Toy of the Year. In 2006 it was inducted into the American Toy Hall of Fame. Since then, however, Hasbro has dealt with health and safety concerns, environmental legislation, and claims of sexism related to the Easy-Bake design.

In early 2007 nearly a million of the pink-and-purple ovens were recalled. Hasbro had received 249 reports of children getting their hands or fingers caught in the oven’s opening, including 77 reports of burns, 16 of which were reported as second- and third-degree burns, with one leading to a partial finger amputation for a 5-year-old girl.

After the recall, a redesigned oven was launched, powered by the heat source the Easy-Bake used from the beginning – an incandescent bulb. Environmental legislation announced by President George W. Bush that same year, however, required a phase-out of incandescent bulbs by 2012. In 2011 Hasbro launched a new oven, powered by a heating element.

The next year, a New Jersey teen, McKenna Pope, collected 40,000 signatures – including those of several celebrity chefs – asking Hasbro to launch an Easy-Bake that was gender neutral. McKenna claimed the oven’s feminine-looking pinks and purples alienated her younger brother. At the 2013 Toy Show, Hasbro launched an oven in black and silver. Responding to this pressure may have proved controversial internally, however, because it was not Hasbro’s first attempt to appeal to boys. In 2002 it had launched the Queasy Bake Cookerator, making “boy friendly” treats such as Chocolate Crud Cake and Dip ‘N Drool Dog Bones. The product failed to reach adequate sales and was withdrawn.

It can be difficult – even for an established product such as the Easy-Bake and an established manufacturer such as Hasbro – to keep up with the various pressures from different stakeholders.

Overview | 13

large that may also be benefited (more jobs for more people leading to more tax reve­ nue) or disadvantaged (toxic waste in the water system/market failures).

The private enterprise system needs laws to make corrections when markets do not produce outcomes desirable for the people who live in a society. The laws are set by governments elected to act on behalf of the whole society – and they are designed to protect all stakeholders according to a mutual sense of justice. In this sense, govern­ ments establish rules for the overall economic system designed to balance the needs of the society with the drivers of profit.

Stakeholders in an oil spill On April 20th 2010, an explosion on the Deepwater Horizon oil rig, operated by British

Petroleum in the Gulf of Mexico, triggered the largest marine oil spill of its type in U.S. history.

The rig sank, 11 people were killed, 17 were seriously wounded and oil flowed underwater from the well, discharging more than 200 million gallons before it was declared fully capped in September. On April 30th President Barack Obama said: “This oil spill is the worst environmental disaster America has ever faced ... Make no mistake: We will fight this spill with everything we’ve got for as long as it takes. We will make BP pay for the damage their company has caused. And we will do whatever’s necessary to help the Gulf Coast and its people recover from this tragedy.”

The scale of the disaster resulted in adverse effects on a very wide range of stakeholders. Owners saw their investment in BP halved as the market capitalization of the company plunged from $180 billion in April 2010 to $90 billion by June of that year. Employees suffered not only from the direct and indirect effects of the deaths and injuries, but from the impact of working for the world’s largest oil producer one day, and its most infamous the next. Customers felt less inclined to buy BP products with BP-branded gas stations in the U.S. (most of which are not owned by BP) suffering losses of between 10% and 40% of sales.

It was, however, society that felt the largest impacts. In Louisiana, for example, 17% of all jobs are related to the oil industry. Job losses in the state followed a moratorium on offshore drilling, implemented while investigations were underway. Jobs were lost in tourism (the industry reports losing $23 billion in the region) and fishing (reported losses of $2.5 billion), as the effects of the spill and cleanup efforts devastated both industries. Health issues included 143 cases of chemical poisoning in the first two months of the disaster alone, with the American Journal of Disaster Medicine suggesting “cancers, liver and kidney disease, mental health disorders, birth defects and developmental disorders should be anticipated among sensitive populations and those most heavily exposed.” The oil spill area included more than 8,000 species of fish, birds, mollusks, crustaceans, sea turtles and marine mammals, with effects on these animals including death from oil or the cleanup chemicals, disease, birth defects and mutations, and lesions and sores.

The company was charged with 11 counts of manslaughter under U.S. law for the deaths of workers and tried under provisions of the Clean Water Act. The U.S. Government National Commission investigation into the disaster placed blame for the spill squarely at the feet of BP and its contractors Halliburton and Transocean, citing cost cutting and insufficient safety procedures. By July 2015 agreement had been reached to settle all federal and state claims, leaving BP a total bill of $53.8 billion for cleanup, compensation, and environmental fines. The disaster is one of the most vivid examples in recent history of how errors in business can negatively and dramatically impact a wide range of stakeholders.

14 | Intro to Business: A Primer

Everyday life – risk Think about tossing a coin. You cannot consistently predict when you flip a coin whether it will land with the “head” or the “tail” side up. Not knowing which side will land facing up is a form of uncertainty. Place a bet with a friend about which side will land facing up and the amount of the bet is a measure of the risk. If you bet 20 cents, then the risk associated with the bet is small. If you are in the same economic position and bet $100,000, then the risk associated with the bet is enormous.

All areas of law or regulation that influence business practice contribute to our shared definition of fairness. Examples include establishing standards of conduct in negotiat­ ing contracts with a company’s buyers or suppliers, providing information (advertising) to consumers, providing information to potential investors, and negotiating with em­ ployees or their representatives.

To summarize, we have an overall economic system based on privately owned busi­ nesses, regulated to ensure the rights of all stakeholders are protected, and fueled by transactions between buyers and sellers in various markets. Next, let’s look at the no­ tion of a market.

Markets – the engine that keeps it all running

Everyday life – specialization and complexity It is Sunday morning and you decide to en­ joy breakfast at a local café. Your need is specialized and so is the café business serv­ ing breakfast – but think about the com­ plexity of the separate activities in different types of industries and markets that have to be precisely coordinated to provide your breakfast experience: agriculture (growing the tomatoes, collecting the eggs); transport (moving everything from supplier to whole­ saler to your table); grocery wholesaling (from the napkins to the ketchup); construc­ tion (the building you are sitting in); furniture (the chair you are sitting in); food service (cooks, kitchen hands, wait-staff); banking (lending money to all of the other industries to keep them operating); entertainment (the music playing in the background) …. it’s a complex web of markets matching supply with demand.

A market – according to our definition – is a mechanism that facilitates the exchange of goods and services between buyers and sellers. From cavemen trading stone tools for bison meat, to the NASDAQ (an electronic market for buyers and sellers of stock), informal and formal markets have existed as long as human demand has been able to find a source of supply.

Some terms you’ll come across in relation to markets are specialization, uncertainty, and risk.

In an economic context, specialization is a measure of how broadly or narrow­ ly the range of activities performed by a business is defined. A bicycle shop, for example, is a more specialized retail store than Wal-Mart because the bicycle shop focuses on a narrow and deep range of products. Specialization creates an op­ portunity for greater efficiency and in­ creased productivity. The division of tasks that comes with specialization introduces a need for coordination of those specialized tasks. These different levels of special­ ization and different kinds of coordinating mechanisms create a complex economic environment.

Markets are also characterized by uncertainty and risk. Uncertainty is not knowing an exact outcome or not being able to predict the exact consequences of a choice in a decision situation. The greater the uncertainty, the less you can know about the results of a particular choice. Decision makers must work to reduce uncertainty by compiling as much relevant information as possible about a decision situation. Risk is also asso­

Overview | 15

All areas of law or regulation that influence business practice contribute to our shared definition of fairness. Examples include establishing standards of conduct in negotiat- ing contracts with a company’s buyers or suppliers, providing information (advertising) to consumers, providing information to potential investors, and negotiating with em- ployees or their representatives.

To summarize, we have an overall economic system based on privately owned busi- nesses, regulated to ensure the rights of all stakeholders are protected, and fueled by transactions between buyers and sellers in various markets. Next, let’s look at the no- tion of a market.

Markets – the engine that keeps it all running

A market – according to our definition – is a mechanism that facilitates the exchange of goods and services between buyers and sellers. From cavemen trading stone tools for bison meat, to the NASDAQ (an electronic market for buyers and sellers of stock), informal and formal markets have existed as long as human demand has been able to find a source of supply.

Some terms you’ll come across in relation to markets are specialization, uncertainty, and risk.

In an economic context, specialization is a measure of how broadly or narrow- ly the range of activities performed by a business is defined. A bicycle shop, for example, is a more specialized retail store than Wal-Mart because the bicycle shop focuses on a narrow and deep range of products. Specialization creates an op- portunity for greater efficiency and in- creased productivity. The division of tasks that comes with specialization introduces a need for coordination of those specialized tasks. These different levels of special- ization and different kinds of coordinating mechanisms create a complex economic environment.

Markets are also characterized by uncertainty and risk. Uncertainty is not knowing an exact outcome or not being able to predict the exact consequences of a choice in a decision situation. The greater the uncertainty, the less you can know about the results of a particular choice. Decision makers must work to reduce uncertainty by compiling as much relevant information as possible about a decision situation. Risk is also asso-

ciated with the consequences of choice; therefore risk is a measure of the significance of those decisions.

Decision making – the critical skill

When planning, organizing, operating, and controlling a company, decisions are con­ stantly made and the quality of those deci­ sions determines, to a large extent, whether and how the company will achieve its goals. In today’s world of work, teams make the vast majority of strategic, high-impact decisions. These teams can range from product devel­ opment teams and quality control teams to top management teams comprised of exec­ utives from each business function.

The process of defining problems and op­ portunities that merit attention, generating and evaluating alternative courses of action, and committing to the action that is most likely to produce the optimal result is one way to describe the decision-making process.

Decision making also involves comparing the economic and opportunity rewards (benefits) and sacrifices (costs) involved in a course of action and committing to the one that best meets your goals. The objective is to make the parties involved “better off” than they were before the transaction took place. Typically, good decisions are commitments that help you accomplish your goals in whatever way you define them. Business decisions primarily focus on gain­ ing economic rewards, which means there is an assumption that we only engage in trans­ actions that offer the potential to improve our “position.” When we choose a course of action, it requires a sacrifice to obtain the reward. In economic terms, this sacrifice is called a “cost.” When evaluating alternative choices, a decision maker considers two kinds of costs, the economic cost and the opportunity cost:

An economic cost is the money spent imple­ menting the decision.

An opportunity cost is the cost of what you gave up doing when you committed to the course of action you chose.

Everyday life – risk Think about tossing a coin. You cannot consistently predict when you flip a coin whether it will land with the “head” or the “tail” side up. Not knowing which side will land facing up is a form of uncertainty. Place a bet with a friend about which side will land facing up and the amount of the bet is a measure of the risk. If you bet 20 cents, then the risk associated with the bet is small. If you are in the same economic position and bet $100,000, then the risk associated with the bet is enormous.

Everyday life – opportunity cost Consider being offered two jobs. One of­ fers $10,000 more in base salary but few prospects for promotion. The other offers less money but has more opportunities for promotion and future training. You have two choices: Take the higher paying job, or the lower paying job. The economic cost of taking the second job is $10,000. The op­ portunity cost of taking the first job is the chance for promotion, future training, and higher pay in the future. In the long run, op­ portunity costs are often more important than economic costs, but economic costs generally easier to determine than oppor­ tunity costs.

16 | Intro to Business: A Primer

Assessing opportunity costs is important to determine the true cost of any decision. Opportunity cost can measure anything that is of value. The opportunity cost is not the sum of the available alternatives, but rather the benefit of the best single alternative. If there is no explicit accounting or monetary cost attached to a course of action, ignoring opportunity costs may create an illusion that the benefits cost nothing at all, turning them into a hidden cost associated with that action. The opportunity cost of a compa­ ny’s decision to build a new plant on vacant land the company owns, for example, is the loss of the land for another purpose, such as using it to build a facility to be leased to another business, or to have access to the cash that could have been generated from selling the land. Only one set of choices is possible. Only one set of benefits is attainable.

Accounting – keeping track of financial outcomes

Every business keeps track of its financial health through accounting. Accounting is a set of rules applied to a company’s financial records that allows owners and managers to monitor, analyze, and plan the finances of the business. In short, accounting deals with the business resource of “money” we discussed at the beginning of this chapter.

Whatever business you are in, the stakeholders in your business – and that, as we know, might be owners and shareholders, potential buyers, customers, or even the govern­ ment’s tax office – need to have a consistent frame of reference for assessing the fi­ nancial health of your company. That consistent frame of reference is the company’s financial reports. To understand the financial reports, however, we need to understand some of the basic principles that underpin the rules and principles of accounting.

There are two major types of accounting: Financial Accounting and Management Accounting.

FINANCIAL ACCOUNTING produces the balance sheets, income state­ ments, and cash flow statements that ensure external stakeholders can access the information they need. These stakeholders are usually peo­ ple and groups outside the company who need accounting information to decide whether or not to engage in some activity with the company. That might include individual investors; stockbrokers and financial ana­ lysts who offer investment assistance; consultants; bankers; suppliers; la­ bor unions; customers; local, state, and federal governments; and gov­ ernments of foreign countries in which the company does business. MANAGEMENT ACCOUNTING provides vital information about a com­ pany to internal users. Because it is for internal use, it does not have to conform to the restrictions of outside regulation and can be expressed in whatever way is most useful for managers. Information can be reported in dollars, units, hours worked, products manufactured, number of de­ fective products, or the quantity of con- tracts signed. The job of a man­ agement accountant is to produce information that is relevant to specific segments of the company’s products, tasks, plants, or activities. The goal of that information is to enable managers to make more informed and effective decisions.

Overview | 17

The reports a management accountant produces might forecast revenues, predict costs of planned activities, and provide analysis based on those forecasts. By describing how alternative actions might affect the company’s profit and solvency, forecasts and analyses help managers plan.

We’ll talk in greater detail about financial accounting and reports such as income state­ ments, cash flow statements, and balance sheets in Chapters 4 & 5. More detail will be provided on managerial accounting including budgets, cost analysis, and management reporting in Chapters 2 & 3, which cover marketing and production

18 | Intro to Business: A Primer

Chapter 1 Review Questions

Business Basics 1. What are the four main business stakeholder groups? 2. What are the primary functions of business? 3. What are the four major activities involved in managing a business? 4. What is the difference between performance effectiveness and

performance efficiency?

The Private Enterprise System 5. How would you define supply? 6. How would you define demand? 7. How would define a market? 8. What are the four conditions that must exist for the free enterprise

system to exist? 9. What are the implications of the relationship between supply and

demand? 10. What are the differences between internal and external

stakeholders? 11. What is specialization? 12. How would you illustrate the concept of “uncertainty”? 13. How would you illustrate the concept of “risk”?

Decision Making 14. What is the difference between an economic cost and an

opportunity cost? 15. What is the main purpose of the accounting function of a business? 16. What are the differences between financial and managerial

accounting?

MARKETING: how do we identify, entice and add value for customers?

Learning Goals

After reading this chapter you will be able to:

ƒ Describe the role of a marketing manager. ƒ Describe the key activities of marketing research. ƒ Discuss the seven steps of information gathering for market research. ƒ Define and differentiate the “4P’s” of marketing. ƒ Discuss the importance of market segmentation. ƒ Describe the purposes and goals of marketing strategy. ƒ Define “diminishing returns” and discuss why this matters to

marketing. ƒ Compare and contrast the concepts of risk, ambiguity, and

conformance with regard to marketing.

Overview of Marketing Basics

No matter how good a firm is at offering its products and services, it has to strive for constant improvement because satisfying the customer is a never-ending process. From buying a bottle of shampoo or ordering a cup of coffee, to choosing a health-care provider or setting up a retirement plan, the abundance of choice in the market makes decision making increasingly complex for consumers. The same is true for customers in business-to-business markets, like the electronic sensor market.

For any company, understanding the relationship its customers have with the company and its product, and how those relationships develop or deteriorate over time, is critical to the long-term profitability and sustainability of the firm.

Today’s customers have access to a wealth of information, as well as many choices in the marketplace. Acquiring and retaining customers can, therefore, be challenging. But a satisfied and/or loyal customer – a “captured” customer – is, in simple economic terms, an asset that yields future cash-flows and contributes to a firm’s future growth.

Without unlimited resources, it is impossible for any firm to excel in every aspect of its product: that is, to provide the highest quality, fastest delivery and widest variety at the lowest price. Therefore, firms must make tradeoffs on the basis of what they do best, what their competitors are offering, and what criteria they think matter most to their customers. Managers often struggle to determine the “best” configuration of

2

20 | Intro to Business: A Primer

product-service offerings that will appeal to their chosen target markets and to poten­ tial customers.

The Marketing Manager’s Role

Ideally, all company activities should satisfy customer needs. The role of a marketing manager is to focus the company’s efforts on identifying, satisfying, and following up on its customers’ needs - all at a profit. The marketing manager has to understand how:

ƒ To clearly define, describe and forecast the needs of its customers by using data (Market Research),

ƒ To determine how to select specific markets and satisfy customer needs through balancing products, services, and benefits (Marketing Mix), and

ƒ To analyze its competitive advantages, plans, and actions (Marketing Strategy).

Market Research A successful marketing manager cannot afford to implement best-practice initiatives for all possible product offerings to ensure the company can be “everything to every­ body.” Nor can they use “spray and pray” tactics until they find the most popular prod­ uct that will stick. With limited resources available, a marketing manager’s first step is to view the business from a customer’s perspective.

Most marketing managers combine the customer perspective with their sense of the market that comes from experience. However, experience is not always a good thing. Experience may include information acquired over a number of years that has become outdated and is no longer timely or relevant to today’s decisions. Sometimes industry folklore – stories repeated often but without a firm factual foundation – can create misleading impressions that may lead an organization in the wrong direction. Timely market research to ensure you have an up-to-date understanding of your market and customers helps keep decision making on track.

Organizing information

Any research assignment is a systematic gathering, recording, and analyzing of data related to a subject or problem you would like to understand. In particular, market re­ search is simply an orderly and objective way of learning about the group of people who buy from you or who are most likely to do so.

Market research is not a perfect science because it deals with people and their con­ stantly changing likes, dislikes, and behaviors – all potentially affected by hundreds of influences. It is an attempt to learn about markets scientifically and to gather facts and opinions in an orderly and objective way. Market research seeks to find out how things are, not how you think they are or would like them to be, and can define what specific

Marketing | 21

products or services people want to buy, rather than focusing on what you want to sell them.

Market research answers the questions every business must ask to succeed, such as:

ƒ Who are my customers and potential customers? ƒ What kind of people are they? ƒ Where do they live? ƒ Can and will they buy from my business? ƒ Am I offering the kinds of goods or services they want at the best

place, at the best time, and in the right amounts? ƒ Are my prices consistent with buyers’ opinions of the product’s value? ƒ Are my promotional programs working by creating awareness in the

market- place? ƒ Are my sales programs working to create accessibility for my product

through the distribution channels? ƒ What do customers think of my business? ƒ How do our value propositions (a product or a service that creates

value for the customer) compare with those of our competitors? ƒ Are there specific reasons customers would make the decision to

purchase from our business rather than from competitors?

Information gathering We often engage in information gathering to allow us to systematically organize knowl­ edge. It ensures that such knowledge and information is timely and meaningful. Sound information gathering provides what you need to:

ƒ Identify problems and potential problems in your current market that you can solve in a unique manner

ƒ Acquire facts about your market to develop a strategy and implement action plans

ƒ Assist you in making better decisions and correcting problems as needed

ƒ Reduce implementation risks ƒ Discover unknown opportunities

Many managers conduct informal research every day. In their daily managerial duties, they check returned items to see if there is a pattern of dissatisfaction. They meet a former customer and ask why they have not been in lately. They look at a competitor’s ad to see what they are charging for the same products. These activities help provide a framework that enables managers to objectively evaluate the meaning of the informa­ tion they gather about their business.

A more formal information gathering or research process may include the following seven steps:

22 | Intro to Business: A Primer

1. Defining the problem or opportunity 2. Assessing available information 3. Reviewing internal records and files; interviewing employees 4. Collecting outside data (primary research) 5. Organizing and interpreting data 6. Making a decision and taking action 7. Assessing the results of the action

DEFINING THE PROBLEM OR OPPORTUNITY: Defining the problem or assessing the opportunity is the first step of the research process. This process is often overlooked, yet it is the most important step. You have to be able to see beyond the symptoms of a problem to get at its cause. Labeling the problem as “a decline in sales” is not defining a cause, but identifying a symptom.

You must establish an outline of the problem that includes causes that can be objec­ tively measured and tested. Look at your list of possible causes frequently while you are gathering your facts, but do not let it get in the way of the facts. To define your problem, list every possible influence that may have caused it. For example, if sales have declined:

ƒ Have your customers changed? ƒ Have customer tastes changed? ƒ Have customers’ buying habits changed? ƒ Do our services still meet our customers’ needs? ƒ Is our product still relevant?

Everyday Life - available information Imagine you sell tires. You might guess that sales of new cars three years ago would have a strong effect on present retail sales of tires. To test this idea, you might com- pare new car sales of six years ago with re­ placement tire sales from three years ago. What if you discovered that new tire sales three years ago were 10 percent of the new car sales three years before that? Repeat- ing this exercise for previous years reveals that in each case tire sales were about 10 percent of new car sales made three years before. You could then logically conclude that the total market for replacement tire sales in your area this year should be about 10 percent of new car sales in your locality three years ago.

ASSESSING AVAILABLE INFORMATION: Once you have formally defined your prob- lem, assess the information that is immedi- ately available. You may already have all the information you need to determine if your hypothesis is correct, and solutions to the problem may have become obvious in the process of defining it. Stop there. You have reached a point of diminishing returns (we’ll talk about this term in depth a little later). You will be wasting time and money if you do further marketing research that doesn’t offer additional insight.

If you are uncertain whether you need addi- tional information, weigh the cost of more information against its usefulness. This pres- ents a dilemma similar to guessing, in ad- vance, what return you will receive on your advertising dollar. You do not know what re­

Marketing | 23

turn you will get, or even if you will get a return. The best you can do is to balance that uncertainty against the cost of gathering more data to make a more informed decision.

Begin by “thinking cheap and staying as close to home as possible.” Before considering anything elaborate, such as market surveys or field experiments, explore your own re­ cords and files. Look at sales records, complaints, receipts, and any other records that can help you better understand where your customers live, work, what they buy, and how they buy.

Naturally, the more localized the figures you can find from published sources, the bet­ ter. For instance, there may be a national decline in new housing starts, but if you sell new appliances in an area in which new housing is booming, you need to base your estimate of market potential on local, not national conditions. Newspapers and local radio and television stations may be able to help you find this information.

Keep in mind that there are many sources of published material and much of it is free. You can find it online, in libraries, newspapers, magazines, and in trade and general business publications. Trade associations and government agencies are also rich sourc­ es of information.

INTERVIEWING EMPLOYEES: When you have finished reviewing the available in­ formation in your records, turn to that other valuable internal source of customer in­ formation: your employees. Employees may be the best source of information about customer likes and dislikes. They hear customers’ complaints about your products or services, they are aware of what customers are looking for but you are not offering, and can probably supply good customer profiles from their day-to-day contacts whether it’s face to face, on the phone, or online.

BEYOND SEARCH ENGINES - GATHERING PRIMARY INFORMATION: Once you have exhausted the basic sources for information about your market, the next step is to collect information not commonly available in published form. Primary research is the collection of original data. Primary research can be as simple as asking customers or suppliers how they feel about your store or service firm, or as complex as the surveys conducted by sophisticated professional marketing research firms. Primary research in­ cludes among its tools direct mail questionnaires, telephone or on-the-street surveys, experiments, panel studies, test marketing, behavior observation, and more.

It is critical to ask the right questions and to avoid creating a bias in the responses. If the questions are not carefully crafted, people may answer the way they think they are expected to answer, rather than telling you how they really feel about your product, service, or business.

INTERPRETING DATA: After collecting the data you must organize it into meaningful information. Go back to your definition of the problem, compare it with your findings, and prioritize and rank the data.

ƒ What marketing strategies are suggested? ƒ How can they be accomplished? ƒ How are they different from what I am doing now?

24 | Intro to Business: A Primer

ƒ What current activities should be increased? ƒ What current activities must I drop or decrease in order to devote

adequate resources to new strategies?

MAKING DECISIONS AND TAKING ACTION: Prioritize each possible tactic from the standpoint of determining the:

ƒ Immediate goal to be achieved; ƒ Cost to implement; ƒ Time to accomplish, and ƒ Measurement of success.

Research can only take you so far The Internet makes collecting information for market research easier than ever

before. The Internet, however, also makes a clear vision of the future harder to define because of the precarious uncertainties it has introduced for many traditional industries and institutions.

The most research-driven institutions in the world, universities, are watching their entire business model change – and all their expertise in the scientific method cannot produce a clear conclusion about their own future. In the United States for example, Congress, concerned the nation’s universities were at risk from a range of forces, asked the National Academies for a full report on the future. The Academies produced a list of 10 actions necessary to secure the university sector including policy, funding, productivity, and partnership priorities in the U.S. It could not, however, predict how a new university sector might look. A recent Ernst and Young report on universities concluded: “the dominant university model … will prove unviable in all but a few cases over the next 10-15 years”, but could not confirm what would take its place.

Innovators in higher education are offering their own solutions. Western Governors University, for example, an online university created by several U.S. state governments, offers competency- based programs that are, unlike existing university programs, low-cost and self-paced. Coursera, an education technology company, gives millions of people access to teaching from highly respected professors through Massive Open Online Courses (MOOCs). Founded by Stanford University professors, Coursera has more than four million users and is working with the American Council on Education to offer the equivalent to university credits.

The traditional news media – newspapers delivered to your door, with television and radio bulletins delivered at scheduled times – also saw its business model collapse as the Internet delivered a 24­ hour news cycle and user-generated content. When Amazon’s Jeff Bezos purchased the Washington Post, commentators suggested a “back to the future” model would follow in which wealthy, tech- savvy individuals would buy and transform traditional media outlets. The news website BuzzFeed was already offering a new model for news: user-generated content mixed with material by staff journalists and organized by what’s “viral” on the web at any moment. Announcing that his company had made its first profit in September 2013, BuzzFeed CEO Jonah Peretti said: “We don’t have the trust the traditional news brands have won over the past 100 years, but we are working hard to earn it, and it won’t take us 100 years to get there.”

But where exactly, is “there”? Universities and news media have total access to information for data-driven decision making. No amount of data, however, can guarantee the future. Information can tell you how things are today, but cannot make the decision for you on what you should do about it tomorrow.

Marketing | 25

If your market research suggests 10 possible strategies, select two or three that appear to have the greatest potential impact or are most easily achievable and begin there. For each strategy, develop tactics, which may include:

ƒ Staff responsibilities ƒ Necessary steps ƒ Budget allocations ƒ Timelines with deadlines for accomplishing strategic steps ƒ Progress measurements

Based on this information, make a final decision on the strategies and go to work on the tactics.

ASSESSING THE RESULTS OF THE ACTION: Analyze your progress against success measures. If adjustments are appropriate, make them. At the conclusion of the time you have allotted for accomplishing your goal, take a hard look at the results.

ƒ Did you achieve your goal? ƒ Should the decision be renewed on a larger scale?

If you are disappointed in the results, determine why the plan went awry.

The possibilities revealed

Market research should also identify trends that may affect sales and profitability lev­ els in the future. Population shifts, legal developments, and the local economic situa­ tion should be monitored to enable early identification of problems and opportunities. Competitor activity should also be monitored. Competitors may be entering or leaving the market, for example. To provide competitive insight, it is also very useful to under­ stand the strategies your competitors have chosen.

Good information about the market is critical. Research provides knowledge that can disclose problems – and a lack of knowledge can easily be remedied through research. The success of any business is based on its ability to build an increasing pool of satisfied customers. Customers buy something because they believe they will be “better off”, in some way, as a result of the transaction. It is critical, therefore, that every business works out exactly who its customers are and how to create value for them. That is the role of Marketing.

The Marketing Mix

The 4Ps of Marketing Marketing defines your actions for competing in the marketplace. At the simplest lev­ el, a high-end vehicle manufacturer such as Rolls-Royce spends its marketing budget enticing high-net-worth individuals, while the value marketing programs of a manufac­

26 | Intro to Business: A Primer

turer such as Hyundai appeal to a much broader audience. Rolls-Royce and Hyundai do not compete in the same market “segment”, which means their customers are look­ ing for cars, but different types of cars. Their marketing programs, therefore, are very different. Hyundai, however, competes with KIA and Suzuki in the same small-vehicle market segment. All three are competing for the same customers, so their challenge is to design marketing programs that make them stand out from the others – to differen­ tiate their offering in the market.

Traditionally marketing covers the 4 P’s of Product, Price, Promotion and Place, and the way a company configures these elements is the marketing mix.

Product

What are you selling and how can you manipulate it to deliver better value for your customers? Does the business concentrate on a narrow product line, developing highly specialized products or services? Does it offer different versions of its products or ser­ vices to different types of customers? Adjustments to the offerings – through research and development, revised designs, new packaging, etc. – are all a key part of the mar­ keting mix.

Price

Price and pricing policies are vital to business revenues. Each product or service must be priced to satisfy customers and deliver on the company’s profit target. But pricing also includes determining a credit policy: Do you allow your customer to pay for the product after they receive it, or do they need to pay for it when they receive it? The tim­ ing of payment by customers will have an impact on the cash available to the business at any given time.

Promotion

No business can expect customers to just stumble across their offering and buy. Each business needs to create awareness for the value proposition they are offering. This can be done by taking advantage of resources such as the Internet, advertising campaigns, sales efforts, special financing deals, or any other creative promotional or sales activ­ ities the company can imagine and implement. The cost of these activities, however, also has to be factored into the price of the products or services.

Place, or distribution channel

The way you get your product or service into your customers’ hands or lives is equally important. Businesses need to make their value propositions accessible. A manufac­ turer might work through established distributors or agents, for example, to get their products to the right place. A retailer has to consider cost vs traffic flow for their store – a high-traffic location will have higher rent but a low- cost, low-traffic location will re­

Marketing | 27

quire more expenditure on promotions to bring people in. Online retail requires search engine optimization. Making the product accessible is critical to the marketing mix.

Place might be as simple as displaying products that are often bought on an impulse, such as flavored popcorn, candy, or magazines, in a highly visible spot in a high-traffic area of a store (checkout line), or as complex as developing an Internet-based market­ ing plan to reach customers anywhere around the world.

There are more than four P’s to great marketing campaigns, however. Precision, for ex­ ample – identifying precisely who your customers are and what they want. Prepara­ tion is another – doing the careful research and design work to satisfy your customers’ needs. And what about pizzazz – getting customers excited about choosing your value proposition over a competitor’s? Just like business itself, marketing is much more inter­ esting than its basic definition.

Service is another way that an organization can increase perceived value and differen­ tiate itself from competitors offering similar or identical products. Whether it’s a free

The Four P’s go viral California start-up Dollar Shave Club took on the market powerhouses in the

shaving business not just with an alternative value proposition (razors delivered to your door through a monthly subscription), but also with a quirky video ad that went viral on YouTube and won marketing awards for its creativity.

Dollar Shave Club’s value proposition started as home delivery of razor blades for as low as $1 a month (plus shipping) then expanded with a range of personal grooming products for men – included wet wipes for (ahem) the other cheeks.

The company’s online ad “Our Blades Are F***ing Great” features founder and Chief Executive Michael Dubin riding on a forklift, lobbing stray tennis balls, dancing with a fuzzy bear, and poking fun at the high-priced, complex razor products sold by his competitors. It won Best Out-of-Nowhere Video Campaign at the 2012 Ad Age Viral Video Awards plus two 2013 Webby Awards.

When the company launched publicly in March 2012 it attracted close to $10 million in venture capital. By mid-2015, Dollar Shave was valued at $615 million. Forbes Magazine said: “The company’s millions are dwarfed by those earned by Gillette or Schick, but its deft understanding of marketing’s 4P’s (product, price, place, and promotion) showed that big-name consumer brands are vulnerable.”

Some big-name brands, however, have shown they can also play the YouTube game. Dove’s “Real Beauty Sketches” campaign had more than 114 million total views in its first month in early 2013 and was labeled the most viral ad release of all time.

In the Dove video, an FBI-trained sketch artist draws women who are hidden behind a curtain, first based on their own self-description, and then based on the way a stranger describes them. In each case, the picture drawn from the stranger’s description is more attractive and closer to the way the participants actually look - suggesting women are too critical of their appearance and don’t see their true beauty.

Two brilliantly successful marketing campaigns in the personal products market, one from a start­ up focused on men and another, from an established brand, for women. Both achieved outstanding awareness thanks to ads on YouTube.

Thinking about the 4 Ps, however, what is the biggest difference between the two campaigns?

28 | Intro to Business: A Primer

massage when you sign up for personal training, a luxury car dealer offering roadside service, or a mass market retail store with greeters to help customers find what they need quickly, service enhancements are increasingly important in the mix.

Because the resources available for marketing in any organization will be limited, con­ centrating the company’s marketing efforts on one or a few key market segments – or target marketing – is one way to use resources efficiently. Markets can be segmented in several ways:

GEOGRAPHIC: Focusing on understanding the needs of customers in a particular geographical area. DEMOGRAPHIC: Focusing on the attributes of the market based upon gender, age, income, education, or other measurable factors. PSYCHOGRAPHIC: Identifying and promoting to people most likely to buy the product based on lifestyle and behaviors. This may be based on interests, fears, behaviors, or actions that can be categorized into groups, e.g., young health-conscious professionals, retired couples on fixed in­ comes, families with new babies, etc.

Target marketing enables you to identify, access, communicate with, and sell to those who are most likely to purchase your products.

Marketing the key function for online streaming Netflix and other online streaming services like Hulu and Amazon Prime –

have threatened the business model of cable television by capitalizing on a shift in customer demand to viewing on multiple devices and focusing their efforts on

marketing.

Cable subscriptions continue to decline, whereas Netflix told investors in early 2016 that it would reach the 75+ million subscribers around the world in the first quarter, and now operates in 190 countries – excluding China. According to Wall Street research firm Pacific Crest, year over year growth in cable subscriptions, in contrast, went negative for the first time in 2015.

TDG Senior Analyst Joel Espelian says the future of broadcasting is about marketing, not technology.

“Today the clearest example of this phenomenon is Netflix, which doesn’t broadcast anything. Nevertheless, the marketing function of broadcasting (i.e., getting new content in front of viewers at a single point in time) is highly relevant to Netflix.”

Netflix began offering original content in 2012. At the Emmy Awards for television in September 2013, its popular House of Cards won Best Director, the first television series never seen on a television channel to win an award. In 2015 the Venice Film Festival selected Netflix feature Beasts Of No Nation as a competition selection. It was a controversial choice, not because of its unflinching portrayal of a child soldier facing the horrors of war, but because Netflix launched the film via streaming video at the same time as its cinema release. Many cinemas boycotted the film, arguing for the continuation of exclusive cinema-first releases.

The traditional business model of the cable television business was built on offering a broad range of content to a high number of subscribers. However, customers who were taught by cable to expect content “on demand” now want it all the time, and everywhere – and for a better price!

Marketing | 29

Marketing Strategy

A company’s marketing strategy has one goal: to deliver value to customers while making a profit. Business incorporates many trade-offs – balancing one need or demand with anoth­ er – and this is the most important: delivering just enough value to the customer at a price that allows the business to meet its profit target. The profit target will depend on the type of business. Some businesses focus on selling a relatively small number of products but make a large profit on each one (aircraft engines, for example) others focus on sell­ ing huge volume for a smaller profit on each (canned soda, for example).

Setting a marketing strategy involves iden­ tifying customer groups, or target markets, that your business can serve better than your competitors, and tailoring your product offer­ ings, prices, distribution, promotional efforts, and services toward that particular market segment.

Ideally, the marketing strategy should address unmet customer needs that represent ade­ quate potential size and profitability. A good marketing strategy recognizes that a business cannot be all things to all people and must analyze its market and its own capabilities in delivering value. By focusing on a target mar­ ket that your business can serve best, you increase the effectiveness of marketing ac­ tivities and provide a better return on the marketing budget.

Marketing strategy is most successful when the company overall has a “marketing ori­ entation”. A marketing orientation requires managers to constantly gather information about their customers’ needs through research, to share that information throughout the firm, and to use it to help build long-term relationships between the organization and its customers.

After marketing program decisions are made, owners and managers need to evaluate the results of their decisions. Standards of performance need to be set so results can be evaluated against them. Sound data on industry norms and past performance provide the basis for comparisons against present performance. Owners and managers need to audit their company’s performance on a periodic basis, at least quarterly.

In CapsimCore Business Simulation the rate of diminishing returns applies to your promotion budget. The first $1,500,000 you invest buys 36% awareness for your product. Spending an additional $1,500,000, for a total of $3,000,000, creates 50% awareness. Therefore, the second $1,500,000 you invest buys only 14% more awareness. The investment be­ yond $1,500,000 yields a lower return per dollar invested compared to the initial $1,500,000. The return of your promo­ tional dollars diminishes beyond the initial $1,500,000 and will impact your decision regarding spending beyond this amount. Investing beyond $3,000,000 in a single year is just not worth it.

30 | Intro to Business: A Primer

Spending more on marketing programs is not always better. The law of diminishing return states that investing additional resources may initially increase productivity, but after a certain point, spending more will result in a lower return per dollar invested. The concept of diminishing returns, or the rate of diminishing returns, states that add­ ing additional investment beyond a certain threshold will not add proportional returns. Spending money beyond this point does not yield as much as the amount spent prior to that point.

Diminishing returns may also be associated with other aspects of business, such as hiring too many employees, and investing in additional plant and equipment that isn’t used efficiently.

Marketing Reality

Irrespective of up or down economic cycles, today’s business environment is more competitive than at any other time in recent history. To a certain extent, companies can re-engineer, restructure, and cut costs, but the heart of the business must be a sus­ tainable and profitable business model that nurtures growth. Creating a sustainable and profitable business model can prove to be even more difficult than creating a product itself. Many “dot bomb” businesses were able to produce a product, but unable to back it up with a profitable business model.

In such a competitive business environment, managers must have a clear understand­ ing of customer needs and their firm’s own capabilities to grow revenue within the constraints of sustainability and profitability. While evaluating various possible market alternatives, managers typically refrain from implementing revolutionary changes in their product or service offerings and instead engage in evolutionary market moves. This makes sense, as it is always easier to modify the “core engine” of a product or ser­ vice offering by adding one or many “engine variants”, rather than introducing a “new core engine” that might capture new markets. With limited resources at their disposal, it is imperative that managers understand the complexities of product or service “drivers” that truly reflect evolving customer needs and competitive activity, so their decisions return the most “bang for the buck.”

In other words, to create, capture and maintain demand for their product and service offerings, businesses have to perform a balancing act between the external environ­ ment (changing customer demands) and the internal environment (the firm’s given op­ erational challenges) to maximize growth opportunities. It requires carefully calibrating the company’s responses and approach to the following issues:

AMBIGUITY – WHAT DO OUR CUSTOMERS REALLY WANT? Companies lacking a clear understanding of customer choices often take a shotgun approach, hoping that at least one of their offerings will succeed. Unfortunately, this approach is neither efficient nor profitable for most firms. Markets are often flooded with products and services that offer relatively little added value to customers and weaken the seller’s bottom line.

Marketing | 31

RISK – WILL OUR ENVISIONED OFFERINGS BE SUCCESSFUL? Managers face com­ plex choices when deciding which product-service bundles to offer. Potential product/ service drivers (e.g., price or specific product-service features) can have several variants, and managers often use experience, benchmarking analysis, or simply gut feel to de­ cide what will be attractive to customers. On the one hand, such “informed guessing” might spur new and innovative ideas; it might also lead to depleted profits and chaos.

CONFORMANCE – CAN WE DELIVER WHAT WE PROMISED? Although it is import­ ant for companies to understand market value drivers, they must also support custom­ er preferences and align them with effective operations management. Even if firms succeed in identifying and delivering attractive product-service packages, their efforts may prove futile unless they can efficiently deliver on their promises under resource constraints.

In summary, the key questions to determine marketing performance include:

ƒ Do the products and services the company is offering provide value to customers?

ƒ Are existing and potential customers aware of the products and services available from the company?

ƒ Is it easy for the customer to purchase what he or she wants and at a competitive price?

Profits a greater challenge than marketing for online businesses The Internet has spawned a wide range of businesses that have overcome the

traditional challenge of marketing – ensuring lots of people know about what they offer – but have not overcome the critical challenge of business operations: bringing in more money than the company pays out to deliver their value proposition.

Companies we have already looked at in this program, such as Zynga and Square, have valuations in the billions but are yet to make a profit. Twitter squeaked out its first profit in 2015, but faces concerns about the slow growth in Twitter users, and the high percentage of people who sign up eventually abandon the service.

Twitter has been outpaced in both size and growth rate by Instagram.

When Facebook paid a billion dollars for Instagram in 2012, the vastly popular photo-sharing site hadn’t made a cent. It has been valued recently at $35 billion, but still wasn’t making a profit in early 2016 – even though Mark Zuckerberg told investors in 2013 that Facebook would generate “a lot of profit” from Instagram. What he didn’t say, at that time, was when.

In late 2013, Pinterest – the online scrapbooking site set up in 2010 – was valued at $3.8 billion. Slate.com said: “That’s an impressive feat for a company without any revenue. Note: That’s not no profit. That’s no revenue whatsoever.” By late 2015, that valuation was up to $5 billion, Pinterest had more than 70 million users and had begun to earn revenue, leveraging its loyal consumer base through sponsored content under ‘promoted pins’ in conjunction with big retailers and the Pinterest Shop.

Pinterest and Instagram both understand the value of information to drive new concepts in the marketplace. They and many other online businesses have Product, Place, and Promotion working for them. However, until they are successful with Price – and can bring in more than they spend – they do not have a true business model.

32 | Intro to Business: A Primer

ƒ Do the employees make sure the customers’ needs are truly satisfied and leave them with the feeling that they would enjoy coming back?

The Sales Forecast

How will you know how much of your product to produce if you cannot make a rea­ sonable prediction about how much you will sell? One of the most critical aspects of marketing management is to create a sales forecast to predict how many units of a product will sell in the future.

The sales forecast process often begins by assessing how the total market will perform in a given period – one year, for example. From there, using all relevant information, you attempt to assess your performance and what market share your company will realize from that total forecast. This requires speculating on your competitors’ performance as well. Forecasting sales is a challenging task due to the multiple variables involved in the process: What will the overall economic climate be like?

ƒ Will consumers make decisions on the same basis they have in the past?

ƒ At what level will our competitors perform? ƒ Will existing competitors introduce new products, and if so, when? ƒ Will there be new competitors, or will existing competitors drop out

of the market? ƒ At what price can we sell our products given the many alternative

product choices available?

Answering these questions provides insight for making better decisions for production schedules and allocating resources to attract new customers or retain existing custom­ ers. You will have the opportunity to practice sales forecasting and build skills in this area several times during the business simulation experience.

However, keep this in mind: What customers prefer is of interest, but what really mat­ ters is what customers choose!

Marketing | 33

Chapter 2 Review Questions 1. What are the three key responsibilities of a marketing manager? 2. What are the major components of marketing research? 3. What steps should you follow to collect information for marketing

research? 4. What are the 4P’s? 5. What are some other important factors beyond the 4P’s? 6. How can one “segment” the market? Why is segmentation

important? 7. What is marketing strategy? 8. When dealing with “marketing reality,” what are the three questions

that need to be addressed? 9. Why would a company need to forecast sales?

3 PRODUCTION:how does a business create goods and services to sell?

Learning Goals

After reading this chapter you will be able to:

ƒ Differentiate between operations and production. ƒ Describe the purpose of production schedules. ƒ Discuss the importance of inventory control. ƒ Describe an economy of scale. ƒ Discuss the five components of supply chain management. ƒ Discuss why it is important to manage quality. ƒ Describe how to measure productivity. ƒ Define the accounting equation. ƒ Discuss the typical types of managerial accounting reports ƒ Describe how to calculate contribution margins and why these are

valuable.

Production basics

The story so far….. We know that a business exists to make a profit by offering goods and services that satisfy customer needs in a marketplace. We know that there are many types of mar­ kets – physical and virtual. We have discovered how to define customer needs and how important it is to promote our products and to make them accessible to customers.

Now let’s talk about production: creating something to sell at a cost and level of quality that allows the company to satisfy customer needs and make a profit.

Production is a process that uses resources such as cash, labor, and raw materials – to create a value proposition that is attractive to a particular market.

If “profit” is the answer to “why does a business exist?” and “marketing” holds the an­ swers to “who does the business sell to?” then “production” is the answer to the “how, what, and when” questions about business.

Let’s begin with an overview of production management. A production process can be defined as: any activity that increases the similarity between the pattern of demand for goods and the quantity, form, and distribution of these goods to the marketplace.

Production | 35

Inputs to outputs

Production is the act of making products that will be traded or sold commercially based on decisions about what goods to produce, how to produce them, the costs to produce them, and how to optimize the mix of resource inputs used in their production. Produc­ tion information is combined with market information such as demand to determine the quantity of products to produce and sell at an optimal price point.

A business needs a production process whether it provides products or services. The production process involves planning, procuring goods or expertise to produce the product or service, plus assigning and organizing tasks to get the products or services to the market. It is important to differentiate “production” from “operations” in the busi­ ness context.

OPERATIONS describe the full range of management activities that en­ able a company to be profitable and sustainable. PRODUCTION involves the actual process of creating goods and ser­ vices.

Production can take the form of mass production, where a large number of standard products are created in a traditional assembly line process; it can be a very specialized process with individual or small quantities of a good being created; or it might involve running the logistics necessary to deliver a service efficiently. Inputs, therefore, can be raw materials like steel and chemicals; human in puts like specialized computer pro­ grammers, designers, or engineers; and money from a few thousand dollars to start a home-crafts business to millions of dollars for sophisticated manufacturing equip­ ment. The concepts are the same whatever the business may be.

Core functions in production management Production management seeks to develop an efficient, relatively low-cost, and high-quality production process for creating specific products and services. Good pro­ duction management is important if business goals, for both manufacturing and ser­ vice-oriented companies, are to be met. The profit and value of each company is de­ termined, to some ex- tent, by its production management process.

The primary resources that firms use for the production process include:

HUMAN RESOURCES: employees and their skills as applied to the pro­ duction process. RAW MATERIALS: the cost of all the goods needed to create the prod­ ucts or services. CAPACITY: the annual production capabilities of the facilities, technolo­ gy, machinery, and equipment.

Each of these resources costs money. Employees need to be paid, materials have to be purchased, plus there are buildings, production facilities, and computer systems that require time and money to be maintained for ongoing production. The objective of

36 | Intro to Business: A Primer

production management is to use these resources in the most efficient manner possi­ ble. This will enable the organization to take advantage of higher production levels by producing more units at a lower cost per unit.

Whatever the business is selling, its production process is the conversion of inputs (such as skills and raw materials) into outputs (goods or services) as efficiently as possible. The process can include sourcing, manufacturing, storing, shipping, packaging, and more. Because it is based on a flow concept (the steps have to flow in a logical order to get the product or service ready for sale) production is measured as a “rate of output per period of time.”

In any manufacturing environment – and your CapsimCore Business Simulation is in the manufacturing business – it is the Production Manager who has responsibility for scheduling the production sequence, type of product to be produced, and the volume of production. The three elements of management we discussed in Chapter 1 – plan­ ning, organizing, and controlling – are clearly necessary for production management. Following are some key concepts you will need to understand, along with some of the functions performed in the production department.

Scheduling production A master production schedule determines when the products will be produced and in what quantities. Dates must be met, specified quantities must be produced on time, and costs controlled to ensure this process goes smoothly and meets commitments. One tool to help with this process is a PERTchart. PERT stands for “Program Evaluation and Review Technique.” This is a graphical representation that tracks production events and their time frames from start to finish. A PERT chart maps out the production pro­ cess, which can help to identify problems before the process even begins.

Production | 37

A new season for BlackBerry? Inventory management is critical to prevent stockouts and have smooth flow of

product from your company to your customers. Production, however, is based on sales forecasts - and if the forecasts are not met?

BlackBerry, learned the answer to that question the hard way.

In 2009, Fortune magazine named BlackBerry as the fastest growing company in the world. It held a 43% market share of the personal smartphone market at its peak in 2010. By May 2012, however, Bloomberg reported: “stockpiles of BlackBerry smartphones and PlayBook tablets have swollen by two-thirds in the past year because of slumping sales”. The BlackBerry Z10 phone, released in January 2013, could not compete with iPhone and Android devices and the result was close to a billion dollars in unsold BlackBerries left on the shelf. The company completely misjudged the shifts in its market. It had to write-down of $934 million in unsold inventory and lay off 4,500 people, a third of its workforce.

BlackBerry has held on, growing its mobile device management software business and in late 2015 launched a new Android phone, the BlackBerry Priv. This time it faced a different problem – demand outstripping supply. In November 2015, customers hoping to buy the Priv from the BlackBerry website were met with a notice saying shipments were being phased, leaving some customers waiting.

After severely over- estimating the popularity of its new product in 2013 and underestimating the its competitors, BlackBerry’s challenge is not to make the opposite mistake and undersupply the Priv.

Inventory control

As goods are produced, they also need to be managed. Inventory control is the process of efficiently managing inventory. It is important to have enough products to sell, but not to have too many products unnecessarily sitting in the warehouse tying up cash. An efficient inventory control system minimizes the costs associated with inventory.

Companies must also manage inventory while it is in the process of being built. This is described as work-in-process inventory, or products that are only partially complet­ ed but have required an investment of resources. Products cannot be sold until they are complete, and monitoring the status of products still involved in production is important.

Another cost directly associated with inventory is carrying cost. Carrying cost is the cost of maintaining completed products. Inventory ties up space, cash, and human resourc­ es. A popular method for reducing carrying costs is the just-in-time (JIT) inventory sys­ tem. This system is based on having just enough products on hand to satisfy consumer demand. Product should always be available, without overstocking on what might be needed for the future.

The JIT system is often associated with a materials requirement planning system that ensures materials are available when needed. A materials requirement planning sys­ tem or MRP helps determine when the materials to produce the product are needed to meet production deadlines. As a firm develops a forecast of the demand for its prod­ ucts, it determines the time at which the materials need to arrive at the production site to meet the anticipated market demand.

38 | Intro to Business: A Primer

Everyday life – economies of scale You are setting up a small business in your local area and need a business card. The cost to print 50 business cards is $25, which is 50 cents per card. How- ever, if you were to place an order for 500 business cards, the total cost is $50, reducing the cost to 10 cents per card. The more business cards printed in each print “run,” the lower the cost per individual business card. The cost for the printing company is in setting the job up; the small additional cost in ink and pa- per to run a larger print run is marginal, so the cost per unit comes down.

Can Tesla achieve economies of scale and keep its promise? Electric vehicles were first popular in the late 19th and early 20th centuries –

before Ford Motor Company developed the production technologies to mass produce gasoline-fueled cars with internal combustion engines. For the next century and more, gas-powered cars ruled the highways with high-volume manufacturing providing the economies of scale to make them affordable. In the late 20th century, high oil prices,

environmental concerns, and advances in battery technology brought electric cars back into the mainstream.

Most traditional car companies, including Ford, GM, BMW, Toyota, Honda, and Nissan, have released electric or electric/gasoline hybrid cars. By 2013, however, it was an automotive start-up, Tesla Motors from California, not only winning all the awards but also proving it had a profitable model for electric cars that might challenge the traditional car companies. Tesla opened a “new” market segment: luxury electric cars, with a longer battery life and range of up to 300 miles (480 kilometers), designed for discerning motorists and sold not through dealerships but their own, branded stores. It wasn’t offering the battery version of a gas-powered car with fewer extras, but a new sought-after trend in upscale motoring.

When Tesla made its first profit in 2013, CEO Elon Musk said his company’s goal had always been to mass-produce fully electric cars at a price affordable to the average consumer, and would do it “within five years.” Musk was standing by his product life-cyle strategy – entering at the high end where customers will pay more then driving down costs and building volume.

In Tesla’s favor is improving battery technology and range which will lower costs; parts vendors demonstrating they can revamp their own production and reduce the cost of parts; more efficient manufacturing – the company says it is steadily cutting the number of worker hours necessary to build each car; plus it is fast expanding capacity, pumping money into a Gigafactory and additional production capacity.

The major car makers, however, are not sitting by while Tesla muscles into their space – battery technology is replicable, plus they already have experience in mass manufacturing. Perhaps Tesla’s biggest advantage is the strong support it enjoys from its investors. By mid-2015 Tesla’s market cap was $33 billion with sales of around 55,000 cars that year. GM’s market cap was $58 billion, less than twice Tesla’s, and it sold 10 million cars. As 247wallst.com said, “something is wrong with this picture.”